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INFINERA CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include our expectations regarding earnings, revenue, gross margin, expenses, cash flows and other financial items; any statements of the plans, strategies and objectives of management for future operations and personnel; factors that may affect our operating results; anticipated customer activity; statements concerning new products or services, including new product costs, delivery dates and revenue; statements related to capital expenditures; statements related to future economic conditions, performance, market growth or our sales cycle; statements related to our convertible senior notes; statements related to the effects of litigation on our financial position, results of operations or cash flows; statements related to the timing and impact of transfer pricing reserves; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing. These statements are often identified by the use of words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," or "will," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included elsewhere in this Form 10-Q and in our other SEC filings, including our Annual Report on Form 10-K for the fiscal year ended December 28, 2013 filed on February 21, 2014. Such forward-looking statements speak only as of the date of this report. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Overview We were founded in December 2000 with a unique vision for optical networking. Prior to this, communications service provider optical networks were built from fairly commoditized products, broadly known as wavelength division multiplexing ("WDM") systems. The continued growth in bandwidth demand has increased the need for the delivery of high-capacity low-cost bandwidth throughout the network. We believe that in many cases, traditional point-to-point network architectures do not provide the required flexibility to meet this demand. It takes large amounts of low-cost bandwidth, pervasive Optical Transport Network ("OTN") switching, and the intelligence of bandwidth management to manage these larger networks and deliver high-capacity services quickly and cost-effectively. We believe this can best be achieved with photonic integrated circuits ("PICs") and that only through photonic integration can network operators efficiently scale their network bandwidth without significant increases in space, power or operational workload. We provide optical transport networking equipment, software and services to telecommunications service providers, internet content providers, cable operators, and wholesale network operators, including subsea network operators (collectively, "Service Providers") across the globe. Optical transport networks are deployed by Service Providers facing significant demands for transmission capacity prompted by increased use of high-speed Internet access, mobile broadband, high-definition video streaming services, business Ethernet services, cloud-based services and wholesale bandwidth services. The Infinera Intelligent Transport Network is an architecture for Service Providers to address the increasing demand for cloud-based services and data center connectivity. This architectural approach helps Service Providers use time as a weapon to increase revenues with reliable, differentiated services while reducing operating costs through scale, multi-layer convergence and automation. The Infinera Intelligent Transport Network is based on platforms built with our unique PICs. As traffic patterns in the optical network continue to grow to accommodate increased demands for transmission capacity, we believe that the Infinera Intelligent Transport Network architecture is uniquely enabled to deliver improvements in these areas compared to competitive WDM systems that still rely on discrete optical components rather than PICs. We also believe that this enables Service Providers to deploy reliable, high-capacity, efficient optical network solutions that are easy to use and to improve the integration between the layers of Service Provider networks with the lowest total cost of ownership. 23-------------------------------------------------------------------------------- Table of Contents Our DTN platform currently supports 10 Gigabits per second ("Gbps") and 40 Gbps WDM transmission capacity combined with integrated switching capabilities. Our DTN-X platform supports 100 Gbps WDM transmission capacity with 500 Gbps super-channels and also integrates 5 Terabits per second of OTN switching capacity in a single bay. The DTN-X platform leverages the unique capabilities of our 500 Gbps PICs to deliver high-capacity Intelligent Transport Networks that reduce power, cooling and space, while simplifying transport network operations. Our ATN platform supports direct wavelength connectivity to DTN and DTN-X nodes, reducing equipment costs and providing unique network management capabilities across our Intelligent Transport Network. As of September 27, 2014, we have sold our network systems for deployment in the optical networks of 136 customers worldwide, including CenturyLink, Colt, Cox Communications, DANTE, Deutsche Telekom, Equinix, Interoute, KDDI, Level 3, NTT, OTE, Pacnet, Rostelecom, Telefonica, TeliaSonera International Carrier, Vodafone and XO Communications. Since the commencement of shipping our DTN-X platform in the second quarter of 2012, we have 49 customers who have purchased our DTN-X platform. In September 2014, we introduced the Infinera Cloud Xpress ("CX") family of metro optical platforms, designed for network operators delivering cloud-based services to consumers and businesses worldwide. The CX platform is optimized for the metro cloud, the transport network that interconnects multiple data centers within a metro area. We anticipate commencing shipments of our CX platform in the fourth quarter of 2014. We do not have long-term sales commitments from our customers. To date, a few of our customers have accounted for a significant portion of our revenue. One customer accounted for over 10% of our revenue in the third quarter of 2014, and three customers each accounted for over 10% of our revenue in the corresponding period in 2013. One customer accounted for over 10% of our revenue in the nine months ended September 27, 2014, and no single customer accounted for over 10% of our revenue in the corresponding period in 2013. We are headquartered in Sunnyvale, California, with employees located throughout the Americas, Europe and the Asia Pacific region. We expect to continue to add personnel in the United States and internationally to develop our products and provide additional geographic sales and technical support coverage. We primarily sell our products through our direct sales force, with a small portion sold indirectly through resellers. We derived 97% of our revenue from direct sales to customers in each of the three and nine month periods ended September 27, 2014, respectively, and 96% and 94% of our revenue for the three and nine months ended September 28, 2013, respectively. Our strategy is to leverage channel partners where appropriate to expand our presence in certain geographies and markets; however, we expect to continue generating a substantial majority of our revenue from direct sales. As we move forward with a broader product offering, we will evaluate using more indirect sales channels to maximize the potential sales of our products. In the remainder of 2014, our goal is to continue our growth in the 100 Gbps technology cycle with additional network builds to both new and existing customers. We also anticipate customers who deployed the DTN-X platform over the past two years to buy additional capacity for their networks, which if they do, will drive additional revenue. In addition, as manufacturing volumes continue to grow, we expect to gain financial leverage from our manufacturing assets, which along with increased capacity sales, will also improve gross margin levels. We anticipate generating positive cash flows over the remainder of the fiscal year. Our year-over-year and quarter-over-quarter revenue will likely be volatile and may be impacted by several factors including general economic and market conditions, time-to-market development of new products, acquisitions of new customers, spending patterns of existing customers and the timing of large product deployments. Critical Accounting Policies and Estimates Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our condensed consolidated financial statements, which we have prepared in accordance with the U.S. generally accepted accounting principles ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates, assumptions and judgments that can affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. 24-------------------------------------------------------------------------------- Table of Contents An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes that there have been no significant changes during the nine months ended September 27, 2014 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013. Results of Operations The following sets forth, for the periods presented, certain unaudited condensed consolidated statements of operations information (in thousands, except percentages): Three Months Ended September 27, 2014 September 28, 2013 % of total % of total Amount revenue Amount revenue Change % Change Revenue: Product $ 147,178 85 % $ 121,332 85 % $ 25,846 21 % Services 26,381 15 % 20,688 15 % 5,693 28 % Total revenue $ 173,559 100 % $ 142,020 100 % $ 31,539 22 % Cost of revenue: Product $ 86,703 50 % $ 66,685 47 % $ 20,018 30 % Services 11,554 7 % 6,964 5 % 4,590 66 % Total cost of revenue $ 98,257 57 % $ 73,649 52 % $ 24,608 33 % Gross profit $ 75,302 43 % $ 68,371 48 % $ 6,931 10 % Nine Months Ended September 27, 2014 September 28, 2013 % of total % of total Amount revenue Amount revenue Change % Change Revenue: Product $ 413,784 86 % $ 350,322 86 % $ 63,462 18 % Services 67,989 14 % 54,708 14 % 13,281 24 % Total revenue $ 481,773 100 % $ 405,030 100 % $ 76,743 19 % Cost of revenue: Product $ 251,047 52 % $ 222,330 55 % $ 28,717 13 % Services 26,765 6 % 19,973 5 % 6,792 34 % Total cost of revenue $ 277,812 58 % $ 242,303 60 % $ 35,509 15 % Gross profit $ 203,961 42 % $ 162,727 40 % $ 41,234 25 % Revenue Total revenue increased by $31.5 million, or 22%, during the three months ended September 27, 2014 compared to the corresponding period in 2013 and increased by $76.7 million, or 19%, during the nine months ended September 27, 2014 compared to the corresponding period in 2013. Total product revenue increased by $25.8 million, or 21%, during the three months ended September 27, 2014 compared to the corresponding period in 2013 as a result of growth in DTN-X deployments across multiple customer verticals as the 100G cycle continued to be strong. We continue to see customers adding new routes and additional capacity to their existing networks. Total product revenue increased by $63.5 million, or 18%, during the nine months ended September 27, 2014 compared to the corresponding period in 2013. This increase was driven by stronger demand as our customers 25-------------------------------------------------------------------------------- Table of Contents continued to deploy our products to meet the growing bandwidth needs of their networks. In addition, we continued to win opportunities with new customers. Total services revenue increased by $5.7 million, or 28%, during the three months ended September 27, 2014 compared to the corresponding period in 2013. Total services revenue increased by $13.3 million, or 24%, during the nine months ended September 27, 2014 compared to the corresponding period in 2013. The increase in both the quarter and year-to-date periods of fiscal 2014 was due to higher levels of deployment services as customers built out new networks utilizing our teams' expertise as well as higher on-going support services as we continued to grow our installed base. The following table summarizes our revenue by geography and sales channel for the periods presented (in thousands, except percentages): Three Months Ended September 27, 2014 September 28, 2013 % of total % of total Amount revenue Amount revenue Change % Change Total revenue by geography: Domestic $ 120,769 70 % $ 103,113 73 % $ 17,656 17 % International 52,790 30 % 38,907 27 % 13,883 36 % $ 173,559 100 % $ 142,020 100 % $ 31,539 22 % Total revenue by sales channel: Direct $ 167,512 97 % $ 135,699 96 % $ 31,813 23 % Indirect 6,047 3 % 6,321 4 % (274 ) (4 )% $ 173,559 100 % $ 142,020 100 % $ 31,539 22 % Nine Months Ended September 27, 2014 September 28, 2013 % of total % of total Amount revenue Amount revenue Change % Change Total revenue by geography: Domestic $ 367,802 76 % $ 270,437 67 % $ 97,365 36 % International 113,971 24 % 134,592 33 % (20,621 ) (15 )% $ 481,773 100 % $ 405,029 100 % $ 76,744 19 % Total revenue by sales channel: Direct $ 468,295 97 % $ 378,780 94 % $ 89,515 24 % Indirect 13,478 3 % 26,249 6 % (12,771 ) (49 )% $ 481,773 100 % $ 405,029 100 % $ 76,744 19 % Our revenue in North America continued to grow as many of our large customers are based in this region. As a result, North America represented the majority of our revenue, accounting for 70% of total revenue in the three months ended September 27, 2014. After a relatively soft first half of fiscal 2014, our international revenue increased by $13.9 million to 30% of total revenue for the three months ended September 27, 2014 from 27% of total revenue in the corresponding period in 2013. The Europe, Middle East and Africa region was the strongest as several customers made the decision to expand their networks utilizing our solution. During the nine months ended September 27, 2014, our revenue in North America represented 76% of total revenue. Our international revenue decreased by $20.6 million to 24% of total revenue for the nine months ended September 27, 2014 from 33% of total revenue in the corresponding period in 2013. International revenue decreased as a percentage of total revenue during the nine months ended September 27, 2014 due to strong demand within North America. International revenue decreased in absolute dollars during the nine months ended September 27, 2014 due to relative weakness during the first half of 2014 as compared to particularly strong demand in Europe during the nine months ended September 28, 2013. We believe that our DTN-X platform is well positioned as existing customers continue to build out their networks and as we gain opportunities to deploy our products with new customers. We continue to see strong 26-------------------------------------------------------------------------------- Table of Contents demand across multiple regions and customer verticals. As a result, we currently expect that these dynamics will drive our revenue slightly higher in the fourth quarter of 2014 on a sequential basis and represent significant year-over-year growth. Cost of Revenue and Gross Margin Gross margin decreased to 43% in the three months ended September 27, 2014 from 48% in the corresponding period of 2013. The decrease was primarily driven by a greater mix of lower margin network footprint sales during the three months ended September 27, 2014. Gross margin increased to 42% in the nine months ended September 27, 2014 from 40% in the corresponding period of 2013. This increase was primarily due to leverage gained from our vertically integrated operating model as volumes continue to grow and an improved ratio of capacity additions to existing networks versus new network builds. Based on our current outlook, we expect that gross margin in the fourth quarter of 2014 will be consistent with the prior quarter as we anticipate continued manufacturing leverage associated with higher volumes as well as favorable mix of additional capacity versus new network builds. Operating Expenses The following tables summarize our operating expenses for the periods presented (in thousands, except percentages): Three Months Ended September 27, 2014 September 28, 2013 % of total % of total Amount revenue Amount revenue Change % Change Operating expenses: Research and development $ 35,051 20 % $ 32,528 23 % $ 2,523 8 % Sales and marketing 20,794 12 % 17,720 13 % 3,074 17 % General and administrative 11,977 7 % 11,678 8 % 299 3 % Total operating expenses $ 67,822 39 % $ 61,926 44 % $ 5,896 10 % Nine Months Ended September 27, 2014 September 28, 2013 % of total % of total Amount revenue Amount revenue Change % Change Operating expenses: Research and development $ 96,135 20 % $ 93,935 23 % $ 2,200 2 % Sales and marketing 56,738 12 % 52,921 13 % 3,817 7 % General and administrative 36,612 8 % 32,976 8 % 3,636 11 % Total operating expenses $ 189,485 40 % $ 179,832 44 % $ 9,653 5 % Research and Development Expenses Research and development expenses increased by $2.5 million, or 8%, during the three months ended September 27, 2014 compared to the corresponding period in 2013 primarily due to increased compensation costs of $3.0 million as we have increased headcount to drive our future product roadmap. In addition, we had increased facilities and depreciation costs of $1.2 million, and discretionary spend of $0.6 million in order to support our growing business. These increases were primarily offset by $2.3 million of decreased prototype and non-recurring engineering expenses due to the timing of certain projects. 27-------------------------------------------------------------------------------- Table of Contents Research and development expenses increased by $2.2 million, or 2%, during the nine months ended September 27, 2014 compared to the corresponding period in 2013 primarily due to increased compensation costs of $3.8 million as we have increased headcount to drive our future product roadmap. In addition, we had increased facilities and depreciation costs of $2.2 million, increased costs of professional outside services of $1.1 million, and increased other discretionary spending of $0.6 million in order to support our growing business. These increases were partially offset by a decrease in prototype and non-recurring engineering expense of $3.8 million due to timing of certain projects and decreased stock-based compensation expense of $1.7 million due to lower equity activity as compared to the corresponding period in the prior year. Sales and Marketing Expenses Sales and marketing expenses increased by $3.1 million, or 17%, during the three months ended September 27, 2014 compared to the corresponding period in 2013 primarily due to increased compensation costs of $1.2 million due to higher headcount to support the continued expansion of our business and higher sales commissions associated with revenue growth. We also had increased expenses related to customer lab trials of $0.7 million and increased trade show and other marketing related expenses of $0.7 million as we are launching new products and preparing to address new markets. In addition, we had $0.5 million of higher discretionary spending in order to support our growing business. Sales and marketing expenses increased by $3.8 million, or 7%, during the nine months ended September 27, 2014 compared to the corresponding period in 2013 primarily due to increased compensation costs of $1.7 million due to higher headcount to support the continued expansion of our business and higher sales commissions associated with revenue growth. We also had increased travel, trade show and other marketing related expenses of $1.6 million and other discretionary spending of $0.5 million in order to support our growing business. General and Administrative Expenses General and administrative expenses increased by $0.3 million, or 3%, during the three months ended September 27, 2014 compared to the corresponding period in 2013 primarily due to higher compensation and personnel-related costs of $0.7 million, and other discretionary spending of $0.1 million. These increases were partially offset by decreased costs of legal fees of $0.5 million as litigation activity has declined. General and administrative expenses increased by $3.6 million, or 11%, during the nine months ended September 27, 2014 compared to the corresponding period in 2013 primarily due to higher compensation and personnel-related costs of $2.8 million due to an increase in headcount as we continue to grow our team to support our growing business. In addition, we had increased costs of professional outside services of $0.6 million and increased equipment and software costs of $0.6 million. These increases were partially offset by decreased depreciation expense of $0.4 million. Other Income (Expense), Net Three Months Ended Nine Months Ended September 27, September 28, September 27, September 28, 2014 2013 Change % Change 2014 2013 Change % Change (In thousands) Interest income $ 373 $ 232 $ 141 61 % $ 1,046 $ 636 $ 410 64 % Interest expense (2,781 ) (2,578 ) (203 ) 8 % (8,186 ) (3,427 ) (4,759 ) 139 % Other gain (loss), net (24 ) (444 ) 420 (95 )% (1,017 ) (805 ) (212 ) 26 % Total other income (expense), net $ (2,432 ) $ (2,790 ) $ 358 (13 )% $ (8,157 ) $ (3,596 ) $ (4,561 ) 127 % Interest income increased by $0.1 million and $0.4 million during the three and nine months ended September 27, 2014, respectively, compared to the corresponding periods in 2013. These increases were primarily driven by a higher investment balance as a result of both our cash generated from operations over the past year and the proceeds from the issuance in May 2013 of $150.0 million aggregate principal amount of 1.75% convertible senior notes due June 1, 2018 (the "Notes"). 28-------------------------------------------------------------------------------- Table of Contents Interest expense for the three and nine months ended September 27, 2014 consisted of cash interest payments and amortization of discount and issuance costs related to the Notes. The nine months ended September 28, 2013 had significantly lower interest expense as the Notes were not issued until May 2013. The change in other gain (loss), net, for the three months ended September 27, 2014 as compared to the same period of 2013 was primarily due to an decrease in foreign currency transaction losses. The change in other gain (loss), net, for the nine months ended September 27, 2014 as compared to the same period of 2013 was primarily due to a $0.2 million gain from the disposal of our remaining auction rate securities. Income Tax Provision Provision for income taxes for the three and nine months ended September 27, 2014 was $0.2 million and $1.1 million, respectively, on pre-tax income of $5.0 million and $6.3 million, respectively. This compared to a tax provision of $0.3 million and $1.2 million, respectively, on a pre-tax income of $3.7 million and a pre-tax loss of $20.7 million, respectively, for the three and nine months ended September 28, 2013. In all periods, the tax expense primarily represents foreign taxes of our overseas subsidiaries compensated on a cost plus basis and remains relatively similar in all periods, regardless of the level of consolidated earnings. Because of our significant loss carryforward position and corresponding full valuation allowance, we have not been subject to federal or state tax on our U.S. income because of the availability of loss carryforwards, with the exception of nominal amounts of state taxes for which the losses are limited by statute. The release of transfer pricing reserves in the future will have a beneficial impact to tax expense, but the timing of the impact depends on factors such as expiration of the statute of limitations or settlements with tax authorities. No significant releases are expected in the near future based on information available at this time. Liquidity and Capital Resources Nine Months Ended September 27, September 28, 2014 2013 (In thousands) Net cash flow provided by (used in): Operating activities $ 17,237 $ 9,395 Investing activities $ (48,443 ) $ (140,030 ) Financing activities $ 17,837 $ 164,479 September 27, December 28, 2014 2013 (In thousands) Cash and cash equivalents $ 110,864 $ 124,330 Short-term and long-term investments 262,599 237,079 Long-term restricted cash 4,224 3,904 $ 377,687 $ 365,313 Cash, cash equivalents and short-term investments consist of highly-liquid investments in certificates of deposits, money market funds, commercial paper, corporate bonds and U.S. treasuries. Long-term investments primarily consist of corporate bonds. The restricted cash balance amounts are primarily pledged as collateral for certain stand-by and commercial letters of credit related to customer proposal guarantees, value added tax licenses and property leases. Operating Activities Net cash provided by operating activities for the nine months ended September 27, 2014 was $17.2 million as compared to $9.4 million for the corresponding period in 2013. Net income for the nine months ended September 27, 2014 was $5.2 million, which included non-cash charges of $49.1 million, compared to a net loss of $21.9 million for the corresponding period in 2013, which included non-cash charges of $45.5 million. 29-------------------------------------------------------------------------------- Table of Contents Net cash used to fund working capital was $37.2 million for the nine months ended September 27, 2014. Accounts receivables increased by $35.5 million due to the higher revenue levels and the timing of invoicing of network deployments and collections during the period. Inventory increased by $9.0 million in order to support the higher revenue levels. Accounts payable increased by $11.0 million primarily reflecting increased inventory purchases and timing of payments during the period. Net cash used to fund working capital was $14.2 million for the nine months ended September 28, 2013. Accounts receivables decreased by $19.8 million primarily due to improved linearity of shipments. Inventory increased by $3.6 million to support the growing revenue levels. Accounts payable decreased by $30.6 million primarily reflecting the timing of inventory purchases and improved linearity of supply during the period. Investing Activities Net cash used in investing activities in the nine months ended September 27, 2014 was $48.4 million compared to net cash used in investing activities of $140.0 million in the corresponding period of 2013. Investing activities for the nine months ended September 27, 2014 included net cash used of $28.3 million associated with purchases, maturities and sales of investments and $14.4 million of capital expenditures in the period. We also invested an additional $5.5 million in an existing cost-method equity investment during the third quarter of 2014. Net cash used in investing activities for the nine months ended September 28, 2013 included $126.5 million from purchases, maturities, calls and sales of investments in the period, and $13.6 million of capital expenditures. The increase in net cash used in investing activities during the nine months ended September 28, 2013 was primarily related to the investment of the proceeds received from the issuance of the Notes. Financing Activities Net cash provided by financing activities in the nine months ended September 27, 2014 was $17.8 million compared to $164.5 million in the corresponding period of 2013. Financing activities for the nine months ended September 27, 2014 and the corresponding period in 2013 included net proceeds from the exercise of stock options and issuance of shares under the employee stock purchase plan ("ESPP"). These proceeds were offset by the minimum tax withholdings paid on behalf of employees for net share settlements of restricted stock units. Financing activities for the nine months ended September 28, 2013 also included net proceeds from the issuance of the Notes of $144.5 million. Liquidity We believe that our current cash, cash equivalents and investments, together with cash generated from operations, exercise of employee stock options and purchases under our ESPP will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. If these sources of cash are insufficient to satisfy our liquidity requirements beyond 12 months, we may require additional capital from equity or debt financings to fund our operations, to respond to competitive pressures or strategic opportunities, or otherwise. We may not be able to secure timely additional financing on favorable terms, or at all. The terms of any additional financing may place limits on our financial and operating flexibility. If we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer dilution in their percentage ownership of us, and any new securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. In May 2013, we issued the Notes, which will mature on June 1, 2018, unless earlier purchased by us or converted. Interest is payable semi-annually in arrears on June 1 and December 1 of each year, commencing December 1, 2013. The net proceeds from the Notes issuance were approximately $144.5 million and intended to be used for working capital and other general corporate purposes. Upon conversion, it is our intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the Notes as cash, shares of common stock or a combination of cash and shares of common stock, at our election, for any remaining conversion obligation. The carrying value of the Notes was $114.9 million as of September 27, 2014, which represents the liability component of the $150.0 million principal balance, net of a $35.1 million debt discount. The debt discount is currently being amortized over the remaining term until maturity of the Notes on June 1, 2018. Any future redemption or conversion of the Notes could impact the timing of the repayment of these Notes. As of September 27, 2014, contractual obligations related to the Notes are payments of $1.3 million due within 2014, $2.6 million due each year from 2015 through 2017 and $151.3 million due in 2018. These amounts represent 30-------------------------------------------------------------------------------- Table of Contents principal and interest cash payments over the term of the Notes. Any future redemption or conversion of the Notes could impact the amount or timing of our cash payments. For more information regarding the Notes, see Note 9, "Convertible Senior Notes," to the Notes to Condensed Consolidated Financial Statements. As of September 27, 2014, we had $317.6 million of cash, cash equivalents, and short-term investments, including $16.8 million of cash and cash equivalents held by our foreign subsidiaries. Our cash in foreign locations is used for operational and investing activities in those locations, and we do not currently have the need or the intent to repatriate those funds to the United States. Our policy with respect to undistributed foreign subsidiaries' earnings is to consider those earnings to be indefinitely reinvested. If we were to repatriate these funds, we would be required to accrue and pay U.S. taxes on such amounts, however, due to our significant net operating loss carryforward position for both federal and state tax purposes, as well as the full valuation allowance provided against our U.S. and state net deferred tax assets, we would currently be able to offset any such tax obligations in their entirety. However, foreign withholding taxes may be applicable. Off-Balance Sheet Arrangements As of September 27, 2014, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Item 3. Quantitative and Qualitative Disclosures about Market Risk For quantitative and qualitative disclosures about market risk affecting us, see "Quantitative and Qualitative Disclosures About Market Risk" in Item 7A. of Part II of our Annual Report on Form 10-K for the fiscal year ended December 28, 2013, which is incorporated herein by reference. Our exposure to market risk has not changed materially since December 28, 2013. Market Risk and Market Interest Risk Holders may convert the Notes prior to maturity upon the occurrence of certain circumstances. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election. As of September 27, 2014, the fair value of the Notes was $167.3 million. The fair value was determined based on the quoted bid price of the Notes in an over-the-counter market on September 26, 2014. The fair value of the Notes is subject to interest rate risk, market risk and other factors due to the convertible feature. The fair value of the Notes will generally increase as interest rates fall and decrease as interest rates rise. In addition, the fair value of the Notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines in value. The interest and market value changes affect the fair value of the Notes but do not impact our financial position, cash flows or results of operations due to the fixed nature of the debt obligation. Additionally, we do not carry the Notes at fair value. We present the fair value of the Notes for required disclosure purposes only. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures An evaluation was performed by management, with the participation of our chief executive officer ("CEO") and our chief financial officer ("CFO"), of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d -15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")). Disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Based on this evaluation, our CEO and CFO have concluded that, as of the end of the fiscal period covered by this quarterly report on Form 10-Q, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms and that such information is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosures. 31 -------------------------------------------------------------------------------- Changes in Internal Control over Financial Reporting There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the three months ended September 27, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Inherent Limitations of Internal Controls Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within us have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. 32-------------------------------------------------------------------------------- Table of Contents |