ITEM 1. Legal Proceedings.
On January 21, 2016, ViaSat, Inc., or ViaSat, filed a lawsuit in California state court, 37-2016-00002323-CU-BC-NC, later removed to the U.S. District Court for the Southern District of California, against us alleging, among other things, breach of contract, breach of the implied covenant of good faith and fair dealing and misappropriation of trade secrets. On February 19, 2016, we responded to ViaSat’s lawsuit and alleged counterclaims against ViaSat including, among other things, patent misappropriation, breach of contract, breach of the implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition. In its response filed March 16, 2016, ViaSat denied our counterclaims. On September 28, 2018 the matter was remanded back to the California Superior Court, County of San Diego, North County Division 3:16-cv-00463, D.I. 197.
In April 2019, the California Superior Court denied the parties’ cross motions for summary adjudication. At the court’s direction, the parties participated in a mandatory mediation process, but no resolution was reached. Trial took place in June and July of 2019 and the jury returned a verdict on July 17, 2019. The jury found against us for breach of contract, willful and malicious misappropriation of trade secrets, and breach of the covenant of good faith and fair dealing implied by law in the parties’ contract. The jury also found that ViaSat breached the same contract and misappropriated our trade secrets. The jury awarded damages of $49.3 million to ViaSat for our breaches of contract, and $1 to ViaSat for our trade secret misappropriation claim. The jury awarded $1 to us for ViaSat’s misappropriation of trade secrets and awarded no damages to us for ViaSat’s breach of contract. ViaSat filed post-trial motions seeking up to approximately $10.0 million for attorney’s fees and approximately $6.2 million for so-called “cost-of-proof” sanctions and an order that we pay ViaSat ongoing royalties on sales after December 31, 2018. ViaSat also sought a new trial and judgment in its favor notwithstanding the verdict on its trade secret damages claim. We filed post-trial motions for entry of judgment in our favor notwithstanding the verdict on ViaSat’s breach of contract and trade secret damages claims and for a new trial, and moved to reduce the total damages awarded to ViaSat to no more than $12.8 million pursuant to a provision of the contract containing a limitation on liability for claims arising from the contract. The Court denied the post-trial motions filed by both parties, and on December 5, 2019, the Court entered judgment, or the December 2019 Judgment, against us in the amount of $49.3 million, and against ViaSat in the amount of $1. On January 17, 2020, the Court awarded ViaSat an additional $0.1 million in costs. On December 20, 2019, we filed a notice of appeal of the December 2019 Judgment, and ViaSat filed a notice of cross-appeal on December 26, 2019. The parties’ respective appeals are pending and we filed our opening appellate brief on August 19, 2020. ViaSat’s responsive brief is due November 17, 2020. As of September 30, 2020, we have accrued a total of $28.0 million in litigation and settlement-related accruals. The amount of such accruals is based upon currently available information and is subject to significant judgment and a variety of assumptions and known and unknown uncertainties, which may change quickly and significantly from time to time. As a result, actual losses could significantly exceed the amount of such accruals, and no conclusion as to our ultimate exposure from these proceedings should be drawn from such accruals. In view of the numerous legal, technical and factual issues involved in this lawsuit, we are not able to provide an estimate of the likely outcome or range of outcomes, if any, at this time.
On November 6, 2019, ViaSat filed a second lawsuit in California Superior Court, County of San Diego, North County Division, 37-2019-00060731, D.I. 01, against us alleging breach of contract, breach of the implied covenant of good faith and fair dealing, and misappropriation of trade secrets. ViaSat’s complaint relies on the verdict in the first lawsuit, seeks damages on sales of our products after December 31, 2018, and its claims for relief include preliminary and permanent injunctive relief prohibiting sales of our products alleged by ViaSat to misappropriate its trade secrets. On January 17, 2020, we responded to ViaSat’s second lawsuit with a general denial and moved to stay the case. On February 28, 2020, the court issued an order granting our motion to stay the case pending outcome of the appeal in the first lawsuit. In view of the numerous legal, technical and factual issues involved in this lawsuit, we are not able to provide an estimate of the likely outcome or range of outcomes, if any, at this time.
On June 9, 2020, ViaSat filed a third lawsuit in California Superior Court, County of San Diego, North County Division, Case No. 37-2020-00019223, against us alleging breach of contract, breach of the implied covenant of good faith and fair dealing, and misappropriation of trade secrets. ViaSat’s complaint concerns different products than those involved in the first two suits. ViaSat claims such products also use ViaSat’s confidential information and trade secrets, and ViaSat’s claims for relief include damages and preliminary and permanent injunctive relief prohibiting sales of our products alleged by ViaSat to misappropriate its trade secrets. We filed a demurrer in response to the complaint on July 30, 2020 and the Court stayed the action until after the resolution of the appeal of the December 2019 Judgment. In view of the numerous legal, technical and factual issues involved in this lawsuit, we are not able to provide an estimate of the likely outcome or range of outcomes, if any, at this time.
On July 28, 2017, we filed a lawsuit in the Commonwealth of Massachusetts Superior Court - Business Litigation Session against ViaSat asserting commercial disparagement, libel, slander of title, unfair competition, intentional interference with advantageous relations and intentional interference with contractual relations. On April 5, 2018, ViaSat responded to our action and alleged counterclaims including, among other things, breach of contract, breach of the implied covenant of good faith and fair dealing, misappropriation of trade secrets, and unfair competition. On December 13, 2018, the Massachusetts court entered an order staying the Massachusetts litigation pending resolution of the first California state court action discussed above. On December 12, 2019, the Massachusetts court entered an order continuing the stay of the Massachusetts litigation to and including July 10, 2020. On July 6, 2020, the Massachusetts court entered an order continuing the stay of the Massachusetts litigation to and including December 4, 2020.
We intend to continue to engage in a vigorous defense and pursuit of Acacia favorable judgments of the ongoing litigation matters described above. The ultimate resolution of these proceedings may have a material adverse effect on our results of operations and cash flows, potentially in the near term. In addition, the timing of the final resolution of these proceedings is uncertain. We will continue to incur litigation and other expenses as a result of these proceedings, which could have a material impact on our business, consolidated financial position, results of operations and cash flows.
In addition, from time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business or on our consolidated financial position, results of operations or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
ITEM 1A. Risk Factors.
The following risk factors and other information included in this Quarterly Report on Form 10-Q should be carefully considered. This description of risk factors includes any material changes to, and supersedes the description of, risk factors associated with our business previously disclosed in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019, and in Part II, Item 1A, “Risk Factors” of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2020. These risk factors may be important to understanding other statements in this Quarterly Report on Form 10-Q. The following information should be read in conjunction with the condensed consolidated financial statements and related notes in Part I, Item 1, “Condensed Consolidated Financial Statements (Unaudited)” and Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q.
The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. Please see page 1 of this Quarterly Report on Form 10-Q for a discussion of some of the forward-looking statements that are qualified by these risk factors. If any of these risks occurs, our business, financial condition, operating results, cash flow and prospects could be materially and adversely affected.
Because of the following factors, as well as other factors affecting our financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.
Risks Related to the Merger
Our proposed Merger may be delayed or not occur at all for a variety of reasons, including the possibility that the Merger Agreement is terminated prior to the completion of the Merger.
On July 8, 2019, we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Cisco Systems, Inc., a California corporation, or the Parent, and Amarone Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of the Parent, or the Merger Sub. The Merger Agreement provides for the merger of the Merger Sub with and into us, which we refer to herein as the Merger, with us surviving the Merger as a wholly owned subsidiary of the Parent. Completion of the Merger is subject to customary closing conditions, including (i) obtaining antitrust approval in China, (ii) the absence of governmental injunctions or other legal restraints prohibiting the Merger or imposing certain antitrust restraints and (iii) the absence of a “Material Adverse Effect,” as defined in the Merger Agreement. In addition, the obligation of each party to consummate the Merger is conditioned upon, among other things, the accuracy of the representations and warranties of the other party (subject to certain materiality exceptions), and material compliance by the other party with its covenants under the Merger Agreement. Therefore, the Merger may not be completed or may not be completed as quickly as expected.
Failure to complete the Merger could adversely affect our business and the market price of our common stock in a number of ways, including:
•the market price of our common stock may decline to the extent that the current market price reflects an assumption that the Merger will be consummated;
•if the Merger Agreement is terminated under certain circumstances specified in the Merger Agreement, we would be required to pay the Parent a termination fee of $120 million (including under specified circumstances in connection with an alternative acquisition proposal);
•we have incurred, and will continue to incur, significant expenses for professional services in connection with the Merger for which we will have received little or no benefit if the Merger is not consummated; and
•a failed Merger may result in negative publicity and/or give a negative impression of us in the investment community or business community generally.
The Merger could divert management’s attention, disrupt our relationships with third parties and employees and result in negative publicity or legal proceedings, any of which could negatively impact our operating results and ongoing business.
We have expended, and continue to expend, significant management time and resources in an effort to complete the Merger, which may have a negative impact on our ongoing business. Uncertainty regarding the outcome of the Merger and our future could disrupt our business relationships with our existing and potential customers, suppliers, vendors, landlords and other business partners, who may attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than us. Uncertainty regarding the outcome of the Merger could also adversely affect our ability to recruit and retain key personnel and other employees. The pendency of the Merger may also result in negative publicity and a negative impression of us in the financial markets, and it has led to, and may result in additional, litigation against us and our directors and officers. Such litigation is distracting to management and has required, and may in the future require, us to incur significant costs. Such litigation could result in the Merger being delayed and/or enjoined by a court of competent jurisdiction, which could prevent the Merger from becoming effective. The occurrence of any of these events individually or in combination could have a material and adverse effect on our business, financial condition and results of operations.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities and must generally operate our business in the ordinary course, subject to certain exceptions. These restrictions could prevent us from pursuing attractive business opportunities that may arise prior to the consummation of the Merger. Although we may be able to pursue such activities with the Parent’s consent, the Parent may not be willing to provide its consent for us to do so.
If the Merger occurs, our stockholders will not be able to participate in any upside to our business.
If the Merger is consummated, our stockholders will receive $70.00 in cash per share, without interest and subject to applicable tax withholding, of our common stock owned by them, and will not receive any shares of the Parent’s common stock. As a result, if our business following the Merger performs well, our current stockholders will not receive any additional consideration and will therefore not receive any benefit from any such future performance of our business.
Litigation could delay and/or prevent the Merger from becoming effective or from becoming effective within the expected timeframe.
We and our directors were named as defendants in several lawsuits brought by purported stockholders challenging the Merger and seeking various forms of injunctive and declaratory relief, as well as awards of damages, costs, expert fees and attorneys’ fees. While the plaintiffs in these lawsuits have dismissed their claims in exchange for our filing of supplemental disclosure regarding the Merger, which we filed on August 27, 2019, we may be subject to additional future litigation challenging the Merger. One of the conditions to the completion of the Merger is that no injunction by any governmental entity of competent jurisdiction, such as a court, will be in effect that prohibits or makes illegal the consummation of the Merger. As such, if any future plaintiffs are successful in obtaining an injunction prohibiting the consummation of the Merger, then such injunction may prevent the Merger from becoming effective or from becoming effective within the expected timeframe, either of which could substantially harm our business.
Risks Related to Our Business and Industry
The extent to which the novel coronavirus SARS-CoV-2, referred to as the COVID-19 pandemic, or COVID-19, has adversely affected, and may continue to adversely affect, our business, results of operations and financial condition, or the business and financial condition of our customers and suppliers, is uncertain.
The global spread of the novel coronavirus, severe acute respiratory syndrome coronavirus 2, SARS-CoV-2, and the coronavirus disease, COVID-19, has resulted in authorities imposing, and businesses and individuals implementing, numerous unprecedented measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place/stay-at-home and social distancing orders, and shutdowns and has created significant uncertainty and economic disruption, both near-term and potentially long-term. The COVID-19 pandemic has caused us to modify our business practices to include company-wide travel and visitor restrictions, work-from-home policies, social distancing and various other recommended preventive measures, including additional cleaning and disinfection procedures within our facilities, daily self-health assessments or, where required by local law, onsite health screening and temperature taking, support for local contact tracing efforts, and the required use of face masks or cloth face coverings when onsite at our facilities. As additional information about COVID-19 and how it is transmitted becomes available, we may implement further measures that we determine are in the best interests of our employees, customers, partners, vendors and suppliers. These modifications have affected the way we conduct our product development, validation and qualification, customer sales and support services, including onsite support, and other activities, which could have an adverse effect on our business, results of operations and financial condition. While we have taken steps to mitigate the impact of COVID-19 on our financial results for the nine month period ended September 30, 2020, the extent to which the COVID-19 pandemic could affect our business, results of operations and financial condition in the future is difficult to predict and depends on numerous evolving factors including: the duration and scope of the pandemic; government, social, business and other actions that have been and will be taken in response to the pandemic; the availability of reliable and effective testing, vaccines or other therapies; and the effect of the pandemic on short- and long-term general economic conditions. We have and may continue to experience short- or long-term constrained supply or volatility in customer demand, which could materially and adversely affect our business, results of operations and financial condition in future periods. In addition, several of our customers, contract manufacturers, suppliers and other business partners have experienced and are continuing to experience similar challenges and any adverse impact or disruption to their businesses, results of operations and financial condition could have a downstream adverse impact to ours. For example, our third-party contract manufacturers, foundries and other service providers have significant manufacturing operations in China, Singapore, Taiwan, Thailand and the United States, and each of these countries has been affected by the COVID-19 pandemic and have taken and continue to take measures to try to contain it. These measures have in some instances resulted in temporary shutdowns, reduction in capacity utilization and disruption in the movement of components and products through our supply chain. There is a significant degree of uncertainty and lack of visibility as to the impact, extent and duration of the COVID-19 pandemic, including the adverse impact of negative economic conditions created or exacerbated by the pandemic, new information that may emerge concerning the severity of the virus and required or voluntary actions to contain its impact. As a result, it is difficult to predict the nature and extent to which the COVID-19 pandemic and responsive measures related thereto will impact our business, results of operations and financial condition, or the business and financial condition of our customers and suppliers.
We depend on a limited number of customers for a significant percentage of our revenue and the loss or temporary loss of a major customer for any reason could harm our financial condition.
We have historically generated most of our revenue from a limited number of customers. Our five largest customers, which differed by period, collectively accounted for 81% of our revenue in 2019, 74% of our revenue in 2018, 70% of our revenue in 2017, 75% of our revenue in the nine months ended September 30, 2020 and 79% of our revenue in the nine months ended September 30, 2019. In 2019, ZTE accounted for 27% of our revenue, Cisco Systems, Inc. and its affiliates, together Cisco, accounted for 17% of our revenue, Infinera Corporation, or Infinera, accounted for 17% of our revenue and ADVA Optical Networking North America, Inc., or ADVA, accounted for 13% of our revenue. In 2018, ZTE accounted for 20% of our revenue, Infinera, which on October 1, 2018 acquired another of our customers, Coriant, Inc, or Coriant, including all 2018 revenue from Infinera and Coriant, accounted for 17% of our revenue, ADVA accounted for 15% of our revenue and Cisco accounted for 14% of our revenue. In 2017, ZTE accounted for 30% of our revenue, ADVA accounted for 15% of our revenue and Coriant accounted for 11% of our revenue. In the nine months ended September 30, 2020, ZTE accounted for 19% of our revenue, Infinera accounted for 19% of our revenue and Cisco accounted for 15% of our revenue. In the nine months ended September 30, 2019, ZTE accounted for 27% of our revenue, Cisco accounted for 18% of our revenue, Infinera accounted for 15% of our revenue and ADVA accounted for 13% of our revenue. As a consequence of the concentrated nature of our customer base, our quarterly revenue and results of operations may fluctuate from quarter to quarter and are difficult to estimate, and any delay, reduction or cancellation of orders or any acceleration or delay in anticipated product purchases, including as a result of COVID-19 related disruptions in the operations and supply chains of our customers, or the acceptance of shipped products by our larger customers or any government-mandated inability to sell to any of our larger customers could materially affect our revenue and results of operations in any quarterly period.
For example, in April 2018, the U.S. Department of Commerce imposed a seven-year denial of export privileges that prohibited sales of U.S.-regulated commodities, software and technology to ZTE and an affiliated company, or the ZTE Ban, based on adverse findings relating to the activities covered by ZTE’s 2016 settlement with the U.S. Department of Commerce to resolve charges of export control violations by ZTE. The ZTE Ban added ZTE and the affiliate to the “Denied Persons List,” suspending U.S. export privileges of ZTE and the affiliate, prohibiting them from participating in transactions subject to U.S. Department of Commerce export control regulations, and prohibiting other businesses and individuals, including us, from certain activities in support of ZTE’s business. In June 2018, ZTE and the U.S. Department of Commerce reached a new settlement imposing additional penalties and compliance measures upon ZTE, pursuant to which the ZTE Ban was lifted and ZTE was removed from the Denied Persons List. Although this further U.S. Department of Commerce action ended the export control restriction specifically targeting ZTE, any violations by ZTE of the latest settlement may trigger a new, ten-year denial order. We may suspend our business with ZTE or other customers if we conclude or are notified by the U.S. Department of Commerce that such business presents an unacceptable risk of noncompliance with U.S. regulations, if new licensing requirements or other regulatory restrictions are imposed on such business, or if we determine that continued business with such customers is not feasible or desirable.
We may be unable to sustain or increase our revenue from our larger customers, grow revenues with new or other existing customers at the rate we anticipate or at all, or offset the discontinuation of concentrated purchases by our larger customers with purchases by new or existing customers. These larger customers may also reduce or discontinue their purchases of our products in the event they transition to internally developed products or determine to divide their purchases of our products between us and a second source, including to mitigate against actual or perceived supply chain risks related to COVID-19. We expect that such concentrated purchases will continue to contribute materially to our revenue for the foreseeable future and that our results of operations may fluctuate materially as a result of such larger customers’ buying patterns. For example, one of our larger customers made significant purchases in the first and second quarters of 2019 and had reduced orders in the third quarter of 2019 before returning to a higher level of purchasing in the fourth quarter of 2019. We have experienced similar unevenness in purchases by our larger customers in prior years. Further, the markets our customers sell into may experience slower deployment than anticipated or these customers may lose market share with their end customers. In addition, we have seen, and may in the future see consolidation of our customer base which could result in loss of customers, reduced purchases or may increase the concentration of our customer purchases. The loss or temporary loss of such customers, or a significant delay or reduction in their purchases, could materially harm our business, financial condition, results of operations and prospects.
The future success of our business is substantially dependent on our successful development and release of new products.
The markets for our products are characterized by changes and improvements in existing technologies and the introduction of new technology approaches. The future success of our business will depend in large part upon the continuing relevance of our technological capabilities, our ability to interpret customer and market requirements in advance of product deliveries and our ability to introduce in a timely manner new products that address our customers’ requirements for more cost-effective bandwidth solutions. The development of new products is a complex process, and we may experience delays and failures in completing the development, qualification, introduction and volume ramp of new products. Our successful product development depends on a number of factors, including the following:
•the accurate prediction of market requirements, changes in technology and evolving standards;
•the availability of qualified product designers and technologies needed to solve difficult design challenges in a cost-effective, reliable manner;
•our ability to design products that meet customers’ cost, size, acceptance and specification criteria and performance requirements, as well as requirements and specifications established by industry groups or standards bodies;
•our ability to manufacture new products with acceptable quality and manufacturing yields in a sufficient quantity to meet customer demand and according to customer needs;
•our ability to provide onsite support to our customers in connection with the integration of our products into their product offerings, as well as the ramp and deployment of such product offerings, which has been made more challenging while COVID-19 related travel bans and restrictions, quarantines, shelter-in-place/stay-at-home and social distancing orders remain in place;
•our ability to offer new products at competitive prices;
•our dependence on suppliers to deliver in a timely manner materials that are critical components of our products;
•our dependence on single-source supplier and the impact of industry-wide component constraints;
•our dependence on third-party manufacturers to successfully manufacture our products in accordance with the specifications that we and our customers require;
•the identification of and entry into new markets for our products;
•the acceptance of our customers’ products by the market and the lifecycle of such products; and
•our ability to deliver products in a timely manner within our customers’ product planning and deployment cycle.
In general, a new product development effort may last two years or longer, and requires significant investments in engineering hours, third-party development costs, equipment, prototypes and sample materials, as well as sales and marketing expenses, which will not be recouped if the product launch is unsuccessful. We may not be able to design and introduce new products in a timely or cost-efficient manner, and our new products may be costlier to develop, may fail to meet the requirements of the market or our customers, or may be adopted by customers slower than we expect. In that case, we may not reach our expected level of production orders and may lose market share, which could adversely affect our ability to maintain our current revenue levels or resume revenue growth.
The failure to increase sales of our products to our customers and expand our customer base as anticipated could adversely affect our future revenue and business.
We believe that our future success will depend, in part, on our ability to expand sales of our products to our existing customers for use in a customer’s existing or new product offerings. Our future success will also depend on our ability to continue to expand our customer base and drive the adoption of our products in adjacent markets. Our efforts to increase product sales to new and existing customers may generate less revenue than anticipated or take longer than anticipated. Further, our customers may elect to develop in-house modules, purchase modules that incorporate our DSP ASICs from alternate sources, or purchase lower-cost components, such as our DSP ASICs or silicon PICs, in place of modules, which could negatively affect our revenue. If we are unable to increase sales to our new and existing customers, expand our customer base or expand into adjacent markets as anticipated, our business, financial condition, results of operations and prospects could be adversely affected.
Product quality problems, defects, errors or vulnerabilities in our products could harm our reputation and adversely affect our business, financial condition, results of operations and prospects.
We produce highly complex products that incorporate advanced technologies and that we believe to be state-of-the-art for our industry. Despite our testing prior to their release, our products may contain undetected defects or errors, including design, contract manufacturing or supplier quality issues, especially when first introduced or when new versions are released. Product defects or errors have in the past and in the future could affect the performance of our products and could delay the development or release of new products or new versions of products. Allegations of unsatisfactory performance could cause us to lose revenue or market share, damage our reputation in the market and with customers, increase our warranty costs and related returns which would negatively impact our gross margins, cause us to incur substantial costs in redesigning the products, cause us to lose significant customers, subject us to liability for damages or divert our resources from other tasks, any one of which could materially adversely affect our business, financial condition, results of operations and prospects. For example, in May 2017, we announced a quality issue at one of our contract manufacturers, which we refer to as the Quality Issue, that affected a portion of the units manufactured by that contract manufacturer over approximately four months and negatively impacted our product performance. This resulted in a charge to the cost of revenue in our condensed consolidated statement of operations during the second quarter of 2017.
From time to time, we have had to replace certain components of products that we had shipped and provide remediation in response to the discovery of defects or bugs, including deficiencies in components provided by our suppliers and failures in software protocols or defective component batches resulting in reliability issues, in such products, and we may be required to do so in the future. We may also be required to provide full replacements or refunds or extend warranty terms for such defective products. Such remediation could have a material effect on our business, financial condition, results of operations and prospects.
Quality control problems in manufacturing could result in delays in product shipments to customers or in quality problems with our products which could adversely affect our business.
We have and in the future may again experience quality control problems in our manufacturing operations or the manufacturing operations of our contract manufacturers. For example, we experienced product quality control problems in the second quarter of 2017 in connection with the Quality Issue. If we are unable to promptly identify and correct certain quality
issues in our products prior to the products’ being shipped to customers, failure of our deployed products could cause failures in our customers’ products, which could require us to issue a product recall or trigger epidemic failure claims pursuant to our customer contracts, which may require us to indemnify or pay liquidated damages to affected customers, repair or replace damaged products, or discontinue or significantly delay shipments. Quality control problems with materials provided by suppliers may adversely impact our ability to ship our products to customers. Undetected quality problems may prompt unexpected product returns and adversely affect warranty costs. As a result, we could experience a decline in revenue from existing customers or the loss of a customer entirely or incur additional costs that would adversely affect our gross margins. In addition, even if a problem is identified and corrected at the manufacturing stage, product shipments to our customers could be delayed, which would negatively affect our revenue, competitive position and reputation.
If we fail to accurately predict market requirements or market demand for our products, our business, competitive position and operating results will suffer.
We operate in a dynamic and competitive industry and use significant resources to develop new products for existing and new markets. After we have developed a product, there is no guarantee that our customers will integrate our product into their equipment or devices and, ultimately, bring the equipment and devices incorporating our product to market, including because we may be considered a sole-source supplier with a relatively limited operating history or, with respect to certain of our products, because we have enabled a second source supplier who may capture market share. In addition, there is no guarantee that cloud, network and communications service providers will ultimately choose to purchase network equipment that incorporates our products. In these situations, we may never produce or deliver significant quantities of our products, even after incurring substantial development expenses. From the time a customer elects to integrate our interconnect technology into their product, it typically takes 18 to 24 months for high-volume production of that product to commence. After volume production begins, we cannot be assured that the equipment or devices incorporating our product will gain market acceptance by network operators.
If we fail to accurately predict and interpret market requirements or market demand for our new products, our business and growth prospects will be harmed. If high-speed networks are deployed to a lesser extent or more slowly than we currently anticipate, including as a result of market uncertainty and changes to network deployment schedules as a result of COVID-19, we may not realize anticipated benefits from our investments in research and development. For example, between 2017 and 2019 our industry experienced a slowdown in the rate of new network deployments in the China long-haul and metro network markets, which, when combined with weakening prices and excess inventory, resulted in a corresponding slowdown in the order rate of certain of our China-based customers. Although these order rates began to improve in 2019, the impact of COVID-19 on China and the risk of the pandemic returning to China in the future has adversely impacted, and may continue to adversely impact, our China-based customers and further disrupt the timing and scope of their network deployment schedules. The combined impact of governmental policy, the cyclical nature of a major market and uncertainties around COVID-19 impacts has made it difficult to predict demand from Chinese customers. As a result, our business, competitive position, market share and operating results have experienced, and may continue to experience, pressure.
As demand for our products in one market grows, demand in another market may decrease. For example, if we sell our products directly to content providers in addition to network equipment manufacturers, our sales to network equipment manufacturers may decrease due to reduced demand from their customers or due to dissatisfaction by network equipment manufacturers with this change in our business model. Further, the inter-data center market is subject to upgrade cycles and volatility driven by changing priorities. In addition, even in the event of expansion in our markets, we may not experience a corresponding increase in demand for our products or competition may drive pricing pressure. Any reduction in demand in one market that is not offset by an increase in demand in another market could adversely affect our market share or results of operations.
Additionally, the ongoing COVID-19 pandemic has significantly increased economic and demand uncertainty. It is likely that the current pandemic and continued spread of COVID-19 will cause an economic slowdown, and it is possible that it could cause a global recession. There is a significant degree of uncertainty and lack of visibility as to the extent and duration of any such slowdown or recession. Given the significant economic uncertainty and volatility created by the pandemic, it is difficult to predict the nature and extent of impacts on demand for our products.
Negative economic conditions created or exacerbated by the ongoing COVID-19 pandemic could adversely impact our business in various respects.
Our results of operations could be adversely affected by general conditions in the global economy. For example, a slowdown in the economies of, or adverse changes in economic conditions in, one or more of the countries in which we operate as a result of the ongoing COVID-19 pandemic could adversely affect demand for our products, change the mix of products we
sell to a mix with a lower average gross margin, adversely affect our net sales, cause customers or other business partners to delay or fail to make payments owed to us, result in slower inventory turnover, adversely impact the rate of return on our investments or otherwise materially adversely affect our business, financial condition, stock price and results of operations. Further, a prolonged COVID-19 pandemic could result in the imposition of additional quarantines or closures of office spaces or manufacturing facilities, travel and transportation restrictions and/or import and export restrictions after the various responsive measures that are currently in place are lifted, any of which could contribute to a general slowdown in the global economy and the economies of the markets in which we operate. Although these economic factors did not have a material effect on our operations during the three and nine month periods ended September 30, 2020, they may materially affect our operations in the future. In addition, even where certain economic factors have not or do not adversely affect our operations, such economic factors may adversely affect the operations of our customers, contract manufacturers, suppliers and other business partners. The extent and duration of such economic impacts remain largely uncertain and dependent on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of COVID-19, the extent and effectiveness of containment actions taken, the availability of reliable and effective testing, vaccines or other therapies and the impact of these and other factors on our operations and the global economy.
We may not be able to maintain or improve our gross margins.
We may not be able to maintain or improve our gross margins. Factors such as significant decreases in our revenue, slow introductions of new products, our failure to effectively reduce the cost of existing products, our failure to maintain or improve our product mix or pricing, changes in customer demand or share allocation, annual, semi-annual or quarterly price reductions in excess of industry forecasts and pricing discounts required under the terms of our customer contracts, pricing pressure resulting from increased competition, the availability of superior, ‘good enough’ or lower-cost technologies, market consolidation or the potential for future macroeconomic or market volatility to reduce sales volumes have and may continue to adversely impact our gross margins. Our gross margins could also be adversely affected by unfavorable production yields or variances, increases in or the inability to secure appropriate periodic decreases in costs of components and materials, the timing changes in our inventory, warranty costs and quality-related returns, changes in foreign currency exchange rates (including any substantial changes resulting from the ongoing COVID-19 pandemic), potential inability to reduce manufacturing costs in response to any decrease in our revenue and possible exposure to inventory valuation reserves. Our competitors have a history of reducing their prices to increase or avoid losing market share, and we may have to reduce our prices to continue to effectively compete. If we are unable to maintain or improve our gross margins, our financial results will be adversely affected.
We generate a significant portion of our revenue from international sales and rely on foreign manufacturers to make our products, and therefore are subject to additional risks associated with our international operations.
Since January 1, 2013, we have shipped our products to customers located in 24 foreign countries. In 2019, 2018, 2017, and the nine months ended September 30, 2020 and 2019, we derived 85%, 83%, 84%, 83% and 85%, respectively, of our revenue from sales to customers with ship-to locations outside the United States. A significant portion of our international sales are made to customers with ship-to locations in China. In 2019, 2018, 2017, and the nine months ended September 30, 2020 and 2019, we derived 34%, 29%, 39%, 26% and 34%, respectively, of our revenue from sales to customers with ship-to locations in China. We also work with manufacturing facilities outside of the United States. We have expanded, and in the future may further expand, our international operations to locate additional functions related to the development, manufacturing and sale of our products outside of the United States. Our international operations are subject to inherent risks, and our results of operations could be adversely affected by a variety of factors, many of which are beyond our control, including:
•U.S. or foreign governmental action, such as export control or import restrictions, that could prevent or significantly hinder our ability to produce or sell our products to certain customers or customers in certain foreign jurisdictions or build our products internationally;
•greater difficulty in enforcing contracts and accounts receivable obligations and longer collection periods, which may be exacerbated by the ongoing COVID-19 pandemic;
•difficulties in managing, staffing and overseeing international offices and foreign manufacturers, including while COVID-19 related travel bans and restrictions, quarantines, shelter-in-place/stay-at-home and social distancing orders remain in place;
•increased travel, infrastructure and legal compliance costs associated with multiple international locations;
•the impact of general economic and political conditions in economies outside the United States, including the uncertainty related to the withdrawal of the United Kingdom from the European Union, commonly known as Brexit, the terms of the post-Brexit relationship between the United Kingdom and the European Union, and
heightened economic and political uncertainty within the United Kingdom, and within and among European Union member states;
•tariff and trade barriers, changes in custom and duties requirements or compliance interpretations and other regulatory requirements or contractual limitations on our ability to sell or develop our products in certain foreign markets and our ability to pass through to our customers any tariff or trade costs imposed on our products;
•heightened risk of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of, or irregularities in, financial statements;
•certification requirements;
•greater difficulty documenting and testing our internal controls;
•reduced protection for intellectual property rights in some countries;
•potentially adverse tax consequences, including further reform to the U.S. tax code and international tax rules such as the base erosion and profit shifting initiative;
•the effects of changes in currency exchange rates;
•changes in service provider and government spending patterns;
•social, political and economic instability;
•higher incidence of corruption or unethical business practices that could expose us to liability or damage our reputation; and
•natural disasters, major public health issues (including the COVID-19 pandemic discussed further in the risk factor “The extent to which the COVID-19 pandemic has adversely affected, and will continue to adversely affect our business, results of operations and financial condition, or the business and financial condition of our customers and suppliers, is uncertain,” above), acts of war or terrorism and other catastrophic events.
The U.S. Tax Cuts and Jobs Act, or the Tax Act, enacted in December 2017, made far-ranging changes to the corporate tax system that previously existed and established a quasi-territorial system for taxing foreign-source income of multinational corporations. It is not known what specific additional measures might be proposed or how they would be implemented or enforced, or what effect emerging tax reform or other near-term Congressional action may have on other companies’ or our business practices. Further, pending or new legislation or executive action in the United States that could significantly increase our cost of manufacturing and, consequently, adversely affect our business, financial condition or results of operations, may be enacted.
In addition, international customers may also require that we comply with additional testing or customization of our products to conform to local regulations or other standards, including environmental considerations, which could materially increase the costs to sell our products in those markets.
As we continue to operate on an international basis, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks could harm our international operations and reduce our international sales.
Changes in U.S. trade policies could disrupt global supply, manufacturing and customer relationships, which may materially increase costs of components contained in our products, increase our manufacturing costs and make our products more expensive or unavailable in foreign markets.
The current U.S. Administration has made significant changes to U.S. trade policy, including new or increased tariffs on a broad range of goods imported into the United States, particularly from China, with additional tariffs and other actions still under consideration. Since we rely primarily upon non-U.S. manufacturers to make our products, such actions, whether adopted or threatened, and the perceived negative effect of such actions, could have a disproportionate impact on us and make our products more expensive and less competitive in domestic markets. Further, these changes in U.S. trade policy have triggered retaliatory protectionist actions by affected countries, the continuation or expansion of which could restrict our ability to do business in or with affected countries or could prohibit, reduce or discourage purchases of our products by foreign customers, leading to increased costs of components contained in our products, increased costs of manufacturing our products, and higher prices and reduced demand for our products in foreign markets. For example, there are risks that the Chinese government may,
among other things, impose additional or increased tariffs on imports of U.S. goods, require Chinese companies to use more local suppliers, compel companies that do business in China to partner with local companies, impose regulatory restrictions on items made by contract manufacturers and other suppliers in China, or provide incentives to government-backed local customers to buy from local suppliers rather than companies like ours. In addition, foreign governments may pursue internal programs and policies to develop domestic technologies that reduce foreign customers’ demand for our products. For example, China’s Made in China 2025 program aims to build industries in numerous technological sectors, including 5G mobile communications, among others. As a result, risk of doing business in China is likely to increase, if it has not already, including the risk of theft of intellectual property and data and potentially different treatment of foreign owned intellectual property rights and data than that owned or developed in China. Changes in, and responses to, U.S. trade policy could reduce the competitiveness of our products through increased costs and cause our sales and revenues to drop, which could materially and adversely impact our business and results of operations. Moreover, escalating and retaliatory tariffs or other protectionist measures among the U.S. and other countries may depress the overall economic condition of countries in which our customers are located, such as China, which could harm our business.
We are subject to government regulation, including import, export, economic sanctions, privacy, and anti-corruption laws and regulations that may limit our sales opportunities, expose us to liability and increase our costs.
We are subject to those government regulations that relate to various aspects of our business. Government regulations that are applicable to us are increasingly prevalent, continue to evolve and vary from jurisdiction to jurisdiction.
Our products are subject to export controls, including, where applicable, the U.S. Department of Commerce’s Export Administration Regulations and economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Controls, and similar laws and regulations that apply in other jurisdictions in which we produce, distribute or sell our products. Export control and economic sanctions laws and regulations include restrictions and prohibitions on the sale or supply of certain products and on our transfer of parts, components, and related technical information and know-how to certain countries, regions, governments, persons and entities. For example, in April 2018, the U.S. Department of Commerce imposed the ZTE Ban. The ZTE Ban added ZTE and an affiliate to the “Denied Persons List,” suspending U.S. export privileges of ZTE and the affiliate, prohibiting them from participating in transactions subject to U.S. Department of Commerce export control regulations, and prohibiting other businesses and individuals, including us, from certain activities in support of ZTE’s business. In June 2018, ZTE and the U.S. Department of Commerce reached a new settlement imposing additional penalties and compliance measures upon ZTE, pursuant to which the ZTE Ban was terminated and ZTE was removed from the Denied Persons List. Although this further U.S. Department of Commerce action authorized us to resume sales to and related activities involving ZTE, any violations by ZTE of the latest settlement may trigger a new ten-year denial order.
The U.S. Congress or U.S. regulatory authorities have taken, and may in the future take, legislative or regulatory action that may materially interfere with our ability to manufacture our products or make sales to our customers, particularly in China, or that could impede sales by such customers in the United States. For example, in May 2019, the U.S. Department of Commerce designated Huawei Technologies Co. Ltd., or Huawei, and numerous affiliated companies on its “Entity List” upon finding reasonable cause to believe that the companies have been involved in activities contrary to the national security or foreign policy interests of the United States. This designation imposed new requirements for export licenses for exports, reexports, and in-country transfers of any items or technologies subject to the U.S. export control regulations, and requests for licenses are reviewed with a presumption of denial. In May 2020, the U.S. Department of Commerce expanded the export restriction on Huawei to cover certain foreign-produced items produced from certain U.S. technologies, software or plant when there is knowledge that such items are included in a transaction in which Huawei is a party. In June 2020, the U.S. Department of Commerce designated additional Chinese entities, including FiberHome Technologies Group and an affiliated company, or FiberHome, on the Entity List upon determining that they are enabling activities contrary to the foreign policy interests of the United States relating to Chinese repression and surveillance of ethnic groups in China’s Xinjiang Uighur region. U.S. regulators may also impose new export license requirements for items that can currently be furnished under broad license exceptions, or new restrictions on previously non-controlled emerging or foundational items and technologies for which exports to countries such as China are deemed to present undesirable national security risks.
Even without such action, we would be prohibited from exporting our products to any foreign recipient if we have knowledge that a violation of U.S. export regulations has occurred, is about to occur, or is intended to occur in connection with any item subject to U.S. regulation. In addition, our suppliers may restrict our rights to use their components in products destined for end users or end uses that present heightened regulatory or reputational risks, and some customers may decline to purchase our products that contain parts or components from, or that were manufactured by, suppliers and service providers that present heightened regulatory or reputational risks. The loss or temporary loss of customers as a result of such future regulatory or supply chain limitations could materially harm our business, financial condition, results of operations and prospects. Further,
our association with such customers could subject us to actual or perceived reputational harm among current or prospective investors in our common stock, suppliers or customers, customers of our customers, other parties doing business with us, or the general public. Any such reputational harm could result in the loss of investors in our common stock, suppliers or customers, which could harm our business, financial condition, results of operations or prospects. We may suspend our business with ZTE or other customers, suppliers or partners, if we conclude or are notified by the U.S. Department of Commerce that such business presents an unacceptable risk of noncompliance with U.S. regulations, if new licensing requirements or other regulatory restrictions are imposed on such business, or if we determine that continued business with such customers, suppliers or partners is not feasible or desirable.
In addition, various countries regulate imports and exports of certain products, through permitting and licensing requirements, and have enacted laws that could limit our ability to produce and distribute our products. Exports, re-exports, transfers within foreign countries and imports of our products, including by our partners, must comply with these laws and regulations, and any violations may result in reputational harm, government investigations, penalties and/or a denial or curtailment of our ability to export our products. Complying with import, export and sanctions laws for a particular sale may be time consuming, may increase our costs and may result in the delay or loss of sales opportunities. Although we take precautions to prevent our products from being provided in violation of such laws and regulations, if we are found to be in violation of sanctions or export control laws, we and the individuals working for us could incur substantial fines and penalties. Changes in export, sanctions or import laws or regulations may affect whether it feasible and profitable for us to manufacture our products in and distribute our products from countries that impose regulatory restrictions on the movement of our parts, components, finished products, and related technologies. For example, in December 2019, China published a proposed new, comprehensive export control law that would, if adopted, create a system through which China may selectively restrict exports of products and technologies from China, perhaps in response to regulatory actions affecting China that may be imposed by adversary trading partners such as the United States. Such regulatory changes may also delay the introduction and sale of our products in international markets, cause us to spend resources to seek necessary government authorizations or to develop different versions of our products, or, in some cases, prevent the export or import of our products to certain countries, regions, governments, persons or entities altogether, any of which could adversely affect our business, financial condition and operating results.
New regulations in the United States and other countries that purport to protect national telecommunications systems and infrastructure may reduce the demand for products and services provided by certain of our customers, which may, in turn, reduce the demand for our products. In particular the U.S. government is pressing foreign governments to ban or severely restrict the use of Huawei equipment and services in national 5G network infrastructure. While many countries continue to allow Huawei technologies in 5G network infrastructure, such restrictions have been implemented in several countries, including the United States, the United Kingdom, Australia, Japan and New Zealand, and dozens of other countries have not yet decided.
In addition, in June 2020, the U.S. Federal Communications Commission, or FCC, designated ZTE and Huawei as national security threats and prohibited money from the FCC’s Universal Service Fund from being used to purchase, obtain, maintain, improve, modify, or otherwise support any equipment or services produced or provided by ZTE or Huawei.
Pursuant to an executive order issued in May 2019 and extended in May 2020, the U.S. government is developing a new regulatory mechanism through which it may block imports into the United States of certain information and communications products and services designed, developed, manufactured, or supplied by entities owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary, where the transaction presents an undue risk to U.S. information and communications technology or services, critical infrastructure or the digital economy of the United States, or other unacceptable risks to the national security of the United States or the security and safety of United States persons.
A similar type of supply chain risk regulation has already been imposed in U.S. government contracting regulations, which were revised in August 2019 to prohibit U.S. government agencies from directly or indirectly procuring, or obtaining, or extending or renewing contracts to procure or obtain, certain equipment, systems or services that include, as a substantial or essential component or critical technology, certain equipment or services produced or provided by Huawei or ZTE, or their subsidiaries or affiliates, or, with respect to certain video surveillance and telecommunications equipment or services, produced or performed by Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, or Dahua Technology Company, or their subsidiaries or affiliates. These restrictions may be extended to target additional suppliers. Interim regulations effective in August 2020 extended these restrictions to prohibit the award, extension or renewal of U.S. government contracts to entities that use the restricted equipment or services, even if such use is unrelated to any U.S. government contract. In addition, further regulations prohibit recipients of U.S. government grant or loan funding from using such funding for acquiring the restricted equipment or services or awarding, extending or renewing contracts with entities that use the restricted equipment or services. U.S. regulators are reportedly considering additional measures that may be used to remove companies such as ZTE and Huawei from the supply chains of U.S. companies.
We are required to comply with various data protection laws and regulations in each of the states and countries where we maintain offices or conduct business, including laws and regulations relating to data privacy, security, and breach notification and reporting. These laws and regulations, known as data protection regulations, are complex, frequently conflict with one another, and have become more onerous in recent years. Complying with existing and future regulatory requirements relating to data privacy, security and breach response could cause us to incur substantial expenses and may require us to change our business practices in a manner that could harm our business and any non-compliance may result in lawsuits, regulatory fines, or other actions or liability. Our business may also be harmed if these privacy-related laws or any newly adopted privacy-related laws are interpreted or implemented in a manner that is inconsistent among different states and countries or inconsistent with our current policies and practices, or those of our customers, suppliers, or other business partners. If we or our suppliers fail to comply with such laws or regulations, we could face sanctions for such noncompliance, and our customers may refuse to purchase our products, which would have a material adverse effect on our business, financial condition and results of operations.
We are also subject to various domestic and international anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, as well as other similar anti-bribery and anti-kickback laws and regulations. These laws and regulations generally prohibit companies and their intermediaries from offering or making improper payments to non-U.S. officials for the purpose of obtaining, retaining or directing business. Our exposure for violating these laws and regulations increases as our international presence expands and as we increase sales and operations in foreign jurisdictions.
The markets in which we operate are highly competitive.
The market for high-speed optical interconnect technology is highly competitive. We are aware of a number of companies that have developed or are developing coherent DSP ASICs, coherent and non-coherent PICs, 100 to 1,200 Gbps and above modules and indium phosphide based optics, among other technologies, that compete directly with some or all of our current and proposed product offerings.
Competitors may be able to more quickly and effectively:
•develop or respond either directly or in partnership with other market participants to new technologies or technical standards;
•react to changing customer requirements and expectations;
•devote needed resources to the development, production, promotion and sale of products;
•attain high manufacturing yields on new product designs;
•establish and take advantage of operations in lower-cost regions;
•bring relevant products to the market or enable their customers to bring relevant products to the market through a faster integration cycle; and
•deliver competitive products, including products incorporating our DSP ASICs and PICs, at lower prices, with lower gross margins or at lower costs than our products.
In order to expand market acceptance of our products, we must differentiate our products from those of our competition while continuing to meet the changing needs of our customers. We cannot provide assurance that we will be successful in making this differentiation or increasing acceptance of our products as we have limited resources dedicated to marketing of our products. In addition, we may take other steps to expand market acceptance of our products, including through strategic transactions or otherwise, which steps may not be successful and may lead to a decrease in our revenues either in the short-term or long-term. The same standardization that allows for the integration of our products into diverse optical systems carries the side effect of lowing the competitive threshold for new market entrants. Established companies in related industries or newly funded companies targeting markets we serve, such as semiconductor manufacturers and data communications providers, may also have significantly more resources than we do and may in the future develop and offer competing products. Further, companies that have historically been competitors or industry participants on the component level have in the past and may continue to establish joint ventures or other strategic partnerships to compete with our products. All of these risks may be increased if the market were to further consolidate through mergers or other business combinations between our competitors or if more capital is invested in the market to create additional competitors.
We may not be able to compete successfully with our competitors and aggressive competition in the market may result in lower prices for our products and/or decreased gross margins. New technology and investments from existing competitors and competitive threats from newly funded companies may erode our technology and product advantages and slow our overall
growth and profitability. Any such development could have a material adverse effect on our business, financial condition and results of operations.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable effort and expense. As a result, our sales and revenue are difficult to predict and may vary substantially from period to period, which may cause our results of operations to fluctuate significantly.
The timing of our sales and revenue recognition is difficult to predict because of the length and unpredictability of our products’ sales cycles. A sales cycle is the period between initial contact with a prospective network equipment manufacturer customer and any sale of our products. Customer orders are complex and difficult to complete because prospective customers generally consider a number of factors over an extended period of time before committing to purchase the products we sell. Customers often view the purchase of our products as a significant and strategic decision and require considerable time to evaluate, test and qualify our products prior to making a purchase decision and placing an order. The length of time that customers devote to their evaluation, contract negotiation and budgeting processes varies significantly. Our products’ sales cycles can be lengthy in certain cases. During the sales cycle, we expend significant time and money on sales and marketing activities and make investments in evaluation equipment, all of which lower our operating margins, particularly if no sale occurs or if the sale is delayed as a result of extended qualification processes or delays from our customers’ customers. Even if a customer decides to purchase our products, there are many factors affecting the timing of our recognition of revenue, which makes our revenue difficult to forecast. For example, there may be unexpected delays in a customer’s internal procurement processes.
Even after a customer makes a purchase, there may be circumstances or terms relating to the purchase that delay our ability to recognize revenue from that purchase. For example, recognizing revenue from the sale of our products may be subject to delivery to the customer or their carrier or the products may be placed into a remote stocking location. In addition, the significance and timing of our product enhancements, and the introduction of new or similar products by our competitors, may also affect customers’ purchases both in the short-term and long-term. Further, our customers’ solutions often require components from other optical providers and any inability by those providers to ship products or maintain continuity of supply could have an impact on the sales of our customers, which impact could pass through to us. For all of these reasons, it is difficult to predict whether a sale will be completed, the particular period in which a sale will be completed or the period in which revenue from a sale will be recognized. If our sales cycles lengthen, our revenue could be lower than expected, which would have an adverse effect on our business, financial condition, results of operations and prospects.
The industry in which we operate is volatile and subject to significant cyclicality.
Industries focused on semiconductor and optical network technologies can be volatile and highly cyclical. The markets are characterized by constant and rapid technological change and price erosion, increasing effects of competition, and frequent new product introductions and technology displacement, including those driven by fragmented and proprietary system designs. The industries are further impacted by evolving technical standards, short product life cycles both for semiconductors and optical technologies and for many of the end products in which they are used, and changes in end market demand, as the industry has recently experienced across China, as well as within inter-data center and metro markets. In addition, product demand in the markets in which we compete is tied to the aggregate capital expenditures of telecommunications and network and content service providers as they build out and upgrade their network infrastructure. Capital expenditures can be highly cyclical due to the importance and focus of local initiatives, such as the ongoing telecommunications build out and upgrade in China and the expansion of the inter-data center market, government funding and other factors, thus resulting in wide fluctuations in product supply and demand. From time to time, these factors, together with changes in general economic conditions, have caused significant industry upturns and downturns that have had a direct impact on the financial stability of our customers, their customers and our suppliers. Periods of industry downturns have been characterized by diminished demand for products, unanticipated declines in telecommunications and communications system capital expenditures, industry consolidation, excess capacity compared to demand, high inventory levels and periods of inventory adjustment, under-utilization of manufacturing capacity, changes in revenue mix and erosion of average selling prices, any of which could result in an adverse effect on our business, financial condition and results of operations. We expect our business to continue to be subject to cyclical downturns, such as the cyclical downturn in China between 2017 and 2019, even when overall economic conditions are relatively stable. Additionally, although conditions in China began to improve in 2019, the impact of COVID-19 on China and the risk of the pandemic returning to China in the future, combined with the impact of governmental policy, has adversely impacted, and may continue to adversely impact, China which may adversely impact overall economic conditions in China and lead to an extended or new cyclical downturn. To the extent we cannot offset recessionary periods or periods of reduced growth that may occur in the industry or in our target markets in particular through increased market share or otherwise, our business can be adversely affected, revenue may decline and our financial condition and results of operations may be harmed. In
addition, in any future economic downturn or periods of inflationary increase we may be unable to reduce our costs quickly enough to maintain profitability levels.
If we fail to attract, retain and motivate key personnel, or if any of our key personnel become ill, are required to self-quarantine or otherwise become unwilling or unable to perform their duties as a result of the COVID-19 pandemic, our business could suffer.
Our business depends on the services of highly qualified employees in a variety of disciplines, including optical systems and networking, digital signal processing, large-scale ASIC design and verification, mixed-signal ASIC design, silicon photonic integration, system software development, hardware design and high-speed electronics design. Our success depends on the skills, experience and performance of these employees and members of our senior management team, as well as our ability to attract and retain other highly qualified management and technical personnel. There is intense competition for qualified personnel in our industry and a limited number of qualified personnel with expertise in the areas that are relevant to our business, and as a result we may not be able to attract and retain the personnel necessary for the expansion and success of our business. Competition for qualified personnel and the ability to attract and onboard such quality personnel may increase, perhaps significantly, as a result of COVID-19 related preventative measures. All of our founders are currently employees of our company. The loss of services of any of our founders, other members of our senior management team or key personnel, or our inability to continue to attract qualified personnel, could have a material adverse effect on our business. In addition, in response to the COVID-19 pandemic, we modified our business practices to include company-wide travel and visitor restrictions, work-from-home policies, social distancing and various other recommended preventive measures. These measures have affected the way we conduct our product development, validation, and qualification, customer support, and other activities, and apply to all our employees worldwide, including our key personnel, some of whom continue to work onsite supporting our business-critical operations. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus, and disruptions to our business operations resulting from illness, quarantines, self-isolation or on the ability of our employees to perform their jobs or work onsite could lead to unavailability of key personnel and could harm our ability to develop and design our products in a timely manner or meet required milestones or customer commitments.
Customer requirements for new products, as well as specifications established by industry groups and standards bodies, are increasingly challenging, which could lead to significant executional risk in designing such products or make our products obsolete. We may incur significant expenses long before we can recognize revenue from new products, if at all, due to the costs and length of research, development and manufacturing process cycles.
Network equipment manufacturers seek increased performance optical interconnect products, at lower prices and in smaller and lower-power designs. These requirements can be technically challenging, and are sometimes customer-specific, which can require numerous design iterations. Because of the increasing level of complexity of design requirements, including stringent customer-imposed acceptance criteria and specifications established by industry groups or standards bodies, executing on our product development goals is difficult and sometimes unpredictable. These difficulties could result in product sampling delays and/or missing targets on key specifications and customer requirements and acceptance criteria. Our failure to meet our customers’ requirements could result in our customers seeking alternative suppliers, which would adversely affect our reputation and results of operations.
We design our products to conform to regulations established by governments and to standards set by industry groups and standards bodies worldwide. Various industry groups are currently considering whether and to what extent to create standards applicable to our current products or those under development. Because certain of our products are designed to conform to current specific industry standards, if competing or new standards emerge that are preferred by our customers, or if our customers prefer a proprietary solution, we may have to make significant expenditures to develop new products. If our customers adopt new or competing industry standards with which our products are not compatible, or industry groups adopt standards or governments issue regulations with which our products are not compatible, our existing products would become less desirable to our customers and our net revenues and results of operations would suffer.
Additionally, we and our competitors often incur significant research and development and sales and marketing costs for products that, at the earliest, will be purchased by our customers long after much of the cost is incurred and, in some cases, may never be purchased due to changes in industry or customer requirements in the interim.
We depend on third parties for a significant portion of the fabrication, assembly and testing of our products.
The fabrication, assembly and testing of our products is done by third-party contract manufacturers, foundries and other service providers. As a result, we face competition for manufacturing capacity in the open market. We rely on foundries to manufacture wafers and on third-party contract manufacturers to assemble, test and manufacture substantially all of our
coherent DSP ASICs, silicon PICs, modules and other components. Our contract manufacturers, foundries and other service providers implement any customer-specific configurations and packaging before customer shipments. Accordingly, we cannot directly control our product delivery schedules and quality assurance. This lack of control has in the past and in the future could result in product shortages or quality assurance problems. For example, we experienced product shortages in the second quarter of 2017 in connection with the Quality Issue. These issues have in the past and in the future could delay shipments of our products, increase our assembly or testing costs or lead to costly epidemic failure claims. In addition, the consolidation of contract manufacturers and foundries, as well as the increasing capital intensity and complexity associated with fabrication in smaller process geometries, has limited the number of available contract manufacturers and foundries and increased our dependence on a smaller number of contract manufacturers and foundries. The limited number of contract manufacturers or foundries could also increase the costs of components or manufacturing and adversely affect our results of operations, including our gross margins. In addition, to the extent we engage additional contract manufacturers or foundries, introduce new products with new manufacturers or foundries, move existing production lines to new manufacturers or foundries and/or vertically integrate processes by assuming new responsibilities internally, we could experience supply disruptions during the transition process.
Further, our third-party contract manufacturers, foundries and other service providers have significant manufacturing operations in China, Singapore, Taiwan, Thailand and the United States, and each of these countries has been affected by the COVID-19 pandemic and have taken and continue to take measures to try to contain it. These measures have in some instances resulted in temporary shutdowns, reduction in capacity utilization and disruption in the movement of components and products through our supply chain. In addition, certain of our third-party contract manufacturers, foundries and other service providers have been and will be disrupted by worker absenteeism, quarantines and travel and health-related restrictions that impact the ability of their facilities to operate at full capacity. While we are staying in close communication with these business partners and acting to mitigate the impact of this dynamic and evolving situation, the duration, nature and extent of the effect of COVID-19 on our supply chain is not determinable and depends on future developments, which are highly uncertain and cannot be predicted.
Because we rely on third-party contract manufacturers, foundries and other service providers, we face several significant risks in addition to those discussed above, including:
•a lack of guaranteed supply of manufactured wafers and other raw and finished components and incorporated products and potential higher wafer, component and incorporated product prices due to limited and, at times, single-source, suppliers and industry-wide component constraints;
•the limited availability of, or potential delays in obtaining access to, key process and leading edge technologies;
•the location of contract manufacturers, foundries and other service providers in regions that are subject to earthquakes, typhoons, tsunamis and other natural disasters;
•the location of contract manufacturers, foundries and other service providers in regions that are and historically have been disproportionately impacted by major public health issues, such as the ongoing COVID-19 pandemic, and our inability to effectively manage, staff and oversee the activities of these providers while COVID-19 related travel bans and restrictions, quarantines, shelter-in-place/stay-at-home and social distancing orders remain in place;
•competition with our contract manufacturers’, foundries’ and other service providers’ other customers for allocated capacity or supply during periods of capacity constraint or supply shortages; and
•potential regulatory changes, including in the United States, that could in the future prohibit, or increase our costs relating to, the use of contract manufacturers, foundries and other service providers in certain regions.
The manufacture of our products is a highly complex and technologically demanding process that utilizes many state of the art manufacturing processes and specialized components. Our foundries, suppliers, and contract manufacturers have from time to time experienced lower than anticipated manufacturing yields for our wafers or PIC components and modules. This often occurs during the production or assembly of new products or the installation and start-up of new process technologies and can occur even in mature processes due to break downs in mechanical systems, process controls, clean room controls, equipment failures, environmental controls and conditions, calibration errors and the handling of the material from station to station as well as damage resulting from the shipment and handling of the products to various points of processing and from changes to and turnover of trained personnel that assemble, test and package our products.
We depend on a limited number of suppliers, some of which are sole sources, and our business could be disrupted if they are unable to meet our needs.
We depend on a limited number of suppliers of the key materials, including silicon wafers, substrate materials and components, equipment used to manufacture and test our products, and key design tools used in the design, testing and manufacturing of our products. Some of these suppliers are sole sources and in certain instances we face capacity competition from some of our suppliers. With some of these suppliers, we do not have long-term agreements and instead purchase materials and equipment through a purchase order process. As a result, these suppliers may stop supplying us materials and equipment, become subject to new regulatory restrictions, delays or fees that impact their ability to work with us, limit the allocation of supply and equipment to us due to increased industry demand or significantly increase their prices at any time with little or no advance notice. Our reliance on sole source suppliers or a limited number of suppliers could result in delivery problems, reduced control over product pricing and quality, and our inability to identify and qualify another supplier in a timely manner. Some of our suppliers may experience quality, manufacturing or financial difficulties that could cause them to terminate development efforts related to, or prevent them from supplying to us in desired quantities, or at all, materials, or equipment used in, the design and manufacture of our products. In addition, our suppliers, including our sole source suppliers, may experience manufacturing delays or shutdowns due to circumstances beyond their control such as labor issues, political unrest, natural disasters or major public health issues. For example, certain of our contract manufacturers and suppliers have experienced manufacturing delays and shutdowns as a result of the ongoing COVID-19 pandemic. Our suppliers, including our sole source suppliers, could also determine to discontinue the manufacture of materials, components, equipment or tools that may be difficult for us to obtain from alternative sources. In addition, the suppliers of design tools that we rely on may not maintain or advance the capabilities of their tools in a manner sufficient to meet the technological requirements for us to design advanced products or provide such tools to us at reasonable prices. Further, the industry in which our suppliers operate is subject to a trend of consolidation. To the extent this trend continues, we may become dependent on even fewer suppliers to meet our material and equipment needs. In the event we need to establish relationships with additional suppliers, doing so may be a time-consuming process and require that we agree to terms, including on costs, that are less favorable to us, and there are no assurances that we would be able to enter into necessary arrangements with these additional suppliers in time to avoid supply constraints in sole sourced components.
Any supply deficiencies or industry allocation shortages relating to the materials, equipment or tools we use to design and manufacture our products could materially and adversely affect our ability to fulfill customer orders and our results of operations. Lead times for the purchase of certain materials, equipment and tools from suppliers have increased and in some instances, have exceeded the lead times provided to us by our customers. In some cases, these lead time increases have limited our ability to respond to or meet customer demand. We have in the past and may in the future, experience delays or reductions in supply shipments, which could reduce our revenue and profitability. In addition, potential regulatory changes, including in the United States, could in the future prohibit, or increase our costs relating to, the use of suppliers in certain regions. If key components or materials are unavailable, our costs would increase and our revenue would decline.
We may not be able to manufacture our products in volumes or at times sufficient to meet customer demands, which could result in delayed or lost revenue and harm to our reputation.
Given the high level of sophisticated functionality embedded in our products, our manufacturing processes are complex and often involve more than one manufacturer. This complexity may result in lower manufacturing yields and may make it more difficult for our current and future contract manufacturers to scale to higher production volumes. In addition, as a result of the ongoing COVID-19 pandemic, certain of our suppliers have shifted some of their manufacturing capacity to the production of personal protective equipment, medical devices or subcomponents and other COVID-19 related activities, which has extended, and could continue to extend, lead times and the overall availability of components and other materials used in the manufacture of our products. If we are unable to manufacture our products in volumes or at times sufficient to meet demand, our customers could postpone or cancel orders or seek alternative suppliers for these products, or lower cost, easier to manufacture competitive products, which would harm our reputation and adversely affect our results of operations.
If our customers do not qualify our manufacturing lines or the manufacturing lines of our subcontractors for volume shipments, our operating results could suffer.
Our manufacturing lines have passed our qualification standards, as well as our technical standards. However, our customers may also require that our manufacturing lines pass their specific qualification standards and that we, and any subcontractors that we may use, be registered under international quality standards. In addition, many of our customers require that we maintain our ISO certification. In the event we are unable to maintain process controls required to maintain ISO certification, or in the event we fail to pass the ISO certification audit for any reason, we could lose our ISO certification. In addition, we may encounter quality control issues in the future as a result of relocating our manufacturing lines or ramping new products to full volume production. We may be unable to obtain customer qualification of our or our subcontractors’ manufacturing lines or we may experience delays in obtaining customer qualification of our or our subcontractors’ manufacturing lines. Such delays or failure to obtain qualifications would harm our operating results and customer
relationships. If we introduce new contract manufacturers and move any production lines from existing internal or external facilities, the new production lines will likely need to be re-qualified with our customers. Any delay in the qualification of our or our subcontractors’ manufacturing lines may adversely affect our operations and financial results. Any delay in the qualification or requalification of our or our subcontractors’ manufacturing lines may delay the manufacturing of our products or require us to divert resources away from other areas of our business, which could adversely affect our operations and financial results.
Our results of operations may suffer if we do not effectively manage our inventory, and we may continue to incur inventory-related charges.
We need to manage our inventory of component parts and finished goods effectively to meet changing customer requirements. Accurately forecasting customers’ product needs is difficult. Our product demand forecasts are based on multiple assumptions, each of which may introduce error into our estimates. In the event we overestimate customer demand or if our customers overstate their demand for our products to us in an attempt to mitigate against potential future COVID-19 related supply shortages, we may allocate resources to manufacturing products that we may not be able to sell. As a result, we could hold excess or obsolete inventory, which would reduce our profit margins and adversely affect our financial results. Conversely, if we underestimate customer demand or if sufficient manufacturing capacity or critical components are unavailable, we could forego revenue opportunities, lose market share and damage our customer relationships.
Also, due to our industry’s use of inventory management techniques, such as direct order fulfillment, to reduce inventory levels and the period of time inventory is held, any disruption in the supply chain could lead to more immediate shortages in product or component supply. Additionally, any enterprise system failures, including implementing new systems or upgrading existing systems that help us manage our financial, purchasing, inventory, sales, invoicing and product return functions, could harm our ability to fulfill orders and interrupt other billing and logistical processes.
Some of our products and supplies have in the past, and may in the future, become obsolete or be deemed excess while in inventory due to rapidly changing customer specifications, changes to product structure, components or bills of material as a result of engineering changes, or a decrease in customer demand. We also have exposure to contractual liabilities to our contract manufacturers for inventories purchased by them on our behalf, based on our forecasted requirements, which may become excess or obsolete. Our inventory balances also represent an investment of cash. To the extent our inventory turns are slower than we anticipate based on historical practice, our cash conversion cycle extends and more of our cash remains invested in working capital. If we are not able to manage our inventory effectively, we may need to write down the value of some of our existing inventory or write off non-saleable or obsolete inventory. We have from time to time incurred significant inventory-related charges and taken excess or obsolete inventory from our contract manufacturers. Incurring any such charges or taking any such inventory in future periods could materially and adversely affect our results of operations.
Certain of our customers may require that we ship our finished products to a central location, which is not controlled by us. If that facility is damaged, or if our relationship with that facility deteriorates, we may suffer losses or be forced to find an alternate facility. In addition, revenue is only recognized once our customers take delivery of the products from this location, rather than when we ship them, which could have an adverse effect on our results of operations. We often lack insight into when customers will take delivery of our products, making it difficult to forecast our revenue.
Our operating history makes it difficult to evaluate our current business and future prospects and may increase the risk associated with investments by investors in our common stock.
We were founded in 2009 and shipped our first products in 2011. Our relatively limited operating history, combined with the rapidly evolving, complex, cyclical and competitive nature and consolidation of our industry, suppliers, manufacturers and customers, make it difficult to evaluate our current business and future prospects. We have encountered and may continue to encounter risks and difficulties frequently experienced by companies in constantly evolving, complex industries, including unpredictable and volatile revenues and increased expenses as we seek to grow our business. If we do not manage these risks and overcome these difficulties successfully, our business, financial condition, results of operations and prospects could be adversely affected, and the market price of our common stock could decline. Further, we have limited historic financial data, and we operate in a rapidly evolving and increasingly competitive market. As such, any predictions about our future revenue and expenses may not be as accurate as they would be if we had a longer operating history or operated in a more predictable market.
Since we began commercial shipments of our products, our revenue, gross profit and results of operations have varied and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control.
It is difficult for us to accurately forecast our future revenue and gross profit and plan expenses accordingly and, therefore, it is difficult for us to predict our future results of operations.
Our revenue growth rate in prior periods is not likely to be indicative of our future growth or performance.
Our revenue growth rate in prior periods is not likely to be indicative of our future growth or performance. During the years ended December 31, 2019 and December 31, 2016, we experienced revenue growth rates of 37% and 100%, respectively, as compared to the immediately preceding annual period, and during the nine months ended September 30, 2020 and 2019 we experienced revenue growth rates of 25% and 44%, respectively, as compared to the same period in the prior year. Conversely, during the years ended December 31, 2018 and 2017, our revenue declined 12% and 19%, respectively, as compared to the immediately preceding annual period. The revenue growth rates we experienced in the years ended December 31, 2019 and December 31, 2016 and the nine months ended September 30, 2020 and 2019 are not likely to be repeated in future periods. Our revenue for any prior annual or quarterly period should not be relied upon as any indication of our future revenue or revenue growth. In addition, the ongoing COVID-19 pandemic will in the short-run and may in the longer term adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect the demand for our products. If we are unable to maintain consistent revenue or revenue growth, our business, financial condition, results of operations and prospects could be materially adversely affected.
We have had a history of operating losses, and we may not maintain or increase our profitability.
Although we were profitable in the nine months ended September 30, 2020 and 2019 and the years ended December 31, 2014 through 2017 and again in the year ended December 31, 2019, we incurred operating losses in the years ended December 31, 2009 through 2013 and again in the year ended December 31, 2018. We may not be able to sustain or increase profitability on a quarterly or annual basis and have experienced variability on a quarter to quarter basis. If we are unable to sustain or increase profitability, the market value of our stock may decline, and investors in our common stock could lose all or a part of their investment.
We may not be able to successfully manage our business if we are unable to maintain our internal systems, processes and controls.
In order to effectively manage our operations and any future growth, we need to continue to maintain our internal systems, processes and controls. Furthermore, in light of the ongoing COVID-19 pandemic, modified processes, procedures and controls may be required to respond to changes in our business environment, as the vast majority of our employees are required to work from home and many onsite locations remain closed. We may not be able to successfully maintain and implement improvements to our internal control systems, processes and controls in an efficient, cost effective or timely manner. In addition, our systems and processes, including any that we adopt in response to COVID-19 related changes in our business environment, may not prevent or detect all errors, omissions or fraud. We may experience difficulties in maintaining and managing improvements to our systems or processes and controls, which could impair our ability to provide products to our customers in a timely manner, causing us to lose customers, limit us to smaller deployments of our products or increase our technical support costs.
If we do not effectively expand and train our direct sales force, we may be unable to add new customers or increase sales to our existing customers, and our business will be adversely affected.
We depend on our direct sales force to increase sales with existing customers and to obtain new customers. As such, we have invested and will continue to invest in our sales organization. In recent periods, we have been adding personnel and other resources to our sales function as we focus on growing our business, entering new markets and increasing our market share, and we expect to incur additional expenses in expanding our sales personnel in order to achieve revenue growth. There is significant competition for sales and sales operations personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, training, retaining and integrating sufficient numbers of sales personnel to support our growth, particularly in international markets. New hires require significant training and may take significant time before they achieve full productivity. Additional personnel may not become productive as quickly as we expect, and we may be unable to hire, retain or integrate into our corporate culture sufficient numbers of qualified individuals in the markets where we do business or plan to do business. If we are unable to hire, integrate and train a sufficient number of effective sales personnel, or the sales personnel we hire are not successful in increasing sales to our existing customer base or obtaining new customers, our business, financial condition, results of operations and prospects will be adversely affected.
Most of our long-term customer contracts do not commit customers to specified purchase commitments, and our customers may decrease, cancel or delay their purchases at any time with little or no advance notice to us.
Most of our customers purchase our products pursuant to individual purchase orders or contracts that do not contain purchase commitments. Although some of our customers have committed, subject to agreed upon terms and conditions, including reschedule and cancellation rights, to purchase a specified share of their required volume for a particular product from us, monitoring and enforcing these commitments can be difficult. Some customers provide us with their expected, non-binding forecasts for our products several months in advance, but customers may decrease, cancel or delay purchase orders already in place, and the impact of any such actions may be intensified given our dependence on a small number of large customers. If any of our major customers decrease, stop or delay purchasing our products, or change the mix of our products that they are purchasing, for any reason, our business and results of operations would be harmed. For example, one of our larger customers provided a non-binding forecast for 2018, but actual orders were approximately 40% lower than the forecasted amount. Also, several of our customers have historically experienced period-to-period demand variability or elected to defer purchases scheduled for the fourth quarter into the first quarter of the following year, resulting in a decrease in our anticipated revenue during the fourth quarter. Our customers often lack visibility to end customer demand, and in the event that any of our customers lose significant market share with one or more end customers, those losses could pass through to us and materially and adversely affect our results of operations. Cancellation or delays of such orders may cause us to fail to achieve our short-term and long-term financial and operating goals and result in excess and obsolete inventory.
Acquisitions or other strategic transactions that we may pursue in the future, whether or not consummated, could result in operating and financial difficulties.
We may in the future acquire businesses or assets or engage in other strategic transactions in an effort to increase our growth, enhance our ability to compete, complement our product offerings, enter new and adjacent markets, obtain access to additional technical resources, enhance our intellectual property rights, expand market acceptance of our products or pursue other competitive opportunities. If we seek acquisitions, we may not be able to identify suitable acquisition candidates at prices we consider appropriate. We are in an industry that is actively consolidating and, as a result, there is no guarantee that we will successfully and satisfactorily bid against third parties, including competitors, if we identify a target we seek to acquire.
We cannot readily predict the timing or size of our future acquisitions or other strategic transactions, or the success of such acquisitions or transactions. Failure to successfully execute on any future acquisition or other strategic transactions could have a material adverse effect on our business, prospects, financial condition and results of operations.
To the extent that we consummate acquisitions, we may face financial risks as a result, including increased costs associated with merged or acquired operations, increased indebtedness, economic dilution to gross and operating profit and earnings per share, or unanticipated costs and liabilities, including the impairment of assets and expenses associated with restructuring costs and reserves, the failure to realize expected synergies and unforeseen accounting charges. We would also face operational risks, such as difficulties in integrating the operations, retention of key personnel and our ability to maintain and support products of the acquired businesses, disrupting their or our ongoing business, increasing the complexity of our business, failing to successfully further develop the combined, acquired or remaining technology, and impairing management resources and management’s relationships with employees and customers as a result of changes in their ownership and management. Further, the evaluation and negotiation of potential acquisitions, as well as the integration of an acquired business, may divert management time and other resources.
If we are unable to successfully carry out any future acquisition or other strategic transaction, our business, financial condition and prospects for growth could suffer. In addition, we may not realize the benefits of any future acquisition or other strategic transaction to the extent anticipated and the perception of the effectiveness of our management team and our company may suffer in the marketplace. Further, even if we are able to achieve the long-term benefits associated with any future acquisition or other strategic transaction, our short-term financial conditions may be materially and adversely affected.
We may need additional equity, debt or other financing in the future, which we may not be able to obtain on acceptable terms, or at all, and any additional financing may result in restrictions on our operations or substantial dilution to our stockholders.
We may need to raise funds in the future, for example, to develop new technologies, expand our business or acquire complementary businesses. We may try to raise additional funds through public or private financings, strategic relationships or other arrangements. Our ability to obtain debt or equity funding will depend on a number of factors, including market conditions, interest rates, our operating performance and investor interest. Further, the COVID-19 pandemic has already caused significant disruptions in the financial markets, and may continue to cause such disruptions, which could impact our ability to
raise additional funds. Additional funding may not be available to us on acceptable terms or at all. If adequate funding is not available, we may be required to reduce expenditures, including curtailing our growth strategies and reducing our product development efforts, or forgo acquisition opportunities. If we succeed in raising additional funds through the issuance of equity or convertible securities, then the issuance could result in substantial dilution to existing stockholders. If we raise additional funds through the issuance of debt securities or preferred stock, these new securities would have rights, preferences and privileges senior to those of the holders of our common stock. In addition, any preferred equity issuance or debt financing that we may obtain in the future could have restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions.
If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our results of operations could fall below expectations of securities analysts and investors, resulting in a decline in the market price of our stock.
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires management to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as described in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q, the results of which form the basis for making judgments about the carrying values of assets, liabilities, equity, revenue and expenses that are not readily apparent from other sources. Significant assumptions and estimates used in preparing our condensed consolidated financial statements include those related to revenue recognition, stock-based compensation, inventories and the related contract manufacturing liabilities and income taxes. If our assumptions change or if actual circumstances differ from those in our assumptions, our results of operations may be adversely affected and may fall below the expectations of securities analysts and investors, resulting in a decline in the market price of our stock.
We may face product liability and other types of claims, which could be expensive and time consuming and result in substantial damages to us and increases in our insurance rates.
Despite quality assurance measures, defects may occur in our products. The occurrence of any defects in our products could give rise to product liability or epidemic failure claims, which could divert management’s attention from our core business, be expensive to defend, result in the loss of key customer contracts and result in sizable damage awards against us and, depending on the nature or scope of any network outage caused by a defect in or epidemic failure related to our products, could also harm our reputation. Our current insurance coverage may not be sufficient to cover these claims. Moreover, in the future, we may not be able to obtain insurance in amount or scope sufficient to provide us with adequate coverage against potential liabilities. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage, could harm our reputation in the industry and reduce product sales. We would need to pay any product losses in excess of our insurance coverage out of cash reserves, harming our financial condition and adversely affecting our financial performance and operating results.
In addition, we have also been forced to expend significant resources in the defense of the matters brought against us as described in Part II, Item 1 “Legal Proceedings” in this Quarterly Report on Form 10-Q, and we may need to continue to do so in the future. Class action, derivative lawsuits and other securities or other litigation, whether successful or not, could result in substantial costs, damage, indemnification or settlement awards and divert management’s attention and resources from running our business, which could materially harm our reputation, financial condition and results of operations.
Our business and operating results may be adversely affected by natural disasters, major public health issues, including the ongoing COVID-19 pandemic, or other catastrophic events beyond our control.
Our internal manufacturing headquarters and new product introduction labs, design facilities, assembly and test facilities, and supply chain, and those of our contract manufacturers, are subject to risks associated with natural disasters, such as earthquakes, fires, tsunami, typhoons, volcanic activity, floods and major public health issues, including pandemics, as well as other events beyond our control such as power loss, facilities structural damage, telecommunications failures, system failures or Internet failures and uncertainties arising out of terrorist attacks in the United States and armed conflicts or terrorist attacks overseas. The majority of our semiconductor products are currently fabricated and assembled in China, Japan, Malaysia, Philippines, Singapore, Taiwan and the United States. The majority of the internal and outsourced assembly and test facilities we utilize or plan to utilize are located in China and Thailand, countries that have been affected by the COVID-19 pandemic and have taken and continue to take measures to try and contain it. There is considerable uncertainty regarding such measures and potential future measures, and restrictions on the ability of our employees to travel to and access these facilities or on our
support operations, or similar limitations imposed on our assembly and fabrication partners, could limit our capacity to meet customer demand and have a material adverse effect on our financial condition and results of operations. Additionally, some of our internal design, assembly and test facilities are located in California (design only), New Jersey and Massachusetts, regions with significant community spread of COVID-19 and a history of severe weather activity and, in the case of California, above average seismic activity and wildfires. Further, our research and development personnel are concentrated primarily in our headquarters in Maynard, Massachusetts and in our research center in Holmdel, New Jersey. Any catastrophic loss or significant disruption or damage to any of these facilities or to any facilities that we use in the future would likely disrupt our operations, delay production, and adversely affect our product development schedules, shipments and revenue. For example, as a result of the extension of the lunar new year holidays in China due to the COVID-19 pandemic, shipments of certain supplies and components used by our contract manufacturers in the manufacture of our products and the operations of our contract manufacturers and other suppliers were disrupted, which resulted in delayed shipment of certain of our products to our customers during the first quarter of 2020. In addition, any such catastrophic loss or significant damage could result in significant expense to repair or replace the facility and could significantly curtail our research and development efforts in a particular product area or primary market, which could have a material adverse effect on our operations and operating results.
Breaches, failures or interruptions of our cybersecurity systems could degrade our ability to conduct our business operations and deliver products to our customers, compromise the integrity of the software embedded in our products, result in significant data losses and the theft of our intellectual property, damage our reputation, expose us to liability to third parties and require us to incur significant additional costs to maintain the security of our networks and data.
We increasingly depend upon our information technology, or IT, systems to conduct virtually all of our business operations, ranging from our internal operations and product development and manufacturing activities to our marketing and sales efforts and communications with our customers and business partners. While we have developed and implemented security measures and internal controls designed to prevent, detect and respond to cyber and other security threats and incidents, such measures cannot guarantee security and may not be successful in preventing security breaches.
In the ordinary course of business, we are subject to and have experienced incursion attempts from a variety of sources, including phishing and malware attacks or other malfeasance. Computer programmers may attempt to penetrate our network security, or that of our website and email services, and misappropriate our proprietary information, provide false or misleading instructions to our personnel, embed malicious code in our products or cause interruptions of our service. Work-from-home and other measures that we have adopted in response to the COVID-19 pandemic introduce additional cybersecurity risks. Because the techniques used by such computer programmers to access or sabotage networks change frequently and may not be recognized until launched against a target, we may be unable to anticipate these techniques. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system. We have also outsourced a number of our business functions to third-party contractors, including our manufacturers and logistics providers, and our business operations also depend, in part, on the success of our contractors’ own cybersecurity measures and adherence to their contractual obligations to us, including in connection with their use of and access to our systems. Additionally, we depend upon our employees, customers, suppliers, manufacturers, contractors and other third parties, or our related parties, to appropriately handle confidential data and deploy our IT resources in a safe and secure fashion that does not expose our network systems to security breaches and the loss of data. Data may be accessed or modified improperly as a result of related party theft, error or malfeasance and third parties may attempt to fraudulently induce our related parties into disclosing sensitive information such as user names, passwords or other information in order to gain access to our data or IT systems or our related parties’ data or IT systems. These types of breaches of our cybersecurity may compromise our confidential information and/or our financial information and adversely affect our business or result in legal proceedings. In addition, if our cybersecurity systems and those of our related parties fail to protect against unauthorized access, sophisticated cyberattacks and the mishandling of data by our related parties, our ability to conduct our business effectively could be damaged in a number of ways, including:
•sensitive data regarding our related parties or business, including intellectual property and other proprietary data, could be stolen;
•our electronic communications systems, including email and other methods, could be disrupted, and our ability to conduct our business operations could be seriously damaged until such systems can be restored;
•our ability to process customer orders and deliver products could be degraded or disrupted, resulting in delays in revenue recognition; and
•defects and security vulnerabilities could be introduced into the software embedded in or used in the development of our products, thereby damaging the reputation and perceived reliability and security of our products.
The steps we have taken to protect our intellectual property rights and data may be inadequate to protect such assets from disclosure or theft by third parties. If unauthorized disclosure or theft were to occur, we might not be able to prevent others from using what we regard as our intellectual property and data to compete with us. Existing trade secret, copyright, patent and trademark laws offer only limited protection. In addition, the laws of some foreign countries do not protect our intellectual property rights and data or allow enforcement of confidentiality covenants to the same extent as the laws of the United States. For example, doing business in China poses risks, including but not limited to, theft of intellectual property and data and potentially different treatment of foreign owned intellectual property rights and data than that owned or developed in China. If we have to resort to legal proceedings to enforce our intellectual property rights or protect our data, the proceedings could be burdensome, protracted and expensive and could involve a high degree of risk and be unsuccessful.
Should any of the above events occur, we could be subject to significant claims for liability from our customers and regulatory actions from governmental agencies, including sanctions and civil or criminal penalties. In addition, our ability to protect our intellectual property rights could be compromised and our reputation and competitive position could be significantly harmed. Additionally, we could incur significant costs in order to upgrade our cybersecurity systems and remediate damages. Consequently, our competitive position, reputation, financial performance and results of operations could be adversely affected.
We are subject to environmental, health and safety laws and regulations, which could subject us to liabilities, increase our costs or restrict our business or operations in the future.
Our operations and our products are subject to a variety of environmental, health and safety laws and regulations in each of the jurisdictions in which we operate or sell our products. These laws and regulations govern, among other things, the handling and disposal of hazardous substances and wastes, employee health and safety and the use of hazardous materials in, and the recycling of, our products. Failure to comply with present and future environmental, health or safety requirements, or the identification of contamination, could cause us to incur substantial costs, monetary fines, civil or criminal penalties and curtailment of operations. In addition, these laws and regulations have increasingly become more stringent over time. The identification of presently unidentified environmental conditions, more vigorous enforcement of current environmental, health and safety requirements by regulatory agencies, the enactment of more stringent laws and regulations or other unanticipated events could restrict our ability to use or expand our facilities, require us to incur additional expenses or require us to modify our manufacturing processes or the contents of our products, which could have a material adverse effect on our business, financial condition and results of operations.
If we do not achieve the anticipated financial, operational and effective tax rate efficiencies expected from our corporate tax structure, our financial condition and results of operations could be adversely affected.
In 2015, we implemented a reorganization of our corporate structure and intercompany relationships to more closely align our corporate structure with the international nature of our business activities. This corporate restructuring has allowed us to achieve financial and operational efficiencies and to reduce our overall effective tax rate through changes in our international procurement, manufacturing and sales operations, and in the ways we develop, own and use certain intellectual property. This corporate restructuring has also allowed us to achieve financial and operational efficiencies.
The Tax Act, enacted in December 2017, made far-ranging changes to the U.S. corporate tax system that previously existed. This legislation established a quasi-territorial system for taxing foreign-source income of multinational corporations and, among other items, made changes to the rules governing taxable and tax-free cross-border transfers of intangible property. Certain changes to the U.S. corporate tax system resulting from the Tax Act, mainly that foreign earnings are no longer deferred but are currently subject to U.S. taxes, have, and are expected to continue to, negatively affect the financial, operational and effective tax rate efficiencies of this corporate restructuring.
We cannot provide assurance that these tax benefits and operational efficiencies will continue into future periods. Our efforts in connection with this corporate restructuring have required and will continue to require us to incur expenses for which we may not realize related benefits. If any of the tax benefits are challenged by the applicable taxing authorities upon audit or if there are adverse changes in domestic or international tax laws, including any legislation enacted in pursuance of the Base Erosion and Profit Shifting Initiative, described below, our results of operations may be negatively affected. In addition, if we do not operate our business in a manner that is consistent with this corporate restructuring or any applicable tax laws, we may fail to achieve the financial, operational and effective tax rate efficiencies that we anticipate and our results of operations may be negatively affected.
The implementation of our corporate restructuring increases the likelihood that unfavorable tax law changes, unfavorable government review of our tax returns, changes in our geographic earnings mix or imposition of withholding taxes on repatriated earnings could have an adverse effect on our effective tax rate and our operating results.
We have expanded and may continue to expand our operations into multiple non-U.S. jurisdictions in connection with our 2015 corporate restructuring, including those having tax rates higher and lower than those we are subject to in the United States. As a result, our effective tax rate will be influenced by the amounts of income and expense attributed to each such jurisdiction, which is materially affected by our valuation and pricing of intercompany transactions, both of which can be based on significant management assumptions or estimates. If such amounts were to change so as to increase the amounts of our net income subject to taxation in higher tax jurisdictions, or if we were to commence operations in jurisdictions assessing relatively higher tax rates, our effective tax rate could be adversely affected. In addition, the COVID-19 pandemic and responsive measures related thereto could materially change the geographic mix of revenue earned in U.S. and non-U.S. jurisdictions, as well as the income and expense attributed to such jurisdictions. As a result, the COVID-19 pandemic and responsive measures related thereto could have a material impact on our effective tax rate. As a result of our corporate restructuring, we will be subject to periodic audits or other reviews by tax authorities in the jurisdictions in which we conduct our activities in the future and there is a risk that the tax authorities could challenge our tax positions, including the assumptions and estimates on which we base the valuation and pricing of intercompany transactions.
The Tax Act established a quasi-territorial system for taxing foreign-source income of multinational corporations and other tax proposals are being considered by legislative bodies in some of the foreign jurisdictions in which we operate that could negatively affect our effective tax rate and other tax liabilities.
We cannot predict the form or timing of potential legislative changes, but any newly enacted tax law could have a material adverse impact on our tax provision, net income and cash flows. This could result in additional tax liabilities or other adjustments to our historical results.
The final determination of our income tax liability may be materially different from our income tax provision.
The final determination of our income tax liability, which includes the impact of our corporate restructuring, may be materially different from our income tax provision. We are subject to income taxes in the United States and, as a result of our corporate restructuring, have become subject to income taxes in international jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are some transactions where the ultimate tax determination is uncertain. Additionally, our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file or will file as a result of the implemented corporate restructuring. Although we believe our tax estimates, which include the impact of anticipated tax benefits in connection with our corporate restructuring, are and will be appropriate, the ultimate tax outcome may materially differ from the tax amounts recorded in our condensed consolidated financial statements and may materially affect our income tax provision, net income or cash flows in the period or periods for which such determination is made.
We are also subject to periodic examination of our income tax returns by the Internal Revenue Service, or IRS, in the United States and will be subject to periodic examination of our income tax and other returns by taxing authorities in other tax jurisdictions. For example, we have been selected for examination by the IRS for our income tax years 2014 through 2017 and by the State of New Jersey for income tax years 2015 through 2017. We assess and will continue to assess on a regular basis the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. The outcomes from these examinations may have an adverse effect on our operating results and financial condition.
Furthermore, our provision for income tax could increase as we further expand our international operations, adopt new products or undertake intercompany transactions in light of acquisitions, changing tax laws, expiring rulings and our current and anticipated business and operational requirements.
Our ability to utilize certain net operating loss carryforwards and tax credit carryforwards may be limited under Sections 382 and 383 of the Internal Revenue Code.
As of December 31, 2019, we had net operating loss carryforward amounts, or NOLs, of approximately $42.4 million and $117.1 million for U.S. federal and state income tax purposes, respectively, and research and development and other credit carryforward amounts of approximately $17.3 million, $21.7 million and $1.3 million for U.S. federal, state and foreign income tax purposes, respectively. The state net operating loss carryforwards and portions of the federal net operating loss carryforward will expire at various dates beginning in 2029 through 2039. Federal net operating loss carryforwards generated after December 31, 2017 are subject to carryforward indefinitely. The federal and state tax credit carryforwards will expire at various dates
beginning in 2020 through 2039 and $0.7 million of such carryforwards will expire between 2020 and 2022 if not used. Utilization of these net operating loss and tax credit carryforward amounts could be subject to a substantial annual limitation if ownership changes under Sections 382 and 383 of the Internal Revenue Code and similar state provisions are triggered by changes in the ownership of our capital stock. Our existing NOLs may be subject to limitations arising from previous ownership changes, including in connection with our initial public offering, or IPO, a follow-on offering in 2016, and any future follow-on public offerings. Future changes in our stock ownership, some of which are outside of our control, could result in an ownership change. There is also a risk that due to regulatory and legislative changes, such as suspensions on the use of NOLs, or other unforeseen reasons, our existing NOLs could expire or otherwise be unavailable to offset future income tax liabilities. Additionally, state NOLs generated in one state generally cannot be used to offset income generated in another state. For these reasons, we may be limited in our ability to fully utilize the tax benefit from the use of our NOLs, even if our profitability would otherwise allow for it.
We are a multinational organization faced with increasingly complex tax issues in many jurisdictions, and we could be obligated to pay additional taxes in various jurisdictions, including in the United States.
As a multinational organization, we are subject to taxation in jurisdictions around the world with increasingly complex tax laws, the application of which can be uncertain. The amount of taxes we pay in these jurisdictions could increase substantially as a result of changes in the applicable tax principles, including increased tax rates, new tax laws or revised interpretations of existing tax laws and precedents, which could have a material adverse effect on our liquidity and operating results. In addition, the authorities in these jurisdictions could review our tax returns and impose additional tax, interest and penalties, and the authorities could claim that various withholding requirements apply to us or our subsidiaries or assert that benefits of tax treaties are not available to us or our subsidiaries, any of which could have a material impact on us and the results of our operations.
There is growing pressure in many jurisdictions (including the United States) and from multinational organizations such as the Organization for Economic Co-operation and Development, or OECD, and the European Union, or EU, to amend existing international tax rules in order to render them more responsive to current global business practices. For example, the OECD has published measures for reform of the international tax rules as a product of its Base Erosion and Profit Shifting, or BEPS, initiative, which aims to standardize and modernize global tax policy and was endorsed by the G20 finance ministers. Many of the initiatives in the BEPS package will require amendments to the domestic tax legislation of various jurisdictions. Separately, the EU is asserting that a number of country-specific favorable tax regimes and rulings in certain member states may violate, or have violated, EU law, and may require some or all of the associated tax benefits to be refunded to the various taxing authorities by benefited taxpayers. Depending on the final form of the BEPS guidance and the legislation ultimately enacted by the OECD members, BEPS could have material adverse consequences on our effective tax rate, the amount of tax we pay and on our financial position and results of operations. Certain changes to the U.S. corporate tax system resulting from the Tax Act, in particular the requirement to subject foreign earnings to U.S. income taxes on a current basis, have had, and are expected to continue to have, a negative effect on our financial, operational and effective tax rate efficiencies.
Other legislative and regulatory proposals, including tax legislation and administrative guidance in response to the COVID-19 pandemic, as well as case law, may also affect our tax position or our business practices and operations, depending on whether and in what form they may ultimately take effect. Although we monitor these developments, due to the unpredictability and interdependency of these potential changes, it is very difficult to assess to what extent these changes may be implemented in the United States and other jurisdictions in which we conduct our business or to what extent these changes may impact the way in which we conduct our business or our effective tax rate due to the unpredictability and interdependency of these potential changes. For example, we have monitored the litigation in Altera Corp v. Commissioner, ultimately concluding that no adjustment is necessary, as described in Note 13, Income Taxes, of the “Notes to Consolidated Financial Statements” contained in Part I, Item 1 of this Quarterly Report on Form 10-Q. Changes in tax laws and related regulations and practices could have a material adverse effect on our business operations, effective tax rate and financial position and results of operations.
We are exposed to credit risk and fluctuations in the market values of our investment portfolio.
Credit ratings and pricing of our domestic and international investments can be negatively affected by liquidity, credit deterioration, financial results, economic risk, political risk, sovereign risk or other factors. As a result, the value and liquidity of our cash, cash equivalents and marketable securities may fluctuate substantially. Further, the COVID-19 pandemic has already caused significant disruptions in the financial markets, and may continue to cause such disruptions, which has adversely impacted, and could continue to adversely impact the return from our portfolio of cash equivalents and marketable securities. Ongoing and future fluctuations in credit ratings and market values could result in significant realized losses in our investment portfolio.
Risks Related to Our Intellectual Property
Our products may infringe the intellectual property rights of others, which could result in expensive litigation or require us to obtain a license to use the technology from third parties, or we may be prohibited from selling certain products in the future.
Companies in the industry in which we operate frequently are sued or receive informal claims of patent infringement or infringement of other intellectual property rights. We have, from time to time, received such claims from companies, including from competitors, suppliers and customers, some of whom have substantially more resources and have been developing relevant technologies for much longer than us.
Third parties may in the future assert claims against us concerning our existing products or with respect to future products under development, or with respect to products that we may acquire through acquisitions. We have entered into and may in the future enter into indemnification obligations in favor of our customers that could be triggered upon an allegation or finding that we are infringing other parties’ proprietary rights. If we do infringe a third party’s rights and are unable to provide a sufficient work around, we may need to negotiate with holders of those rights in order to obtain a license to those rights or otherwise settle any infringement claim. A party that makes a claim of infringement against us may obtain an injunction preventing us from shipping products containing the allegedly infringing technology. We have from time to time received notices from third parties alleging infringement of their intellectual property and, in some cases, have entered into license agreements with such third parties with respect to such intellectual property. Any license agreements that we wish to enter into the future with respect to intellectual property rights may not be available to us on commercially reasonable terms, or at all. Generally, a license, if granted, would include payments of up-front fees, ongoing royalties or both. These payments or other terms, including any that restrict our ability to utilize the licensed technology in specified markets or geographic locations, could have a significant adverse effect on our operating results. In addition, in the event we are granted such a license, it is possible the license would be non-exclusive and other parties, including competitors, may be able to utilize such technology. Our larger competitors may be able to obtain licenses or cross-license their technology on better terms than we can, which could put us at a competitive disadvantage. In addition, our larger competitors may be able to buy such technology and preclude us from licensing or using such technology.
We may not in all cases be able to resolve allegations of infringement through licensing arrangements, settlement, alternative designs or otherwise. We may take legal action to determine the validity and scope of the third-party rights or to defend against any allegations of infringement. Holders of intellectual property rights could become more aggressive in alleging infringement of their intellectual property rights and we may be the subject of such claims asserted by a third party. For example, as described further in Part II, Item 1 “Legal Proceedings” in this Quarterly Report on Form 10-Q, on January 21, 2016, ViaSat, Inc. filed a suit against us alleging, among other things, breach of contract, breach of the implied covenant of good faith and fair dealing and misappropriation of trade secrets. In the course of pursuing any of these means or defending against any lawsuits filed against us, we have incurred, and in the future may continue to incur, significant costs and diversion of our resources and our management’s attention. Due to the competitive nature of our industry, it is unlikely that we could increase our prices to cover such costs. In addition, such claims could result in significant penalties or injunctions that could prevent us from selling some of our products in certain markets or result in settlements or judgments that require payment of significant royalties or damages.
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.
Our future success will depend, in large part, upon our intellectual property rights, including patents, copyrights, design rights, trade secrets, trademarks and know-how. We maintain a program of identifying technology appropriate for patent and trade secret protection. Our practice is to require employees and consultants to execute non-disclosure and proprietary rights agreements upon commencement of employment or consulting arrangements. These agreements acknowledge our exclusive ownership of all intellectual property developed by the individuals during their work for us and require that all proprietary information disclosed will remain confidential. Such agreements may not be enforceable in full or in part in all jurisdictions and any breach could have a negative effect on our business and our remedy for such breach may be limited.
Despite our efforts, these measures can only provide limited protection. Unauthorized third parties may try to copy or reverse engineer portions of our products, may breach our cybersecurity defenses or may otherwise obtain and use our intellectual property. Patents owned by us may be invalidated, circumvented or challenged. Any of our pending or future patent applications, whether or not being currently challenged, may not be issued with the scope of the claims we seek, if at all. Legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in other countries are uncertain and may afford little or no effective protection for our proprietary rights. Consequently, we may be unable to prevent our intellectual property rights from being exploited abroad. Policing the unauthorized use of our proprietary rights is
expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of management resources, either of which could harm our business. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property. If we cannot protect our proprietary technology against unauthorized copying or use, we may not remain competitive.
Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to developing and protecting their technology or intellectual property rights than we do. In addition, our attempts to protect our proprietary technology and intellectual property rights may be further limited as our employees may be recruited by our current or future competitors and may take with them significant knowledge of our proprietary information. Consequently, others may develop services and methodologies that are similar or superior to our services and methodologies or may design around our intellectual property.
We may be subject to intellectual property litigation that could divert our resources.
In recent years, there has been significant litigation involving patents and other intellectual property rights in our industry. As we continue to gain greater market visibility, we face a higher risk of being the subject of intellectual property infringement claims. The risk of patent litigation has been amplified by the increase in the number of a type of patent holder, which we refer to as a non-practicing entity, whose sole business is to assert such claims. We could incur substantial costs in prosecuting or defending any intellectual property litigation. If we sue to enforce our rights or are sued by a third party that claims that our products infringe its rights, the litigation could be expensive and could divert our management resources.
Confidentiality arrangements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.
We have devoted substantial resources to the development of our technology, business operations and business plans. In order to protect our trade secrets and proprietary information, we rely in significant part on confidentiality arrangements with our employees, licensees, independent contractors, advisers, channel partners, resellers and customers. These arrangements may not be effective to prevent disclosure of confidential information, including trade secrets, and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, if others independently discover trade secrets and proprietary information, we would not be able to assert trade secret rights against such parties. Effective trade secret protection may not be available in every country in which our services are available or where we have employees or independent contractors. The loss of trade secret protection could make it easier for third parties to compete with our products by copying functionality. In addition, any changes in, or unexpected interpretations of, the trade secret and employment laws in any country in which we operate may compromise our ability to enforce our trade secret and intellectual property rights. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.
We may be subject to damages resulting from claims that our employees or contractors have wrongfully used or disclosed alleged trade secrets of their former employees or other parties.
We could in the future be subject to claims that employees or contractors, or we, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of our competitors or other parties. Litigation may be necessary to defend against these claims. If we fail in defending against such claims, a court could order us to pay substantial damages and prohibit us from using technologies or features that are essential to our products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of these parties. In addition, we may lose valuable intellectual property rights or personnel. A loss of key personnel or their work product could hamper or prevent our ability to develop, market and support potential products or enhancements, which could severely harm our business. Even if we are successful in defending against these claims, such litigation could result in substantial costs and be a distraction to management.
We license technology from third parties, and our inability to maintain those licenses could harm our business.
We incorporate technology, including software, which we license from third parties into our products. We cannot be certain that our licensors are not infringing the intellectual property rights of third parties or that our licensors have sufficient rights to the licensed intellectual property in all jurisdictions in which we may sell our products. Some of our agreements with our licensors may be terminated for convenience by them. If we are unable to continue to license any of this technology because of intellectual property infringement claims brought by third parties against our licensors or against us, or if we are unable to
continue our license agreements or enter into new licenses on commercially reasonable terms, our ability to develop and sell products containing that technology would be severely limited, and our business could be harmed. Additionally, if we are unable to license necessary technology from third parties, we may be forced to acquire, at the same or higher cost, or expend additional resources to develop alternative technology of lower quality or performance standards. This would limit and delay our ability to offer new or competitive products and increase our costs of production. As a result, our margins, market share and operating results could be significantly harmed.
The use of open source software in our offerings may expose us to additional risks and harm our intellectual property.
Open source software is typically freely accessible, usable and modifiable. Certain open source software licenses require a user who intends to distribute the open source software as a component of the user’s software to disclose publicly part or all of the source code to the user’s software. In addition, certain open source software licenses require the user of such software to make any derivative works of the open source code available to others on unfavorable terms or at no cost. This can subject previously proprietary software to open source license terms.
We monitor and control our use of open source software that goes into or is used by our products in an effort to avoid unanticipated conditions or restrictions on our ability to successfully commercialize our products and believe that our compliance with the obligations under the various applicable licenses has mitigated the risks that we have triggered any such conditions or restrictions. However, such use may have inadvertently occurred in the development and offering of proprietary software on our products. Additionally, if a third-party software provider has incorporated certain types of open source software into software that we have licensed from such third party, we could be subject to the obligations and requirements of the applicable open source software licenses. This could harm our intellectual property position and have a material adverse effect on our business, results of operations and financial condition.
The terms of many open source software licenses have not been interpreted by U.S. or foreign courts, and there is a risk that those licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to successfully commercialize our products. For example, certain open source software licenses may be interpreted to require that we offer the software on our products that include the open source software for no cost; that we make available the source code for modifications or derivative works we create based upon, incorporating or using the open source software (or that we grant third parties the right to decompile, disassemble, reverse engineer, or otherwise derive such source code); that we license such modifications or derivative works under the terms of the particular open source license; or that otherwise impose limitations, restrictions or conditions on our ability to use, license, host, or distribute our products in a manner that limits our ability to successfully commercialize our products.
We could, therefore, be subject to claims alleging that we have not complied with the restrictions or limitations of the applicable open source software license terms or that our use of open source software infringes the intellectual property rights of a third party. In that event, we could incur significant legal expenses, be subject to significant damages, be enjoined from further sale and distribution of the software on our products that uses the open source software, be required to pay a license fee, be forced to reengineer the software on our products, or be required to comply with the foregoing conditions of the open source software licenses (including the release of the source code to our proprietary software), any of which could adversely affect our business. Even if these claims do not result in litigation or are resolved in our favor or without significant cash settlements, the time and resources necessary to resolve them could harm our business, results of operations, financial condition and reputation.
Additionally, the use of open source software can lead to greater risks than the use of third-party commercial software, as open source software does not come with warranties or other contractual protections regarding indemnification, infringement claims or the quality of the code.
Risks Related to the Ownership of Our Common Stock
Our stock price has been and may continue to be volatile and investors in our common stock may be unable to sell their shares at or above the price at which they were purchased.
The trading prices of the securities of technology companies, including technology companies in the industry in which we operate, have been highly volatile. Some of the factors that may cause the market price of our common stock to fluctuate include:
•price and volume fluctuations in the overall stock market from time to time;
•volatility in the market price and trading volume of comparable companies, in particular optical industry peer companies;
•actual or anticipated changes in our earnings or fluctuations in our operating results or in the expectations of securities analysts covering our industry or issuing market projection reports;
•announcements regarding the pending Merger;
•announcements of technological innovations, new products, strategic alliances or other transactions, or significant agreements by us or by our competitors;
•announcements by our customers regarding significant increases or decreases in capital expenditures and their results of operations;
•failure to accurately predict and interpret market requirements or market demand for our products;
•departure of key personnel;
•litigation involving us or that may be perceived as having an impact on our business;
•changes in general economic, industry and market conditions and trends, including the economic slowdown and delayed deployment and network expansion in China and the uncertainty related to Brexit and the COVID-19 pandemic;
•investors’ general perception of us;
•significant short interest in our stock;
•sales of large blocks of our stock;
•loss of any of our key customers;
•a lack of guaranteed supply of manufactured wafers and other raw and finished components and incorporated products;
•announcements regarding further industry consolidation;
•changes in regulations or legislation in the United States and other jurisdictions in which we do business, including domestic and international tax reform, trade policy and tariffs and export controls that could impede our ability to sell our products to our customers in certain foreign jurisdictions, particularly in China, or that could impede sales by such customers in the United States;
•actions or announcements by activist shareholders or others; and
•other factors such as political unrest, terrorist attacks, other hostilities, natural disasters, and potential public health crises, such as the COVID-19 pandemic.
In the past, following periods of volatility in the market price of a company’s securities, securities class action and shareholder derivative litigation has often been brought against that company. Class action and derivative litigation has been initiated against us and certain of our executive officers and directors in the past. Because of the volatility of our stock price, we may become the target of additional securities litigation in the future. Class action, derivative lawsuits and other securities litigation, whether successful or not, could result in substantial costs, damage, indemnification or settlement awards and divert management’s attention and resources from running our business, which could materially harm our reputations, financial condition and results of operations.
Our quarterly operating results or other operating metrics have fluctuated significantly, and they are likely to continue to do so, which could cause the trading price of our common stock to decline.
Our quarterly operating results and other operating metrics have fluctuated in the past and are likely to continue to do so in the future. We expect that this trend will continue as a result of a number of factors, many of which are outside of our control and may be difficult to predict, including:
•the level of demand for our products and our ability to maintain and increase our customer base;
•the timing and success of new product introductions by us or our competitors or any other change in the competitive landscape of our market;
•the mix of products sold in a quarter;
•export control laws, tariffs, developments in trade policy or regulations that could impede our ability to sell our products to certain customers or other customers in certain foreign jurisdictions;
•pricing pressure as a result of competition or otherwise or price discounts negotiated by our customers;
•our ability to ramp production of new products with our contract manufacturers;
•delays or disruptions in our supply or manufacturing chain, including any delays or distributions related to the ongoing COVID-19 pandemic;
•our ability to reduce manufacturing costs;
•errors in our forecasting of the demand for our products, which could lead to lower revenue or increased costs;
•seasonal and period-over-period buying patterns of some of our customers;
•introduction of new products, with initial sales at relatively small volumes with resulting higher product costs;
•increases in and timing of sales and marketing, research and development and other operating expenses that we may incur to grow and expand our operations and to remain competitive;
•insolvency, credit consolidation or other difficulties faced by our customers, affecting their ability to purchase or pay for our products;
•insolvency, credit consolidation or other difficulties confronting our suppliers and contract manufacturers leading to disruptions in our supply or distribution chain;
•levels of product order rescheduling, cancellations, returns and contractual price protection rights, including the impact of product quality problems on our reputation;
•adverse litigation judgments, settlements or other litigation-related costs;
•the pending Merger;
•product recalls, regulatory proceedings or other adverse publicity about our products;
•fluctuations in foreign exchange rates;
•the impact of the Tax Act and other legislative and regulatory proposals to reform U.S. taxation of international business activities;
•costs related to the acquisition of businesses, talent, technologies or intellectual property, including potentially significant amortization costs and possible write-downs; and
•general economic conditions in either domestic or international markets, particularly as a result of the impact of the COVID-19 pandemic and any resulting short-term and potential longer term economic slowdown.
Any one of the factors above or the cumulative effect of some of the factors above may result in significant fluctuations in our operating results.
The variability and unpredictability of our quarterly operating results or other operating metrics could result in our failure to meet our expectations or those of any analysts that cover us or investors in our common stock with respect to revenue or other operating results for a particular period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our common stock could fall substantially, and we could face costly lawsuits, including securities class action suits.
Because we do not expect to pay any dividends on our common stock for the foreseeable future, returns to investors in our common stock will be limited to any increase in the value of our common stock.
We have never paid cash dividends on our common stock and do not anticipate that we will pay any cash dividends to holders of our common stock in the foreseeable future. Instead, we plan to retain any earnings to maintain and expand our existing operations. Accordingly, investors in our common stock must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any return on their investment.
Anti-takeover provisions in our restated certificate of incorporation and our amended and restated by-laws, as well as provisions of Delaware law, might discourage, delay or prevent a change in control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Our restated certificate of incorporation and amended and restated by-laws and Delaware law contain provisions that may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which an investor in our common stock might otherwise receive a premium for their shares of our common stock. These provisions may also prevent or delay attempts by our stockholders to replace or remove our management. Our corporate governance documents include provisions:
•establishing a classified board of directors with staggered three-year terms so that not all members of our board are elected at one time;
•providing that directors may be removed by stockholders only for cause and only with a vote of the holders of at least 75% of the issued and outstanding shares of voting stock;
•limiting the ability of our stockholders to call and bring business before special meetings and to take action by written consent in lieu of a meeting;
•requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors;
•authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock; and
•limiting the liability of, and providing indemnification to, our directors and officers.
As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which limits the ability of stockholders holding more than 15% of our outstanding voting stock from engaging in certain business combinations with us. Any provision of our amended and restated certificate of incorporation or amended and restated by-laws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors in our common stock are willing to pay for our common stock.
The existence of the foregoing provisions and anti-takeover measures could limit the price that investors in our common stock might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that an investor in our common stock could receive a premium for their common stock in an acquisition.
Our restated certificate and our amended and restated by-laws provide that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our restated certificate and our amended and restated by-laws provide that the Court of Chancery of the State of Delaware (or, in the case of our by-laws, if the Court of Chancery does not have jurisdiction, the United States District Court for the District 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 certificate of incorporation or our by-laws; or any action asserting a claim against us that is governed by the internal affairs doctrine; and our by-laws provide that such court is the exclusive forum for any action against us or any director or officer or other employee of ours to interpret, apply, enforce or determine the validity of our certificate of incorporation or our by-laws. The choice of forum provision 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 such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation or our by-laws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.
We have incurred and expect that we will continue to incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies. These increased costs and demands could adversely affect our business, operating results and financial condition.
As a public company, we will continue to incur significant legal, accounting and other expenses. We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the rules and regulations of the Nasdaq Global Select Market and other applicable securities rules and regulations impose various requirements on public companies, including establishment and maintenance of effective disclosure and financial controls and corporate governance practices. These requirements have increased and will continue to increase our
legal, accounting and financial compliance costs and have made and will continue to make some activities more time consuming and costly.
The Sarbanes-Oxley Act requires, among other things, that we assess the effectiveness of our internal control over financial reporting annually and the effectiveness of our disclosure controls and procedures quarterly. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, we are required to furnish a report by our management on the effectiveness of our internal control over financial reporting and an attestation report on internal control over financial reporting issued by our independent registered public accounting firm. Compliance with Section 404, including documentation and evaluation of our internal control over financial reporting is both costly and challenging. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would require additional financial and management resources and could adversely affect the market price of our common stock.
Furthermore, investor perceptions of our company may suffer if deficiencies are found, and this could cause a decline in the market price of our stock. Irrespective of compliance with Section 404, any failure of our internal control over financial reporting could have a material adverse effect on our stated operating results and harm our reputation.
In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations, and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We have and will continue to invest resources to comply with evolving laws, regulations and standards, and this investment has and may result in increased general and administrative expense and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies, regulatory authorities may initiate legal proceedings against us and our business may be harmed.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
ITEM 3. Defaults Upon Senior Securities.
None.
ITEM 4. Mine Safety Disclosures.
Not applicable.
ITEM 5. Other Information.
None.