QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 25, 2021
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 001-33486
INFINERA CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
77-0560433
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
6373 San Ignacio Avenue
San Jose, CA95119
(Address of principal executive offices, including zip code)
(408) 572-5200
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of exchange on which registered
Common stock, par value $0.001 per share
INFN
The Nasdaq Global Select Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒No☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒No☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated Filer
☐
Non-accelerated filer
☐
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes☐ No☒
As of October 29, 2021, 210,787,524 shares of the registrant’s Common Stock, $0.001 par value, were issued and outstanding.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.Basis of Presentation and Significant Accounting Policies
Basis of Presentation
Infinera Corporation (the “Company”) prepared its interim condensed consolidated financial statements that accompany these notes in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”), consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2020.
The Company has made certain estimates, assumptions and judgments that can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Significant estimates, assumptions and judgments made by management include revenue recognition, stock-based compensation, employee benefit and pension plans, inventory valuation, accrued warranty, operating and financing lease liabilities, restructuring and other related costs, fair value measurement of the debt component of the convertible senior notes, loss contingencies, and accounting for income taxes. Other less significant estimates, assumptions and judgments made by management include allowances for sales returns, allowances for credit losses, useful life of intangible assets, and property, plant and equipment. Management believes that the estimates and judgments upon which they rely are reasonable based upon information available to them at the time that these estimates and judgments are made. The Company expects uncertainties around its key accounting estimates to continue to evolve depending on the duration and degree of impact associated with the outbreak of a novel strain of the coronavirus (“COVID-19”). These estimates may change as new events occur and additional information emerges, and such changes are recognized or disclosed in the Company's condensed consolidated financial statements.
The interim financial information is unaudited, but reflects all adjustments that are, in management’s opinion, necessary to provide a fair presentation of results for the interim periods presented. All adjustments are of a normal recurring nature. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company balances and transactions have been eliminated. The Company reclassified certain amounts reported in previous periods to conform to the current presentation.
This interim information should be read in conjunction with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2020.
For the three months ended September 25, 2021, no customer accounted for 10% or more of the Company's total revenue. For the three months ended September 26, 2020, one customer accounted for 15% of the Company's total revenue. For the nine months ended September 25, 2021, no customer accounted for 10% of the Company's total revenue and for the nine months ended September 26, 2020, one customer accounted for 13% of the Company's total revenue.
There have been no material changes in the Company’s significant accounting policies for the nine months ended September 25, 2021 compared to those disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2020.
2.Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
In December 2019, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2019-12, "Simplifying the Accounting for Income Taxes" (“ASU 2019-12”), as part of its simplification initiative. ASU 2019-12 removes certain exceptions from Accounting Standards Codification ("ASC") 740, "Income Taxes" ("ASC 740"), including (i) the exception to the incremental approach for intra period tax allocation when there is a loss from continuing operations and income or a gain from other items such as discontinued operations or other comprehensive income; (ii) the exception to accounting for outside basis differences of equity method investments and foreign subsidiaries; and (iii) the exception to limit tax benefit recognized in interim period in cases when the year-to-date losses exceeds anticipated losses. ASU 2019-12 also simplifies U.S. GAAP in several other areas of
10
ASC 740 such as (i) franchise taxes and other taxes partially based on income; (ii) step-up in tax basis goodwill considered part of a business combination in which the book goodwill was originally recognized or should be considered a separate transaction; (iii) separate financial statements of entities not subject to tax; and (iv) interim recognition of enactment of tax laws or rate changes. ASU 2019-12 is effective for the Company for fiscal years (and interim periods within those fiscal years) beginning after December 15, 2020. The Company adopted ASU 2019-12 in the first quarter of 2021 and the impact of the adoption was not material to the Company's consolidated financial statements.
Accounting Pronouncements Not Yet Effective
In October 2021, the FASB issued ASU 2021-08, "Business Combinations (Topic 805)” (“ASU 2021-08”). The ASU improves the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to recognition of an acquired contract liability and payment terms and their effect on subsequent revenue recognized by the acquirer. The update is effective for annual and interim periods within the fiscal year beginning after December 15, 2022, and early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the period in which we will adopt ASU 2021-08 and evaluating the impact that the adoption of ASU 2021-08 would have on its consolidated financial statements.
In August 2020, the FASB issued ASU 2020-06, "Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40)" ("ASU 2020-06"). The ASU simplifies accounting for convertible instruments by removing major separation models required under current U.S. GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument with no separate accounting for embedded conversion features. This update removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. This update also simplifies the diluted net income per share calculation in certain areas. The update is effective for annual and interim periods beginning after December 15, 2021, and early adoption is permitted for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company elected not to early adopt ASU 2020-06. The Company is currently evaluating the impact of the adoption of ASU 2020-06 would have on its consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04 (Topic 848), "Reference Rate Reform - Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2020-04”), which provides temporary optional expedients and exceptions to the existing guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate ("LIBOR") and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. The update was effective upon issuance and may generally be applied through December 31, 2022 to any new or amended contracts, hedging relationships, and other transactions that reference LIBOR. The Company will apply the amendments when its relevant contracts are modified upon transition to alternative reference rates.
3. Leases
The Company has operating leases for real estate and automobiles. The operating lease expense for thethree- and nine-month periods ended September 25, 2021 was $5.1 million and $17.7 million (including $0.2 million and $2.6 million of rent expense due to restructuring resulting in abandonment of certain lease facilities), respectively. The operating lease expense for the three- and nine-month periods ended September 26, 2020 was $6.4 million and $21.5 million (including $0.4 million and $1.8 million of rent expense due to restructuring resulting in abandonment of certain lease facilities), respectively. Variable lease cost, short-term lease cost and sublease income were immaterial during thethree- and nine-month periods ended September 25, 2021 and September 26, 2020.
As of September 25, 2021, $16.5 million was included in accrued expenses and other current liabilities and $65.3 million as long-term operating lease liabilities. As of December 26, 2020, $14.9 million was included in accrued expenses and other current liabilities and $76.1 million as long-term operating lease liabilities.
The following table presents maturity of lease liabilities under the Company's non-cancelable operating leases as of September 25, 2021 (in thousands):
11
Remainder of 2021
$
6,007
2022
22,547
2023
17,320
2024
15,139
2025
14,136
Thereafter
30,810
Total lease payments
105,959
Less: interest(1)
24,182
Present value of lease liabilities
$
81,777
(1) Calculated using the interest rate for each lease.
The following table presents supplemental information for the Company's non-cancelable operating leases for the nine months ended September 25, 2021 (in thousands, except for weighted average and percentage data):
Weighted average remaining lease term
6.06 years
Weighted average discount rate
9.21
%
Cash paid for amounts included in the measurement of lease liabilities
$
17,563
Leased assets obtained in exchange for new operating lease liabilities
$
2,216
Financing Lease Obligations
During the three- and nine-month periods ended September 25, 2021, there were none and one new finance lease arrangements, respectively. The lease term for existing arrangements range from three to five years with options to purchase at the end of certain lease terms. Finance lease expense for the three- and nine-month periods ended September 25, 2021 was approximately $0.3 million and $0.9 million, respectively. Finance lease expense for the three- and nine-month periods ended September 26, 2020 was $0.2 million and $0.7 million, respectively.
As of September 25, 2021, $1.4 million was included in accrued expenses and other current liabilities and $1.2 million in other long-term liabilities. As of December 26, 2020, $1.1 million was included in accrued expenses and other current liabilities and $1.4 million in other long-term liabilities.
The following table presents maturity of lease liability under the Company's finance leases as of September 25, 2021 (in thousands):
Remainder of 2021
$
451
2022
1,363
2023
828
2024
177
Thereafter
—
Total lease payments
2,819
Less: interest (1)
175
Present value of lease liabilities
$
2,644
(1) Calculated using the interest rate for each lease.
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The following table presents supplemental information for the Company's finance leases for the nine months ended September 25, 2021 (in thousands, except for weighted average and percentage data):
Weighted average remaining lease term
1.87 years
Weighted average discount rate
7.01
%
Cash paid for amounts included in the measurement of lease liabilities
$
1,185
Leased assets obtained in exchange for new finance lease liabilities
$
1,208
Finance leases included in Property, Plant, & Equipment, net in the Condensed Consolidated Balance Sheets were as follows (in thousands):
September 25, 2021
December 26, 2020
Computer hardware
$
1,208
$
—
Laboratory and manufacturing equipment
$
1,973
$
1,973
Leasehold and building improvements
$
2,415
$
2,512
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4. Revenue Recognition
Disaggregation of Revenue
The following table presents the Company's revenue disaggregated by revenue source (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Product
$
270,818
$
261,906
$
782,420
$
778,325
Services
84,996
78,305
242,528
223,746
Total revenue
$
355,814
$
340,211
$
1,024,948
$
1,002,071
The Company sells its products directly to customers who are predominantly service providers and to channel partners that sell on its behalf. The following table presents the Company's revenue disaggregated by geography, based on the shipping address of the customer (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
United States
$
163,583
$
167,043
$
496,416
$
503,792
Other Americas
28,877
27,521
77,985
73,041
Europe, Middle East and Africa
114,815
101,334
323,998
287,080
Asia Pacific
48,539
44,313
126,549
138,158
Total revenue
$
355,814
$
340,211
$
1,024,948
$
1,002,071
The following table presents the Company's revenue disaggregated by sales channel (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Direct
$
259,349
$
269,653
$
795,672
$
782,330
Indirect
96,465
70,558
229,276
219,741
Total revenue
$
355,814
$
340,211
$
1,024,948
$
1,002,071
Contract Balances
The following table provides information about receivables, contract assets and contract liabilities from contracts with customers (in thousands):
September 25, 2021
December 26, 2020
Assets (Liabilities)
Accounts receivable, net
$
273,371
$
319,428
Contract assets
$
40,689
$
51,583
Deferred revenue
$
(137,873)
$
(163,056)
Revenue recognized for the three- and nine-month periods ended September 25, 2021 that was included in the deferred revenue balance at the beginning of the reporting period was $20.1 million and $74.0 million, respectively. Revenue recognized for the three- and nine-month periods ended September 26, 2020 that was included in the deferred revenue balance at the beginning of the reporting period was $31.5 million and $70.4 million, respectively. Changes in the contract asset and liability balances during the three- and nine-month periods ended September 25, 2021 and September 26, 2020 were not materially impacted by other factors.
Transaction Price Allocated to the Remaining Performance Obligation
The Company’s remaining performance obligations represent the transaction price allocated to performance obligations that are unsatisfied or partially satisfied, consisting of deferred revenue and backlog. The Company’s backlog represents purchase orders received from customers for future product shipments and services. The Company’s backlog is subject to future events that could cause the amount or timing of the related revenue to
14
change, and, in certain cases, may be canceled without penalty. Orders in backlog may be fulfilled several quarters following receipt or may relate to multi-year support service obligations.
The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially satisfied) pursuant to contracts that are not subject to cancellation without penalty at the end of the reporting period (in thousands):
Remainder of 2021
2022
2023
2024
2025
Thereafter
Total
Revenue expected to be recognized in the future as of September 25, 2021
$
356,165
$
192,869
$
40,115
$
14,954
$
4,200
$
4,772
$
613,075
5. Fair Value Measurements
The following tables represent the Company’s fair value hierarchy for its assets and liabilities measured at fair value on a recurring basis (in thousands):
As of September 25, 2021
As of December 26, 2020
Fair Value Measured Using
Fair Value Measured Using
Level 1
Level 2
Total
Level 1
Level 2
Total
Assets (Liabilities)
Foreign currency exchange forward contracts
$
—
$
(55)
$
(55)
$
—
$
(72)
$
(72)
During the three- and nine-month periods ended September 25, 2021, there were no transfers of assets or liabilities between Level 1 and Level 2 of the fair value hierarchy. As of each of September 25, 2021 and December 26, 2020, none of the Company’s existing assets or liabilities were classified as Level 3.
The Company classifies certain facilities-related charges within Level 3 of the fair value hierarchy and applies fair value accounting on a nonrecurring basis when impairment indicators exist or upon the existence of observable fair values. The fair values are classified as Level 3 measurements due to the significance of unobservable inputs. This analysis requires management to make assumptions and estimates regarding industry and economic factors, future operating results and discount rates.
The Company measures goodwill and intangible assets at fair value on a nonrecurring basis when there are identifiable events or changes in circumstances that may have a significant adverse impact on the fair value of these assets. The Company performed an analysis of impairment indicators of these assets and noted no adverse impact to their fair values as of September 25, 2021.
Facilities-related Charges
In connection with the 2018 Restructuring Plan (as defined in Note 9, “Restructuring and Other Related Costs” to the Notes to Condensed Consolidated Financial Statements), for the three- and nine-month periods ended September 25, 2021, the Company calculated the fair value of $0.2 million and $2.6 million, respectively, in facilities-related charges based on estimated future discounted cash flows and classified the fair value as a Level 3 measurement due to the significance of unobservable inputs. These inputs included the amount and timing of estimated sublease rental receipts that the Company could reasonably obtain over the remaining lease term at the discount rate.
Cash
As of September 25, 2021, the Company had $203.5 million of cash, including $85.0 million of cash held by its foreign subsidiaries.
As of December 26, 2020, the Company had $298.0 million of cash, including $87.4 million of cash held by its foreign subsidiaries. The Company's cash held by its foreign subsidiaries is used for operating and investing activities in those locations, and the Company does not currently have the need or the intent to repatriate those funds to the United States.
15
6. Derivative Instruments
Foreign Currency Exchange Forward Contracts
The Company transacts business in various foreign currencies, has international sales, cost of sales, and expenses denominated in foreign currencies, and carries foreign-currency-denominated account balances, subjecting the Company to foreign currency risk. The Company’s primary foreign currency risk management objective is to protect the U.S. dollar value of future cash flows and minimize the volatility of reported earnings. The Company utilizes foreign currency forward contracts, which are primarily short term in nature.
Historically, the Company entered into foreign currency exchange forward contracts to manage its exposure to fluctuation in foreign exchange rates that arise from its Euro and British pound denominated account balances. Gains and losses on these contracts were intended to offset the impact of foreign exchange rate fluctuations on the underlying foreign currency denominated account balances, and therefore did not subject the Company to material balance sheet risk.
As of September 25, 2021 and December 26, 2020, the Company posted collateral of $0.9 million for both periods, on its derivative instruments to cover potential credit risk exposure. This amount is classified as other long-term restricted cash on the accompanying condensed consolidated balance sheets.
For both the three months ended September 25, 2021 and September 26, 2020, the before-tax effect of the foreign currency exchange forward contracts was immaterial, and for the nine months ended September 25, 2021 and September 26, 2020, the before-tax effect of the foreign currency exchange forward contracts was a net gain of $0.8 million and $0.2 million, respectively, included in other gain (loss), net in the condensed consolidated statements of operations. In each of these periods, the impact of the gross gains and losses was offset by foreign exchange rate fluctuations on the underlying foreign currency denominated amounts.
As of September 25, 2021, the Company did not designate foreign currency exchange forward contracts as hedges for accounting purposes. Accordingly, changes in the fair value are recorded in the accompanying condensed consolidated statements of operations. These contracts were entered into with one institution with high credit quality and the Company consistently monitors the creditworthiness of the counterparties.
The fair value of derivative instruments not designated as hedging instruments in the Company’s condensed consolidated balance sheets was as follows (in thousands):
As of September 25, 2021
As of December 26, 2020
Gross Notional(1)
Prepaid expenses and other current assets
Other Accrued Liabilities
Gross Notional(1)
Other Accrued Liabilities
Foreign currency exchange forward contracts
Related to Euro denominated monetary balances
$
17,826
$
3
$
—
$
23,605
$
(59)
Related to British Pound denominated monetary balances
17,462
—
(58)
4,868
(13)
$
35,288
$
3
$
(58)
$
28,473
$
(72)
(1)Represents the face amounts of forward contracts that were outstanding as of the end of the period noted.
Accounts Receivable Factoring
The Company sells certain designated trade account receivables based on factoring arrangements with well-established factoring companies. Pursuant to the terms of the arrangements, the Company accounts for these transactions in accordance with ASC Topic 860, "Transfers and Servicing". The Company's factor purchases trade accounts receivables on a non-recourse basis and without any further obligations. Trade accounts receivables balances sold are removed from the condensed consolidated balance sheets and cash received is reflected as cash provided by operating activities in the condensed consolidated statements of cash flows. The difference between the fair value of the Company's trade receivables and the proceeds received is recorded as interest expense in the Company's condensed consolidated statements of operations. For the three- and nine-month periods ended September 25, 2021, the Company's recognized factoring related interest expense was approximately $0.1 million and $0.4 million, respectively, and for the three- and nine-month periods ended September 26, 2020, the Company's recognized factoring related interest expense was approximately $0.1 million and $0.3 million,
16
respectively. For the three- and nine-month periods ended September 25, 2021, the Company's gross amount of trade accounts receivables sold was approximately $26.7 million and $94.0 million, respectively, and for the three- and nine-month periods ended September 26, 2020, the Company's gross amount of trade accounts receivables sold was approximately $16.3 million and $61.6 million, respectively.
7. Goodwill and Intangible Assets
Goodwill
Goodwill is recorded when the purchase price of an acquisition exceeds the fair value of the net tangible and identified intangible assets acquired.
The following table presents details of the Company’s goodwill during the nine months ended September 25, 2021 (in thousands):
Balance as of December 26, 2020
$
273,426
Foreign currency translation adjustments
(8,668)
Balance as of September 25, 2021
$
264,758
The gross carrying amount of goodwill may change due to the effects of foreign currency fluctuations as a portion of these assets are denominated in foreign currency. To date, the Company has not recognized any impairment losses on goodwill.
Intangible Assets
The following tables present details of the Company’s intangible assets as of September 25, 2021 and December 26, 2020 (in thousands, except for weighted average data):
September 25, 2021
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
Weighted Average Remaining Useful Life (In Years)
Intangible assets with finite lives:
Trade names
$
1,000
$
(1,000)
$
—
—
Customer relationships and backlog
159,836
(102,209)
57,627
4.3
Developed technology
187,646
(148,067)
39,579
2.3
Total intangible assets with finite lives
$
348,482
$
(251,276)
$
97,206
December 26, 2020
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
Weighted Average Remaining Useful Life (In Years)
Intangible assets with finite lives:
Trade names
$
1,000
$
(1,000)
$
—
—
Customer relationships and backlog
162,098
(90,667)
71,431
4.9
Developed technology
192,285
(138,834)
53,451
3.0
Total intangible assets with finite lives
$
355,383
$
(230,501)
$
124,882
The gross carrying amount of intangible assets and the related amortization expense of intangible assets may change due to the effects of foreign currency fluctuations as a portion of these assets are denominated in foreign currency. Amortization expense was $9.0 million and $27.0 million for the three- and nine-month periods ended September 25, 2021, respectively and was $12.0 million and $38.5 million for the three- and nine-month periods ended September 26, 2020, respectively.
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Intangible assets are carried at cost less accumulated amortization and impairment, if any. Amortization expenses are recorded to the appropriate cost and expense categories.
The following table summarizes the Company’s estimated future amortization expense of intangible assets with finite lives as of September 25, 2021 (in thousands):
The Company’s restricted cash balance is held in deposit accounts at various banks globally. These amounts primarily collateralize the Company’s issuances of standby letters of credit and bank guarantees.
Allowance for Credit Losses
The following table provides a rollforward of the allowance for doubtful accounts for accounts receivable for the nine months ended September 25, 2021 (in thousands):
Balance as of December 26, 2020
$
2,912
Additions(1)
1,019
Write offs(2)
(2,274)
Other(3)
(33)
Balance as of September 25, 2021
$
1,624
(1) The new additions during the nine months ended September 25, 2021 are primarily due to specific reserves.
(2) The write offs during the nine months endedSeptember 25, 2021 are primarily amounts fully reserved previously.
(1)Included in computer software at September 25, 2021 and December 26, 2020 were $23.4 million and $25.4 million, respectively, related to enterprise resource planning (“ERP”) systems that the Company implemented. The unamortized ERP costs at September 25, 2021 and December 26, 2020 were $7.9 million and $10.8 million, respectively. Also included in computer software at September 25, 2021 and December 26, 2020 was $19.5 million and $17.0 million, respectively, related to term licenses. The unamortized term license costs at September 25, 2021 and December 26, 2020 was $9.6 million and $12.0 million, respectively.
(2)Depreciation expense was $12.0 million and $10.9 million (which includes depreciation of capitalized ERP cost of $0.7 million for both periods) for the three months ended September 25, 2021 and September 26, 2020, respectively. Depreciation expense was $33.2 million and $35.8 million (which includes depreciation of capitalized ERP cost of $1.9 million and $2.0 million, respectively) for the nine months ended September 25, 2021 and September 26, 2020, respectively.
9. Restructuring and Other Related Costs
In December 2018, the Company implemented a restructuring initiative (the “2018 Restructuring Plan”) as part of a comprehensive review of the Company's operations and ongoing integration activities in order to optimize resources for future growth, improve efficiencies and address redundancies following the October 1, 2018 acquisition of Telecom Holding Parent LLC (“Coriant”), a privately held global supplier of open network solutions for many of the largest global network operators (the “Acquisition”). As part of the 2018 Restructuring Plan, the Company made several changes to improve its research and development efficiency by consolidating its manufacturing and development sites, including closure of its Berlin, Germany site, reducing headcount at its Munich, Germany site, and processing changes to leverage the Company's engineering and product line development resources across regions and prioritizing research and development initiatives. The Berlin and Munich initiatives were substantially completed in fiscal year 2020. In connection with the Acquisition, the Company assumed restructuring liabilities associated with Coriant's previous restructuring and reorganization plans consisting of termination benefits primarily comprised of severance payments. These costs are recorded at estimated fair value.
During 2020, the Company implemented a new restructuring initiative (the "2020 Restructuring Plan") that was primarily intended to reduce costs and consolidate its operations. The identified cost reduction initiatives under the 2020 Restructuring Plan were substantially completed, with the majority of associated payments made in fiscal year 2020 and the remaining amounts was substantially paid by the third quarter of fiscal year 2021.
In 2021, the Company announced a plan to restructure certain international research & development operations (the "2021 Restructuring Plan"). The Company estimates it will incur total costs related to the restructuring ranging from $10.0 million to $12.0 million, of which $7.4 million was recorded in the three months ended September 25, 2021. The 2021 Restructuring Plan is expected to be substantially completed with the associated payments made in fiscal year 2022. Additional restructuring activities may occur in the future in connection with the Company’s ongoing transformation initiatives.
The following table presents restructuring and other related costs included in cost of revenue and operating expenses in the accompanying consolidated statements of operations under the 2021 Restructuring Plan, the 2020 Restructuring Plan, the 2018 Restructuring Plan and Coriant's previous restructuring and reorganization plans (in thousands):
Restructuring liabilities are reported within accrued expenses, operating lease liabilities and other long-term liabilities in the accompanying condensed consolidated balance sheets (in thousands):
Severance and other related expenses
Lease related impairment charges
Asset impairment
Others
Total
Balance at December 26, 2020
$
10,241
$
—
$
—
$
230
$
10,471
Charges
5,568
2,639
155
1,509
9,871
Cash Payments
(6,020)
(1,739)
—
(381)
(8,140)
Non-Cash Settlements and Other
150
(900)
(155)
(12)
(917)
Balance at September 25, 2021
$
9,939
$
—
$
—
$
1,346
$
11,285
As of September 25, 2021, the Company's restructuring liability was primarily comprised of $9.4 million related to the 2021 Restructuring Plan and $1.6 million is related to assumed restructuring liabilities associated with Coriant's previous restructuring and reorganization plans, which was substantially completed in previous years. The liability related to the 2021 Restructuring Plan is expected to be paid by end of fiscal year 2022.
10. Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss includes certain changes in equity that are excluded from net loss. The following table sets forth the changes in accumulated other comprehensive loss by component for the nine months ended September 25, 2021 (in thousands):
Foreign Currency Translation
Actuarial Gain (Loss) on Pension
Accumulated Tax Effect
Total
Balance at December 26, 2020
$
732
$
(11,666)
$
(964)
$
(11,898)
Other comprehensive loss before reclassifications
(1,078)
—
—
(1,078)
Amounts reclassified from accumulated other comprehensive loss
—
2,569
—
2,569
Net current-period other comprehensive income (loss)
(1,078)
2,569
—
1,491
Balance at September 25, 2021
$
(346)
$
(9,097)
$
(964)
$
(10,407)
11. Basic and Diluted Net Loss Per Common Share
Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed using net loss and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the assumed exercise of outstanding in-the-money stock options, assumed release of outstanding restricted stock units (“RSUs”) and performance shares (referred to herein as the “PSUs”), and assumed issuance of common stock under the Company’s 2007 Employee Stock Purchase Plan (the “ESPP”) using the treasury stock method. The Company includes the common shares underlying PSUs in the calculation of diluted net income per common share only when they become contingently issuable.
Potentially dilutive common shares also include the assumed conversion of $402.5 million in aggregate principal amount of the Company's 2.125% convertible senior notes due September 1, 2024 (the “2024 Notes”) from the conversion spread and $200 million in aggregate principal amount of the Company's 2.50% convertible senior notes due March 1, 2027 (the “2027 Notes”) from the conversion spread (each further discussed in Note 12, “Debt” to the Notes to Condensed Consolidated Financial Statements). The Company would include the dilutive effects of the 2024 Notes and 2027 Notes in the calculation of diluted net income per common share if the average market price is above the conversion price. Upon conversion of the 2024 Notes and 2027 Notes, it is the Company’s intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the 2024 Notes and 2027 Notes being converted; therefore, only the conversion spread relating to the 2024 Notes and 2027 Notes would be included in the Company’s diluted earnings per share calculation unless their effect is anti-dilutive.
The following table sets forth the computation of net loss per common share – basic and diluted (in thousands, except per share amounts):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Net loss
$
(53,794)
$
(35,896)
$
(137,710)
$
(196,799)
Weighted average common shares outstanding - basic and diluted
209,183
189,589
206,201
185,737
Net loss per common share - basic and diluted
$
(0.26)
$
(0.19)
$
(0.67)
$
(1.06)
The Company incurred net losses during the three- and nine-month periods ended September 25, 2021 and September 26, 2020, and as a result, potential common shares from stock options, RSUs, PSUs and the assumed release of outstanding shares under the ESPP were not included in the diluted shares used to calculate net loss per share, as their inclusion would have been anti-dilutive. Additionally, due to the net loss position during these periods, the Company excluded the potential shares issuable upon conversion of the 2024 Notes and the 2027 Notes in the calculation of diluted earnings per share as their inclusion would have been anti-dilutive.
The following sets forth the potentially dilutive shares excluded from the computation of the diluted net loss per share because their effect was anti-dilutive (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Stock options outstanding
—
542
—
584
Restricted stock units
11,699
12,674
13,278
14,440
Performance stock units
2,891
3,566
2,964
3,735
Employee stock purchase plan shares
1,440
1,831
1,085
1,358
Total
16,030
18,613
17,327
20,117
12. Debt
$200 million 2.50% Convertible Senior Notes due March 1, 2027
In March 2020, the Company issued the 2027 Notes due on March 1, 2027, unless earlier repurchased, redeemed or converted. The 2027 Notes are governed by an indenture dated as of March 9, 2020 (the “2027 Indenture”), between the Company and U.S. Bank National Association, as trustee. The 2027 Notes are unsecured, and the 2027 indenture does not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior debt or other indebtedness, or the issuance or repurchase of the Company's other securities by the Company.
Interest is payable semi-annually in arrears on March 1 and September 1 of each year, commencing on September 1, 2020. The net proceeds to the Company were approximately $193.3 million after deducting initial purchasers' fee and other debt issuance costs. The Company intends to use the net proceeds for general corporate purposes, including working capital to fund growth and potential strategic projects.
Upon conversion, it is the Company’s intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the 2027 Notes. For any remaining conversion obligation, the Company intends to pay or deliver, either cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election. The initial conversion rate is 130.5995 shares of common stock per $1,000 principal amount of 2027 Notes, subject to anti-dilution adjustments, which is equivalent to a conversion price of approximately $7.66 per share of common stock.
Throughout the term of the 2027 Notes, the conversion rate may be adjusted upon the occurrence of certain events, including for any cash dividends. Holders of the 2027 Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a 2027 Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than canceled, extinguished or forfeited. Prior to December 1, 2026, holders may convert their 2027 Notes under the following circumstances:
•during any fiscal quarter commencing after the fiscal quarter ended on June 27, 2020 (and only during such fiscal quarter) if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
•during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of 2027 Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day;
•if the Company calls any or all of the 2027 Notes for redemption, such 2027 Notes called for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date;
•upon the occurrence of specified corporate events described under the 2027 Indenture, such as a consolidation, merger or binding share exchange; or
•at any time on or after December 1, 2026 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their 2027 Notes at any time, regardless of the foregoing circumstances.
If the Company undergoes a fundamental change as defined in the 2027 Indenture, holders may require the Company to repurchase for cash all or any portion of their 2027 Notes at a repurchase price equal to 100% of the principal amount of the 2027 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, upon the occurrence of a “make-whole fundamental change” (as defined in the 2027 Indenture), the Company may, in certain circumstances, be required to increase the conversion rate by a number of additional shares for a holder that elects to convert its 2027 Notes in connection with such make-whole fundamental change.
The net carrying amounts of the debt obligation were as follows (in thousands):
September 25, 2021
December 26, 2020
Principal
$
200,000
$
200,000
Unamortized discount (1)
(58,333)
(64,223)
Unamortized issuance cost (1)
(3,599)
(3,963)
Net carrying amount
$
138,068
$
131,814
(1)Unamortized debt conversion discount and issuance costs will be amortized over the remaining life of the 2027 Notes, which is approximately 65 months.
As of September 25, 2021 and December 26, 2020, the carrying amount of the equity component of the 2027 Notes was $67.8 million.
In accounting for the issuance of the 2027 Notes, the Company separated the 2027 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a
similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the 2027 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense over the term of the 2027 Notes.
The Company allocated the total issuance costs incurred to the liability and equity components of the 2027 Notes based on their relative values. Issuance costs attributable to the liability component were recorded as a reduction to the liability portion of the 2027 Notes and will be amortized as interest expense over the term of the 2027 Notes. The issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.
The Company recorded a deferred tax liability of $16.2 million in connection with the issuance of the 2027 Notes, and a corresponding reduction in valuation allowance. The impact of both was recorded to stockholders' equity.
The Company determined that the embedded conversion option in the 2027 Notes does not require separate accounting treatment as a derivative instrument because it is both indexed to the Company’s own stock and would be classified in stockholders’ equity if freestanding.
The following table sets forth total interest expense recognized related to the 2027 Notes (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Contractual interest expense
$
1,250
$
1,250
$
3,750
$
2,774
Amortization of debt issuance costs
125
113
364
250
Amortization of debt discount
2,012
1,823
5,890
4,041
Total interest expense
$
3,387
$
3,186
$
10,004
$
7,065
For the three- and nine-month periods ended September 25, 2021, the debt discount and debt issuance costs for the 2027 Notes were amortized, using an annual effective interest rate of 9.92%, to interest expense over the term of the 2027 Notes.
As of September 25, 2021, the fair value of the 2027 Notes was $262.6 million. The fair value was determined based on the quoted bid price of the 2027 Notes in an over-the-counter market on September 24, 2021 (the last trading day of the fiscal quarter). The 2027 Notes are classified as Level 2 of the fair value hierarchy.
Based on the closing price of the Company’s common stock of $8.21 per share as reported on the Nasdaq Stock Market on September 24, 2021 (the last trading day of the fiscal quarter), the if-converted value of the 2027 Notes exceeded the principal amount by $14.4 million.
Asset-based revolving credit facility
On August 1, 2019, the Company entered into a Credit Agreement (the "Credit Agreement") with Wells Fargo Bank. The Credit Agreement provides for a senior secured asset-based revolving credit facility of up to $100 million (the "Credit Facility"), which the Company may draw upon from time to time. The Company may increase the total commitments under the Credit Facility by up to an additional $50 million, subject to certain conditions. The Credit Agreement provides for a $50 million letter of credit sub-facility and a $10 million swing loan sub-facility.
On December 23, 2019, the Company exercised its option to increase the total commitments under the Credit Facility and entered into an Increase Joinder and Amendment Number One to the Credit Agreement (the “Amendment”), with BMO Harris Bank N.A. and Wells Fargo Bank, National Association, as administrative agent. The Amendment increased the total commitments under the Credit Facility to $150 million.
The proceeds of the loans under the Credit Agreement, as amended by the Amendment (the “Amended Credit Agreement”) may be used to pay the fees, costs and expenses incurred in connection with the Amended Credit Agreement and for working capital and general corporate purposes. The Credit Facility matures, and all outstanding loans become due and payable, on March 5, 2024. Availability under the Credit Facility is based upon periodic borrowing base certifications valuing certain inventory and accounts receivable, as reduced by certain
reserves. The Credit Facility is secured by first-priority security interest (subject to certain exceptions) in inventory, certain related assets, specified deposit accounts, and certain other accounts in certain domestic subsidiaries.
Loans under the Amended Credit Agreement bear interest, at the Company's option, at either a rate based on LIBOR for the applicable interest period or a base rate, in each case plus a margin. The margin ranges from 2.00% to 2.50% for LIBOR rate loans and 1.00% to 1.50% for base rate loans, depending on the utilization of the Credit Facility. The commitment fee payable on the unused portion of the Credit Facility ranges from 0.375% to 0.625% per annum, also based on the current utilization of the Credit Facility. The letter of credit will accrue a fee at a per annum rate equal to the applicable LIBOR rate margin multiplied by the average amount of the letter of credit usage during the immediately preceding quarter, in addition to the fronting fees, commissions and other fees.
The Amended Credit Agreement contains customary affirmative covenants, such as financial statement reporting requirements and delivery of borrowing base certificates. The Amended Credit Agreement also contains customary covenants that limit the ability of the Company and its subsidiaries to, among other things, incur debt, create liens and encumbrances, engage in certain fundamental changes, dispose of assets, prepay certain indebtedness, make restricted payments, make investments, and engage in transactions with affiliates. The Amended Credit Agreement also contains a financial covenant that requires the Company to maintain a minimum amount of liquidity and customary events of default.
In connection with the Credit Facility, the Company incurred lender and other third-party costs of approximately $4.9 million for the period ended December 28, 2019, which are recorded as a deferred asset and are amortized to interest expense using a straight-line method over the term of the Credit Facility. For the three- and nine-month periods ended September 25, 2021, the Company recorded $0.3 million and $0.9 million, respectively, as amortization of deferred debt issuance cost and $0.3 million and $0.8 million, respectively, as contractual interest expense and related charges.
In January 2021, the Company repaid in full the then outstanding principal balance of $77.0 million. As of September 25, 2021, the Company had availability of $137.9 million under the Credit Facility and had letters of credit outstanding of approximately $12.1 million.
Finance Assistance Agreement
During March 2019, the Company signed an agreement with a third-party contract manufacturer that governs the transfer of the activities from the legacy Coriant manufacturing facility in Berlin, Germany to the contract manufacturer. Subsequently in May 2019, the Company entered into a financing assistance agreement with the contract manufacturer whereby the contract manufacturer agreed to provide funding of up to $40.0 million to cover severance, retention and other costs associated with the transfer. The funding is secured against certain foreign assets, carries a fixed interest rate of 6% and is repayable in 12 months from the date of each draw down. In October 2020, the Company and the contract manufacturer amended the payment terms to extend the due date by six months, set the fixed interest rate at 3% during such period, and allow for the phased transfer of inventory to offset the amount due. In April 2021, the Company repaid the entire outstanding principal balance and accrued interest of $24.6 million and $1.8 million, respectively.
Mortgage Payable
In March 2019, the Company mortgaged a property it owns. The Company received proceeds of $8.7 million in connection with the loan. The loan carries a fixed interest rate of 5.25% and is repayable in 59 equal monthly installments of approximately $0.1 million each with the remaining unpaid principal balance plus accrued unpaid interest due five years from the date of the loan.
On September 24, 2021, the loan was amended to reduce the interest rate from 5.25% to 3.80% for the remaining 31 equal monthly installments of approximately $0.1 million each. In connection with the amendment, the Company paid a fee of $0.1 million which is being amortized over the remaining life of the loan.
As of September 25, 2021, $7.9 million of the loan remained outstanding, of which $0.5 million was included in short-term debt and $7.4 million was included in long-term debt.
$400.5 million 2.125% Convertible Senior Notes due September 1, 2024
In September 2018, the Company issued the 2024 Notes due on September 1, 2024, unless earlier repurchased, redeemed or converted. The 2024 Notes are governed by a base indenture dated as of September 11, 2018 and a first supplemental indenture dated as of September 11, 2018 (together, the “2024 Indenture”), between
the Company and U.S. Bank National Association, as trustee. The 2024 Notes are unsecured, and the 2024 Indenture does not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior debt or other indebtedness, or the issuance or repurchase of the Company's other securities by the Company.
Interest is payable semi-annually in arrears on March 1 and September 1 of each year, which commenced on March 1, 2019. The net proceeds to the Company were approximately $391.4 million, of which approximately $48.9 million was used to pay the cost of the capped call transactions with certain financial institutions (“Capped Calls”). The Company also used a portion of the remaining net proceeds to fund the cash portion of the purchase price of the Acquisition, including fees and expenses relating thereto, and intends to use the remaining net proceeds for general corporate purposes.
The Capped Calls have an initial strike price of $9.87 per share, subject to certain adjustments, which corresponds to the initial conversion price of the 2024 Notes. The Capped Calls have initial cap prices of $15.19 per share, subject to certain adjustments. The Capped Calls cover, subject to anti-dilution adjustments, 40.8 million shares of common stock. The Capped Calls transactions are expected generally to reduce or offset potential dilution to the Company's common stock upon any conversion of the 2024 Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of converted 2024 Notes, as the case may be, with such reduction and/or offset subject to a cap. The Capped Calls expire on various dates between July 5, 2024 and August 29, 2024. The Capped Calls were recorded as a reduction of the Company’s stockholders’ equity in the accompanying condensed consolidated balance sheets.
Upon conversion, it is the Company’s intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the 2024 Notes. For any remaining conversion obligation, the Company intends to pay or deliver, either cash, shares of its common stock, or a combination of cash and shares of its common stock, at the Company’s election. The initial conversion rate is 101.2812 shares of common stock per $1,000 principal amount of 2024 Notes, subject to anti-dilution adjustments, which is equivalent to a conversion price of approximately $9.87 per share of common stock.
Throughout the term of the 2024 Notes, the conversion rate may be adjusted upon the occurrence of certain events, including for any cash dividends. Holders of the 2024 Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a 2024 Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than canceled, extinguished or forfeited. Prior to June 1, 2024, holders may convert their 2024 Notes under the following circumstances:
•during any fiscal quarter commencing after the fiscal quarter ended on December 29, 2018 (and only during such fiscal quarter) if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
•during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of 2024 Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day;
•if the Company calls the 2024 Notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date;
•upon the occurrence of specified corporate events described under the 2024 Indenture, such as a consolidation, merger or binding share exchange; or
•at any time on or after June 1, 2024 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their 2024 Notes at any time, regardless of the foregoing circumstances.
If the Company undergoes a fundamental change as defined in the 2024 Indenture, holders may require the Company to repurchase for cash all or any portion of their 2024 Notes at a repurchase price equal to 100% of the principal amount of the 2024 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, upon the occurrence of a “make-whole fundamental change” (as defined in the 2024 Indenture), the Company may, in certain circumstances, be required to increase the conversion
rate by a number of additional shares for a holder that elects to convert its 2024 Notes in connection with such make-whole fundamental change.
The net carrying amounts of the debt obligation were as follows (in thousands):
September 25, 2021
December 26, 2020
Principal
$
402,500
$
402,500
Unamortized discount (1)
(74,320)
(90,213)
Unamortized issuance cost (1)
(4,851)
(5,889)
Net carrying amount
$
323,329
$
306,398
(1)Unamortized debt conversion discount and issuance costs will be amortized over the remaining life of the 2024 Notes, which is approximately 35 months.
As of September 25, 2021 and December 26, 2020, both the carrying amounts of the equity component of the 2024 Notes were $128.7 million.
In accounting for the issuance of the 2024 Notes, the Company separated the 2024 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the 2024 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The debt discount is amortized to interest expense over the term of the 2024 Notes.
The Company allocated the total issuance costs incurred to the liability and equity components of the 2024 Notes based on their relative values. Issuance costs attributable to the liability component were recorded as a reduction to the liability portion of the 2024 Notes and will be amortized as interest expense over the term of the 2024 Notes. The issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.
The Company recorded a deferred tax liability of $30.9 million in connection with the issuance of the 2024 Notes, and a corresponding reduction in valuation allowance. The impact of both was recorded to stockholders' equity.
The Company determined that the embedded conversion option in the 2024 Notes does not require separate accounting treatment as a derivative instrument because it is both indexed to the Company’s own stock and would be classified in stockholders’ equity if freestanding.
The following table sets forth total interest expense recognized related to the 2024 Notes for the three- and nine-month periods ended September 25, 2021 and September 26, 2020 (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Contractual interest expense
$
2,139
$
2,139
$
6,415
$
6,415
Amortization of debt issuance costs
355
321
1,038
940
Amortization of debt discount
5,429
4,918
15,893
14,397
Total interest expense
$
7,923
$
7,378
$
23,346
$
21,752
For the three- and nine-month periods ended September 25, 2021, the debt discount and debt issuance costs were amortized, using an annual effective interest rate of 9.92%, to interest expense over the term of the 2024 Notes.
As of September 25, 2021, the fair value of the 2024 Notes was $445.1 million. The fair value was determined based on the quoted bid price of the 2024 Notes in an over-the-counter market on September 24, 2021 (the last trading day of the fiscal quarter). The 2024 Notes are classified as Level 2 of the fair value hierarchy.
Based on the closing price of the Company’s common stock of $8.21 per share as reported on the Nasdaq Stock Market on September 24, 2021 (the last trading day of the fiscal quarter), the if-converted value of the 2024 Notes did not exceed their principal amount.
13. Commitments and Contingencies
The following table sets forth commitments and contingencies related to our various obligations (in thousands):
Payments Due by Period
Total
Remainder of 2021
2022
2023
2024
2025
Thereafter
Operating leases(1)(2)
$
105,959
$
6,007
$
22,547
$
17,320
$
15,139
$
14,136
$
30,810
Financing lease obligations(3)
2,819
451
1,363
828
177
—
—
2027 Notes, including interest(4)
227,500
—
5,000
5,000
5,000
5,000
207,500
2024 Notes, including interest(4)
428,159
—
8,553
8,553
411,053
—
—
Mortgage Payable, including interest(4)
8,652
260
781
781
6,830
—
—
Total contractual obligations
$
773,089
$
6,718
$
38,244
$
32,482
$
438,199
$
19,136
$
238,310
(1)The Company leases facilities under non-cancelable operating lease agreements. These leases have varying terms that range from one to 11 years. The above payment schedule includes interest. See Note 3, "Leases" to the Notes to Condensed Consolidated Financial Statements for more information.
(2) The Company has contractual commitments to remove leasehold improvements and return certain properties to a specified condition when the leases terminate. At the inception of a lease with such conditions, the Company records an asset retirement obligation liability and a corresponding capital asset in an amount equal to the estimated fair value of the obligation. Asset retirement obligations were $4.9 million and $5.0 million as of September 25, 2021 and December 26, 2020, respectively. All of the $4.9 million as of September 25, 2021 is classified as other long-term liabilities on the accompanying condensed consolidated balance sheets.
(3) The Company has finance leases for manufacturing and other equipment. The above payment schedule includes interest. See Note 3, "Leases" to the Notes to Condensed Consolidated Financial Statements for more information.
(4) See Note 12, "Debt" to the Notes to Condensed Consolidated Financial Statements for more information.
Legal Matters
Oyster Optics LLC
On July 29, 2019, Oyster Optics filed a complaint against the Company, Coriant (USA) Inc., Coriant North America, LLC and Coriant Operations, Inc. in the United States District Court for the Eastern District of Texas. The complaint asserted infringement of U.S. Patent No. 6,665,500 (the “Oyster patent in suit”). The complaint sought unspecified damages and a permanent injunction. On October 7, 2019, the Company filed its answer to the complaint asserting among other things, counterclaims and defenses based on non-infringement, invalidity, and a license to the Oyster patent in suit. On December 27, 2019, the Company filed Inter Partes Review ("IPR") petitions with the U.S. Patent and Trademark Office ("USPTO"), in which the Company requested the USPTO to invalidate the asserted claims of the Oyster patent in suit. On June 26, 2020, the USPTO granted institution on all but one of the asserted claims. On June 22, 2021, the Patent Trial and Appeal Board ruled on the Company's IPR petition, determining that ten of the eleven claims remaining at issue in the IPR were unpatentable. In July 2021, the parties entered into a settlement agreement and all claims in the lawsuit were dismissed with prejudice.
The Company is subject to the possibility of various losses arising in the ordinary course of business. These may relate to disputes, litigation and other legal actions. In the preparation of its quarterly and annual financial statements, the Company considers the likelihood of loss or the incurrence of a liability, including whether it is probable, reasonably possible or remote that a liability has been incurred, as well as the Company’s ability to reasonably estimate the amount of loss, in determining loss contingencies. In accordance with U.S. GAAP, an estimated loss contingency is accrued when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. The Company regularly evaluates current information to determine whether any accruals should be adjusted and whether new accruals are required.As of each of September 25, 2021 and December 26, 2020, the Company has accrued the estimated liabilities associated with certain loss contingencies.
Indemnification Obligations
From time to time, the Company enters into certain types of contracts that contingently require it to indemnify parties against third-party claims. The terms of such indemnification obligations vary. These contracts may relate to: (i) certain real estate leases under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company’s use of the applicable premises; and (ii) certain agreements with the Company’s officers, directors and certain key employees, under which the Company may be required to indemnify such persons for liabilities.
In addition, the Company has agreed to indemnify certain customers for claims made against the Company’s products, where such claims allege infringement of third-party intellectual property rights, including, but not limited to, patents, registered trademarks, and/or copyrights. Under the aforementioned intellectual property indemnification clauses, the Company may be obligated to defend the customer and pay for the damages awarded against the customer under an infringement claim as well as the customer’s attorneys’ fees and costs. These indemnification obligations generally do not expire after termination or expiration of the agreement containing the indemnification obligation. In certain cases, there are limits on and exceptions to the Company’s potential liability for indemnification. The Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. The maximum potential amount of any future payments that the Company could be required to make under these indemnification obligations could be significant.
As permitted under Delaware law and the Company’s charter and bylaws, the Company has agreements whereby it indemnifies certain of its officers and each of its directors. The term of the indemnification period is for the officer’s or director’s lifetime for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements could be significant; however, the Company has a director and officer insurance policy that may reduce its exposure and enable it to recover all or a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal.
On August 12, 2020, the Company entered into an Open Market Sale Agreement (the “Sales Agreement”) with Jefferies LLC (“Jefferies”), as sales agent and/or principal, pursuant to which the Company issued and sold through Jefferies, from time to time, shares of the Company’s common stock, par value $0.001 per share (the “Shares”), having an aggregate offering price of $96.3 million. Subject to the terms and conditions of the Sales Agreement, Jefferies will use its commercially reasonable efforts to sell the Shares from time to time, based upon the Company’s instructions. The Company has provided Jefferies with customary indemnification rights, and Jefferies will be entitled to a compensation of 3% of the gross proceeds per Share sold. Sales of the Shares, if any, under the Sales Agreement may be made in transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act of 1933, as amended. The Company has no obligation to sell any of the Shares and may at any time suspend sales under the Sales Agreement or terminate the Sales Agreement.
During the year ended December 26, 2020, we sold 12 million shares of common stock under the Sales Agreement, for net proceeds of approximately $93.4 million, after paying Jefferies a sales commission of approximately $2.9 million related to services provided as the sales agent with respect to the sales of those shares.
2007 Equity Incentive Plan, 2016 Equity Incentive Plan, 2019 Inducement Equity Incentive Plan and Employee Stock Purchase Plan
In February 2007, the Company’s board of directors adopted the 2007 Equity Incentive Plan (the “2007 Plan”) and the Company’s stockholders approved the 2007 Plan in May 2007. The Company reserved a total of 46.8 million shares of common stock for issuance under the 2007 Plan. Upon stockholder approval of the 2016 Equity Incentive Plan (the “2016 Plan”), the Company has ceased granting equity awards under the 2007 Plan; however, the 2007 Plan will continue to govern the terms and conditions of the awards previously granted under the 2007 Plan. As of September 25, 2021, there were no remaining options or RSUs to purchase shares of the Company's common stock under the 2007 Plan.
In February 2016, the Company's board of directors adopted the 2016 Plan and the Company's stockholders approved the 2016 Plan in May 2016. In May 2018, May 2019, May 2020 and May 2021, the Company's stockholders approved amendments to the 2016 Plan to increase the number of shares authorized for issuance under the 2016 Plan by 1.5 million shares, 7.3 million shares, 8.1 million shares and 4.4 million shares, respectively. As of September 25, 2021, the Company reserved a total of 35.2 million shares of common stock for the award of stock options, RSUs and PSUs to employees, non-employees, consultants and members of the Company's board of directors pursuant to the 2016 Plan, plus any shares subject to awards granted under the 2007 Plan that, after the effective date of the 2016 Plan, expire, are forfeited or otherwise terminate without having been exercised in full to the extent such awards were exercisable, and shares issued pursuant to awards granted under the 2007 Plan that, after the effective date of the 2016 Plan, are forfeited to or repurchased by the Company due to failure to vest. The 2016 Plan has a maximum term of 10 years from the date of adoption, or it can be earlier terminated by the Company's board of directors. The 2007 Plan was canceled; however, it continues to govern outstanding grants under the 2007 Plan.
In July 2019, the Company's board of directors approved a new 2019 Inducement Equity Incentive Plan and set the maximum number of shares to be issued at 750,000.
In February of 2007, the Company's board of directors adopted the ESPP and the Company's stockholders approved the ESPP in May of 2007. The ESPP was last amended by the Company's stockholders in May 2019 to increase the shares authorized under the ESPP to a total of approximately 31.6 million shares of common stock. The ESPP has a 20-year term. Eligible employees may purchase the Company’s common stock through payroll deductions at a price equal to 85% of the lower of the fair market values of the stock as of the beginning or the end of six-month offering periods. An employee’s payroll deductions under the ESPP are limited to a maximum of 15% of the employee’s compensation and an employee may not purchase more than 3,000 shares per purchase period.
Stock-based Compensation Plans
As described above, the Company has stock-based compensation plans pursuant to which the Company has granted stock options, RSUs and PSUs, as well as an ESPP for all eligible employees.
The following tables summarize the Company’s equity award activity and related information (in thousands, except per share data):
Number of Stock Options
Weighted Average Exercise Price Per Share
Aggregate Intrinsic Value
Outstanding at December 26, 2020
51
$
7.57
$
174
Options exercised
(51)
$
7.57
$
108
Outstanding at September 25, 2021
—
$
—
$
—
Number of Restricted Stock Units
Weighted Average Grant Date Fair Value Per Share
Aggregate Intrinsic Value
Outstanding at December 26, 2020
12,468
$
5.99
$
136,781
RSUs granted
6,568
$
8.74
RSUs released
(6,733)
$
5.95
$
59,919
RSUs canceled
(604)
$
6.79
Outstanding at September 25, 2021
11,699
$
7.52
$
96,045
Number of Performance Stock Units
Weighted Average Grant Date Fair Value Per Share
Aggregate Intrinsic Value
Outstanding at December 26, 2020
3,466
$
5.36
$
38,022
PSUs granted
659
$
8.61
PSUs released
(235)
$
7.49
$
2,237
PSUs canceled
(999)
$
4.88
Outstanding at September 25, 2021
2,891
$
6.09
$
23,736
Expected to vest at September 25, 2021
2,693
$
22,110
The aggregate intrinsic value of the stock options that have been exercised is calculated as the difference between the fair market value of the common stock at the date of exercise and the exercise price of the underlying stock options.
The aggregate intrinsic value of unreleased RSUs and unreleased PSUs is calculated using the closing price of the Company's common stock of $8.21 at September 24, 2021 (the last trading day of the fiscal quarter). The aggregate intrinsic value of RSUs and PSUs released is calculated using the fair market value of the common stock at the date of release.
The following table presents total stock-based compensation cost for instruments granted but not yet amortized, of the Company’s equity compensation plans as of September 25, 2021. These costs are expected to be amortized on a straight-line basis over the following weighted-average periods (in thousands, except for weighted average period data):
The fair value of the ESPP shares was estimated at the date of grant using the following assumptions:
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Volatility
38%
97%
38% - 50%
42% - 97%
Risk-free interest rate
0.05%
0.12%
0.05% - 0.06%
0.12% - 1.56%
Expected life
0.5 years
0.5 years
0.5 years
0.5 years
Estimated fair value
$2.22
$3.42
$2.22 - $3.11
$2.17- $3.42
Total stock-based compensation expense
$1,379
$1,650
$4,449
$4,511
Restricted Stock Units
Pursuant to the 2016 Plan, the Company has granted RSUs to employees and non-employee members of the Company's board of directors. All RSUs awarded are subject to each individual's continued service to the Company through each applicable vesting date. The Company accounted for the fair value of the RSUs using the closing market price of the Company’s common stock on the date of grant. Amortization of stock-based compensation related to RSUs for the three- and nine-month periods ended September 25, 2021 was approximately $10.4 million and $31.8 million, respectively, and for the three- and nine-month periods ended September 26, 2020 was approximately $8.8 million and $26.8 million, respectively.
Performance Stock Units
Pursuant to the 2016 Plan, the Company has granted PSUs to certain of the Company’s executive officers, senior management and certain employees. All PSUs awarded are subject to each individual's continued service to the Company through each applicable vesting date and if the performance metrics are not met within the time limits specified in the award agreements, the PSUs will be canceled.
PSUs granted to the Company’s executive officers and senior management under the 2016 Plan during the first half of 2018 are based on the total stockholder return ("TSR") of the Company's common stock price relative to the TSR of the individual companies listed in the S&P North American Technology Multimedia Networking Index (“SPGIIPTR”) over the span of one year, two years and three years. The number of shares to be issued upon vesting of these PSUs range from zero to two times the target number of PSUs granted depending on the Company’s performance against the individual companies listed in the SPGIIPTR.
PSUs granted to the Company's executive officers and senior management under the 2016 Plan during 2019, 2020 and the first quarter of 2021 are based on performance criteria related to specific financial targets over the span of a three-year performance period. These PSUs may become eligible for vesting to begin before the end of the three-year performance period, if the applicable financial targets are met. The number of shares to be issued upon vesting of these PSUs are capped at the target number of PSUs granted. Certain other employees were awarded PSUs that will only become eligible to vest upon the achievement of specific financial and operational performance criteria.
The following table summarizes by grant year, the Company’s PSU activity for the nine months ended September 25, 2021 (in thousands):
Total Number of Performance Stock Units
2018
2019
2020
2021
Outstanding at December 26, 2020
3,466
109
1,757
1,600
—
PSUs granted
659
—
—
—
659
PSUs released
(235)
(104)
(131)
—
—
PSUs canceled
(999)
(5)
(664)
(330)
—
Outstanding at September 25, 2021
2,891
—
962
1,270
659
Stock-based compensation expense related to PSUs for the three- and nine-month periods ended September 25, 2021 was approximately $1.7 million and $2.2 million, respectively. Stock-based compensation
expense related to PSUs for the three- and nine-month periods ended September 26, 2020 was approximately $1.4 million and $4.4 million, respectively.
Stock-Based Compensation
The following tables summarize the effects of stock-based compensation on the Company’s consolidated balance sheets and statements of operations for the periods presented (in thousands):
September 25, 2021
December 26, 2020
Stock-based compensation effects in inventory
$
3,863
$
3,979
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Income tax benefit associated with stock-based compensation
$
2,444
$
2,034
$
6,637
$
6,299
Stock-based compensation effects in net loss before income taxes
Cost of revenue
$
1,968
$
1,878
$
5,894
$
6,043
Research and development
4,714
4,209
14,082
12,362
Sales and marketing
3,059
2,706
9,069
8,136
General and administration
3,891
3,270
9,500
10,001
Total stock-based compensation expense
$
13,632
$
12,063
$
38,545
$
36,542
15. Income Taxes
Income taxes for the three- and nine-month periods ended September 25, 2021 represented a tax expense of $5.5 million and $9.5 million on pre-tax losses of $48.3 million and $128.2 million, respectively. This compared to a tax expense of $1.4 million and $4.9 million, on pre-tax losses of $34.5 million and $191.9 million for the three- and nine-month periods ended September 26, 2020, respectively. Provision for income taxes increased by approximately $4.6 million during the nine months ended September 25, 2021, compared to the corresponding period in 2020 as a result of additional expenses in foreign jurisdictions.
The Company must assess the likelihood that some portion of or all its deferred tax assets will be recovered from future taxable income within the respective jurisdictions. In the past, the Company established a valuation allowance against its deferred tax assets as it determined that its ability to recover the value of these assets did not meet the “more-likely-than-not” standard. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management judgment is required on an on-going basis to determine whether it needs to maintain the valuation allowance recorded against its net deferred tax assets. The Company must consider all positive and negative evidence, including its forecasts of taxable income over the applicable carryforward periods, its current financial performance, its market environment and other factors in evaluating the need for a valuation allowance against its net U.S. deferred tax assets. At September 25, 2021, the Company does not believe that it is more-likely-than-not that it would be able to utilize its domestic deferred tax assets in the foreseeable future. Accordingly, the domestic net deferred tax assets continued to be fully reserved with a valuation allowance. To the extent that the Company determines that deferred tax assets are realizable on a more-likely-than-not basis, and adjustment is needed, that adjustment will be recorded in the period that the determination is made and would generally decrease the valuation allowance and record a corresponding benefit to earnings.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted and signed into law. The CARES Act includes several provisions for corporations including increasing the amount of deductible interest, allowing companies to carryback certain Net Operating Losses (“NOLs”) and increasing the amount of NOLs that corporations can use to offset income. The aforementioned relief available under the CARES Act did not have a material impact on the Company's provision for income taxes for the nine months ended September 25, 2021.
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the Company’s Chief Executive Officer (“the CEO”). The CEO reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. The Company has one business activity as a provider of optical transport networking equipment, software and related services. Accordingly, the Company is considered a single reporting segment and operating unit structure.
Revenue by geographic region is based on the shipping address of the customer. For more information regarding revenue disaggregated by geography, see Note 4, “Revenue Recognition” to the Notes to Condensed Consolidated Financial Statements.
Additionally, the following table sets forth long-lived assets by geographic region (in thousands):
September 25, 2021
December 26, 2020
United States
$
134,339
$
127,691
Other Americas
2,350
2,668
Europe, Middle East and Africa
15,542
18,605
Asia Pacific and Japan
3,289
4,169
Total property, plant and equipment, net
$
155,520
$
153,133
17. Guarantees
Product Warranties
Activity related to product warranty was as follows (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Beginning balance
$
41,670
$
37,083
$
40,708
$
43,348
Charges to operations
5,267
6,610
16,429
19,167
Utilization
(5,953)
(7,904)
(18,702)
(23,718)
Change in estimate(1)
3,601
6,362
6,150
3,354
Balance at the end of the period
$
44,585
$
42,151
$
44,585
$
42,151
(1)The Company records product warranty liabilities based on the latest quality and cost information available as of the date the revenue is recorded. The changes in estimate shown here are due to changes in overall actual failure rates, the mix of new compared to used units related to replacement of failed units, and changes in the estimated cost of repair and product recalls. As the Company's products mature over time, failure rates and repair costs associated with such products generally decline, leading to favorable changes in warranty reserves.
Letters of Credit and Bank Guarantees
The Company had $24.3 million of standby letters of credit and bank guarantees outstanding as of September 25, 2021, which consisted of $16.8 million related to customer performance guarantees, $0.7 million related to value added tax and customs licenses, $4.9 million related to property leases, $1.8 million related to pension plans, and $0.1 million related to suppliers. Of the $16.8 million related to customer performance guarantees, approximately $4.0 million was used to secure surety bonds in the aggregate of $5.5 million.
The Company had $28.9 million of standby letters of credit and bank guarantees outstanding as of December 26, 2020, which consisted of $19.8 million related to customer performance guarantees, $0.3 million related to a value added tax license, $4.0 million related to property leases, $4.4 million related to pension plans, $0.3 million related to credit cards, and $0.1 million for other liabilities. Of the $19.8 million related to customer performance guarantees, approximately $2.8 million was used to secure surety bonds in the aggregate of $5.5 million.
As of each of September 25, 2021 and December 26, 2020, the Company had a Credit Facility, which included a $50.0 million letter of credit sub-facility, pursuant to which letters of credit in the amount of $12.1 million and $11.5 million, respectively, had been issued and outstanding. Approximately $164.5 million and $169.5 million of assets of certain Company subsidiaries have been pledged to secure this Credit Facility and other obligations as of September 25, 2021 and December 26, 2020, respectively.
18. Pension and Post-Retirement Benefit Plans
As a result of the Acquisition, the Company acquired a number of post-employment plans in Germany, as well as a number of smaller post-employment plans in other countries, including both defined contribution and defined benefit plans. The defined benefit plans expose the Company to actuarial risks such as investment risk, interest rate risk, life expectancy risk and salary risk. The characteristics of the defined benefit plans and the risks associated with them vary depending on legal, fiscal and economic requirements.
Components of Net Periodic Benefit Cost
Net periodic benefit cost for the Company's pension and other post-retirement benefit plans consisted of the following (in thousands):
Three Months Ended
Nine Months Ended
September 25, 2021
September 26, 2020
September 25, 2021
September 26, 2020
Service cost
$
112
$
210
$
341
$
760
Interest cost
315
478
960
1,294
Expected return on plan assets
(721)
(624)
(2,198)
(1,848)
Amortization of actuarial loss
844
536
2,569
1,454
Total net periodic benefit cost
$
550
$
600
$
1,672
$
1,660
The components of net periodic benefit costs other than the service cost component are included in other gain(loss), net, in the Company’s condensed consolidated statements of operations.
Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10% of the greater of the pension benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the pension plan participants.
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve risks, estimates and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results and the timing of certain events to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include, but are not limited to, our expectations regarding revenue, gross margin, operating expenses, cash flows and other financial items; our expectations regarding industry-wide supply chain challenges; the severity, magnitude, duration and effects of the COVID-19 pandemic; the extent to which the COVID-19 pandemic and related impacts will materially and adversely affect our business operations, financial performance, results of operations, financial position, stock price and personnel; achievement of strategic objectives, including in the fourth quarter of 2021; any statements of the plans, strategies and objectives of management for future operations and personnel; remaining payments under the 2020 Restructuring Plan; estimates of payments related to future restructuring; the impact of new customer network footprint on our gross margin; statements regarding our ERP systems; impacts of changes in policy by the presidential administration in the United States; the effects of seasonal patterns in our business; factors that may affect our operating results; anticipated customer acceptance of our solutions; statements concerning new products or services, including new product features; statements related to capital expenditures; statements related to working capital and liquidity; statements related to future economic conditions, performance, market growth or our sales cycle; our ability to identify, attract and retain highly skilled personnel; statements related to our convertible senior notes and credit facility; statements related to the impact of tax regulations; statements related to the effects of litigation on our financial position, results of operations or cash flows; statements related to events beyond our control, such as natural disasters, acts of war or terrorism, epidemics and pandemics; statements related to new accounting standards; statements as to industry trends and other matters that do not relate strictly to historical facts; statements related to the effectiveness or adequacy of our disclosure controls or internal controls over financial reporting; and statements of assumptions underlying any of the foregoing. These statements are often identified using of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” "should," "will," or "would," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included in Part II, Item 1A. of this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission (“SEC"), including our Annual Report on Form 10-K for the fiscal year ended December 26, 2020 as filed on March 3, 2021. You should review these risk factors for a more complete understanding of the risks associated with an investment in our securities. Such forward-looking statements speak only as of the date of this report. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.
Overview
We are a global supplier of networking solutions comprised of networking equipment, software and services. Our portfolio of solutions includes optical transport platforms, compact modular platforms, converged packet-optical transport platforms, optical line systems, disaggregated router platforms, and a suite of networking and automation software offerings, and support and professional services.
Our customers include telecommunications service providers, internet content providers (“ICPs”), cable providers, wholesale carriers, research and education institutions, large enterprises and government entities. Our networking solutions enable our customers to deliver high-bandwidth business and consumer communications services. Our comprehensive portfolio of networking solutions also enables our customers to scale their transport networks as end-user services and applications continue to drive growth in demand for network bandwidth. These end-user services and applications include, but are not limited to, high-speed internet access, business ethernet services, 4G/5G mobile broadband, cloud-based services, high-definition video streaming services, virtual and augmented reality and the Internet of Things.
Our systems are highly scalable, flexible and designed with open networking principles for ease of deployment. We build our systems using a combination of internally manufactured and third-party components. Our portfolio includes systems that leverage our innovative, vertically integrated optical engine technology, comprised of large-scale photonic integrated circuits (“PICs”) and digital signal processors (“DSPs”). We optimize the manufacturing process by using indium phosphide to build our PICs, which enables the integration of hundreds of optical functions onto a set of semiconductor chips. This large-scale integration of our PICs and advanced DSPs
allows us to deliver high-performance transport networking platforms with features that customers care about the most, including low cost per bit, low power consumption and space savings. In addition, we design our optical engines to increase the capacity and reach performance of our products by leveraging coherent optical transmission. We believe our vertical integration strategy becomes increasingly more valuable as our customers transition to 800 gigabits per second (“Gb/s”) per wavelength transmission speeds and beyond, as the combination of our optical integration, DSP, and tightly integrated packaging enables a leading optical performance at higher optical speeds.
Over the past several years, we expanded our portfolio of solutions, evolving from our initial focus on the long-haul and subsea optical transport markets to offer an expanded suite of networking solutions that address multiple markets within the end-to-end transport infrastructure. These markets include metro access, metro aggregation and switching, data center interconnect (“DCI”) transport, and long-haul and subsea transport.
We have grown our solutions portfolio through internal development as well as acquisitions. In 2014, we introduced the Infinera Cloud Xpress to address the emerging DCI market opportunity. In 2015, we entered the metro market with the acquisition of Transmode AB. In October 2018, we closed the Acquisition and expanded our product portfolio and customer base by acquiring Coriant, a privately held global supplier of open network solutions for the largest global network operators. The Acquisition has helped position us as one of the largest providers of vertically integrated transport networking solutions in the industry and enhanced our ability to serve a global customer base and accelerate the delivery of the innovative solutions that our customers demand. The Acquisition has also enabled us to expand the breadth of customer applications we can address, including 600 Gb/s optical transport, metro aggregation and switching, disaggregated routing, and software-enabled multi-layer network management and control. In 2021 we announced the expansion of our solutions portfolio with the planned introduction of a suite of coherent optical pluggables designed to support point-to-point and point-to-multipoint transport applications.
Our high-speed optical transport platforms and pluggable solutions are differentiated by our photonic components and Infinite Capacity Engine (“ICE”) coherent optical engine technology. ICE enables different subsystems that can be customized for a variety of network applications in different transport markets, including metro, DCI, long-haul and subsea. Our latest generation of coherent optical engine technology delivers multi-terabit opto-electronic subsystems powered by our fifth-generation PIC and latest generation DSP (the combination of which we market as ICE6). ICE6 is capable of delivering 800 Gb/s over a single wavelength. ICE6 will be integrated into various networking platforms in our product portfolio.
Our products are designed to be managed by a suite of software solutions that enable simplified network management, multi-layer service orchestration, and automated operations. We also provide software-enabled programmability that offers differentiated capabilities such as Instant Bandwidth. Combined with our differentiated hardware solutions, Instant Bandwidth enables our customers to purchase and activate bandwidth as needed through our unique software licensing feature set. This, in turn, allows our customers to accomplish two key objectives: (1) limit their initial network startup costs and investments; and (2) instantly activate new bandwidth as their customers’ and their own network needs evolve.
We believe our portfolio of solutions benefits our customers by providing a unique combination of highly scalable capacity and features that address various transport applications and ultimately simplify and automate network operations. Our high-performance optical transport solutions leverage the industry shift to open optical network architectures and enable our customers to efficiently and cost-effectively meet bandwidth demand, which continues to grow 30%-35% year over year.
For the three months ended September 25, 2021, no customer accounted for 10% or more of the Company's total revenue. For the three months ended September 26, 2020, one customer accounted for 15% of the Company's total revenue. For the nine months ended September 25, 2021, no customer accounted for 10% of the Company's total revenue and for the nine months ended September 26, 2020, the same customer accounted for 13% of the Company's total revenue.
We are headquartered in San Jose, California, with employees located throughout (i) the United States; (ii) Canada, Latin America and South America ("Other Americas"); (iii) Europe, Middle East and Africa (“EMEA”); and (iv) Asia Pacific and Japan (“APAC”). We sell our products both through our direct sales force and indirectly through channel partners.
COVID-19 was declared a global pandemic in March 2020. Although the COVID-19 pandemic has impacted our employees, business and financial position for more than a year, its future impact on us remains uncertain. We will continue monitoring and adjusting our operations, as appropriate, in response to the ongoing COVID-19 pandemic.
Employees
Since the outset of the COVID-19 pandemic, we have taken a number of precautionary steps to safeguard our business and our employees from its effects, including temporarily closing or substantially limiting the presence of personnel in our offices in several impacted locations, implementing travel restrictions and withdrawing from various industry events. Since a large percentage of our workforce is accustomed to online work environments and online collaboration tools, to date we have been able to remain productive and in contact with one another and our customers and vendors. To the extent that pandemic conditions continue to worsen in certain countries in the future and lead to higher rates of infections among the general population and our own workforce, it may be more difficult for us to maintain these levels of productivity. For those employees who may need to be in offices, laboratory and manufacturing environments, or at business partner sites to perform their roles, we continue to take appropriate measures to protect their health and safety and create and maintain a safe working environment. However, sustained restrictions on the ability of our engineers to work in our offices as a result of restrictions imposed by governments, or us, has made and could continue to make it more difficult for them to collaborate as effectively as desired in the development of new products, which can affect development schedules.
Business Operations
In addition, we have implemented certain business continuity plans in response to the COVID-19 pandemic in order to minimize any business disruption and to protect our supply chain, customer fulfillment sites and support operations. Although we believe these actions have somewhat mitigated the impact of the COVID-19 pandemic on our business, we have experienced some disruption and delays in our supply chain and manufacturing operations, logistics, and customer support operations, including shipping delays, higher transport costs, and certain limitations on our ability to access customer fulfillment and service sites. We are dependent on sole source and limited source suppliers for several key components, and we have experienced capacity issues, longer lead times and increased costs with certain of these component suppliers, impacting our operational processes and results of operations. We have also seen disruptions in customer demand, including due to delays in the customer certification process resulting from customer facility closures or access restrictions. During fiscal 2020 and the first three quarters of fiscal 2021, some of these disruptions negatively impacted our revenue and our results of operations. The impact of the COVID-19 pandemic on our business and results of operations during the remainder of fiscal 2021 and into fiscal 2022 remains uncertain and is dependent in part on future infection rates, the emergence of new strains of the virus, the effectiveness and availability of vaccinations, supply chain resilience and broader global macroeconomic developments.
We continue to monitor the COVID-19 pandemic, including the diversity of associated regulatory restrictions being imposed by governmental authorities in the U.S. and abroad, and actively assess potential implications to our business, supply chain and customer demand. If the COVID-19 pandemic or its adverse effects become more severe or prevalent or are prolonged in the locations where we, our customers, suppliers or contract manufacturers conduct business or remain unpredictable, or we experience more pronounced or long-lasting disruptions in our operations, or in economic activity and demand generally, our business and results of operations in future periods could be materially adversely affected.
Liquidity and Capital Resources
While we believe we have enough cash in combination with our Credit Facility (as defined below) to operate our business for the next 12 months, if the impact of the COVID-19 pandemic to our business and financial position is more extensive or longer lasting than expected, we may need additional capital to enhance liquidity and working capital. We have historically been successful in our ability to secure other sources of financing, such as accessing capital markets, and implementing other cost reduction initiatives such as restructuring, delaying or eliminating discretionary spending to satisfy our liquidity needs. However, our access to these sources of capital could be materially and adversely impacted and we may not be able to receive terms as favorable as we have historically received. Capital markets have been volatile and there is no assurance that we would have access to capital markets at a reasonable cost, or at all, at times when capital is needed. In addition, some of our existing debt has restrictive covenants that may limit our ability to raise new debt, which would limit our ability to access liquidity by those means without obtaining the consent of our lenders.
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our condensed consolidated financial statements, which we have prepared in accordance with the U.S. generally accepted accounting principles (“U.S. GAAP”). The preparation of these financial statements requires management to make estimates, assumptions and judgments that can affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
An accounting policy is deemed to be critical if it requires a significant accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes that there have been no significant changes during the nine months ended September 25, 2021 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 26, 2020.
Due to the COVID-19 pandemic, there has been and continues to be uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require updates to our estimates or judgments or require us to revise the carrying value of our assets or liabilities as of the date we filed this Quarterly Report on Form 10-Q. These estimates may change as new events occur and additional information is obtained. Actual results could differ from these estimates under different assumptions or conditions.
Results of Operations
The following sets forth, for the periods presented, certain unaudited condensed consolidated statements of operations information (in thousands, except percentage data):
Total product revenue increased by $8.9 million, or 3%, during the three months ended September 25, 2021 compared to the corresponding period in 2020. Total product revenue increased by $4.1 million, or 1%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020. For each of these three- and nine-month periods, increased revenue from our ICP, other service provider and cable verticals were partially offset by decreased revenue from certain Tier 1 customers.
Total services revenue increased by $6.7 million, or 9% for the three months ended September 25, 2021 compared to the corresponding period in 2020. Total services revenue increased by $18.8 million, or 8% for the nine months ended September 25, 2021 compared to the corresponding period in 2020. For each of these three- and nine-month periods, this increase was attributable to growth in professional services due to an increase in network installation revenue, somewhat offset by lower maintenance revenue.
We expect our total revenue will be higher in the fourth quarter of 2021 as compared to the third quarter of 2021, driven primarily by demand growth from certain ICP and other service provider customers as well as increased availability of new products introduced in the second quarter of 2021.
The following table summarizes our revenue by geography and sales channel for the periods presented (in thousands, except percentage data):
Three Months Ended
September 25, 2021
September 26, 2020
Amount
% of total revenue
Amount
% of total revenue
Change
% Change
Total revenue by geography:
Domestic
$
163,583
46
%
$
167,043
49
%
$
(3,460)
(2)
%
International
192,231
54
%
173,168
51
%
19,063
11
%
$
355,814
100
%
$
340,211
100
%
$
15,603
5
%
Total revenue by sales channel:
Direct
$
259,349
73
%
$
269,653
79
%
$
(10,304)
(4)
%
Indirect
96,465
27
%
70,558
21
%
25,907
37
%
$
355,814
100
%
$
340,211
100
%
$
15,603
5
%
Nine Months Ended
September 25, 2021
September 26, 2020
Amount
% of total revenue
Amount
% of total revenue
Change
% Change
Total revenue by geography:
Domestic
$
496,416
48
%
$
503,792
50
%
$
(7,376)
(1)
%
International
528,532
52
%
498,279
50
%
30,253
6
%
$
1,024,948
100
%
$
1,002,071
100
%
$
22,877
2
%
Total revenue by sales channel:
Direct
$
795,672
78
%
$
782,330
78
%
$
13,342
2
%
Indirect
229,276
22
%
219,741
22
%
9,535
4
%
$
1,024,948
100
%
$
1,002,071
100
%
$
22,877
2
%
Domestic revenue decreased by $3.5 million, or 2%, during the three months ended September 25, 2021 compared to the corresponding period in 2020, driven primarily by decreased revenue from certain Tier 1 customers, which was partially offset by increased revenue from our ICP, cable and other service provider verticals. Domestic revenue decreased by $7.4 million, or 1%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020, driven primarily by decreased revenue from certain Tier 1 customers, which was partially offset by increased revenue from our ICP and cable verticals.
International revenue increased by $19.1 million, or 11%, during the three months ended September 25, 2021 compared to the corresponding period in 2020, driven primarily by increased revenue from our ICP, cable and other service provider verticals, which was partially offset by decreased revenue from certain Tier 1 customers. International revenue increased by $30.3 million, or 6%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020, driven primarily by strong growth from our cable vertical in EMEA and certain ICP and other service providers in EMEA and APAC, which was partially offset by decreased revenue from Tier 1 customers in APAC and EMEA.
Direct revenue decreased by $10.3 million, or 4%, and indirect revenue increased by $25.9 million, or 37% during the three months ended September 25, 2021 compared to the corresponding period in 2020. The decrease in direct revenue for the third quarter of 2021 was driven by decreased revenue from certain Tier 1 customers, which was partially offset by increased revenue from our other service provider, ICP and cable verticals. The increase in indirect revenue for the third quarter of 2021 was driven by increased revenue from ICP customers who purchased through our indirect sales channel. Direct revenue increased by $13.3 million, or 2%, and indirect revenue increased by $9.5 million, or 4%, during the nine months ended September 25, 2021 compared to the corresponding respective period in 2020. The increase in direct revenue during this period is attributable to increases in our ICP and other service provider verticals offset by decreases at certain Tier 1 customers. The increase in indirect revenue during this period was driven by increased revenue from certain ICP customers who purchased through our indirect sales channel.
Gross profit was $118.1 million during the three months ended September 25, 2021, with gross margin increasing to 33% compared to 32% in the corresponding period in 2020. In the three months ended September 25, 2021, we realized an improvement in our product margins due to a more favorable product mix, ongoing internal cost improvement initiatives, and lower intangible amortization expenses. These factors were partially offset by an $8.6 million charge incurred as a result of the exit from certain product lines. Gross profit was $355.5 million during the nine months ended September 25, 2021, with gross margin increasing to 35% compared to 28% in the corresponding period in 2020. This increase was primarily attributable to an improvement in our product mix, ongoing internal cost improvement initiatives, and lower intangible amortization expenses. These factors were partially offset by an $8.6 million charge incurred as a result of the exit from certain product lines.
We currently expect gross margin in the fourth quarter of 2021 to be lower than the third quarter of 2021 due to increased line system deployment revenues. Over time, we believe our margins will improve as we increase the proportion of revenue derived from sales of our vertically integrated products.
Amortization of Intangible Assets
Amortization of intangible assets decreased by $2.7 million, or 37%, and $10.8 million, or 44%, during the three- and nine-month periods ended September 25, 2021, respectively, compared to the corresponding periods in 2020, due to certain technologies being fully amortized in the third quarter of 2020.
Acquisition and Integration Costs
Integration costs, within cost of revenue, were immaterial for the three months ending September 25, 2021 and remained flat compared to the corresponding period in 2020. Integration costs, within cost of revenue, decreased by $1.8 million during the nine-month period ended September 25, 2021, compared to the corresponding period in 2020, as we completed our integration efforts related to the Acquisition in the first quarter of 2021.
Restructuring and Other Related Costs
Restructuring and other related costs primarily consisting of severance and other related costs decreased by $0.1 million, or 5%, and $2.6 million, or 61% during the three- and nine-month periods ended September 25, 2021, respectively, compared to the corresponding periods in 2020. These decreases primarily reflect the substantial completion of our Munich-related restructuring activities in 2020, which was part of our 2018 Restructuring Plan, partially offset by expenses associated with the 2021 Restructuring Plan. Also, during the three months ended September 25, 2021, we incurred a $1.4 million credit resulting from lower than expected Munich severance and related costs. See Note 9, “Restructuring and Other Related Costs” to the Notes to Condensed Consolidated Financial Statements for more information.
The following tables summarize our operating expenses for the periods presented (in thousands, except percentage data):
Three Months Ended
September 25, 2021
September 26, 2020
Amount
% of total revenue
Amount
% of total revenue
Change
% Change
Operating expenses:
Research and development
$
76,648
22
%
$
65,636
19
%
$
11,012
17
%
Sales and marketing
33,223
9
%
28,954
9
%
4,269
15
%
General and administrative
28,301
8
%
28,183
9
%
118
0
%
Amortization of intangible assets
4,351
1
%
4,696
1
%
(345)
(7)
%
Acquisition and integration costs
—
—
%
1,045
—
%
(1,045)
NMF*
Restructuring and other related costs
6,546
2
%
6,679
2
%
(133)
(2)
%
Total operating expenses
$
149,069
42
%
$
135,193
40
%
$
13,876
10
%
Nine Months Ended
September 25, 2021
September 26, 2020
Amount
% of total revenue
Amount
% of total revenue
Change
% Change
Operating expenses:
Research and development
224,111
22
%
200,906
20
%
$
23,205
12
%
Sales and marketing
99,777
10
%
97,459
10
%
2,318
2
%
General and administrative
87,004
8
%
87,904
9
%
(900)
(1)
%
Amortization of intangible assets
13,148
1
%
13,836
1
%
(688)
(5)
%
Acquisition and integration costs
614
—
%
13,611
1
%
(12,997)
(95)
%
Restructuring and other related costs
8,191
1
%
17,356
2
%
(9,165)
(53)
%
Total operating expenses
$
432,845
42
%
$
431,072
43
%
$
1,773
0
%
*NMF = Not meaningful
Research and Development Expenses
Research and development expenses increased by $11.0 million, or 17%, during the three months ended September 25, 2021, and increased by $23.2 million, or 12%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020. These increases were primarily attributable to higher employee-related costs related to bringing our new technologies to market and investments in future technologies. Our equipment and software spend was also slightly higher in the three and nine months ended September 25, 2021, as we optimized spend to focus on our highest growth opportunities. These increases were partially offset by lower costs related to new products transitioning from development to production, and lower depreciation expense related to older technologies. We expect to increase research and development investments in our vertically integrated product portfolio expansion strategy, which we believe will drive higher revenue and profitability.
Sales and Marketing Expenses
Sales and marketing expenses increased by $4.3 million, or 15%, during the three months ended September 25, 2021 compared to the corresponding period in 2020. This increase was primarily attributable to higher employee compensation expenses. Sales and marketing expense increased by $2.3 million, or 2%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020. This increase primarily reflects higher employee compensation expenses which were partially offset by decreases attributable to reductions in travel and marketing-related expenses, principally driven by the impact of the COVID-19 pandemic. We expect sales and marketing costs to increase in the fourth quarter 2021, primarily as a result of increased sales commissions.
General and Administrative Expenses
General and administrative expenses increased by $0.1 million, or immaterial, during the three months ended September 25, 2021 compared to the corresponding period in 2020. The increase was largely due to higher
employee compensation related costs partially offset by lower professional fees and lower facility costs due to site closures. General and administrative expenses decreased by $0.9 million, or 1%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020. The decrease was primarily attributable to reductions in professional services, lower facility operating costs due to site closures and higher tax credits, partially offset by litigation settlements, higher employee compensation costs and software license fees.
Amortization of Intangible Assets
Amortization of intangible assets decreased by $0.3 million, or 7%, during the three months ended September 25, 2021, and decreased by $0.7 million, or 5%, during the nine months ended September 25, 2021 compared to the corresponding periods in 2020, primarily due to lower amortization of the value of customer relationships and backlog.
Acquisition and Integration Costs
Integration costs decreased by $1.0 million, during the three months ended September 25, 2021, and decreased by $13.0 million, during the nine months ended September 25, 2021 compared to the corresponding periods in 2020, primarily due to the completion of our integration efforts related to the Acquisition in the first quarter of 2021.
Restructuring and Other Related Costs
Restructuring and other related costs decreased by $0.1 million, or 2%, during the three months ended September 25, 2021, compared to the corresponding period in 2020. The decrease in the three months ended September 25, 2021 was primarily due to the substantial completion of restructuring initiatives under the 2018 Restructuring Plan in 2020, partially offset by expenses associated with the 2021 Restructuring Plan. Also, during the three-month period ended September 25, 2021, we recognized a $1.0 million credit that resulted from lower than expected Munich severance and related costs.
Restructuring and other related costs decreased by $9.2 million, or 53%, during the nine months ended September 25, 2021, compared to the corresponding period in 2020. The decrease in the nine months ended September 25, 2021 was primarily due to the substantial completion of restructuring initiatives under the 2018 Restructuring Plan in 2020. Also, during the nine months ended September 25, 2021, we recognized a $1.0 million credit that resulted from lower than expected Munich severance and related costs. See Note 9, “Restructuring and Other Related Costs” to the Notes to Condensed Consolidated Financial Statements for more information.
Other Income (Expense), Net
Three Months Ended
September 25, 2021
September 26, 2020
Change
% Change
(In thousands)
Interest income
$
22
$
7
$
15
214
%
Interest expense
(12,622)
(12,645)
23
—
%
Other gain (loss), net
(4,763)
5,018
(9,781)
(195)
%
Total other expense, net
$
(17,363)
$
(7,620)
$
(9,743)
128
%
Nine Months Ended
September 25, 2021
September 26, 2020
Change
% Change
(In thousands)
Interest income
89
85
$
4
5
%
Interest expense
(36,482)
(33,875)
(2,607)
8
%
Other loss, net
(14,439)
(9,656)
(4,783)
50
%
Total other expense, net
$
(50,832)
$
(43,446)
$
(7,386)
17
%
Interest income during the three- and nine-month periods ended September 25, 2021 and September 26, 2020, respectively, was immaterial.
Interest expense had no significant change during the three months ended September 25, 2021 compared to the corresponding period in 2020, primarily due to increased accretion of debt discount and amortization of debt issuance costs on the 2027 Notes and the 2024 Notes, which was partially offset by a decrease in interest expense on the Credit Facility, which was repaid in January 2021, and the Finance Assistance Agreement, which was repaid in April 2021.
Interest expense increased by $2.6 million, or 8%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020, primarily due to increased accretion of debt discount and amortization of debt issuance costs on the 2027 Notes and the 2024 Notes, contractual interest on the 2027 Notes, and a nonrecurring interest credit from a supplier in 2020. This increase was partially offset by a decrease in interest expense on the Credit Facility, which was repaid in January 2021, and the Finance Assistance Agreement, which was repaid in April 2021, and a decrease in other interest related charges.
Other gain (loss), net, increased by $9.8 million, or 195%, during the three months ended September 25, 2021 compared to the corresponding period in 2020, primarily due to an increase in unrealized foreign exchange losses driven by foreign currency exchange rate changes.
Other loss, net, increased by $4.8 million, or 50%, during the nine months ended September 25, 2021 compared to the corresponding period in 2020, primarily due to as increase in unrealized foreign exchange losses driven by foreign currency exchange rate changes.
Income Tax Benefit/Expense
Income tax expense increased by $4.1 million, or 301%, during the three months ended September 25, 2021 compared to the corresponding period in 2020, primarily as a result of additional expenses in foreign jurisdictions.
Income tax expense increased by approximately $4.6 million, or 94%, during the nine months ended September 25, 2021, compared to the corresponding period in 2020, primarily as a result of additional expenses in foreign jurisdictions.
Liquidity and Capital Resources
Nine Months Ended
September 25, 2021
September 26, 2020
(In thousands)
Net cash flow provided by (used in):
Operating activities
$
26,759
$
(164,516)
Investing activities
$
(32,314)
$
(27,148)
Financing activities
$
(96,729)
$
276,849
September 25, 2021
December 26, 2020
(In thousands)
Cash
$
203,484
$
298,014
Restricted cash
12,916
17,369
$
216,400
$
315,383
Our restricted cash balance amounts are primarily pledged as collateral for certain standby letters of credit related to customer performance guarantees, value added tax licenses and property leases.
Operating Activities
Net cash provided by operating activities during the nine months ended September 25, 2021 was $26.8 million compared to $164.5 million net cash used in operating activities for the corresponding period in 2020.
Net loss during the nine months ended September 25, 2021 was $137.7 million, which included non-cash charges of $139.0 million such as depreciation, amortization of intangibles, restructuring charges and other related costs, amortization of debt discount and debt issuance costs, operating lease expense, and stock-based compensation, compared to a net loss during the nine months ended September 26, 2020of $196.8 million, which included non-cash charges of $152.2 million.
Net cash provided by working capital was $25.5 million during the nine months ended September 25, 2021. Accounts receivable decreased by $42.5 million due to timing of customer billings and collections. Inventory levels increased by $24.9 million due to our efforts to purchase more inventory to manage lead time due to the industry semiconductor shortage. Prepaid and other assets decreased by $15.0 million primarily due to timing of tax payments and a lower contract asset balance due to timing of billings and revenue recognition. Accounts payable decreased by $2.1 million primarily due to timing of payment to suppliers. Accrued liabilities and other expenses increased by $19.1 million primarily due to higher accrued compensation and related benefits. Deferred revenue decreased by $24.2 million due primarily to the amortization of annual maintenance renewals during the period.
Net cash used to fund working capital was $119.9 million during the nine months ended September 26, 2020. Accounts receivable decreased by $55.3 million due to strong cash collections. Inventory levels decreased by $63.2 million due to management's efforts to reduce inventory. Accounts payable decreased by $117.8 million primarily due to the timing of payment to suppliers. Prepaid and other assets increased by $25.5 million primarily due to timing of tax payments and an increase in contract assets. Accrued liabilities and other expenses decreased by $73.5 million primarily due to payment of the fiscal 2019 corporate bonus, restructuring liabilities, tax liabilities and purchases of shares of our common stock under our 2007 ESPP in 2020. Deferred revenue decreased by $21.5 million due to amortization of maintenance renewals and lower renewals during the quarter, which are typically contracted on an annual or multi-year basis.
Investing Activities
Net cash used in investing activities during the nine months ended September 25, 2021 was$32.3 million primarily for purchase of property and equipment.
Net cash used in investing activities during the nine months ended September 26, 2020 was $27.1 million entirely for purchase of property and equipment.
Financing Activities
Net cash used in financing activities during the nine months ended September 25, 2021 was $96.7 million compared to net cash provided by financing activities of $276.8 million in the corresponding period of 2020. Financing activities during the nine months ended September 25, 2021 primarily included payments of $77.0 million towards the Credit Facility, a $24.6 million repayment of the financing assistance arrangement (as described below), and a $5.5 million term license purchase. The period also included net proceeds of $16.5 million from the issuance of shares of our common stock under the ESPP. These proceeds were offset by tax withholdings in the amount of $4.7 million paid on behalf of certain employees for net share settlements of RSUs.
Net cash provided by financing activities during the nine months ended September 26, 2020 was $276.8 million. Financing activities during the nine months ended September 26, 2020 included proceeds of $31.0 million from our common stock "at-the-market" offering program, $194.5 million from the issuance of the 2027 Notes and $55.0 million of proceeds from the Credit Facility (as described below). The period also included net proceeds of $15.4 million from the issuance of shares of our common stock under the ESPP. Payments during this period included $8.0 million towards the Credit Facility, a $5.3 million repayment of the financing assistance arrangement, $2.4 million in debt issuance cost, tax withholdings of $2.0 million paid on behalf of certain employees for net share settlements of RSUs, and $1.1 million for finance lease obligations.
Liquidity
We believe that our current cash, along with the Credit Facility, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures, and the interest payments on the Notes and the Credit Facility for at least 12 months. If the impact of the COVID-19 pandemic to our business and financial position is more extensive or longer lasting than expected and our existing sources of cash are insufficient to satisfy our liquidity requirements, we may require additional capital from equity or debt financings to fund our operations, to respond to competitive pressures or strategic opportunities, or otherwise. In addition, we are continuously evaluating alternatives for efficiently funding our capital expenditures and ongoing operations. We may, from time to time engage in a variety of financing transactions for such purposes. We may not be able to secure timely additional financing on favorable terms, or at all. The terms of any additional financings may place limits on our financial and operating flexibility. If we raise additional funds through further issuances of equity or equity-linked securities, our existing stockholders could suffer dilution in their percentage ownership of us, and any new securities we issue could have rights, preferences and privileges senior to those of holders of our common stock.
On March 9, 2020, we issued the 2027 Notes, which will mature on March 1, 2027, unless earlier repurchased, redeemed or converted. Interest is payable semi-annually in arrears on March 1 and September 1 of each year, commencing on September 1, 2020. The net proceeds from the 2027 Notes issuance were approximately $194.5 million and we intend to use the net proceeds for general corporate purposes, including working capital to fund growth and potential strategic projects.
Upon conversion, it is our intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the 2027 Notes. For any remaining conversion obligation, we intend to pay or deliver, as the case may be, cash, shares of our common stock, or a combination of cash and shares of our common stock, at our election. As of September 25, 2021, long-term debt, net, included $138.1 million outstanding for the 2027 Notes, which represents the liability component of the $200.0 million principal balance, net of $61.9 million of unamortized debt discount and debt issuance costs. The debt discount and debt issuance costs are currently being amortized over the remaining term until maturity of the 2027 Notes on March 1, 2027. To the extent that the holders of the 2027 Notes request conversion during an early conversion window, we may require funds for repayment of such 2027 Notes prior to their maturity date.
As of September 25, 2021, contractual obligations related to the 2027 Notes are payments of zero due for the remainder of 2021, $5.0 million due each year from 2022 through 2026 and $207.5 million due in 2027. These amounts represent principal and interest cash payments over the term of the 2027 Notes. Any future redemption or conversion of the Notes could impact the amount or timing of our cash payments. For more information regarding the 2027 Notes, see Note 12, “Debt” to the Notes to Condensed Consolidated Financial Statements.
On August 1, 2019, we entered into the Credit Agreement with Wells Fargo Bank, and on December 23, 2019 we entered into the Amendment to the Credit Agreement with BMO Harris Bank N.A. and Wells Fargo Bank, as administrative agent. The Amended Credit Agreement provides for the Credit Facility, a senior secured asset-based revolving credit facility of up to $150.0 million, which we may draw upon from time to time. The Credit Agreement provided us with the option to increase the total commitments under the Credit Facility from the initial $100.0 million amount by up to an additional $50.0 million to $150.0 million, subject to certain conditions. On December 23, 2019, we exercised this option to increase the total commitments under the Credit Facility and entered into the Amendment to the Credit Agreement. The Amended Credit Agreement provides for a $50.0 million letter of credit sub-facility and a $10.0 million swing loan sub-facility.
The proceeds of the loans under the Amended Credit Agreement may be used to pay the fees, costs and expenses incurred in connection with the Amended Credit Agreement and for working capital and general corporate purposes. The Credit Facility matures, and all outstanding loans become due and payable, on March 5, 2024. Availability under the Credit Facility is based upon periodic borrowing base certifications valuing certain inventory and accounts receivable, as reduced by certain reserves. The Credit Facility is secured by first-priority security interest (subject to certain exceptions) in inventory, certain related assets, specified deposit accounts, and certain other accounts in certain domestic subsidiaries.
Loans under the Amended Credit Agreement bear interest, at our option, at either a rate based on LIBOR for the applicable interest period or a base rate, in each case plus a margin. The margin ranges from 2.00% to 2.50% for LIBOR rate loans and 1.00% to 1.50% for base rate loans, depending on the utilization of the Credit Facility. The commitment fee payable on the unused portion of the Credit Facility ranges from 0.375% to 0.625% per annum, also based on the current utilization of the Credit Facility. Letters of credit issued pursuant to the Credit Facility will accrue a fee at a per annum rate equal to the applicable LIBOR rate margin times the average amount of the letter of credit usage during the immediately preceding quarter in addition to the fronting fees, commissions and other fees.
In January 2021, we repaid in full the then outstanding principal balance of $77.0 million. For more information regarding the Credit Facility, see Note 12, “Debt” to the Notes to Consolidated Financial Statements.
In May 2019, we entered into a financing assistance agreement with a third-party contract manufacturer whereby the contract manufacturer agreed to provide funding of up to $40.0 million to cover severance, retention and other costs associated with the transfer of our manufacturing operations in Berlin, Germany to the contract manufacturer. The funding was secured against certain foreign assets, carried a fixed interest rate of 6% and repayable in 12 months from the date of each draw down. In October 2020, the payment terms were amended to extend the due date by six months, set the fixed interest rate at 3% during such period, and allowed for the phased transfer of inventory to offset the amount due. In April 2021, we repaid the entire outstanding principal balance and accrued interest of $24.6 million and $1.8 million, respectively.
In September 2018, we issued the 2024 Notes, which will mature on September 1, 2024, unless earlier repurchased, redeemed or converted. Interest is payable semi-annually in arrears on March 1 and September 1 of each year, which commenced on March 1, 2019. The net proceeds from the 2024 Notes issuance were approximately $391.4 million, of which approximately $48.9 million was used to pay the cost of the Capped Calls. We also used a portion of the remaining net proceeds to fund the cash portion of the purchase price of the Acquisition, including fees and expenses relating thereto, and intend to use the remaining net proceeds for general corporate purposes.
Upon conversion, it is our intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the 2024 Notes. For any remaining conversion obligation, we intend to pay or deliver, as the case may be, cash, shares of our common stock, or a combination of cash and shares of our common stock, at our election. As of September 25, 2021, long-term debt, net, included $323.3 million for 2024 Notes which represents the liability component of the $402.5 million principal balance, net of $79.2 million of unamortized debt discount and debt issuance costs. The debt discount and debt issuance costs are currently being amortized over the remaining term until maturity of the 2024 Notes on September 1, 2024. To the extent that the holders of the 2024 Notes request conversion during an early conversion window, we may require funds for repayment of such 2024 Notes prior to their maturity date.
As of September 25, 2021, contractual obligations related to the 2024 Notes are payments of zero due for the remainder of 2021, $8.6 million due each year from 2022 through 2023 and $411.1 million due in 2024. These amounts represent principal and interest cash payments over the term of the 2024 Notes. Any future redemption or conversion of the Notes could impact the amount or timing of our cash payments. For more information regarding the 2024 Notes, see Note 12, “Debt” to the Notes to Consolidated Financial Statements.
As of September 25, 2021, we had $203.5 million of cash including $85.0 million of cash held by our foreign subsidiaries. Our policy with respect to undistributed foreign subsidiaries' earnings is to consider those earnings to be indefinitely reinvested. As a result of the enactment in the United States of the Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”), if and when funds are actually distributed in the form of dividends or otherwise, we expect minimal tax consequences, except for foreign withholding taxes, which would be applicable in some jurisdictions.
Off-Balance Sheet Arrangements
As of September 25, 2021, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Item 3.Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and interest rates. We assess these risks on a regular basis and have established policies that are designed to protect against, but that cannot entirely eliminate the adverse effects of these and other potential exposures.
Foreign Currency Exchange Rate Risk
There have been no material changes to the foreign currency exchange rate risk previously disclosed in Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our Annual Report on Form 10-K for the fiscal year ended December 26, 2020.
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Interest Rate Risk
There have been no material changes to the interest rate risk previously disclosed in Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our Annual Report on Form 10-K for the fiscal year ended December 26, 2020.
Market Risk and Market Interest Risk
For a discussion of our exposure to market risk and market interest risk related to the 2027 Notes and 2024 Notes, see “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 26, 2020. There have been no other material changes to our market risk during the nine months ended September 25, 2021.
Item 4.Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation was performed by our management, with the participation of our CEO and our CFO, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d -15(e) under the Exchange Act). Disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our CEO and CFO concluded that, as of September 25, 2021, our disclosure controls and procedures are effective.
Inherent Limitations on Effectiveness of Controls
Our management, including the CEO and CFO, does not expect that our disclosure controls or our internal controls over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in business conditions or deterioration in the degree of compliance with policies or procedures.
Changes in Internal Control over Financial Reporting
During the three months ended September 25, 2021 there were no changes in our internal control over financial reporting which were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We are continually monitoring and assessing the COVID-19 pandemic situation to minimize the impact, if any, on the design and operating effectiveness on our internal controls.
The information set forth under the heading “Legal Matters” in Note 13, Commitments and Contingencies, in Part I, Item 1 of this Quarterly Report on Form 10-Q is incorporated herein by reference.
Item 1A. Risk Factors
Investing in our securities involves a high degree of risk and a description of the risks and uncertainties associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risks and uncertainties associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 26, 2020. The risks set forth below are not the only risks we face. These, many other factors described in this report and additional risks and uncertainties not currently known to us or that we currently deem to be immaterial could adversely affect our operations, performance and financial condition. Our actual results could differ materially from our forward-looking statements.
Risk Factors Summary
The following is a summary of the principal risks that could adversely affect our business, operations and financial results.
Business and Operational Risk Factors
•Our quarterly results may vary significantly from period to period.
•Supply chain issues, including delays, shortages and increased costs, and our dependency on sole source, limited source or high-cost suppliers could harm our business and operating results.
•Any delays in the development, introduction or acceptance of our new products or in releasing enhancements to our existing products may harm our business.
•Our ability to increase our revenue will depend upon continued demand growth for additional network capacity and on customer capital spending details.
•Aggressive business tactics by our competitors may harm our business.
•The markets in which we compete are highly competitive and we may not be able to compete effectively.
•The effects of the COVID-19 pandemic could have a material adverse effect on our business and results of operations.
•Product performance problems or deployment delays could harm our business and reputation.
•If we lose key personnel or fail to attract qualified personnel, our business may be harmed.
•We are dependent on a small number of key customers for a significant portion of our revenue.
•The manufacturing process for our optical engine and the assembly of our products are very complex.
•Increased consolidation among our customers and suppliers in the communications networking industry has had, and could continue to have, an adverse effect on our business and results of operations.
•Actions that we are taking to restructure our business may not be as effective as anticipated.
•We rely on various third-party service partners to help complement our global operations.
•If our contract manufacturers do not perform as we expect, our business may be harmed.
•We must respond to rapid technological change for our products to be successful.
•If we fail to accurately forecast our manufacturing requirements or customer demand, we could incur additional costs.
•Our large customers have substantial negotiating leverage.
•Our sales cycle can be long and unpredictable, which could result in unexpected revenue shortfalls.
•Any strategic transactions that we undertake could disrupt our business and harm our financial condition and operations.
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Financial and Macroeconomic Risk Factors
•We may be unable to generate the cash flow necessary to make anticipated capital expenditures, service our debt, or grow our business.
•Unfavorable macroeconomic and market conditions may adversely affect our industry, business and financial results.
•If we need additional capital in the future, it may not be available to us on favorable terms, or at all.
•Our international sales and operations subject us to additional risks.
•Our effective tax rate may increase or fluctuate, which could increase our income tax expense and reduce our net income.
•We may be adversely affected by fluctuations in currency exchange rates.
•Our debt obligations may adversely affect our ability to raise additional capital and will be a burden on our future cash resources.
•We may issue additional shares of our common stock in connection with conversions of the Notes.
•The fundamental change provisions of the 2024 Notes and the 2027 Notes may delay or prevent an otherwise beneficial takeover attempt of us.
•The Capped Calls may affect the value of the 2024 Notes and our common stock.
•We are subject to counterparty risk with respect to the Capped Calls.
Legal and Regulatory Risk Factors
•If we fail to protect our intellectual property rights, our competitive position could be harmed, or we could incur significant expense to enforce our rights.
•Claims by others that we infringe on their intellectual property rights could harm our business.
•Security incidents, such as data breaches and cyber-attacks, could compromise our intellectual property and proprietary or confidential information and cause significant damage to our business and reputation.
•If we fail to maintain effective internal control over financial reporting in the future, the accuracy and timing of our financial reporting may be adversely affected.
•We are subject to governmental regulations that could adversely affect our business.
•We are subject to various governmental export control, trade sanctions and import laws and regulations that could impair our ability to compete in international markets or subject us to liability.
•A portion of our revenue is generated by sales to government entities, which are subject to a number of uncertainties, challenges, and risks.
•Our business could be adversely affected if we cannot obtain and maintain required security clearances, or we do not comply with obligations regarding the safeguarding of classified information.
•Failure to comply with anti-bribery and similar laws could subject us to adverse consequences.
General Risk Factors
•The trading price of our common stock has been volatile and is likely to be volatile in the future.
•Future sales of our common stock could cause our stock price to fall.
•Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.
•Exclusive forum provisions in our bylaws will restrict our stockholders’ ability to choose the judicial forum for disputes with us or our directors, officers, or employees.
•Events that are outside of our control, such as natural disasters, terrorist attacks or other catastrophic events, could harm our operations.
For a more complete discussion of the material risks facing our business, see below.
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Business and Operational Risk Factors
Our quarterly results may vary significantly from period to period, which could make our future results difficult to predict and could cause our operating results to fall below investor, analyst or our expectations.
Our quarterly results and, in particular, our revenue, gross margins, operating expenses, operating margins and net income (loss), have historically varied significantly from period to period and may continue to do so in the future. As a result, comparing our operating results on a period-to-period basis may not be meaningful. Our budgeted expense levels are based, in large part, on our expectations of future revenue and the development efforts associated with that future revenue. Consequently, if our revenue does not meet projected levels in the short-term, our inventory levels, cost of goods sold and operating expenses would be high relative to revenue, resulting in potential operating losses. If our revenue or operating results do not meet the expectations of investors or securities analysts or fall below any guidance we provide to the market, the price of our common stock may decline substantially.
Factors that may contribute to fluctuations in our quarterly results, many of which are outside our control and may be difficult to predict, include:
•fluctuations in demand, sales cycles and prices for products and services, including discounts given in response to competitive pricing pressures or to secure long-term customer relationships, as well as the timing of purchases by our key customers;
•changes in customers’ budgets for optical transport network purchases and changes or variability in their purchasing cycles;
•the price, quality and timing of delivery of key components from suppliers, including any price or shipping cost increases or delays in the supply of components that may result from the effects of the COVID-19 pandemic, as well as impacts due to consolidations amongst our suppliers;
•fluctuations in our customer, product or geographic mix, including the impact of new customer deployments, which typically carry lower gross margins, customer consolidation, which may affect our ability to grow revenue, and products powered by our next-generation technologies, which initially tend to be lower margin due to higher per unit production costs and greater variability in production yields;
•the timing, market acceptance and rate of adoption of our new product releases and our competitors' new product releases;
•our ability to manage manufacturing costs, maintain or improve quality, and increase volumes and yields on products manufactured in our internal manufacturing facilities, each of which has been impacted by the effects of the COVID-19 pandemic;
•our ability to successfully restructure or transform our operations within our anticipated time frame and realize our anticipated savings;
•order cancellations, reductions or delays in delivery schedules by our customers;
•our ability to control costs, including our operating expenses and the costs and availability of components we purchase for our products;
•any significant changes in the competitive dynamics of the markets we serve, including any new entrants, new technologies, or customer or competitor consolidation, as well as aggressive pricing tactics by our competitors;
•our ability to manage inventory while timely meeting customer demand and avoiding charges for excess or obsolete inventory;
•readiness of customer sites for installation of our products as well as the availability of third-party service partners to provide contract engineering and installation services for us, each of which has been impacted by the effects of the COVID-19 pandemic;
•any delay in collecting or failure to collect accounts receivable;
•the timing of revenue recognition and revenue deferrals;
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•any future changes in U.S. GAAP or new interpretations of existing accounting rules;
•the impact of a significant natural disaster, as well as interruptions or shortages in the supply of utilities such as water and electricity, in a key location such as our Northern California facilities, which are located near major earthquake fault lines, in areas of high fire risk and in a designated flood zone; and
•general economic and political conditions in domestic and international markets, including those related to any policy changes by the federal government and/or by the presidential administration in the United States, and other factors beyond our control, including the ongoing effects of the COVID-19 pandemic and related response measures.
Supply chain issues, including delays, shortages and increased costs, and our dependency on sole source, limited source or high-cost suppliers could harm our business and operating results.
We are reliant on our global supply chain for the production of components for our products. The global supply chain has experienced disruptions that began in 2020 as a result of the COVID-19 pandemic, leading to delays, shortages and increased costs. Beginning with the fourth quarter of fiscal 2020 and accelerating in the first quarter of fiscal 2021, these disruptions have continued to negatively impact our revenue and our results of operations through the third quarter of fiscal 2021. For example, shortages of certain key components have adversely affected our ability to deliver products to customers in a timely manner, and price increases by our suppliers have negatively affected our gross margin. The global supply chain for components for our products, especially for semiconductor components, continues to experience shortages, longer lead times and increased costs. These shortages, delays and increased costs are expected to continue for the remainder of 2021 and into 2022. We cannot predict with certainty the scope or magnitude of the impact that these supply chain disruptions will have on our business and results of operations. Any efforts that we make to mitigate supply chain issues, such as by making additional purchase commitments over a longer time period with our suppliers or by holding higher levels of inventory, could negatively impact our financial results if we do not accurately forecast customer demand. Further, the lead times required for these mitigation efforts may not allow us to meet increased customer demand in a timely manner.
We currently purchase several key components for our products from sole or limited sources. In particular, we rely on our own production of certain components of our products, such as PICs, and on third parties, including sole source and limited source suppliers, for certain of the components of our products, including ASICs, field-programmable gate arrays, processors, and other semiconductor and optical components. We have increased our reliance on third parties to develop and manufacture components for certain products, some of which require custom development. We purchase most of these components on a purchase order basis and generally only have long-term contracts with these sole source or limited source suppliers. If any of our sole source or limited source suppliers suffer from capacity constraints, lower than expected yields, deployment delays, work stoppages or any other reduction or disruption in output, they may be unable to meet our delivery schedule, which could result in lost revenue, additional product costs and deployment delays that could harm our business and customer relationships. In addition, these same suppliers may decide to no longer manufacture or support specific components necessary for some of our legacy products, which could lead to our inability to fulfill demand without increased engineering and material costs necessary to replace such components. Further, our suppliers could enter into exclusive arrangements with our competitors, refuse to sell their products or components to us at commercially reasonable prices or at all, go out of business or discontinue their relationships with us. We may be unable to develop alternative sources for these components within a suitable time frame to be able to operate our business, or at all.
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The loss of a source of supply, or lack of sufficient availability of key components, could require us to redesign products that use such components, which could result in lost revenue, additional product costs and deployment delays that could harm our business and customer relationships. Due to cross dependencies, any supply chain disruptions could negatively impact the demand for our products in the short term. In addition, if our contract manufacturers do not receive critical components in a timely manner to build our products, then we would not be able to ship certain products in a timely manner and would, therefore, be unable to meet our prospective customers’ product delivery requirements. In the past, we have experienced delivery delays because of lack of availability of components or reliability issues with components that we were purchasing. In addition, some of our suppliers have gone out of business, merged with another supplier, or limited their supply of components to us, which may cause us to experience longer than normal lead times, supply delays and increased prices. We may in the future experience a shortage of certain components as a result of our own manufacturing issues, manufacturing issues at our suppliers or contract manufacturers, capacity problems experienced by our suppliers or contract manufacturers, strong demand in the industry for such components, or other disruptions in our supply chain. In addition, disruptions to global macroeconomic conditions may create pressure on us and our suppliers to accurately project overall component demand and manufacturing capacity. These supplier disruptions may continue to occur in the future, which could limit our ability to produce our products and cause us to fail to meet a customer’s delivery requirements. Any failure to meet our customers’ product delivery requirements could harm our reputation and our customer relationships, either of which would harm our business and operating results.
Any delays in the development, introduction or acceptance of our new products or in releasing enhancements to our existing products may harm our business.
Our products are based on complex technologies, including, in many cases, the development of next-generation PICs, DSPs and specialized application-specific integrated circuits (“ASICs”), each of which are key components of our optical engines. In addition, we may also depend on technologies from outside suppliers, all of which may cause us to experience unanticipated delays in developing, improving, manufacturing or deploying our products. The development process for our optical engines is lengthy, and any modifications entail significant development cost and risks.
At any given time, various new product introductions and enhancements to our existing products are in the development phase and are not yet ready for commercial manufacturing or deployment. We rely on third parties, some of which are relatively early stage companies, to develop, manufacture and deliver components for our next-generation products, which can often require custom development. The development process from laboratory prototype to customer trials, and subsequently to general availability, involves a significant number of simultaneous efforts. These efforts often must be completed in a timely and coordinated manner so that they may be incorporated into the product development cycle for our systems, and include:
•completion of product development, including the development and completion of our next-generation optical engines, and the completion of associated module development;
•the qualification and multiple sourcing of critical components;
•validation of manufacturing methods and processes;
•extensive quality assurance and reliability testing and staffing of testing infrastructure;
•validation of software; and
•establishment of systems integration and systems test validation requirements.
Each of these steps, in turn, presents risks of failure, rework or delay, any one of which could decrease the speed and scope of product introduction and marketplace acceptance of our products. New generations of our optical engines as well as intensive software testing are important to the timely introduction of new products and enhancements to our existing products, which are subject to these development risks. In addition, unexpected intellectual property disputes, failure of critical design elements, limited or constrained engineering resources, and a host of other development execution risks may delay, or even prevent, the introduction of new products or enhancements to our existing products. For example, sustained restrictions on the ability of our engineers to work in our offices and laboratories as a result of COVID-19-related restrictions imposed by governments, or us, has made and could continue to make it more difficult for our engineers to collaborate as effectively as desired in the development of new products, which could affect development schedules. If we do not develop and successfully introduce or enhance products in a timely manner, including the successful development of our next generation optical engine, our competitive position will suffer.
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As we transition customers to new products, we face significant risk that our new products may not be accepted by our current or new customers. To the extent that we fail to introduce new and innovative products that are adopted by customers, we could fail to obtain an adequate return on these investments and could lose market share to our competitors, which could be difficult or impossible to regain. Similarly, we may face decreased revenue, gross margins and profitability due to a rapid decline in sales of current products as customers hold spending to focus purchases on new product platforms. We could incur significant costs in completing the transition, including costs of inventory write-downs of the current product as customers transition to new product platforms. In addition, products or technologies developed by others may render our products noncompetitive or obsolete and result in significant reduction in orders from our customers and the loss of existing and prospective customers.
Our ability to increase our revenue will depend upon continued growth of demand by consumers and businesses for additional network capacity and on the level and timing of capital spending by our customers.
Our future success depends on factors that increase the amount of data transmitted over communications networks and the growth of optical transport networks to meet the increased demand for optical capacity. These factors include the growth of mobile, video and cloud-based services, increased broadband connectivity and the continuing adoption of high-capacity, revenue-generating services. If demand for such bandwidth does not continue, or slows down, the market for optical transport networking equipment may not continue to grow and our product sales would be negatively impacted.
In addition, demand for our products depends on the level and timing of capital spending in optical networks by service providers as they construct, expand and upgrade the capacity of their optical networks. Capital spending is cyclical in our industry and spending by customers can change on short notice. Any future decisions by our customers to reduce capital spending, whether caused by lower customer demand, weakening economic conditions as has been precipitated by the effects of the COVID-19 pandemic, changes in government regulations relating to telecommunications and data networks, customer or other reasons, could have a material adverse effect on our business, financial condition and results of operations.
Aggressive business tactics by our competitors may harm our business.
The markets in which we compete are extremely competitive and this often results in aggressive business tactics by our competitors, including:
•aggressively pricing their optical transport products and other portfolio products, including offering significant one-time discounts and guaranteed future price decreases;
•offering optical products at a substantial discount or for free when bundled together with broader technology purchases, such as router or wireless equipment purchases;
•providing financing, marketing and advertising assistance to customers; and
•influencing customer requirements to emphasize different product capabilities, which better suit their products.
The level of competition and pricing pressure tend to increase when competing for larger high-profile opportunities or during periods of economic weakness when there are fewer network build-out projects. If we fail to compete successfully against our current and future competitors, or if our current or future competitors continue or expand their aggressive business tactics, including those described above, demand for our products could decline, we could experience delays or cancellations of customer orders, and/or we could be required to reduce our prices to compete in the market.
The markets in which we compete are highly competitive and we may not be able to compete effectively.
Competition in the packet-optical equipment market is intense. Our main competitors include WDM system suppliers, such as ADVA Optical Networking, Ciena Corporation, Cisco Systems, Ribbon Communications Inc., Huawei Technologies Co., Ltd., Nokia and ZTE. In addition, there are several other companies that offer one or more products that partially compete with our offerings.
Competition in the markets we serve is based on any one or a combination of the following factors:
•price and other commercial terms;
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•functionality and optical performance;
•existing business and customer relationships;
•the ability of products and services to meet customers’ immediate and future network requirements;
•power consumption;
•heat dissipation;
•form factor or density;
•installation and operational simplicity;
•quality and reliability;
•service and support;
•security and encryption requirements;
•scalability and investment protection; and
•product lead times.
In addition to our current competitors, other companies have, or may in the future develop, products that are or could be competitive with our products. We also could encounter competitor consolidation in the markets in which we compete, which could lead to a changing competitive landscape, capabilities and market share, and could impact our results of operations. For example, in March 2021, Cisco completed its acquisition of optical communications supplier Acacia Communications.
Some of our competitors have substantially greater name recognition and technical, financial and marketing resources. Many of our competitors have more resources and more experience in developing or acquiring new products and technologies, and in creating market awareness for those products and technologies. In addition, many of our competitors have the financial resources to offer competitive products at aggressive pricing levels and/or have the ability to provide financing to customers, which could prevent us from competing effectively. Further, many of our competitors have built long-standing relationships with some of our prospective and existing customers and could, therefore, have an inherent advantage in selling products to those customers.
We also compete with low-cost producers that may increase pricing pressure on us and with a number of smaller companies that provide competition for a specific product, customer segment or geographic market. In addition, we may also face increased competition from system and component companies that develop products based on off-the-shelf hardware that offers the latest commercially available technologies. Due to the narrower focus of their efforts, these competitors may achieve commercial availability of their products more quickly than we can and may provide attractive alternatives to our customers.
The effects of the COVID-19 pandemic could have a material adverse effect on our business and results of operations.
The COVID-19 pandemic has caused disruptions to our business and operations to date and could have a material adverse effect on our business and results of operations in the future. The COVID-19 global pandemic has adversely affected the economies of many countries and has resulted in significant governmental measures to control the spread of COVID-19, including, among others, restrictions on travel, business operations and the movement of people in many regions of the world in which we operate, and the imposition of shelter-in-place or similarly restrictive work-from-home orders impacting many of our offices and employees, including those located in the United States.
As a result of these governmental measures and pursuant to recommended safety guidelines, we have temporarily closed or substantially limited the presence of personnel in our offices in several impacted locations, implemented travel restrictions and withdrawn from various industry events. Our work-from-home policy has at times contributed to delays in certain operational processes, including our routine quarterly financial statement close process in the first quarter of 2020, and may have an impact on our operational processes in the future. We have experienced disruption and delays in our global supply chain and manufacturing operations, logistics operations and customer support operations, including shipping delays, higher transport costs, and certain limitations on our ability
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to access customer fulfillment and service sites. We are dependent on sole source and limited source suppliers for several key components, and we have experienced capacity issues, longer lead times, increased costs and shortages with certain component suppliers, including for semiconductors, impacting our operational processes and results of operations. During fiscal 2020 and the first quarter of fiscal 2021, we experienced disruptions in customer demand due to delays in the customer certification process resulting from customer facility closures or access restrictions. Some of these disruptions negatively impacted our revenue and our results of operations.
The impact of the COVID-19 pandemic on our business and results of operations during the remainder of fiscal 2021 and into fiscal 2022 remains uncertain and is dependent in part on future vaccination and infection rates, the emergence of new strains of the virus, the continued effectiveness and availability of vaccinations, and broader global macroeconomic developments. We may face further disruptions or restrictions on our ability to source, manufacture or distribute our products due to existing or additional governmental restrictions in multiple countries on business operations and movement of people and products. If we experience pronounced disruptions in our operations or in our ability to service our customers, including due to COVID-19 infections or quarantines among our employees and service providers, or if we face curtailed customer demand, these factors may materially adversely impact our business and results of operations. We could also face negative impacts on our liquidity and capital resources during the remainder of fiscal 2021 and during fiscal 2022 due to the effects of the COVID-19 pandemic and its impacts on our customers, third-party service providers and capital markets.
Product performance problems, including undetected errors in our hardware or software, or deployment delays could harm our business and reputation.
The development and production of products with high technology content is complicated and often involves problems with hardware, software, components and manufacturing methods. Complex hardware and software systems, such as our products, can often contain undetected errors or bugs when first introduced or as new versions are released. In addition, errors associated with components we purchase from third parties, including customized components, may be difficult to resolve. We have experienced issues in the past in connection with our products, including failures due to the receipt of faulty components from our suppliers and performance issues related to software updates. From time to time we have had to replace certain components or provide software remedies or other remediation in response to errors or bugs, and we may have to do so again in the future. In addition, performance issues can be heightened during periods where we are developing and introducing multiple new products to the market, as any performance issues we encounter in one technology or product could impact the performance or timing of delivery of other products. Our products may also suffer degradation of performance and reliability over time.
If reliability, quality, security or network monitoring problems develop, a number of negative effects on our business could result, including:
•reduced orders from existing customers;
•declining interest from potential customers;
•delays in our ability to recognize revenue or in collecting accounts receivables;
•costs associated with fixing hardware or software defects or replacing products;
•high service and warranty expenses;
•delays in shipments;
•high inventory excess and obsolescence expense;
•high levels of product returns;
•diversion of our engineering personnel from our product development efforts; and
•payment of liquidated damages, performance guarantees or similar penalties.
Because we outsource the manufacturing of certain components of our products, we may also be subject to product performance problems as a result of the acts or omissions of third parties, and we may not have adequate compensating remedies against such third parties.
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From time to time, we encounter interruptions or delays in the activation of our products at a customer’s site. These interruptions or delays may result from product performance problems or from issues with installation and activation, some of which are outside our control. If we experience significant interruptions or delays that we cannot promptly resolve, the associated revenue for these installations may be delayed or confidence in our products could be undermined, which could cause us to lose customers, fail to add new customers, and consequently harm our financial results.
If we lose key personnel or fail to attract and retain additional qualified personnel when needed, our business may be harmed.
Our success depends to a significant degree upon the continued contributions of our key management, engineering, sales and marketing, and finance personnel, many of whom would be difficult to replace. For example, senior members of our engineering team have unique technical experience that would be difficult to replace. Because our products are complex, we must hire and retain highly trained customer service and support personnel to ensure that the deployment of our products does not result in network disruption for our customers. We believe our future success will depend in large part upon our ability to identify, attract and retain highly skilled personnel, and competition for these individuals is intense in our industry, especially in the San Francisco Bay Area where we are headquartered and, increasingly, in certain cities and regions where we have operations outside the United States as well. In addition, we may not succeed in identifying, attracting and retaining appropriate personnel. The loss of the services of any of our key personnel, the inability to identify, attract or retain qualified personnel in the future or delays in hiring qualified personnel, particularly engineers and sales personnel, could make it difficult for us to manage our business and meet key objectives, such as timely product introductions. These risks may be exacerbated due to labor market changes resulting from the COVID-19 pandemic. In addition, we do not have long-term employment contracts or key person life insurance covering any of our key personnel. If we are unable to attract and retain qualified personnel, we may be unable to manage our business effectively, and our results of operations could suffer.
We are dependent on a small number of key customers for a significant portion of our revenue from period to period and the loss of, or a significant reduction in, orders from one or more of our key customers would reduce our revenue and harm our operating results.
A relatively small number of customers accounts for a large percentage of our revenue from period to period. For example, for the quarter ended September 25, 2021, our top ten customers accounted for approximately 45% of our total revenue. For fiscal 2020, our top ten customers accounted for approximately 43% of our total revenue. For fiscal 2019, our top ten customers accounted for approximately 46% of our total revenue. Our business will likely be harmed if any of our key customers, for whatever reason, substantially reduce, delay or stop their orders from us. In addition, our business will be harmed if we fail to maintain our competitive advantage with our key customers or do not add new larger customers over time. We continue to expect a relatively small number of customers to continue to account for a large percentage of revenue from period to period. However, customer consolidation could reduce the number of key customers that generate a significant percentage of our revenue and may increase the risks relating to dependence on a small number of customers.
Our ability to continue to generate revenue from our key customers will depend on our ability to maintain strong relationships with these customers and introduce competitive new products at competitive prices. In most cases, our sales are made to these customers pursuant to standard purchase agreements, which may be canceled or reduced readily, rather than long-term purchase commitments that would require these customers to purchase any minimum or guaranteed volumes orders. In the event of a cancellation or reduction of an order, we may not have enough time to reduce operating expenses to minimize the effect of the lost revenue on our business. Our operating results will continue to depend on our ability to sell our products to our key customers. In addition, we must regularly compete for and win business with existing and new customers across all of our customer segments.
In addition, the negative effects of the COVID-19 pandemic on global economic conditions may affect the network spending, procurement strategies, or business practices of our key customers. If any of our key customers experience a loss in revenue due to the impact of the COVID-19 pandemic on their consumer or enterprise customers, they may reduce or delay capital spending generally or with respect to our products, which could materially adversely affect our business and results of operations.
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The manufacturing process for our optical engine and the assembly of our finished products are very complex. The partial or complete loss of any of our manufacturing facilities, a reduction in yields of our PICs or an inability to scale capacity to meet customer demands could harm our business.
The manufacturing process for our optical engine, including the PICs, DSPs and specialized ASICs, and the assembly of our finished products are very complex. In the event that any of our manufacturing facilities utilized to build these components and assemble our finished products were fully or partially destroyed, or shut down, as a result of a natural disaster, work stoppage or otherwise, it could severely limit our ability to sell our products. Because of the complex nature of our manufacturing facilities, such loss would take a considerable amount of time to repair or replace. The partial or complete loss of any of our manufacturing facilities, or an event causing the interruption in our use of any such facilities, whether as a result of a natural disaster, like the COVID-19 pandemic, work stoppage or otherwise, for any extended period of time would cause our business, financial condition and results of operations to be harmed.
Minor deviations in the PIC manufacturing process can cause substantial decreases in yields and, in some cases, cause production to be suspended. In the past, we have had significant variances in our PIC yields, including production interruptions and suspensions and may have continued yield variances, including additional interruptions or suspensions in the future. Lower than expected yields from our PIC manufacturing process or defects, integration issues or other performance problems in our products could limit our ability to satisfy customer demand requirements, and could damage customer relations and cause business reputation problems, harming our business and operating results.
Our inability to obtain sufficient manufacturing capacity to meet demand, either in our own facilities or through foundry or similar arrangements with third parties, could harm our relationships with our customers, our business and our results of operations.
Increased consolidation among our customers and suppliers in the communications networking industry has had, and could continue to have, an adverse effect on our business and results of operations.
We have seen increased consolidation in the communications networking industry over the past few years, which has adversely affected our business and results of operations. For example, several of our customers have consolidated in the past. During 2016, Charter Communications acquired Time Warner Cable, Inc. and Altice acquired Cablevision. During 2017, Verizon acquired XO Communications and CenturyLink acquired Level 3 Communications. Customer consolidation has led to changes in buying patterns, slowdowns in spending, redeployment of existing equipment and re-architecture of parts of existing networks or future networks, as the combined companies evaluate the needs of the combined business. Moreover, the significant purchasing power of these large companies can increase pricing and competitive pressures for us, including the potential for decreases in our average selling prices. If one of our customers is acquired by another company that does not rely on us to provide it with products or relies on another provider of similar products, we may lose that customer’s business. Such consolidation may further reduce the number of customers that generate a significant percentage of our revenue and may exacerbate the risks relating to dependence on a small number of customers. Any of the foregoing results will adversely affect our business, financial condition and results of operations.
In addition, our suppliers in the communications networking industry have recently continued to consolidate. For example, Lumentum acquired Oclaro in 2018 and II-VI acquired Finisar in 2019. In June 2021, the stockholders of Coherent and II-VI approved a proposal for Coherent to be acquired by II-VI. Supplier consolidation may lead to increased prices of components for our products, deployment delays and/or a disruption in output. In addition, such consolidation may exacerbate the risks relating to our dependence on a small number of suppliers for certain components and materials that are required to manufacture our products.
Actions that we are taking to restructure our business to cut costs in order to align our operating structure with current opportunities may not be as effective as anticipated.
During 2020 and 2021, we have undertaken certain restructuring initiatives, including the 2020 Restructuring Plan and the recent restructuring of certain international research and development functions, in order to reduce expenses, reallocate resources to align more closely with our evolving business model, and improve operating efficiencies. These activities might not produce the full expense reduction, resource realignment and efficiency benefits we expect, which could harm our business. Further, any anticipated benefits from these restructuring initiatives may be realized later than expected or not at all, and the ongoing costs of implementing these measures may be greater than anticipated. In addition, as a result of these restructuring actions, our ability to
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execute on product development, address key market opportunities and/or meet customer demand could be materially and adversely affected.
We rely on various third-party service partners to help complement our global operations, and failure to adequately manage these relationships could adversely impact our financial results and relationships with customers.
We rely on a number of third-party service partners, both domestic and international, to complement our global operations. We rely upon these partners for certain installation, maintenance, logistics and support functions. In addition, as our customers increasingly seek to rely on vendors to perform additional services relating to the design, construction and operation of their networks, the scope of work performed by our service partners is likely to increase and may include areas where we have less experience providing or managing such services. We must successfully identify, assess, train and certify qualified service partners in order to ensure the proper installation, deployment and maintenance of our products. The vetting and certification of these partners can be costly and time-consuming, and certain partners may not have the same operational history, financial resources and scale as we have. Additionally, certain service partners may provide similar services for other companies, including our competitors. We may not be able to manage our relationships with our service partners effectively, and we cannot be certain that they will be able to deliver services in the manner or time required, that we will be able to maintain the continuity of their services, or that they will adhere to our approach to ethical business practices. Our service partners may also experience challenges in providing services to us as a result of the impact of the COVID-19 pandemic. We may also be exposed to a number of risks or challenges relating to the performance of our service partners, including:
•delays in recognizing revenue;
•liability for injuries to persons, damage to property or other claims relating to the actions or omissions of our service partners;
•our services revenue and gross margin may be adversely affected; and
•our relationships with customers could suffer.
If we do not effectively manage our relationships with third-party service partners, or if they fail to perform these services in the manner or time required, our financial results and relationships with our customers could be adversely affected.
If our contract manufacturers do not perform as we expect, our business may be harmed.
We rely on third-party contract manufacturers to perform a portion of the manufacturing of our products, and our future success will depend on our ability to have sufficient volumes of our products manufactured in a cost-effective and quality-controlled manner. We have engaged third parties to manufacture certain elements of our products at multiple contract manufacturing sites located around the world but do not have long-term agreements in place with some of our manufacturers and suppliers that will guarantee product availability, or the continuation of particular pricing or payment terms. We face a number of risks due to our dependence on contract manufacturers, including:
•reduced control over delivery schedules, particularly for international contract manufacturing sites;
•reliance on the quality assurance procedures of third parties;
•potential uncertainty regarding manufacturing yields and costs;
•potential lack of adequate capacity during periods of high demand;
•potential variability of pricing or payment terms due to agreement length;
•risks and uncertainties associated with the locations or countries where our products are manufactured, including potential manufacturing disruptions caused by social, geopolitical, environmental or health factors, including pandemics or widespread health epidemics, such as the COVID-19 pandemic;
•limited warranties on components;
•potential misappropriation of our intellectual property; and
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•potential manufacturing disruptions (including disruptions caused by geopolitical events, military actions, work stoppages, natural disasters or international health emergencies such as the COVID-19 pandemic).
Any of these risks could impair our ability to fulfill orders. Any delays by our contract manufacturers may cause us to be unable to meet the delivery requirements of our customers, which could decrease customer satisfaction and harm our product sales. In addition, if our contract manufacturers are unable or unwilling to continue manufacturing our products or components of our products in required volumes or our relationship with any of our contract manufacturers is discontinued for any reason, we would be required to identify and qualify alternative manufacturers, which could cause us to be unable to meet our supply requirements to our customers and result in the breach of our customer agreements. Qualifying a new contract manufacturer and commencing volume production is expensive and time-consuming. If we are required to change or qualify a new contract manufacturer, we could lose revenue and damage our customer relationships.
We must respond to rapid technological change and comply with evolving industry standards and requirements for our products to be successful.
The optical transport networking equipment market is characterized by rapid technological change, changes in customer requirements and evolving industry standards. We continually invest in research and development to sustain or enhance our existing products, but the introduction of new communications technologies and the emergence of new industry standards or requirements could render our products obsolete. Further, in developing our products, we have made, and will continue to make, assumptions with respect to which standards or requirements will be adopted by our customers and competitors. If the standards or requirements adopted by our prospective customers are different from those on which we have focused our efforts, market acceptance of our products would be reduced or delayed, and our business would be harmed.
We are continuing to invest a significant portion of our research and development efforts in the development of our next-generation products. We expect our competitors will continue to improve the performance of their existing products and introduce new products and technologies and to influence customers’ buying criteria so as to emphasize product capabilities that we do not, or may not, possess. To be competitive, we must anticipate future customer requirements and continue to invest significant resources in research and development, sales and marketing, and customer support. If we do not anticipate these future customer requirements and invest in the technologies necessary to enable us to have and to sell the appropriate solutions, it may limit our competitive position and future sales, which would have an adverse effect on our business and financial condition. We may not have sufficient resources to make these investments and we may not be able to make the technological advances necessary to be competitive.
If we fail to accurately forecast our manufacturing requirements or customer demand, we could incur additional costs, including inventory write-downs or equipment write-offs, which would adversely affect our business and results of operations.
We generate forecasts of future demand for our products several months prior to the scheduled delivery to our prospective customers. This requires us to make significant investments before we know if corresponding revenue will be recognized. Lead times for materials and components, including ASICs, that we need to order for the manufacture of our products vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time. In the past, we have experienced lengthened lead times for certain components, and we are currently seeing longer lead times with certain components due to industry-wide supply chain challenges, which makes forecasting more challenging. We may be required to purchase increased levels of such components to satisfy our delivery commitments to our customers as a result of longer lead times for components. In addition, we must manage our inventory to ensure we continue to meet our commitments as we introduce new products or make enhancements to our existing products.
If we overestimate market demand for our products and, as a result, increase our inventory in anticipation of customer orders that do not materialize, we will have excess inventory, which could result in increased risk of obsolescence and significant inventory write-downs. Furthermore, this will result in reduced production volumes and our fixed costs will be spread across fewer units, increasing our per unit costs. If we underestimate demand for our products, we will have inadequate inventory, which could slow down or interrupt the manufacturing of our products, cause delays in shipments and our ability to recognize revenue, and result in potential loss of customers to competitors. In addition, we may be unable to meet our supply commitments to customers, which could result in a loss of certain customer opportunities or a breach of our customer agreements.
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Our large customers have substantial negotiating leverage, which may cause us to agree to terms and conditions that result in lower average selling prices and potentially increased cost of sales leading to lower gross margin, each of which would harm our results of operations.
Many of our customers are large service providers and ICPs that have substantial purchasing power and leverage in negotiating contractual arrangements with us. In addition, customer consolidation in the past few years has created combined companies that are even larger and have greater negotiating leverage. Our customers have sought and may continue to seek advantageous pricing, payment and other commercial terms. We have agreed and may continue to agree to unfavorable commercial terms with these customers, including the potential of reducing the average selling price of our products, increasing cost of sales or agreeing to extended payment terms in response to these commercial requirements or competitive pricing pressures. To maintain acceptable operating results, we will need to comply with these commercial terms, develop and introduce new products and product enhancements on a timely basis, and continue to reduce our costs.
Our sales cycle can be long and unpredictable, which could result in an unexpected revenue shortfall in any given quarter.
Our products can have a lengthy sales cycle, which can extend from six to twelve months and may take even longer for larger prospective customers. Our prospective customers conduct significant evaluation, testing, implementation and acceptance procedures before they purchase our products. We incur substantial sales and marketing expenses and expend significant management effort during this time, regardless of whether we make a sale. We have seen a lengthening of our sales cycle as a result of the COVID-19 pandemic, due to delays in the customer certification process for our products resulting from customer facility closures or access restrictions.
Because the purchase of our equipment involves substantial cost, most of our customers wait to purchase our equipment until they are ready to deploy it in their network. As a result, it is difficult for us to accurately predict the timing of future purchases by our customers. In addition, product purchases are often subject to budget constraints, multiple approvals and unplanned administrative processing and other delays, including the need for the customer to obtain external financing. If sales expected from customers for a particular quarter are not realized in that quarter or at all, our revenue will be negatively impacted.
Any acquisitions or strategic transaction that we undertake could disrupt our business and harm our financial condition and results of operations.
We have made strategic acquisitions of businesses, technologies and other assets in the past, including most recently the Acquisition. We may engage in acquisitions, divestitures or other strategic transactions in the future. In order to undertake certain of these transactions, we may use cash, issue equity that could dilute our current stockholders, or incur debt or assume indebtedness. If we are unable to achieve the anticipated efficiencies and strategic benefits of such transactions, it could adversely affect our business, financial condition and results of operations. In addition, the market price of our common stock could be adversely affected if investors and securities analysts react unfavorably to a strategic transaction or if the integration or the anticipated financial and strategic benefits of such transactions are not realized as rapidly as or to the extent anticipated by investors and securities analysts.
Acquisitions, divestitures or other strategic transactions can also result in adverse tax consequences, warranty or product liability exposure related to acquired assets, additional stock-based compensation expense, and write-up of acquired inventory to fair value. Divestitures can also result in contractual, employment or intellectual property liability related to divested assets. In addition, we may record goodwill and other purchased intangible assets in connection with an acquisition and incur impairment charges in the future. If our actual results, or the plans and estimates used in future impairment analyses, are less favorable than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.
Acquisitions, divestitures or other strategic transactions also involve numerous risks that could disrupt our ongoing business and distract our management team, including:
•problems integrating the acquired operations, technologies or products with our own;
•challenges in divesting assets and intellectual property without negatively affecting our retained business lines;
•diversion of management’s attention from our core business;
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•adverse effects on existing business relationships with suppliers and customers;
•risks associated with entering new markets or exiting existing markets; and
•loss of key employees.
Our failure to adequately manage the risks associated with an acquisition, divestment or strategic transaction could have an adverse effect on our business, financial condition and results of operations.
Financial and Macroeconomic Risk Factors
We may be unable to generate the cash flow necessary to make anticipated capital expenditures, service our debt or grow our business.
We may not be able to generate sufficient cash flow from operations to make anticipated capital expenditures, to enable us to service our debt or grow our business. For example, in each of the fiscal years since the completion of the Acquisition, we have had a net loss and negative cash flows from operations and we may continue to incur losses and negative cash flows from operations in the future periods. Our ability to pay our expenses, service our debt and fund planned capital expenditures will depend on our future performance, which will be affected by general economic, competitive, legislative, political, regulatory, public health issues and other factors beyond our control, and our ability to continue to realize synergies and anticipated cost savings. If we are unable to generate sufficient cash flow from operations to service our debt or to make anticipated capital expenditures, we may be required to sell assets, reduce capital expenditures, borrow additional funds or evaluate alternatives for efficiently funding our capital expenditures and ongoing operations, including the issuance of equity, equity-linked and debt securities.
Unfavorable macroeconomic and market conditions may adversely affect our industry, business and financial results.
In the past, unfavorable macroeconomic and market conditions have resulted in sustained periods of decreased demand for optical communications products. The effects of the COVID-19 pandemic have negatively affected the economies of many countries and have created significant uncertainty regarding global macroeconomic conditions. The COVID-19 pandemic has also led to increased disruption and volatility in capital markets and credit markets. These conditions may also result in the tightening of credit markets, which could limit or delay our customers’ ability to obtain necessary financing for their purchases of our products. A lack of liquidity in the capital markets, the continued uncertainty in the global economic environment or inflationary concerns may cause our customers to delay or cancel their purchases, or increase the time they take to pay or default on their payment obligations, each of which would negatively affect our business and operating results. Weakness and uncertainty in the global economy could cause some of our customers to become illiquid, delay payments or adversely affect our collection of their accounts, which could result in a higher level of bad debt expense. In addition, currency fluctuations could negatively affect our international customers’ ability or desire to purchase our products.
Challenging economic conditions have from time to time contributed to slowdowns in the telecommunications industry in which we operate. Such slowdowns may result in:
•reduced demand for our products as a result of constraints on capital spending by our customers;
•increased price competition for our products, not only from our competitors, but also as a result of our customer’s or potential customer’s utilization of inventoried or underutilized products, which could put additional downward pressure on our near-term gross profits;
•risk of excess or obsolete inventories;
•our customers facing financial difficulties, including bankruptcy;
•excess manufacturing capacity and higher associated overhead costs as a percentage of revenue; and
•more limited ability to accurately forecast our business and future financial performance.
A lack of liquidity and economic uncertainty may adversely affect our suppliers or the terms on which we purchase products from these suppliers. It may also cause some of our suppliers to become illiquid. Any of these impacts could limit our ability to obtain components for our products from these suppliers and could adversely impact our supply chain or the delivery schedule to our customers. This also could require us to purchase more
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expensive components, or re-design our products, which could cause increases in the cost of our products and delays in the manufacturing and delivery of our products. Such events could harm our gross margin and harm our reputation and our customer relationships, either of which could harm our business and operating results.
If we need additional capital in the future, it may not be available to us on favorable terms, or at all.
Our business requires significant capital. We have historically relied on outside debt or equity financing as well as cash flow from operations to fund our operations, capital expenditures and expansion. For example, in September 2018, we issued convertible senior notes due September 1, 2024 (the “2024 Notes”) to pay the cost of related capped call transactions, as discussed below, to fund the cash portion of the purchase price of the Acquisition, and for general corporate purposes. In August 2019 and as amended in December 2019, we entered into the Amended Credit Agreement with Wells Fargo Bank and BMO Harris Bank N.A. to provide additional working capital flexibility to manage our business, utilizing the Credit Facility. In addition, in March 2020 we issued convertible senior notes due March 1, 2027 (the “2027 Notes” and, together with the 2024 Notes, the “Notes”) to raise additional funds for general corporate purposes, including working capital to fund growth and potential strategic projects. For additional risks related to the Notes, please see “Common Stock and Indebtedness Risk Factors” below. In August 2020, we entered into the Sales Agreement with Jefferies LLC ("Jefferies") under which we issued and sold through Jefferies, acting as agent and/or principal, shares of our common stock having an aggregate offering price of $96.3 million, to raise funds for general corporate purposes, including working capital and capital expenditures. We may require additional capital from equity or equity-linked financing, debt financing or other financings in the future to fund our operations, respond to competitive pressures or strategic opportunities or to refinance our existing debt obligations. In the event that we require additional capital, we may not be able to secure timely additional financing on favorable terms, or at all, and may be affected by the impacts of the COVID-19 pandemic on capital markets. The terms of any additional financing may place limits on our financial and operating flexibility. If we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer dilution in their percentage ownership of our company, and any new securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us, if and when we require it, our ability to grow or support our business and to respond to business challenges could be limited and our business will be harmed.
Our international sales and operations subject us to additional risks that may harm our operating results.
Sales of our products into international markets continue to be an important part of our business. During fiscal 2020, fiscal 2019 and fiscal 2018, we derived approximately 54%, 52% and 49%, respectively, of our revenue from customers outside of the United States. We expect that significant management attention and financial resources will be required for our international activities over the foreseeable future as we continue to operate in international markets. In some countries, our success in selling our products and growing revenue will depend in part on our ability to form relationships with local partners. Our inability to identify appropriate partners or reach mutually satisfactory arrangements for international sales of our products could impact our ability to maintain or increase international market demand for our products. In addition, many of the companies we compete against internationally have greater name recognition and a more substantial sales and marketing presence.
We have sales and support personnel in the Americas, EMEA (with offices in the Middle East) and APAC (including China). In addition, we have established development centers in Canada, China, Finland, Germany, India, Portugal and Sweden. There is no assurance that our reliance upon development resources in international locations will enable us to achieve meaningful cost reductions or greater resource efficiency.
As a result of having global operations, the sudden disruption of the supply chain and/or the manufacture of our customer’s components caused by events outside of our control could impact our results of operations by impairing our ability to timely and efficiently deliver our products or provide installation and maintenance services to our customers. For example, the global COVID-19 pandemic has disrupted and is expected to continue to disrupt the global supply chain for certain components necessary for our products and could continue to threaten the health and safety of our employees.
Our international operations are subject to inherent risks, and our future results could be adversely affected by a variety of factors, many of which are outside of our control, including:
•greater difficulty in collecting accounts receivable and longer collection periods;
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•difficulties of managing and staffing international offices, and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;
•political, social and economic instability, including wars, terrorism, political unrest, boycotts, curtailment of trade and other business restrictions;
•tariff and trade barriers and other regulatory requirements, contractual limitations, or customer specifications impacting our ability to sell or develop our products in certain foreign markets;
•less effective protection of intellectual property than is afforded to us in the United States or other developed countries;
•potentially adverse tax consequences;
•natural disasters, acts of war or terrorism, and health crises, including the COVID-19 pandemic;
•changes to free trade agreements, trade protection measures, tariffs, export compliance, domestic preference procurement requirements, qualification to transact business and additional regulatory requirements, including changes related to policy and other changes made by the federal government or presidential administration in the United States; and
•effects of changes in currency exchange rates, particularly relative increases in the exchange rate of the U.S. dollar compared to other currencies that could negatively affect our financial results and cash flows.
International customers may also require that we comply with certain testing or customization of our products to conform to local standards. The product development costs to test or customize our products could be extensive and a material expense for us.
Our international operations are subject to increasingly complex foreign and U.S. laws and regulations, including but not limited to anti-corruption laws, such as the Foreign Corrupt Practices Act and the UK Bribery Act, antitrust or competition laws, anti-money laundering laws, various trade controls, national security related regulations, and data privacy laws, among others. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries, and could also materially affect our reputation, our international expansion efforts, our ability to attract and retain employees, our business, and our operating results. Although we have implemented policies, procedures and training designed to ensure compliance with these laws and regulations, there can be no complete assurance that any individual employee, contractor or agent will not violate our policies. Additionally, the costs of complying with these laws (including the costs of investigations, auditing and monitoring) could also adversely affect our current or future business.
As we continue to expand our business globally, our success will depend, in large part, on our ability to effectively anticipate and manage these and other risks and expenses associated with our international operations. For example, political instability and uncertainty in the European Union ("the E.U.") and, in particular, the United Kingdom's exit from the E.U., could slow economic growth in the region, affect foreign exchange rates, and could have a negative impact on near-term economic activity, leading to our customers delaying purchases of our products. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, adversely affecting our business, financial condition and results of operations.
Our effective tax rate may increase or fluctuate, which could increase our income tax expense and reduce our net income.
Our effective tax rate and the amount of our taxable income could be subject to volatility or adversely affected by several factors, many of which are outside of our control, including:
•changes in the valuation of our deferred tax assets and liabilities, and in deferred tax valuation allowances;
•changes in the relative proportions of revenue and income before taxes in the various jurisdictions in which we operate that have differing statutory tax rates;
•changing tax laws, regulations, rates and interpretations in multiple jurisdictions in which we operate;
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•changes to the financial accounting rules for income taxes;
•the tax effects of acquisitions; and
•the resolution of issues arising from tax audits.
For example, the Biden administration has proposed tax reform legislation to increase the U.S. corporate income tax rate, increase U.S. taxation of international business operations and impose a global minimum tax, which could result in increased marginal corporate tax rates. The global minimum tax is also supported by numerous countries and the Organization for Economic Cooperation and Development ("OECD"). Such countries, the OECD and other organizations are also actively considering changes to existing tax laws or have proposed or enacted new laws that could increase our tax obligations in countries where we do business or cause us to change the way we operate our business. Any changes in federal, state or international tax laws or tax rulings could adversely affect our effective tax rate and our results of operations.
We may be adversely affected by fluctuations in currency exchange rates.
A portion of our sales and expenses stem from countries outside of the United States, and are in currencies other than U.S. dollars, and therefore subject to foreign currency fluctuation. Accordingly, fluctuations in foreign currency rates could have a material impact on our financial results in future periods. We currently enter into foreign currency exchange forward contracts to reduce the impact of foreign currency fluctuations on certain non-functional currency account balances, and also to reduce the volatility of cash flows primarily related to forecasted foreign currency revenue and expenses. These forward contracts reduce the impact of currency exchange rate movements on certain transactions, but do not cover all foreign-denominated transactions and therefore do not entirely eliminate the impact of fluctuations in exchange rates on our results of operations and financial condition.
Our debt obligations may adversely affect our ability to raise additional capital and will be a burden on our future cash resources, particularly if we elect to settle these obligations in cash upon conversion or upon maturity or required repurchase.
As of September 25, 2021, the outstanding aggregate principal amount of the 2024 Notes and the 2027 Notes was $402.5 million and $200.0 million, respectively. The degree to which we are leveraged could have important consequences, including, but not limited to, the following:
•our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, litigation, general corporate or other purposes may be limited; and
•a substantial portion of our future cash balance may be dedicated to the payment of the principal of our indebtedness as we have stated the intention to pay the principal amount of each series Notes in cash upon conversion or when otherwise due, such that we would not have those funds available for use in our business.
Our ability to meet our payment obligations under our debt instruments, including the Notes, depends on our future cash flow performance. This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors, as well as other factors that may be beyond our control. There can be no assurance that our business will generate positive cash flow from operations, or that additional capital will be available to us, in an amount sufficient to enable us to meet our debt payment obligations and to fund other liquidity needs. If we are unable to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt, sell assets, reduce or delay capital investments, or seek to raise additional capital. If we are unable to implement one or more of these alternatives, we may be unable to meet our debt payment obligations. As a result, we may be more vulnerable to economic downturns, less able to withstand competitive pressures and less flexible in responding to changing business and economic conditions.
We may issue additional shares of our common stock in connection with conversions of the 2024 Notes, and thereby dilute our existing stockholders and potentially adversely affect the market price of our common stock.
In the event that some or all of each series of Notes are converted and we elect to deliver shares of common stock, the ownership interests of existing stockholders will be diluted, and any sales in the public market of any shares of our common stock issuable upon such conversion could adversely affect the prevailing market price of our common stock. In addition, the anticipated conversion of any series of Notes could depress the market price of our common stock.
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The fundamental change provisions of the 2024 Notes and the 2027 Notes may delay or prevent an otherwise beneficial takeover attempt of us.
If a fundamental change, such as an acquisition of our company, occurs prior to the maturity of the 2024 Notes or 2027 Notes, holders of the applicable series of Notes will have the right, at their option, to require us to repurchase all or a portion of their Notes of such series. In addition, if such fundamental change also constitutes a make-whole fundamental change, the conversion rate for the applicable series of Notes may be increased upon conversion of the such series of Notes in connection with such make-whole fundamental change. Any increase in the conversion rate will be determined based on the date on which the make-whole fundamental change occurs or becomes effective and the price paid (or deemed paid) per share of our common stock in such transaction. Any such increase will be dilutive to our existing stockholders. Our obligation to repurchase any series of Notes or increase the conversion rate upon the occurrence of a make-whole fundamental change may, in certain circumstances, delay or prevent a takeover of us that might otherwise be beneficial to our stockholders.
The Capped Calls may affect the value of the 2024 Notes and our common stock.
In connection with the issuance of the 2024 Notes, we entered into capped call transactions (the "Capped Calls") with certain financial institutions who are the option counterparties. The capped call transactions are expected generally to reduce or offset the potential dilution upon conversion of the 2024 Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted 2024 Notes, as the case may be, with such reduction and/or offset subject to a cap.
From time to time, the option counterparties or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the 2024 Notes. This activity could also cause or avoid an increase or a decrease in the market price of our common stock.
We are subject to counterparty risk with respect to the Capped Calls.
The option counterparties to the capped call transactions are financial institutions, and we will be subject to the risk that any or all of them might default under the capped call transactions. Our exposure to the credit risk of the counterparties will not be secured by any collateral. Past global economic conditions have resulted in the actual or perceived failure or financial difficulties of many financial institutions. If an option counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at the time under the capped call transactions with such option counterparty. Our exposure will depend on many factors but, generally, an increase in our exposure will be correlated to an increase in the market price and in the volatility of our common stock. In addition, upon a default by an option counterparty, we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We can provide no assurance as to the financial stability or viability of the option counterparties.
Legal and Regulatory Risk Factors
If we fail to protect our intellectual property rights, our competitive position could be harmed, or we could incur significant expense to enforce our rights.
We depend on our ability to protect our proprietary technology. We rely on a combination of methods to protect our intellectual property, including limiting access to certain information, and utilizing trade secret, patent, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection. The steps we have taken to protect our proprietary rights may be inadequate to preclude misappropriation or unauthorized disclosure of our proprietary information or infringement of our intellectual property rights, and our ability to police such misappropriation, unauthorized disclosure or infringement is uncertain, particularly in countries outside of the United States. This is likely to become an increasingly important issue if we expand our operations and product development into countries that provide a lower level of intellectual property protection. We do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims, and even if patents are issued, they may be contested, circumvented or invalidated. Moreover, the rights granted under any issued patents may not provide us with a competitive advantage, and, as with any technology, competitors may be able to develop similar or superior technologies to our own now or in the future.
Protecting against the unauthorized use of our products, trademarks and other proprietary rights is expensive, difficult, time consuming and, in some cases, impossible. Litigation may be necessary in the future to
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enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity or scope of the proprietary rights of others. Such litigation could result in substantial cost and diversion of management resources, either of which could harm our business, financial condition and results of operations. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.
Claims by others that we infringe on their intellectual property rights could harm our business.
Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. In particular, many leading companies in the optical transport networking industry, including our competitors, have extensive patent portfolios with respect to optical transport networking technology. In addition, non-practicing patent holding companies seek to monetize patents they have purchased or otherwise obtained. We expect that infringement claims may increase as the number of products and competitors in our market increases and overlaps in technology implementation occur. From time to time, third parties may assert exclusive patent, copyright, trademark and other intellectual property rights to technologies and related standards that are important to our business or seek to invalidate the proprietary rights that we hold. Competitors or other third parties have asserted, and may continue to assert claims or initiate litigation or other proceedings against us or our manufacturers, suppliers or customers alleging infringement of their proprietary rights, or seeking to invalidate our proprietary rights, with respect to our products and technology. In addition, in the past we have had certain patent licenses with third parties that have not been renewed, and if we cannot successfully renew these licenses, we could face claims of infringement. In the event that we are unsuccessful in defending against any such claims, or any resulting lawsuits or proceedings, we could incur liability for damages and/or have valuable proprietary rights invalidated. For additional information regarding certain of the legal proceedings in which we are involved, see the heading “Legal Matters” in Note 13, Commitments and Contingencies, in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Any claim of infringement from a third party, even one without merit, could cause us to incur substantial costs defending against the claim, and could distract our management from running our business. Furthermore, a party making such a claim, if successful, could secure a judgment that requires us to pay substantial damages or could include an injunction or other court order that could prevent us from offering our products. In addition, we might be required to seek a license for the use of such intellectual property, which may not be available on commercially reasonable terms or at all. Alternatively, we may be required to develop non-infringing technology, which would require significant effort and expense and may ultimately not be successful. Any of these events could harm our business, financial condition and results of operations.
Competitors and other third parties have and may continue to assert infringement claims against our customers and sales partners. Any of these claims would require us to initiate or defend potentially protracted and costly litigation on their behalf, regardless of the merits of these claims, because we generally indemnify our customers and sales partners from claims of infringement of proprietary rights of third parties. If any of these claims succeed, we may be forced to pay damages on behalf of our customers or sales partners, which could have an adverse effect on our business, financial condition and results of operations.
We incorporate free and open source licensed software into our products. Although we monitor our use of such open source software closely, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In addition, non-compliance with open source software license terms and conditions could subject us to potential liability, including intellectual property infringement and/or contract claims. In such events, we may be required to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event re-engineering cannot be accomplished in a timely manner, any of which could adversely affect our business, financial condition and results of operations.
Security incidents, such as data breaches and cyber-attacks, could compromise our intellectual property and proprietary or confidential information and cause significant damage to our business and reputation.
In the ordinary course of our business, we maintain sensitive data on our networks, including data related to our intellectual property and data related to our business, customers and business partners, which is considered proprietary or confidential information. This sensitive data includes certain personal information and other data relating to our employees and others. We also utilize third-party service providers to host, transmit, or otherwise process data in connection with our business activities, including our supply chain processes, operations, and
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communications. Companies, especially in the technology industry, have been increasingly subject to a wide variety of security incidents, cyber-attacks and other attempts to gain unauthorized access, and we and our third-party service providers and suppliers have faced and may continue to face security threats and attacks from a variety of sources. In response to the COVID-19 pandemic, many of our employees are working from home and accessing our corporate network via remote devices, which may be less secure than those used in our offices and thus could increase the potential for such events to occur.
While the secure maintenance of this information is critical to our business and reputation, our network and storage applications, and those systems and other business applications maintained by our third-party providers, may be subject to unauthorized access by hackers or breached due to operator error, malfeasance or other system disruptions. It may be difficult to anticipate or immediately detect such security incidents or data breaches and the damage caused as a result. Accordingly, a data breach, security incident, cyber-attack, or any other unauthorized access or disclosure of our information or other information that we or our third-party vendors maintain could compromise our intellectual property, disrupt our operations, and result in loss of or unauthorized access to or acquisition of proprietary or confidential information. While we continually work to safeguard our internal network systems and validate the security of our third-party suppliers and providers to mitigate these potential risks, including through information security policies and employee awareness and training, there is no assurance that such actions will be sufficient to prevent cyber-attacks or security breaches, and we cannot guarantee that our systems and networks or our third-party service providers’ systems and networks have not been breached or that they or any components of our supply chain do not contain exploitable defects or bugs, including defects or bugs that could result in a breach of or disruption to our systems and networks or the systems and networks of third parties that support our operations. We and third-party service providers also may face difficulties or delays in identifying or responding to security breaches and other security-related incidents. We have been subjected in the past to a range of incidents including phishing, emails purporting to come from an executive or vendor seeking payment requests, malware and communications from look-alike corporate domains. While these have not had a material effect on our business or our network security to date, security incidents involving access or improper use of our systems, networks or products, or those of third-party service providers, could compromise confidential or otherwise protected information, destroy or corrupt data, or otherwise disrupt our operations. These security incidents could cause us to incur significant costs and expenses to remediate and otherwise respond to the incident, subject us to regulatory actions and investigations, disrupt key business operations, open us up to liability, and divert attention of management and key information technology resources, any of which could cause significant harm to our business and reputation. Even the perception of inadequate security may damage our reputation and negatively impact our business. Further, we could be required to expend significant capital and other resources to address any data security incident or breach and in an effort to prevent future security incidents and breaches.
Although we maintain insurance coverage that may cover certain liabilities in connection with some security breaches and other security incidents, we cannot be certain our insurance coverage will be adequate for liabilities actually incurred, including any consequential damages that may arise from such security incidents, that insurance will continue to be available to us on commercially reasonable terms (if at all) or that any insurer will not deny coverage as to any future claim. The successful assertion of one or more large claims against us that exceed available insurance coverage, the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, or denials of coverage could have a material adverse effect on our business, including our financial condition, results of operations and reputation.
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If we fail to maintain effective internal control over financial reporting in the future, the accuracy and timing of our financial reporting may be adversely affected.
We are required to comply with Section 404 of the Sarbanes-Oxley Act of 2002. The provisions of the act require, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. Preparing our financial statements involves a number of complex processes, many of which are done manually and are dependent upon individual data input or review. These processes include, but are not limited to, calculating revenue, deferred revenue and inventory costs. While we continue to automate our processes and put in place controls to reduce the likelihood for errors, we expect that for the foreseeable future many of our processes will remain manually intensive and thus subject to human error. If we are unable to implement effective key operation controls around financial processes and successfully manage and monitor manual processes, we may fail to prevent or detect material misstatements in our financial statements, in which case investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our securities may decline. In addition, prior to the Acquisition, we maintained separate internal controls over financial reporting with different financial reporting processes and different ERP systems, and Coriant, as a private company, was not required to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Any issues with our integrated ERP system may cause time delays and impact our ability to undertake financial reporting in a timely manner.
We are subject to governmental regulations that could adversely affect our business.
We are subject to governmental regulations that could adversely affect our business. This includes U.S. and foreign trade control laws that may limit where and to whom we are permitted to sell our products, as well as environmental rules and regulations or other social initiatives that impact how and where we manufacture our products. In particular, our manufacturing operations use substances that are regulated by various federal, state, local, foreign and international laws and regulations governing health, safety and the environment, including WEEE, RoHS and REACH regulations adopted by the European Union. From time to time, the European Union restricts or considers restricting certain substances under these Directives. For example, indium phosphide is currently being considered for restriction under RoHS. Any restriction of indium phosphide or any other substance integral to our systems could materially adversely affect our business, financial condition and operating results. In addition, if we experience a problem complying with these laws and regulations, it could cause an interruption or delay in our manufacturing operations or it could cause us to incur liabilities or costs related to health, safety or environmental remediation or compliance. We could also be subject to liability if we do not handle these substances in compliance with safety standards for handling, storage and transportation and applicable laws and regulations. If we experience a problem or fail to comply with such safety standards or laws and regulations, our business, financial condition and operating results may be harmed.
Changes in regulatory requirements or uncertainty associated with the regulatory environment could delay or impede investment in network infrastructures. The Federal Communications Commission (“FCC”) has jurisdiction over the entire U.S. communications industry and, as a result, our products and our U.S. customers are subject to FCC rules and regulations. In December 2017, the FCC voted to roll back its 2015 order regulating broadband internet service providers as telecommunications service carriers under Title II of the Telecommunications Act. This decision repeals net neutrality regulations that prohibit blocking, degrading, throttling or prioritizing certain types of internet traffic and restores the light touch regulatory treatment of broadband service in place prior to 2015. Similarly, changes in regulatory tariff requirements or other regulations relating to pricing or terms of carriage on communications networks could slow the development or expansion of network infrastructures and adversely affect our business, financial condition and results of operations.
In addition, international regulatory standards could impair our ability to develop products for international customers in the future. Moreover, many jurisdictions, including the United States, the EU and other regions, are evaluating or have implemented regulations relating to cybersecurity, privacy and data protection, which can affect the market and requirements for networking and communications equipment. For example, the General Data Protection Regulation (“GDPR”) has been in effect in the EU since May 2018, and similar regulatory standards are now in effect in the United Kingdom following its exit from the EU on December 31, 2020. These EU and UK laws impose stringent data handling requirements on companies that receive or process personal data of residents of the EU and the UK, respectively, and non-compliance could result in significant penalties, including data protection audits and heavy fines. Additionally, California has enacted the California Consumer Privacy Act (“CCPA”) which, among other things, requires covered companies to provide new disclosures to California consumers and afford such consumers new rights, including the right to opt-out of certain sales of personal information. Enforcement of the CCPA by the California Attorney General began on July 1, 2020. Additionally, a new privacy law, the California Privacy Rights Act (“CPRA”) was approved by California voters in the November 2020 election. The CPRA creates
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obligations relating to certain types of data beginning on January 1, 2022, with implementing regulations expected on or before July 1, 2022, and enforcement beginning July 1, 2023. The CPRA significantly modifies the CCPA, potentially resulting in further uncertainty and requiring us to incur additional costs and expenses in an effort to comply. We cannot fully predict the impact of the GDPR, the CCPA, the CPRA or other laws or regulations, including those enacted in the future, relating to cybersecurity, privacy or data protection on our business or operations, but these laws and regulations may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply. Any failure to obtain the required approvals or comply with such laws and regulations could result in claims, litigation, and regulatory proceedings. These could result in substantial costs, diversion of resources, fines, penalties, and other damages, and harm to our reputation. Any of these could harm our business, financial condition and results of operations.
We are subject to various governmental export control, trade sanctions, and import laws and regulations that could impair our ability to compete in international markets or subject us to liability if we violate these controls.
In some cases, our products are subject to U.S. and foreign export control laws and regulations, including the Export Administration Regulations administered by the U.S. Department of Commerce, and our activities may be subject to trade and economic sanctions, including those administered by the United States Department of the Treasury’s Office of Foreign Assets Control (collectively, “Trade Controls”). As such, a license may be required to export or re-export our products, or provide related services, to certain countries and end-users, and for certain end-uses. Further, our products incorporating encryption functionality may be subject to special controls applying to encryption items and/or certain reporting requirements.
We have procedures in place designed to ensure our compliance with Trade Controls, with which failure to comply could subject us to both civil and criminal penalties, including substantial fines, possible incarceration of responsible individuals for willful violations, possible loss of our export or import privileges, and reputational harm. Further, the process for obtaining necessary licenses may be time-consuming or unsuccessful, potentially causing delays in sales or losses of sales opportunities. Trade Controls are complex and dynamic regimes, and monitoring and ensuring compliance can be challenging, particularly given that our products are widely distributed throughout the world and are available for download without registration. Although we have no knowledge that our activities have resulted in violations of Trade Controls, any failure by us or our partners to comply with applicable laws and regulations would have negative consequences for us, including reputational harm, government investigations, and penalties.
In addition, various countries regulate the import of certain technologies and have enacted laws that could limit our ability to distribute our products and certain product features or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in U.S. and foreign import and export regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the import and export of our products to certain countries altogether. For example, in 2018 and 2019, the United States imposed tariffs on a large variety of products originating from China, including some on components that are supplied to us from China. Depending upon the duration and implementation of these and future tariffs, as well as our ability to mitigate their impact, these tariffs could materially affect our business, including in the form of increased cost of goods sold, increased pricing for customers, and reduced sales. At this time, it remains unclear what additional actions, if any, will be taken by the governments of the United States or China with respect to such trade and tariff matters. Any change in import and export regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies impacted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Failure to comply with these and similar laws on a timely basis, or at all, or any limitation on our ability to develop, export or sell our products would adversely affect our business, financial condition and results of operations.
A portion of our revenue is generated by sales to government entities, which are subject to a number of uncertainties, challenges, and risks.
We currently sell many of our solutions to various government entities, and we may in the future increase sales to government entities. Sales to government entities are subject to a number of risks. Selling to government entities can be highly competitive, expensive, and time consuming, often requiring significant upfront time and expense without any assurance that we will complete a sale. In the event that we are successful in being awarded a government contract, such award may be subject to appeals, disputes, or litigation, including, but not limited to, bid
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protests by unsuccessful bidders. Government demand and payment for our solutions may be impacted by public sector budgetary cycles and funding authorizations, with funding reductions or delays adversely affecting public sector demand for our solutions. Government entities may also have statutory, contractual, or other legal rights to terminate contracts for convenience or due to a default. For purchases by the U.S. federal government, the government may require certain products to be manufactured in the United States and other high cost manufacturing locations, and we may not manufacture all products in locations that meet government requirements, and as a result, our business and results of operations may suffer. Contracts with governmental entities may also include preferential pricing terms, including, but not limited to, “most favored customer” pricing.
Additionally, we may be required to obtain special certifications to sell some or all of our solutions to government or quasi-government entities. Such certification requirements for our solutions may change, thereby restricting our ability to sell into the federal government sector until we have attained the revised certification. If our products and subscriptions are late in achieving or fail to achieve compliance with these certifications and standards, or our competitors achieve compliance with these certifications and standards, we may be disqualified from selling our products to such governmental entities, or be at a competitive disadvantage, which would harm our business, financial condition and results of operations. There are no assurances that we will find the terms for obtaining such certifications to be acceptable or that we will be successful in obtaining or maintaining the certifications.
As a government contractor or subcontractor, we must comply with laws, regulations, and contractual provisions relating to the formation, administration, and performance of government contracts and inclusion on government contract vehicles, which affect how we and our partners do business with government agencies. As a result of actual or perceived noncompliance with government contracting laws, regulations, or contractual provisions, we may be subject to non-ordinary course audits and internal investigations which may prove costly to our business financially, divert management time, or limit our ability to continue selling our products and services to our government customers. These laws and regulations may impose other added costs on our business, and failure to comply with these or other applicable regulations and requirements, including non-compliance in the past, could lead to claims for damages from our channel partners, downward contract price adjustments or refund obligations, civil or criminal penalties, and termination of contracts and suspension or debarment from government contracting for a period of time with government agencies. Any such damages, penalties, disruption, or limitation in our ability to do business with a government would adversely impact, and could have a material adverse effect on, our business, financial condition, results of operations, public perception, and growth prospects.
Our business could be adversely affected if our employees cannot obtain and maintain required security clearances or we cannot maintain a required facility security clearance, or we do not comply with legal and regulatory obligations regarding the safeguarding of classified information.
Our U.S. government contract revenue includes income derived from contracts that require our employees to maintain various levels of security clearances, and may require us to maintain a facility security clearance, to comply with Department of Defense (“DoD”) requirements. The DoD has strict security clearance requirements for personnel who perform work in support of classified programs. In general, access to classified information, technology, facilities, or programs are subject to additional contract oversight and potential liability. In the event of a security incident involving classified information, technology, facilities, programs, or personnel holding clearances, we may be subject to legal, financial, operational, and reputational harm. We are limited in our ability to provide specific information about these classified programs, their risks, or any disputes or claims relating to such programs. As a result, investors have less insight into our classified programs than our other businesses and therefore less ability to fully evaluate the risks related to our classified business or our business overall. Obtaining and maintaining security clearances for employees involves a lengthy process, and it is difficult to identify, recruit, and retain employees who already hold security clearances. If our employees are unable to obtain security clearances in a timely manner, or at all, or if our employees who hold security clearances are unable to maintain their clearances or terminate employment with us, then a customer requiring classified work could terminate an existing contract or decide not to renew the contract upon its expiration. To the extent we are not able to obtain or maintain a facility security clearance, we may not be able to bid on or win new classified contracts, and existing contracts requiring a facility security clearance could be terminated.
Failure to comply with anti-bribery, anti-corruption, anti-money laundering laws, and similar laws, could subject us to penalties and other adverse consequences.
We are subject to the U.S. Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”), the U.S. domestic bribery statute contained in 18 U.S.C. § 201, the U.S. Travel Act, the United Kingdom Bribery Act 2010,
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and possibly other anti-bribery and anti-money laundering laws in the United States and in countries outside of the United States in which we conduct our activities. Anti-corruption and anti-bribery laws have been enforced aggressively in recent years and are interpreted broadly to generally prohibit companies, their employees, agents, representatives, business partners, and third-party intermediaries from authorizing, offering, or providing, directly or indirectly, improper payments or benefits to recipients in the public or private sector.
We sometimes leverage third parties to sell our products and conduct our business abroad. We, our employees, agents, representatives, business partners our third-party intermediaries may have direct or indirect interactions with officials and employees of government agencies or state-owned or affiliated entities and may be held liable for the corrupt or other illegal activities of these employees, agents, representatives, business partners or third-party intermediaries even if we do not explicitly authorize such activities. We cannot assure you that all of our employees and agents will not take actions in violation of applicable law, for which we may be ultimately held responsible. As we increase our international sales and business, our risks under these laws may increase.
These laws also require that we keep accurate books and records and maintain internal controls and compliance procedures designed to prevent any such actions. While we have policies and procedures to address compliance with such laws, we cannot assure you that none of our employees, agents, representatives, business partners or third-party intermediaries will take actions in violation of our policies and applicable law, for which we may be ultimately held responsible.
Any allegations or violation of the FCPA or other applicable anti-bribery, anti-corruption laws, and anti-money laundering laws could result in whistleblower complaints, sanctions, settlements, prosecution, enforcement actions, fines, damages, adverse media coverage, investigations, loss of export privileges, severe criminal or civil sanctions, or suspension or debarment from U.S. government contracts, all of which may have an adverse effect on our reputation, business, results of operations, and prospects. Responding to any investigation or action will likely result in a materially significant diversion of management’s attention and resources and significant defense costs and other professional fees.
General Risk Factors
The trading price of our common stock has been volatile and may be volatile in the future.
The trading prices of our common stock and the securities of other technology companies have been and may continue to be highly volatile. Factors affecting the trading price of our common stock include:
•variations in our operating results;
•announcements of technological innovations, new services or service enhancements, strategic alliances or agreements by us or by our competitors;
•the gain or loss of customers;
•recruitment or departure of key personnel;
•changes in the estimates of our future operating results or external guidance on those results or changes in recommendations or business expectations by any securities analysts that elect to follow our common stock;
•mergers and acquisitions by us, by our competitors or by our customers;
•market conditions in our industry, the industries of our customers and the economy as a whole, including global trade tariffs and fluctuations in currency exchange rates, interest rates or inflation rates;
•social, geopolitical, environmental or health factors, including pandemics or widespread health epidemics such as the COVID-19 pandemic; and
•adoption or modification of regulations, policies, procedures or programs applicable to our business.
In addition, if the market for technology stocks or the broader stock market experience a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition or results of operations. The trading price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. Each of these factors,
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among others, could harm the value of your investment in our common stock. Some companies that have had volatile market prices for their securities have had securities class action lawsuits filed against them. If a suit were filed against us, regardless of its merits or outcome, it could result in substantial costs and divert management’s attention and resources.
Future sales of our common stock could cause our stock price to fall.
We have sold, and plan in the future to sell, shares of our common stock in underwritten offerings and have established, and may in the future establish, “at-the-market” offering programs pursuant to which we may offer and sell shares of our common stock. Sales of securities have resulted and will continue to result in dilution of our existing stockholders, and such sales could cause our stock price to fall.
In addition, if our existing stockholders sell, or indicate an intent to sell, a large number of shares of our common stock in the public market, it could cause our stock price to fall. We may also issue shares of common stock or securities convertible into our common stock from time to time in connection with financings, acquisitions, investments or otherwise. Any such issuance would result in dilution to our existing stockholders and could cause our stock price to fall.
Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.
We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law, which apply to us, may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our amended and restated certificate of incorporation and amended and restated bylaws may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. Our amended and restated certificate of incorporation and amended and restated bylaws:
•authorize the issuance of “blank check” convertible preferred stock that could be issued by our board of directors to thwart a takeover attempt;
•establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from the time of election and qualification until the third annual meeting following their election;
•require that directors only be removed from office for cause;
•provide that vacancies on the board of directors, including newly created directorships, may be filled only by a majority vote of directors then in office rather than by stockholders;
•prevent stockholders from calling special meetings; and
•prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders.
Our amended and restated bylaws designate the Court of Chancery of the State of Delaware and the federal district courts of the United States of America as the exclusive forums for substantially all disputes between us and our stockholders, which will restrict our stockholders’ ability to choose the judicial forum for disputes with us or our directors, officers, or employees.
Our amended and restated bylaws provide that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf; any action asserting a breach of fiduciary duty; any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our amended and restated certificate of incorporation or our bylaws; or any action asserting a claim against us that is governed by the internal affairs doctrine.
These provisions would not apply to suits brought to enforce a duty or liability created by the Exchange Act or any other claim for which the U.S. federal courts have exclusive jurisdiction. Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all such Securities Act actions. Accordingly, both state and federal courts have jurisdiction to entertain such claims. Our stockholders cannot waive compliance with the federal securities laws and the rules and regulations thereunder. To prevent having to litigate
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claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our amended and restated bylaws provide that, unless we consent in writing to the selection of an alternative forum, the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. While the Delaware courts have determined that such choice of forum provisions are facially valid, a stockholder may nevertheless seek to bring a claim in a venue other than those designated in the exclusive forum provisions. In such instance, we would expect to vigorously assert the validity and enforceability of the exclusive forum provisions of our amended and restated certificate of incorporation. This may require significant additional costs associated with resolving such action in other jurisdictions and there can be no assurance that the provisions will be enforced by a court in those other jurisdictions.
These exclusive choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers, and other employees. If a court were to find such exclusive-forum provisions to be inapplicable or unenforceable in an action, we may incur further significant additional costs associated with resolving the dispute in other jurisdictions, all of which could harm our business.
Events that are outside our control, such as natural disasters, human violence or other catastrophic events, could harm our operations.
Our headquarters and the majority of our infrastructure, including our PIC fabrication manufacturing facility, are located in Northern California, an area that is susceptible to earthquakes, fires, floods and other natural disasters. Further, attacks and violence aimed at Northern California or at the United States energy or telecommunications infrastructure could hinder or delay the development and sale of our products. In the event that an earthquake, targeted attack or other man-made or natural catastrophe were to destroy any part of our or our contract manufacturers’ or suppliers' facilities, destroy or disrupt vital infrastructure systems, or interrupt our operations or supply chain for any extended period of time, our business, financial condition and results of operations would be harmed.
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
* Management contract or compensatory plan, contract or arrangement.
** The certification attached as Exhibit 32.1 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the SEC and is not to be incorporated by reference into any of our filings under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Infinera Corporation
By:
/s/ NANCY ERBA
Nancy Erba Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer)
