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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 24, 2016
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number: 001-33486
Infinera Corporation

(Exact name of registrant as specified in its charter)
Delaware
 
77-0560433
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
140 Caspian Court
Sunnyvale, CA 94089
(Address of principal executive offices, including zip code)
(408) 572-5200
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  x
 
Accelerated filer  o
  
 
Non-accelerated filer  o
 
Smaller reporting company  o
 
 
 
  
        (Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of October 28, 2016, 144,573,314 shares of the registrant’s Common Stock, $0.001 par value, were issued and outstanding.


Table of Contents

INFINERA CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED SEPTEMBER 24, 2016
INDEX
 
 
 
Page
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION
 

Item 1.
Condensed Consolidated Financial Statements
INFINERA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par values)
(Unaudited)
 
September 24,
2016
 
December 26,
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
130,996

 
$
149,101

Short-term investments
136,643

 
125,561

Short-term restricted cash
9,700

 

Accounts receivable, net of allowance for doubtful accounts of $807 in 2016 and $630 in 2015
152,467

 
186,243

Inventory
231,528

 
174,699

Prepaid expenses and other current assets
30,520

 
29,511

Total current assets
691,854

 
665,115

Property, plant and equipment, net
120,137

 
110,861

Intangible assets
133,939

 
156,319

Goodwill
187,927

 
191,560

Long-term investments
72,439

 
76,507

Cost-method investment
19,500

 
14,500

Long-term restricted cash
6,467

 
5,310

Other non-current assets
4,196

 
4,009

Total assets
$
1,236,459

 
$
1,224,181

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
76,789

 
$
92,554

Accrued expenses
37,857

 
33,736

Accrued compensation and related benefits
37,942

 
49,887

Accrued warranty
15,875

 
17,889

Deferred revenue
38,063

 
42,977

Total current liabilities
206,526

 
237,043

Long-term debt, net
130,924

 
123,327

Accrued warranty, non-current
22,746

 
20,955

Deferred revenue, non-current
18,369

 
13,881

Deferred tax liability
31,419

 
35,731

Other long-term liabilities
18,161

 
16,183

Commitments and contingencies (Note 16)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value
   Authorized shares – 25,000 and no shares issued and outstanding

 

Common stock, $0.001 par value
Authorized shares – 500,000 as of September 24, 2016 and December 26, 2015
 
 
 
Issued and outstanding shares – 144,536 as of September 24, 2016 and 140,197 as of December 26, 2015
145

 
140

Additional paid-in capital
1,341,501

 
1,300,301

Accumulated other comprehensive income (loss)
(6,010
)
 
1,123

Accumulated deficit
(527,322
)
 
(539,413
)
Total Infinera Corporation stockholders’ equity
808,314

 
762,151

Noncontrolling interest

 
14,910

Total stockholders' equity
808,314

 
777,061

Total liabilities and stockholders’ equity
$
1,236,459

 
$
1,224,181

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

Table of Contents

INFINERA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 24,
2016
 
September 26,
2015
 
September 24,
2016
 
September 26,
2015
Revenue:
 
 
 
 
 
 
 
Product
$
156,188

 
$
202,365

 
$
599,802

 
$
542,190

Services
29,264

 
30,107

 
89,290

 
84,490

Total revenue
185,452

 
232,472

 
689,092

 
626,680

Cost of revenue:
 
 
 
 
 
 
 
Cost of product
91,064

 
117,154

 
331,564

 
306,151

Cost of services
9,786

 
12,513

 
32,842

 
32,816

Total cost of revenue
100,850

 
129,667

 
364,406

 
338,967

Gross profit
84,602

 
102,805

 
324,686

 
287,713

Operating expenses:
 
 
 
 
 
 
 
Research and development
50,855

 
45,466

 
164,541

 
128,144

Sales and marketing
27,960

 
24,721

 
88,434

 
67,298

General and administrative
16,646

 
18,358

 
51,617

 
46,324

Total operating expenses
95,461

 
88,545

 
304,592

 
241,766

Income (loss) from operations
(10,859
)
 
14,260

 
20,094

 
45,947

Other income (expense), net:
 
 
 
 
 
 
 
Interest income
647

 
406

 
1,764

 
1,371

Interest expense
(3,313
)
 
(3,014
)
 
(9,644
)
 
(8,851
)
Other gain (loss), net
(188
)
 
(3,293
)
 
(1,116
)
 
1,788

Total other income (expense), net
(2,854
)
 
(5,901
)
 
(8,996
)
 
(5,692
)
Income (loss) before income taxes
(13,713
)
 
8,359

 
11,098

 
40,255

Provision for (benefit from) income taxes
(2,416
)
 
(151
)
 
(725
)
 
1,473

Net income (loss)
(11,297
)
 
8,510

 
11,823

 
38,782

Less: Loss attributable to noncontrolling interest
(125
)
 

 
(503
)
 

Net income (loss) attributable to Infinera Corporation
$
(11,172
)
 
$
8,510

 
$
12,326

 
$
38,782

Net income (loss) per common share attributable to Infinera Corporation:
 
 
 
 
 
 
 
Basic
$
(0.08
)
 
$
0.06

 
$
0.09

 
$
0.30

Diluted
$
(0.08
)
 
$
0.06

 
$
0.08

 
$
0.27

Weighted average shares used in computing net income (loss) per common share:
 
 
 
 
 
 
 
Basic
143,850

 
134,834

 
142,350

 
131,007

Diluted
143,850

 
145,300

 
145,921

 
141,082

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

Table of Contents

INFINERA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 24,
2016
 
September 26,
2015
 
September 24,
2016
 
September 26,
2015
Net income (loss)
$
(11,297
)
 
$
8,510

 
$
11,823

 
$
38,782

Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale investments
(166
)
 
90

 
476

 
279

Foreign currency translation adjustment
(4,107
)
 
4,729

 
(7,609
)
 
4,699

Net change in accumulated other comprehensive income (loss)
(4,273
)
 
4,819

 
(7,133
)
 
4,978

Less: Comprehensive loss attributable to noncontrolling interest
(125
)
 

 
(503
)
 

Comprehensive income (loss) attributable to Infinera Corporation
$
(15,445
)
 
$
13,329

 
$
5,193

 
$
43,760

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

Table of Contents

INFINERA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended
 
September 24,
2016
 
September 26,
2015
Cash Flows from Operating Activities:
 
 
 
Net income
$
11,823

 
$
38,782

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
45,764

 
22,094

Amortization of debt discount and issuance costs
7,598

 
6,873

Amortization of premium on investments
925

 
2,405

Stock-based compensation expense
29,191

 
23,868

Other loss (gain)
261

 
(448
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
33,044

 
28,838

Inventory
(61,078
)
 
(8,901
)
Prepaid expenses and other assets
(1,625
)
 
(6,058
)
Accounts payable
(13,935
)
 
(2,339
)
Accrued liabilities and other expenses
(7,580
)
 
(7,196
)
Deferred revenue
(805
)
 
700

Accrued warranty
(179
)
 
8,742

Net cash provided by operating activities
43,404

 
107,360

Cash Flows from Investing Activities:
 
 
 
Purchase of available-for-sale investments
(118,017
)
 
(126,940
)
Proceeds from sales of available-for-sale investments

 
67,303

Proceeds from maturities and calls of investments
110,554

 
178,717

Acquisition of business, net of cash acquired

 
(144,445
)
Realized gain from forward contract for business acquisition

 
1,053

Purchase of cost-method investment
(5,000
)
 

Purchase of property and equipment
(32,878
)
 
(26,710
)
Change in restricted cash
(4,950
)
 
127

Net cash used in investing activities
(50,291
)
 
(50,895
)
Cash Flows from Financing Activities:
 
 
 
Security pledge related to Squeeze-out Proceedings
(5,921
)
 

Acquisition of noncontrolling interest
(16,771
)
 

Proceeds from issuance of common stock
16,486

 
23,433

Minimum tax withholding paid on behalf of employees for net share settlement
(3,592
)
 
(5,043
)
Net cash provided by (used in) financing activities
(9,798
)
 
18,390

Effect of exchange rate changes on cash
(1,420
)
 
(247
)
Net change in cash and cash equivalents
(18,105
)
 
74,608

Cash and cash equivalents at beginning of period
149,101

 
86,495

Cash and cash equivalents at end of period
$
130,996

 
$
161,103

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for income taxes, net of refunds
$
5,557

 
$
2,552

Cash paid for interest
$
1,445

 
$
1,317

Supplemental schedule of non-cash investing activities:
 
 
 
Transfer of inventory to fixed assets
$
5,211

 
$
5,861

Common stock issued in connection with acquisition
$

 
$
169,507

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Table of Contents

INFINERA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Basis of Presentation and Significant Accounting Policies
Basis of Presentation
Infinera Corporation (the "Company") prepared its interim condensed consolidated financial statements that accompany these notes in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the "SEC"), consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2015.
The Company has made certain estimates, assumptions and judgments that can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Significant estimates, assumptions and judgments made by management include revenue recognition, stock-based compensation, inventory valuation, accrued warranty, business combinations, fair value measurement of investments and accounting for income taxes. Other estimates, assumptions and judgments made by management include allowances for sales returns, allowances for doubtful accounts, useful life of intangible assets, property, plant and equipment, and fair value measurement of the liability component of the Company's $150.0 million of 1.75% convertible senior notes due June 1, 2018 (the "Notes"). Management believes that the estimates and judgments upon which they rely are reasonable based upon information available to them at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, the Company’s condensed consolidated financial statements will be affected.
The interim financial information is unaudited, but reflects all adjustments that are, in management’s opinion, necessary to provide a fair presentation of results for the interim periods presented. All adjustments are of a normal recurring nature. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
The Company reclassified certain amounts reported in previous periods to conform to the current presentation. This interim information should be read in conjunction with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2015. For the three and nine months ended September 24, 2016, cost of revenue was lower by $2.0 million related to a change in estimate associated with the treatment of manufacturing variances as the Company transitioned the former Transmode business onto the Company’s enterprise resource planning ("ERP") system.
To date, a few of the Company’s customers have accounted for a significant portion of its revenue.  For the three months ended September 24, 2016, two customers individually accounted for 16% and 12% of the Company's total revenue, respectively, and for the corresponding period in 2015, two customers individually accounted for 26% and 16% of the Company's total revenue, respectively. For the nine months ended September 24, 2016, two customers individually accounted for 16% and 10% of the Company's total revenue, respectively, and for the corresponding period in 2015, two customers individually accounted for 18% and 15% of the Company's total revenue, respectively.
There have been no material changes in the Company’s significant accounting policies for the nine months ended September 24, 2016 as compared to those disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2015, with the exception of the Company's adoption of Accounting Standards Update 2016-09, "Improvements to Employee Share-Based Payment Accounting") ("ASU 2016-09"). For more information, see Note 2, "Recent Accounting Pronouncements" to the Notes to Condensed Consolidated Financial Statements.
2.
Recent Accounting Pronouncements
In August 2016, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update 2016-15, "Statement of Cash Flows (Topic 320): Classification of Certain Cash Receipts and Cash Payments" ("ASU 2016-15"), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain transactions are presented and classified in the statement of cash flows. This guidance is effective for the Company in its first quarter of fiscal 2018 and will be applied on a retrospective

7


basis. Early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-15 will have on its condensed consolidated financial statements.
In June 2016, the FASB issued Accounting Standards Update 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" ("ASU 2016-13"), which requires measurement and recognition of expected credit losses for financial assets held. This guidance is effective for the Company in its first quarter of fiscal 2020 and early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on its condensed consolidated financial statements.
In May 2016, the FASB issued Accounting Standards Update 2016-11, "Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting (SEC Update)" ("ASU 2016-11"), which rescinds various standards codified as part of Topic 605, Revenue Recognition in relation to the future adoption of Topic 606. These rescissions include changes to topics pertaining to revenue and expense recognition for freight services in process, accounting for shipping and handling fees and costs, and accounting for consideration given by a vendor to a customer. This guidance is effective for the Company in its first quarter of fiscal 2018 and early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU 2016-11 will have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, which includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax effects of share-based payments and accounting for forfeitures. ASU 2016-09 requires companies to record excess tax benefits and tax deficiencies as income tax benefit or expense in the statement of operations when the awards vest or are settled, eliminates the requirement to reclassify cash flows related to excess tax benefits from operating activities to financing activities on the statement of cash flows, and allows for an accounting policy election to either estimate the number of forfeitures (current U.S. GAAP) or account for forfeitures when they occur, amongst other provisions. This standard provides for prospective, retrospective, or modified retrospective adoption of each of the changes. ASU 2016-09 is effective for the Company in its first quarter of fiscal 2017 and early adoption is permitted.
The Company elected to early adopt ASU 2016-09 as of its third fiscal quarter beginning on June 26, 2016. The Company also elected to change its accounting policy to account for forfeitures when they occur on a modified retrospective basis. The adoption of ASU 2016-09 and the change in the Company’s accounting policy resulted in a $0.2 million increase to additional paid-in capital and accumulated deficit as of December 26, 2015. The Company also recorded $0.3 million of stock-based compensation expense during the three months ended September 24, 2016 to true-up for the differential between the amount of stock-based compensation cost previously recorded for the first six months ended June 25, 2016 and the amount that would have been recorded without assuming forfeitures. Additionally, the Company adopted the change in presentation in the condensed consolidated statement of cash flows related to excess tax benefits on a prospective basis. Accordingly, prior periods have not been adjusted. There was no impact for the change in presentation in the condensed consolidated statement of cash flows related to statutory tax withholding requirements as the Company has historically classified the statutory tax withholding as a financing activity in its consolidated statement of cash flows.
In February 2016, the FASB issued Accounting Standards Update 2016-02, "Leases (Topic 842)" ("ASU 2016-02"), which amends the existing accounting standards for leases. The new standard requires lessees to record a right-of-use asset and a corresponding lease liability on the balance sheet (with the exception of short-term leases). For lessees, leases will continue to be classified as either operating or financing in the income statement. This guidance is effective for the Company in its first quarter of fiscal 2019 and early adoption is permitted. ASU 2016-02 is required to be applied with a modified retrospective approach and requires application of the new standard at the beginning of the earliest comparative period presented. The Company is currently evaluating the impact the adoption of ASU 2016-02 will have on its consolidated financial statements.
In September 2015, the FASB issued Accounting Standards Update 2015-16, "Business Combinations and Simplifying the Accounting for Measurement-Period Adjustments" ("ASU 2015-16"), which eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, an acquirer will recognize a measurement-period adjustment during the period in which it determines the amount of the adjustment. The Company adopted ASU 2015-16 during the first quarter of fiscal 2016. The Company's adoption of ASU 2015-16 had no impact on the Company's financial position, results of operations or cash flow.

8


In July 2015, the FASB issued Accounting Standards Update 2015-11, "Simplifying the Measurement of Inventory" ("ASU 2015-11"), to simplify the guidance on the subsequent measurement of inventory, excluding inventory measured using last-in, first-out or the retail inventory method. Under ASU 2015-11, inventory should be at the lower of cost and net realizable value. This guidance is effective for the Company in its first quarter of fiscal 2017 and early adoption permitted. The Company is currently evaluating the impact the adoption of ASU 2015-11 will have on its consolidated financial statements.
In April 2015, the FASB issued Accounting Standards Update 2015-03, "Simplifying the Presentation of Debt Issuance Costs" ("ASU 2015-03"), which changes the presentation of debt issuance costs in financial statements. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. The Company adopted ASU 2015-03 during the first quarter of fiscal 2016. The December 26, 2015 balance sheet was retrospectively adjusted to reclassify $2.1 million from other non-current assets to a reduction of the Notes payable liability.
In May 2014, the FASB issued Accounting Standards Update 2014-09, "Revenue from Contracts from Customers" ("ASU 2014-09"), which creates a single, joint revenue standard that is consistent across all industries and markets for companies that prepare their financial statements in accordance with GAAP. Under ASU 2014-09, an entity is required to recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to receive in exchange for those goods or services. In July 2015, the FASB decided to delay the effective date of the new revenue standard by one year. In April 2016, the FASB issued Accounting Standards Update 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing," which clarifies the implementation guidance on identifying performance obligations and licensing. In May 2016, the FASB issued Accounting Standards Update 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," which amends the guidance on collectability, noncash consideration, presentation of sales tax and transition. These standards will be effective for the Company's first quarter of 2018. The Company is currently evaluating the impact of these new standards on its consolidated financial statements.
3.
Fair Value Measurements
Pursuant to the accounting guidance for fair value measurements and its subsequent updates, fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.
Valuation techniques used by the Company are based upon observable and unobservable inputs. Observable or market inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions about market participant assumptions based on the best information available. Observable inputs are the preferred source of values. These two types of inputs create the following fair value hierarchy:
Level 1
 
 
Quoted prices in active markets for identical assets or liabilities.
 
 
 
 
 
Level 2
 
 
Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
 
 
 
 
Level 3
 
 
Prices or valuations that require management inputs that are both significant to the fair value measurement and unobservable.
The Company measures its cash equivalents, foreign currency exchange forward contracts and marketable debt securities at fair value and classifies its investments in accordance with the fair value hierarchy. The Company’s money market funds and U.S. treasuries are classified within Level 1 of the fair value hierarchy and are valued based on quoted prices in active markets for identical securities.
The Company classifies its certificates of deposit, commercial paper, U.S. agency notes, corporate bonds and foreign currency exchange forward contracts within Level 2 of the fair value hierarchy as follows:

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Table of Contents

Certificates of Deposit
The Company reviews market pricing and other observable market inputs for the same or similar securities obtained from a number of industry standard data providers. In the event that a transaction is observed for the same or similar security in the marketplace, the price on that transaction reflects the market price and fair value on that day. In the absence of any observable market transactions for a particular security, the fair market value at period end would be equal to the par value. These inputs represent quoted prices for similar assets or these inputs have been derived from observable market data.
Commercial Paper
The Company reviews market pricing and other observable market inputs for the same or similar securities obtained from a number of industry standard data providers. In the event that a transaction is observed for the same or similar security in the marketplace, the price on that transaction reflects the market price and fair value on that day and then follows a revised accretion schedule to determine the fair market value at period end. In the absence of any observable market transactions for a particular security, the fair market value at period end is derived by accreting from the last observable market price. These inputs represent quoted prices for similar assets or these inputs have been derived from observable market data accreted mathematically to par.
U.S. Agency Notes
The Company reviews trading activity and pricing for its U.S. agency notes as of the measurement date. When sufficient quoted pricing for identical securities is not available, the Company uses market pricing and other observable market inputs for similar securities obtained from a number of industry standard data providers. These inputs represent quoted prices for similar assets in active markets or these inputs have been derived from observable market data.
Corporate Bonds
The Company reviews trading activity and pricing for each of the corporate bond securities in its portfolio as of the measurement date and determines if pricing data of sufficient frequency and volume in an active market exists in order to support Level 1 classification of these securities. If sufficient quoted pricing for identical securities is not available, the Company obtains market pricing and other observable market inputs for similar securities from a number of industry standard data providers. In instances where multiple prices exist for similar securities, these prices are used as inputs into a distribution-curve to determine the fair market value at period end.
Foreign Currency Exchange Forward Contracts
As discussed in Note 5, "Derivative Instruments" to the Notes to Condensed Consolidated Financial Statements, the Company mainly holds non-speculative foreign exchange forward contracts to hedge certain foreign currency exchange exposures. The Company estimates the fair values of derivatives based on quoted market prices or pricing models using current market rates. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit risk, foreign exchange rates, and forward and spot prices for currencies.

10

Table of Contents

The following tables represent the Company’s fair value hierarchy for its assets and liabilities measured at fair value on a recurring basis (in thousands): 
 
As of September 24, 2016
 
As of December 26, 2015
 
Fair Value Measured Using
 
Fair Value Measured Using
 
Level 1      
 
Level 2      
 
Level 3      
 
Total        
 
Level 1      
 
Level 2      
 
Level 3      
 
Total        
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
35,629

 
$

 
$

 
$
35,629

 
$
37,829

 
$

 
$

 
$
37,829

Certificates of deposit

 
2,602

 

 
2,602

 

 
5,001

 

 
5,001

Commercial paper

 
40,325

 

 
40,325

 

 
10,997

 

 
10,997

Corporate bonds

 
105,160

 

 
105,160

 

 
163,400

 

 
163,400

U.S. agency notes

 
9,782

 

 
9,782

 

 
10,717

 

 
10,717

U.S. treasuries
56,209

 

 

 
56,209

 
24,851

 

 

 
24,851

Foreign currency exchange forward contracts

 
208

 

 
208

 

 
490

 

 
490

Total assets
$
91,838

 
$
158,077

 
$

 
$
249,915

 
$
62,680

 
$
190,605

 
$

 
$
253,285

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
$

 
$
(263
)
 
$

 
$
(263
)
 
$

 
$
(44
)
 
$

 
$
(44
)
During the three and nine months ended September 24, 2016, there were no transfers of assets or liabilities between Level 1 and Level 2 of the fair value hierarchy.
Investments at fair value were as follows (in thousands): 
 
September 24, 2016
 
Adjusted Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value    
Money market funds
$
35,629

 
$

 
$

 
$
35,629

Certificates of deposit
2,600

 
2

 

 
2,602

Commercial paper
40,340

 

 
(15
)
 
40,325

Corporate bonds
105,215

 
21

 
(76
)
 
105,160

U.S. agency notes
9,787

 

 
(5
)
 
9,782

U.S. treasuries
56,168

 
47

 
(6
)
 
56,209

Total available-for-sale investments
$
249,739

 
$
70

 
$
(102
)
 
$
249,707

 
 
December 26, 2015
 
Adjusted Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value    
Money market funds
$
37,829

 
$

 
$

 
$
37,829

Certificates of deposit
5,000

 
1

 

 
5,001

Commercial paper
10,997

 

 

 
10,997

Corporate bonds
163,797

 

 
(397
)
 
163,400

U.S. agency notes
10,786

 

 
(69
)
 
10,717

U.S. treasuries
24,894

 

 
(43
)
 
24,851

Total available-for-sale investments
$
253,303

 
$
1

 
$
(509
)
 
$
252,795

As of September 24, 2016, the Company’s available-for-sale investments have a contractual maturity term of up to 24 months. Gross realized gains and losses on short-term and long-term investments for the three and nine months ended September 24, 2016 and September 26, 2015 were insignificant in all periods. The specific identification method is used to account for gains and losses on available-for-sale investments.
As of September 24, 2016 and December 26, 2015, the Company held $90.4 million and $98.4 million of cash in banks, respectively, excluding restricted cash.

11

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4.
Cost-method Investments
On September 20, 2016, the Company invested $5.0 million in a privately-held company. In addition to the $5.0 million investment, the transaction included a customer supply agreement and warrants to purchase $10 million of additional preferred stock. The warrants vest and become exercisable upon certain conditions being met.
As of September 24, 2016, the Company had investments totaling $19.5 million in two privately-held companies. These investments are accounted for as cost-method investments as the Company owns less than 20% of the voting securities and does not have the ability to exercise significant influence over operating and financial policies of either entity. The investments are carried at historical cost in the Company's condensed consolidated financial statements. The Company regularly evaluates the carrying value of these cost-method investments for impairment. If the Company believes that the carrying value of the cost basis investments is in excess of estimated fair value, the Company’s policy is to record an impairment charge in other income (expense), net, in the accompanying condensed consolidated statements of operations to adjust the carrying value to estimated fair value, when the impairment is deemed other-than-temporary. As of September 24, 2016, no event had occurred that would adversely affect the carrying value of these investments and thus no impairment charges have been recorded for these cost-method investments.
5.
Derivative Instruments
Foreign Currency Exchange Forward Contracts
The Company transacts business in various foreign currencies and has international sales, cost of sales, and expenses denominated in foreign currencies, and carries foreign-currency-denominated monetary assets and liabilities, subjecting the Company to foreign currency risk. The Company’s primary foreign currency risk management objective is to protect the U.S. dollar value of future cash flows and minimize the volatility of reported earnings. The Company utilizes foreign currency forward contracts, primarily short term in nature.
Historically, the Company enters into foreign currency exchange forward contracts to manage its exposure to fluctuation in foreign exchange rates that arise from its euro and British pound denominated receivables and restricted cash balances. Gains and losses on these contracts are intended to offset the impact of foreign exchange rate fluctuations on the underlying foreign currency denominated accounts receivables and restricted cash, and therefore, do not subject the Company to material balance sheet risk.
During 2016, the Company also entered into foreign currency exchange contracts to reduce the volatility of cash flows primarily related to forecasted revenues and expenses denominated in euro, British pound and Swedish kronor ("SEK"). The contracts are settled for U.S. dollars and SEK at maturity and at rates agreed to at inception of the contracts. The gains and losses on these foreign currency derivatives are recorded to the condensed consolidated statement of operations line item, in the current period, to which the item that is being economically hedged is recorded.
For the three months ended September 24, 2016 and September 26, 2015, the before-tax effect of the foreign currency exchange forward contracts were a loss of $0.2 million and a gain of $0.3 million, respectively, and for the nine months ended September 24, 2016 and September 26, 2015, the before-tax effect of the foreign currency exchange forward contracts were a loss of $0.8 million and a loss of $3.1 million, respectively. In each of these periods, the impact of the gross gains and losses were offset by foreign exchange rate fluctuations on the underlying foreign currency denominated amounts.
As of September 24, 2016, the Company did not designate foreign currency exchange forward contracts as hedges for accounting purposes and accordingly, changes in the fair value are recorded in the accompanying condensed consolidated statements of operations. These contracts were with two high-quality institutions and the Company consistently monitors the creditworthiness of the counterparties.

12


The fair value of derivative instruments in the Company’s condensed consolidated balance sheets was as follows (in thousands):
 
As of September 24, 2016
 
As of December 26, 2015
 
Gross Notional(1)  
 
Prepaid Expense and Other Assets
 
Other Accrued Liabilities
 
Gross Notional(1)  
 
Prepaid Expense and Other Assets
 
Other Accrued Liabilities
Foreign currency exchange forward contracts
 
 
 
 
 
 
 
 
 
 
 
Related to euro denominated receivables
$
24,207

 
$

 
$
(262
)
 
$
46,753

 
$
319

 
$
(44
)
Related to British pound denominated receivables
$
3,749

 
208

 

 
$
6,686

 
171

 

Related to restricted cash
$
258

 

 
(1
)
 
$
252

 

 

 


 
$
208

 
$
(263
)
 


 
$
490

 
$
(44
)
 
 
 
(1) 
Represents the face amounts of forward contracts that were outstanding as of the period noted.
6.Business Combination
On August 20, 2015 (the "Acquisition Date”), the Company completed its public offer to the shareholders of Transmode AB ("Transmode"), acquiring 95.8% of the outstanding common shares and voting interest in Transmode. Transmode is a metro packet-optical networking company based in Stockholm, Sweden. The combination of the two companies brings together a complementary set of customers, products, and technologies into one company. With the acquisition of Transmode, the Company now offers an end-to-end product portfolio of packet-optical solutions for metro, data center interconnect, long-haul and subsea networks.
Shortly after the Acquisition Date, the Company initiated compulsory acquisition proceedings in accordance with Swedish law (the "Squeeze-out Proceedings") in order to acquire the remaining 4.2%, or 1.2 million Transmode shares, not tendered through the end of the offer period. As of the Acquisition Date, the fair value of the noncontrolling interest was approximately $15.4 million, which was based on the implied enterprise value of Transmode at the Acquisition Date. In August 2016, the Company received advance title and paid an undisputed purchase price of $16.8 million to acquire the remaining 4.2% of Transmode shares not tendered in the initial offer. The additional $16.8 million paid resulted in the elimination of the noncontrolling interest and an increase in additional paid-in capital. As of September 24, 2016, the Company continues to maintain a security pledge of approximately $5.9 million required by Swedish law until a final adjustment, if any, is determined. The final amount and timing of the final disposition are currently uncertain and will be determined by an arbitration tribunal at the completion of the Squeeze-out Proceedings.
The Company has accounted for this transaction as a business combination in exchange for total consideration of $350.6 million, which consisted of the following (in thousands, except shares):
Cash
$
181,133

Common stock (7.9 million shares)
169,507

Total
$
350,640

The fair value of the 7.9 million shares of common stock issued was determined based on the closing market price of the Company’s common stock on the Acquisition Date. The Company allocated the fair value of the purchase price of the acquisition to the tangible and intangible assets acquired as well as liabilities assumed, based on their estimated fair values. The excess of the purchase price over the fair values of these identifiable assets and liabilities was recorded as goodwill.

13


The Company prepared an initial determination of the fair value of assets acquired and liabilities assumed as of the acquisition date using preliminary information. In accordance with Accounting Standard Codification 805, "Business Combinations," during the measurement period an acquirer shall retrospectively adjust the provisional amounts recognized at the acquisition date to reflect information obtained about facts and circumstances that existed as of the Acquisition Date that, if known, would have affected the measurement of the amounts recognized as of the Acquisition Date. Accordingly, the Company has recognized measurement period adjustments made during the first quarter of 2016 to the fair value of certain assets acquired and liabilities assumed as a result of additional information obtained. These adjustments were retrospectively applied to the Acquisition Date balance sheet. None of the adjustments had an impact on the Company’s previously reported results of operations.
The following table summarizes the Company’s allocation of the purchase consideration based on the fair value of assets acquired and liabilities assumed as of the Acquisition Date (in thousands):
 
Amounts Recognized as of Acquisition Date
 
Measurement Period Adjustments
 
Total
Cash
$
36,688

 
$

 
$
36,688

Accounts receivable
16,183

 

 
16,183

Inventory
19,886

 

 
19,886

Other assets
8,320

 

 
8,320

Intangible assets, net
161,845

 

 
161,845

Goodwill
187,220

 
669

 
187,889

Current liabilities
(24,320
)
 
(800
)
 
(25,120
)
Deferred tax liabilities
(39,221
)
 
131

 
(39,090
)
Long-term liabilities
(589
)
 

 
(589
)
Noncontrolling interest
(15,372
)
 

 
(15,372
)
Total net assets
$
350,640

 
$

 
$
350,640

The following table presents details of the identified intangible assets acquired at the Acquisition Date (in thousands):
 
Fair Value
 
Estimated Useful Life (Years)
Trade name
$
234

 
0.5
Customer relationships
49,033

 
8
Developed technology
92,450

 
5
In-process technology
20,128

 
N/A
Total
$
161,845

 
 
Goodwill generated from this business combination is primarily attributable to the synergies from combining the operations of Transmode with that of the Company, which resulted in expanded selling opportunities of both metro and long-haul solutions. The goodwill recognized is not tax deductible for Swedish income tax purposes.
Noncontrolling interest was as follows (in thousands):
 
September 24, 2016
 
December 26, 2015
Beginning noncontrolling interest
$
14,910

 
$

Noncontrolling interest investment

 
15,373

Acquisition of noncontrolling interest
(14,407
)
 

Loss attributable to noncontrolling interest
(503
)
 
(463
)
Ending noncontrolling interest
$

 
$
14,910

7.
Goodwill and Intangible Assets
Goodwill
Goodwill is recorded when the purchase price of an acquisition exceeds the fair value of the net tangible and identified intangible assets acquired.
The following table presents details of the Company’s goodwill during the nine months ended September 24, 2016 (in thousands):
Balance as of December 26, 2015
$
191,560

Foreign currency translation adjustments
(3,633
)
Accumulated impairment loss

Balance as of September 24, 2016
$
187,927

The gross carrying amount of goodwill may change due to the effects of foreign currency fluctuations as these assets are denominated in SEK.
Intangible Assets
The following tables present details of the Company’s intangible assets as of September 24, 2016 and December 26, 2015 (in thousands):
 
September 24, 2016
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Weighted Average Remaining Useful Life (In Years)
Intangible assets with finite lives:


 


 


 
 
Trade names
$
234

 
$
(234
)
 
$

 

Customer relationships
49,042

 
(6,753
)
 
42,289

 
6.9

Developed technology
100,285

 
(21,213
)
 
79,072

 
4.0

Other intangible assets
819

 
(554
)
 
265

 
4.9

Total intangible assets with finite lives
$
150,380

 
$
(28,754
)
 
$
121,626

 
5.0

In-process technology
12,313

 

 
12,313

 
 
Total intangible assets
$
162,693

 
$
(28,754
)
 
$
133,939

 
 

14


 
December 26, 2015
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Weighted Average Remaining Useful Life (In Years)
Intangible assets with finite lives:
 
 
 
 
 
 
 
Trade names
$
239

 
$
(168
)
 
$
71

 
0.2

Customer relationships
49,991

 
(2,197
)
 
47,794

 
7.7

Developed technology
94,256

 
(6,629
)
 
87,627

 
4.6

Other intangible assets
819

 
(513
)
 
306

 
5.6

Total intangible assets with finite lives
$
145,305

 
$
(9,507
)
 
$
135,798

 
5.7

In-process technology
20,521

 

 
20,521

 
 
Total intangible assets
$
165,826

 
$
(9,507
)
 
$
156,319

 
 
The gross carrying amount of intangible assets and the related amortization expense of intangible assets may change due to the effects of foreign currency fluctuations as these assets are denominated in SEK. Amortization expense was $6.7 million and $19.8 million for the three and nine months ended September 24, 2016, respectively, and was $2.6 million for the three and nine months ended September 26, 2015.
Intangible assets are carried at cost less accumulated amortization. Amortization expenses are recorded to the appropriate cost and expense categories. During the nine months ended September 24, 2016, the Company transferred $7.8 million of its in-process technology to developed technology, which is being amortized over a maximum useful life of 7 years. In-process technology of $12.3 million as of September 24, 2016 is not subject to amortization. As such, the Company excluded it in the future amortization expense table below.
The following table summarizes the Company’s estimated future amortization expense of intangible assets with finite lives as of September 24, 2016 (in thousands):
 
 
 
Fiscal Years
 
Total
 
Remainder of 2016
 
2017
 
2018
 
2019
 
2020
 
2021 and Thereafter
Total future amortization expense
$
121,626

 
$
6,612

 
$
26,487

 
$
26,487

 
$
25,879

 
$
18,886

 
$
17,275

8.
Balance Sheet Details
The following table provides details of selected balance sheet items (in thousands):
 
September 24, 2016
 
December 26, 2015
Inventory:
 
 
 
Raw materials
$
37,199

 
$
27,879

Work in process
65,540

 
52,599

Finished goods
128,789

 
94,221

Total inventory
$
231,528

 
$
174,699

Property, plant and equipment, net:
 
 
 
Computer hardware
$
12,741

 
$
11,097

Computer software(1)
26,718

 
22,548

Laboratory and manufacturing equipment
215,690

 
189,168

Furniture and fixtures
2,060

 
1,897

Leasehold improvements
43,048

 
38,946

Construction in progress
27,976

 
31,060

Subtotal
$
328,233

 
$
294,716

Less accumulated depreciation and amortization
(208,096
)
 
(183,855
)
Total property, plant and equipment, net
$
120,137

 
$
110,861

Accrued expenses:
 
 
 
Loss contingency related to non-cancelable purchase commitments
$
6,293

 
$
6,821

Professional and other consulting fees
4,198

 
5,363

Taxes payable
4,532

 
3,295

Royalties
5,376

 
4,290

Other accrued expenses
17,458

 
13,967

Total accrued expenses
$
37,857

 
$
33,736

 
 
 
(1) 
Included in computer software at September 24, 2016 and December 26, 2015 were $9.1 million and $7.9 million, respectively, related to an ERP system that the Company implemented. The unamortized ERP costs at September 24, 2016 and December 26, 2015 were $4.3 million and $4.0 million, respectively.

9.
Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) includes certain changes in equity that are excluded from net income. The following table sets forth the changes in accumulated other comprehensive income (loss) by component for the nine months ended September 24, 2016 (in thousands): 
 
 
Unrealized Gain (Loss) on Other Available-for-Sale Securities
 
Foreign Currency Translation     
 
Accumulated Tax Effect
 
Total        
Balance at December 26, 2015
 
$
(506
)
 
$
2,389

 
$
(760
)
 
$
1,123

Net current-period other comprehensive income (loss)
 
476

 
(7,609
)
 

 
(7,133
)
Balance at September 24, 2016
 
$
(30
)
 
$
(5,220
)
 
$
(760
)
 
$
(6,010
)

15


10.
Basic and Diluted Net Income (Loss) Per Common Share
Basic net income (loss) per common share is computed by dividing net income (loss) attributable to Infinera Corporation by the weighted average number of common shares outstanding during the period. Diluted net income (loss) attributable to Infinera Corporation per common share is computed using net income (loss) attributable to Infinera Corporation and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the assumed exercise of outstanding stock options, assumed release of outstanding restricted stock units ("RSUs") and performance stock units ("PSUs"), and assumed issuance of common stock under the Company’s 2007 Employee Stock Purchase Plan ("ESPP") using the treasury stock method. Potentially dilutive common shares also include the assumed conversion of convertible senior notes from the conversion spread (as discussed in Note 11, "Convertible Senior Notes"). The Company includes the common shares underlying PSUs in the calculation of diluted net income per share only when they become contingently issuable. In net loss periods, these potentially diluted common shares have been excluded from the diluted net loss calculation.
The following table sets forth the computation of net income (loss) per common share – basic and diluted (in thousands, except per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
September 24, 2016
 
September 26, 2015
 
September 24, 2016
 
September 26, 2015
Numerator:
 
 
 
 
 
 
 
Net income (loss) attributable to Infinera Corporation
$
(11,172
)
 
$
8,510

 
$
12,326

 
$
38,782

Denominator:
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
143,850

 
134,834

 
142,350

 
131,007

Effect of dilutive securities:
 
 
 
 
 
 
 
Employee equity plans

 
5,397

 
2,580

 
5,911

Assumed conversion of convertible senior notes from conversion spread

 
5,069

 
991

 
4,164

Diluted weighted average common shares outstanding
143,850

 
145,300

 
145,921

 
141,082

 
 
 
 
 
 
 
 
Net income (loss) per common share attributable to Infinera Corporation
 
 
 
 
 
 
 
Basic
$
(0.08
)
 
$
0.06

 
$
0.09

 
$
0.30

Diluted
$
(0.08
)
 
$
0.06

 
$
0.08

 
$
0.27

The Company incurred a net loss during the three months ended September 24, 2016, and as a result, potential common shares from options, RSUs, PSUs and assumed release of outstanding stock under the ESPP were not included in the diluted shares used to calculate net loss per share, as their inclusion would have been anti-dilutive.
During the nine months ended September 24, 2016 and the three and nine months ended September 26, 2015, the effects of certain potentially outstanding shares were not included in the calculation of diluted net income per share as their effect were anti-dilutive under the treasury stock method or the performance condition of the award had not been met.
During the nine months ended September 24, 2016 and the three and nine months ended September 26, 2015, the Company included the dilutive effects of the Notes in the calculation of diluted net income per common share as the average market price was above the conversion price of the Notes. The dilutive impact of the Notes was based on the difference between the Company's average stock price during the period and the conversion price of the Notes. Upon conversion of the Notes, it is the Company’s intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the Notes being converted, therefore, only the conversion spread relating to the Notes would be included in the Company’s diluted earnings per share calculation.


16


The following sets forth the potentially dilutive shares excluded from the computation of the diluted net income (loss) per share because their effect was anti-dilutive (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 24, 2016
 
September 26, 2015
 
September 24, 2016
 
September 26, 2015
Stock options
1,834

 
1

 
61

 
7

RSUs
5,475

 
26

 
2,454

 
535

PSUs
905

 

 
643

 
97

ESPP shares
1,334

 
484

 
638

 
300

Total
9,548

 
511

 
3,796

 
939

11.
Convertible Senior Notes
In May 2013, the Company issued the Notes, which will mature on June 1, 2018, unless earlier purchased by the Company 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 to the Company were approximately $144.5 million.
The Notes are governed by an indenture dated as of May 30, 2013 (the "Indenture"), between the Company, as issuer, and U.S. Bank National Association, as trustee. The Notes are unsecured and do not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior debt or other indebtedness, or the issuance or repurchase of securities by the Company.
Upon conversion, it is the Company's intention to pay cash equal to the lesser of the aggregate principal amount or the conversion value of the Notes. For any remaining conversion obligation, the Company intends to pay cash, shares of common stock or a combination of cash and shares of common stock, at its election. The initial conversion rate is 79.4834 shares of common stock per $1,000 principal amount of Notes, subject to anti-dilution adjustments. The initial conversion price is approximately $12.58 per share of common stock.
Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of certain events, including for any cash dividends. Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than canceled, extinguished or forfeited. Holders may convert their Notes under the following circumstances:

during any fiscal quarter commencing after the fiscal quarter ended on March 28, 2013 (and only during such fiscal quarter) if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day;

during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day;

upon the occurrence of specified corporate events described under the Indenture, such as a consolidation, merger or binding share exchange; or

at any time on or after December 1, 2017 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their Notes at any time, regardless of the foregoing circumstances.
If the Company undergoes a fundamental change as defined in the Indenture governing the Notes, holders may require the Company to repurchase for cash all or any portion of their Notes at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, upon the occurrence of a “make-whole fundamental change” (as defined in the Indenture), the Company may, in certain circumstances, increase the conversion rate by

17

Table of Contents

a number of additional shares for a holder that elects to convert its Notes in connection with such make-whole fundamental change.

The net carrying amounts of the debt obligation were as follows (in thousands):
 
September 24, 2016
 
December 26, 2015
Principal
$
150,000

 
$
150,000

Unamortized discount (1)
(17,565
)
 
(24,560
)
Unamortized issuance cost (1)
(1,511
)
 
(2,113
)
Net carrying amount
$
130,924

 
$
123,327

 
 
 
(1) 
Unamortized debt conversion discount and issuance costs will be amortized over the remaining life of the Notes, which is approximately 20 months.

As of September 24, 2016 and December 26, 2015, the carrying amount of the equity component of the Notes was $43.3 million.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount ("debt discount") is amortized to interest expense over the term of the Notes.
In accounting for the issuance costs of $5.5 million related to the Notes, the Company allocated the total amount incurred to the liability and equity components of the Notes based on their relative values. Issuance costs attributable to the liability component were initially recorded as other non-current assets and will be amortized to interest expense over the term of the Notes. ASU 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. The Company adopted ASU 2015-03 during the first quarter of 2016. The December 26, 2015 balance sheet was retrospectively adjusted to reclassify $2.1 million from other non-current assets to a reduction of the Notes payable liability.
The issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity. Additionally, the Company initially recorded a deferred tax liability of $17.0 million in connection with the issuance of the Notes, and a corresponding reduction in valuation allowance. The impact of both was recorded to stockholders’ equity.
The Company determined that the embedded conversion option in the Notes does not require separate accounting treatment as a derivative instrument because it is both indexed to the Company’s own stock and would be classified in stockholder’s equity if freestanding.
The following table sets forth total interest expense recognized related to the Notes (in thousands): 
 
Three Months Ended
 
Nine Months Ended
 
September 24, 2016
 
September 26, 2015
 
September 24, 2016
 
September 26, 2015
Contractual interest expense
$
656

 
$
656

 
$
1,969

 
$
1,969

Amortization of debt issuance costs
206

 
186

 
602

 
544

Amortization of debt discount
2,391

 
2,162

 
6,996

 
6,328

Total interest expense
$
3,253

 
$
3,004

 
$
9,567

 
$
8,841

The coupon rate is 1.75%. For the three and nine months ended September 24, 2016 and September 26, 2015, the debt discount and debt issuance costs are amortized, using an annual effective interest rate of 10.23%, to interest expense over the term of the Notes.

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As of September 24, 2016, the fair value of the Notes was $156.0 million. The fair value was determined based on the quoted bid price of the Notes in an over-the-counter market on September 23, 2016. The Notes are classified as Level 2 of the fair value hierarchy.
During the three months ended September 24, 2016, the closing price of the Company's common stock did not meet the conversion criteria; therefore, holders of the Notes may not convert their notes during the fourth quarter of 2016. Should the closing price conditions be met during the 30 consecutive trading days prior to the end of the fourth quarter of 2016 or a future quarter, the Notes will be convertible at their holders’ option during the immediately following quarter. Based on the closing price of the Company’s common stock of $8.85 on September 23, 2016, the if-converted value of the Notes did not exceed their principal amount.
12.
Stockholders’ Equity
Stock-based Compensation Plans
The Company has stock-based compensation plans pursuant to which the Company has granted stock options, RSUs and PSUs. The Company also has an ESPP for all eligible employees.
In February 2016, the Company's board of directors adopted the 2016 Equity Incentive Plan ("2016 Plan") and the Company's stockholders approved the 2016 Plan in May 2016. As of September 24, 2016, the Company reserved a total of 7.2 million shares of common stock for issuance of stock options, RSUs and PSUs to employees, non-employees, consultants and members of the Company's board of directors, pursuant to the 2016 Plan, plus any shares subject to awards granted under the Company’s 2007 Equity Incentive Plan (the “2007 Plan”) that, after the effective date of the 2016 Plan, expire, are forfeited or otherwise terminate without having been exercised in full to the extent such awards were exercisable, and shares issued pursuant to awards granted under the 2007 Plan that, after the effective date of the 2016 Plan, are forfeited to or repurchased by the Company due to failure to vest. The 2016 Plan has a maximum term of 10 years from the date of adoption, or it can be earlier terminated by the Company's board of directors. The 2007 Plan was canceled; however, it continues to govern outstanding grants under the 2007 Plan.
The following tables summarize the Company’s equity award activity and related information (in thousands, except per share data): 
 
Number of Stock
Options
 
Weighted-Average
Exercise
Price
  Per Share  
 
  Aggregate  
Intrinsic
Value
Outstanding at December 26, 2015
2,511

 
$
7.26

 
$
28,288

Stock options granted

 
$

 
 
Stock options exercised
(651
)
 
$
4.42

 
$
4,158

Stock options canceled
(26
)
 
$
12.38

 


Outstanding at September 24, 2016
1,834

 
$
8.19

 
$
1,761

Exercisable at September 24, 2016
1,826

 
$
8.19

 
$
1,761

 
 
Number of
Restricted
Stock Units
 
Weighted-
Average
 Grant Date 
Fair Value
Per Share
 
  Aggregate  
Intrinsic
Value
Outstanding at December 26, 2015
4,932

 
$
12.76

 
$
91,285

RSUs granted
2,791

 
$
14.32

 


RSUs released
(1,984
)
 
$
10.63

 
$
23,948

RSUs canceled
(263
)
 
$
13.74

 


Outstanding at September 24, 2016
5,476

 
$
14.28

 
$
48,461

 

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Number of
Performance
Stock Units
 
Weighted-
Average
 Grant Date 
Fair Value
Per Share
 
  Aggregate  
Intrinsic
Value
Outstanding at December 26, 2015
731

 
$
12.35

 
$
13,540

PSUs granted
647

 
$
15.28

 

PSUs performance earned(1)
234

 
$
12.28

 
 
PSUs released
(615
)
 
$
11.25

 
$
8,077

PSUs canceled
(92
)
 
$
15.21

 

Outstanding at September 24, 2016
905

 
$
14.02

 
$
8,008

Expected to vest at September 24, 2016
195

 

 
$
1,725

 
 
 
(1) 
Represents the additional PSUs awarded resulting from the achievement of performance goals above the performance targets established at grant since the original grants were at 100% of target amounts.

The aggregate intrinsic value of unexercised stock options is calculated as the difference between the closing price of the Company’s common stock of $8.85 at September 23, 2016 (the last trading day of the fiscal quarter) and the exercise prices of the underlying stock options. The aggregate intrinsic value of the stock options that have been exercised is calculated as the difference between the fair market value of the common stock at the date of exercise and the exercise price of the underlying stock options.
The aggregate intrinsic value of unreleased RSUs and unreleased PSUs is calculated using the closing price of the Company's common stock of $8.85 at September 23, 2016 (the last trading day of the fiscal quarter). The aggregate intrinsic value of RSUs and PSUs released is calculated using the fair market value of the common stock at the date of release.

The following table presents total stock-based compensation cost for instruments granted but not yet amortized, net of estimated forfeitures, of the Company’s equity compensation plans as of September 24, 2016. These costs are expected to be amortized on a straight-line basis over the following weighted-average periods (in thousands, except for weighted-average period):
 
Unrecognized
Compensation
Expense, Net
 
Weighted-
Average Period
(in years)
Stock options
$
30

 
1.3
RSUs
$
60,952

 
2.6
PSUs
$
7,163

 
1.6
Employee Stock Options
The Company did not grant any stock options during the three and nine months ended September 24, 2016. Amortization of stock-based compensation related to stock options in the three and nine months ended September 24, 2016 and September 26, 2015 was insignificant in both periods.

Employee Stock Purchase Plan

The fair value of the shares was estimated at the date of grant using the following assumptions (expense amounts in thousands):
 
Three Months Ended
 
Nine Months Ended
Employee Stock Purchase Plan
September 24, 2016
 
September 26, 2015
 
September 24, 2016
 
September 26, 2015
Volatility
67%
 
39%
 
56% - 67%
 
39% - 53%
Risk-free interest rate
0.51%
 
0.26%
 
0.51% - 0.52%
 
0.13% - 0.26%
Expected life
0.5 years
 
0.5 years
 
0.5 years
 
0.5 years
Estimated fair value
$3.16
 
$6.43
 
$3.16 - $4.53
 
$5.15 - $6.43
Total stock-based compensation expense
$1,565
 
$1,147
 
$4,054
 
$3,275

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Restricted Stock Units
The Company granted RSUs to employees and members of the Company’s board of directors to receive shares of the Company’s common stock. All RSUs awarded are subject to each individual's continued service to the Company through each applicable vesting date. The Company accounted for the fair value of the RSUs using the closing market price of the Company’s common stock on the date of grant. Amortization of stock-based compensation related to RSUs in the three and nine months ended September 24, 2016 and September 26, 2015 was approximately $7.7 million and $21.4 million, respectively, and $5.6 million and $16.7 million, respectively.
Performance Stock Units
Pursuant to the 2007 Plan, the Company has granted PSUs to certain of the Company’s executive officers, senior management and employees. All PSUs awarded are subject to each individual's continued service to the Company through each applicable vesting date and if the performance metrics are not met within the time limits specified in the award agreements, the PSUs will be canceled.
A number of PSUs granted to the Company’s executive officers and senior management are based on the total shareholder return of the Company's common stock price as compared to the total shareholder return of the S&P North American Technology Multimedia Networking Index ("SPGIIPTR") over the span of one year, two years and three years. The number of shares to be issued upon vesting of these PSUs range from 0 to 2.0 times the target number of PSUs granted depending on the Company’s performance against the SPGIIPTR.
The ranges of estimated values of the PSUs granted that are compared to the SPGIIPTR, as well as the assumptions used in calculating these values were based on estimates as follows:
 
 
2016
 
2015
 
2014
Index
 
SPGIIPTR
 
SPGIIPTR
 
SPGIIPTR
Index volatility
 
18%
 
18% - 19%
 
25%
Infinera volatility
 
55%
 
48%
 
49% - 50%
Risk-free interest rate
 
0.95% - 1.07%
 
0.97% - 1.10%
 
0.66% - 0.71%
Correlation with index
 
0.58 - 0.59
 
0.52
 
0.60
Estimated fair value
 
$10.31 - $16.62
 
$18.08 - $19.29
 
$6.59 - $7.60

In addition, certain other PSUs granted to the Company’s executive officers, senior management and certain employees will only vest upon the achievement of specific financial or operational performance criteria.

The following table summarizes by grant year, the Company’s PSU activity for the nine months ended September 24, 2016 (in thousands):
 
 
Total Number of Performance Stock Units
 
2013
 
2014
 
2015
 
2016
Outstanding at December 26, 2015
 
731

 
147

 
260

 
324

 

PSUs granted
 
647

 

 

 

 
647

PSUs performance earned(1)
 
234

 
70

 
53

 
111

 

PSUs released
 
(615
)
 
(211
)
 
(179
)
 
(225
)
 

PSUs canceled
 
(92
)
 
(6
)
 
(11
)
 
(62
)
 
(13
)
Outstanding at September 24, 2016
 
905

 

 
123

 
148

 
634

 
 
 
(1) 
Represents the additional PSUs awarded resulting from the achievement of performance goals above the performance targets established at grant since the original grants were at 100% of target amounts.
Amortization of stock-based compensation related to PSUs for the three and nine months ended September 24, 2016 was approximately $1.7 million and $4.9 million, respectively, and was approximately $1.6 million and $3.8 million, respectively for the corresponding periods in 2015.

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Table of Contents

Stock-Based Compensation
The following tables summarize the effects of stock-based compensation on the Company’s condensed consolidated balance sheets and statements of operations for the periods presented (in thousands):
 
September 24, 2016
 
December 26, 2015
Stock-based compensation effects in inventory
$
4,378

 
$
3,129

Stock-based compensation effects in property, plant and equipment, net
$
74

 
$
93

 
 
Three Months Ended
 
Nine Months Ended
 
September 24, 2016
 
September 26, 2015
 
September 24, 2016
 
September 26, 2015
Stock-based compensation effects included in net income (loss) before income taxes
 
 
 
 
 
 
 
Cost of revenue
$
756

 
$
645

 
$
2,175

 
$
1,740

Research and development
3,496

 
2,788

 
9,721

 
8,183

Sales and marketing
2,826

 
2,131

 
8,006

 
5,922

General and administration
2,465

 
1,911

 
6,850

 
5,406

 
$
9,543

 
$
7,475

 
$
26,752

 
$
21,251

Cost of revenue – amortization from balance sheet (1)
668

 
976

 
2,439

 
2,617

Total stock-based compensation expense
$
10,211

 
$
8,451

 
$
29,191

 
$
23,868

 
 
 
(1) 
Stock-based compensation expense deferred to inventory and deferred inventory costs in prior periods and recognized in the current period.

13.
Income Taxes
Benefit from income taxes during the three and nine months ended September 24, 2016 was $2.4 million and $0.7 million, respectively, on a pre-tax loss of $13.7 million and pre-tax income of $11.1 million, respectively. This compared to a tax benefit for $0.2 million and tax provision of $1.5 million, respectively, on a pre-tax income of $8.4 million and $40.3 million, respectively, for the three and nine months ended September 26, 2015. The results for the three months ended September 24, 2016 reflect approximately $6.9 million of purchase accounting amortization and other charges related to the acquisition of Transmode, with a corresponding tax benefit of approximately $1.5 million. Exclusive of this tax benefit, provision for income taxes otherwise increased by approximately $2.0 million during the three months ended September 24, 2016 compared to September 26, 2015, which relates to lower forecasted tax expense for the year incurred ratably through the nine months ended September 24, 2016. The results for the nine months ended September 24, 2016 reflected approximately $21.0 million of purchase accounting amortization and other charges related to the acquisition of Transmode, with a corresponding tax benefit of approximately $4.6 million. Exclusive of this tax benefit, provision for income taxes otherwise increased by approximately $1.2 million in the nine months ended September 24, 2016 compared to September 26, 2015, which is attributed to a higher proportion of foreign income earned on a year to date basis related to the Transmode operations and increased spending in certain of the Company's cost-plus foreign subsidiaries.
In all periods, the tax expense and benefit projected in the Company's effective tax rate assumptions primarily represents foreign taxes of the Company's overseas subsidiaries compensated on a cost-plus basis, as well as the operating results of Transmode, inclusive of purchase accounting charges and amortization for the three and nine months ended September 24, 2016. Due to the Company's significant U.S. loss carryforward position and corresponding full valuation allowance, the Company has not been subject to federal or state tax on its U.S. income because of the availability of loss carryforwards, with the exception of some state taxes for which the losses are limited. 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.

22


The Company must assess the likelihood that some portion or all of its deferred tax assets will be recovered from future taxable income within the respective jurisdictions. In the past, the Company established a valuation allowance against its deferred tax assets as it determined that its ability to recover the value of these assets did not meet the “more-likely-than-not” standard. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management judgment is required on an on-going basis to determine whether it needs to maintain the valuation allowance recorded against its net deferred tax assets. The Company has been profitable during the nine consecutive quarters between the second quarter of 2014 and the second quarter of 2016. However, in the quarter ending September 24, 2016, the company incurred a net loss. The Company must consider all positive and negative evidence, including its forecasts of taxable income over the applicable carryforward periods, its current financial performance, its market environment, and other factors in evaluating the need for a valuation allowance against its net U.S. deferred tax assets. At September 24, 2016, the Company does not believe that it is more-likely-than-not that it would be able to utilize its deferred tax assets in the foreseeable future. Accordingly, the domestic net deferred tax assets continued to be fully reserved with a valuation allowance. To the extent that the Company determines that deferred tax assets are realizable on a more-likely-than-not basis, and adjustment is needed, that adjustment will be recorded in the period that the determination is made and would generally decrease the valuation allowance and record a corresponding benefit to earnings.
On March 30, 2016, FASB issued ASU 2016-09, which the Company early adopted as of June 26, 2016. As a result of the adoption of ASU 2016-09, excess windfall tax benefits and tax deficiencies related to the Company's stock option exercises and vesting of RSUs are recognized as an income tax benefit or expense in its condensed consolidated statements of operations in the period they are deducted on the income tax return. Excess windfall tax benefits and tax deficiencies are therefore not anticipated when determining the annual effective tax rate and are instead recognized in the interim period in which those items occur. The adoption of ASU 2016-09 did not have any material impact on our income tax expense for the three and nine months ended September 24, 2016, primarily due to the Company's valuation allowance position.
14.
Segment Information
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the Company’s Chief Executive Officer ("CEO"). The Company’s CEO reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. The Company has one business activity. Accordingly, the Company is considered to be in a single reporting segment and operating unit structure.
Revenue by geographic region is based on the shipping address of the customer. The following tables set forth revenue and long-lived assets by geographic region (in thousands):
Revenue
 
Three Months Ended
 
Nine Months Ended
 
September 24, 2016
 
September 26, 2015
 
September 24, 2016
 
September 26, 2015
Americas:
 
 
 
 
 
 
 
United States
$
104,045

 
$
158,845

 
$
445,270

 
$
440,610

Other Americas
17,390

 
20,874

 
31,916

 
39,944

 
121,435

 
179,719

 
477,186

 
480,554

Europe, Middle East and Africa
51,940

 
41,655

 
176,386

 
114,163

Asia Pacific and Japan
12,077

 
11,098

 
35,520

 
31,963

Total revenue
$
185,452

 
$
232,472

 
$
689,092

 
$
626,680


Property, plant and equipment, net
 
September 24, 2016
 
December 26, 2015
United States
$
112,439

 
$
102,702

Other Americas
247

 
173

 
112,686

 
102,875

Europe, Middle East and Africa
4,447

 
5,417

Asia Pacific and Japan
3,004

 
2,569

Total property, plant and equipment, net
$
120,137

 
$
110,861

15.
Guarantees
Product Warranties
The Company warrants that its products will operate substantially in conformity with product specifications. Hardware warranties provide the purchaser with protection in the event that the product does not perform to product specifications. During the warranty period, the purchaser’s sole and exclusive remedy in the event of such defect or failure to perform is limited to the correction of the defect or failure by repair, refurbishment or replacement, at the Company’s sole option and expense. The Company's hardware warranty periods generally range from one to five years from date of acceptance for hardware and the Company's software warranty is 90 days. Upon delivery of the Company's products, the Company provides for the estimated cost to repair or replace products that may be returned under warranty. The hardware warranty accrual is based on actual historical returns and cost of repair experience and the application of those historical rates to the Company's in-warranty installed base. The provision for warranty claims fluctuates depending upon the installed base of products and the failure rates and costs of repair associated with these products under warranty. Furthermore, the Company's costs of repair vary based on repair volume and its ability to repair, rather than replace, defective units. In the event that actual product failure rates and costs to repair differ from the Company's estimates, revisions to the warranty provision are required. In addition, from time to time, specific hardware warranty accruals may be made if unforeseen technical problems arise with specific products. The Company regularly assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
Activity related to product warranty was as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 24, 2016
 
September 26, 2015
 
September 24, 2016
 
September 26, 2015
Beginning balance
$
40,989

 
$
28,439

 
$
38,844

 
$
27,040

Charges to operations
5,196

 
10,791

 
19,258

 
22,158

Utilization
(5,002
)
 
(3,515
)
 
(13,691
)
 
(8,336
)
Change in estimate(1)
(2,562
)
 
1,026

 
(5,790
)
 
(4,121
)
Balance at the end of the period
$
38,621

 
$
36,741

 
$
38,621

 
$
36,741

 
 
 
(1) 
The Company records hardware warranty liabilities based on the latest quality and cost information available as of that date. The changes in estimate shown here are due to changes in overall actual failure rates, the mix of new versus used units related to replacement of failed units, and changes in the estimated cost of repair. As the Company's products mature over time, failure rates and repair costs generally decline leading to favorable changes in warranty reserves.
Letters of Credit and Bank Guarantees
The Company had $10.1 million of standby letters of credit and bank guarantees outstanding as of September 24, 2016 that consisted of $4.5 million related to property leases, $4.4 million related to customer performance guarantees, and $1.2 million related to value added tax and customs' licenses. The Company had $5.2 million of standby letters of credit and bank guarantees outstanding as of December 26, 2015, respectively. These consisted of $3.1 million related to customer performance guarantees, $1.2 million related to a value added tax and customs' licenses, and $0.9 million related to property leases.

23


As of September 24, 2016 and December 26, 2015, the Company had a line of credit for approximately $1.3 million and $1.5 million, respectively, to support the issuance of letters of credit, of which $0.7 million had been issued and outstanding. The Company has pledged approximately $4.8 million of assets of a subsidiary to secure this line of credit and other obligations as of September 24, 2016 and December 26, 2015.   
16.
Litigation and Contingencies
From time to time, the Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material effect on its consolidated financial position, results of operations or cash flows.
The Company is subject to the possibility of various losses arising in the ordinary course of business. These may relate to disputes, litigation and other legal actions. In the preparation of its quarterly and annual financial statements, the Company considers the likelihood of loss or the incurrence of a liability, including whether it is probable, reasonably possible or remote that a liability has been incurred, as well as the Company’s ability to reasonably estimate the amount of loss, in determining loss contingencies. In accordance with U.S. GAAP, an estimated loss contingency is accrued when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. The Company regularly evaluates current information to determine whether any accruals should be adjusted and whether new accruals are required. As of September 24, 2016, the Company has accrued the estimated liabilities associated with the Company's potential loss contingencies.
Intellectual Property Indemnification
The Company has agreed to indemnify certain customers for claims made against the Company’s products, where such claims allege infringement of third party intellectual property rights, including, but not limited to, patents, registered trademarks, and/or copyrights. Under the aforementioned indemnification clauses, the Company may be obligated to defend the customer and pay for the damages awarded against the customer under an infringement claim as well as the customer’s attorneys’ fees and costs. The Company’s indemnification obligations generally do not expire after termination or expiration of the agreement containing the indemnification obligation. In certain cases, there are limits on and exceptions to the Company’s potential liability for indemnification. Although historically the Company has not made significant payments under these indemnification obligations, the Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. The maximum potential amount of any future payments that the Company could be required to make under these indemnification obligations could be significant.

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Table of Contents

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 revenue, gross margin, operating 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 needs and activity; statements concerning new or existing products or services; statements related to our integration efforts in connection with our acquisition of Transmode and the squeeze-out proceedings; statements related to industry consolidation; 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 related to deferred tax assets; 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 26, 2015 filed on February 23, 2016. 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 provide optical transport networking equipment, software and services to telecommunications service providers, Internet content providers (“ICPs”), cable providers, wholesale and enterprise carriers, research and education institutions, and government entities (collectively, "Service Providers") across the globe. Optical transport networks are deployed by Service Providers facing significant demands for optical bandwidth prompted by increased use of high-speed Internet access, mobile broadband, high-definition video streaming services, business Ethernet services and cloud-based services.
We manufacture large-scale Indium Phosphide photonic integrated circuits ("PICs"), which, together with our coherent digital signal processor ("DSP"), the FlexCoherent Processor, are used as key differentiating subsystems inside most of our Intelligent Transport Network platforms. We believe our optical engines, comprised of PICs, DSPs, ASICs and software incorporated in the Infinera Intelligent Transport Network architecture, give us a structural technology advantage over competing offerings. This advantage enables Service Providers to scale network bandwidth, accelerate service innovation and simplify optical network operations to reduce cost of ownership, and ultimately, create rich end-user experiences for their customers.
Incorporating PICs in our optical engines has enabled us to build significant market share in long-haul and sub-sea networks with Service Providers around the world. Building on our leadership in long-haul and sub-sea, our Cloud Xpress platform also utilizes a PIC-based optical engine and targets the data center interconnect ("DCI") market, which we believe is a rapidly growing market as cloud infrastructures continue to evolve to address the massive ongoing demand of server-to-server traffic.
We also offer a suite of metro-focused solutions. In August 2015, we successfully completed our public offer to the shareholders of Transmode AB ("Transmode"), acquiring 95.8% of the outstanding common shares and voting interest in Transmode, a metro packet-optical networking company based in Stockholm, Sweden. The combination of the two companies brought a complementary set of customers, products and technologies together into one company. With the XTM-Series products from Transmode and Infinera's product portfolio, we believe we are well positioned to address the evolving requirements of our growing customer base by providing an end-to-end portfolio of packet-optical solutions for metro, DCI, long-haul and subsea networks. Shortly after the acquisition, we initiated compulsory acquisition proceedings in accordance with Swedish law (the "Squeeze-out Proceedings"). In August 2016, we acquired the remaining 4.2% of Transmode shares not tendered in the initial offer.

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Table of Contents

We expect revenue to continue to fluctuate for the next several quarters, as the significant decline in revenue we experienced during the third quarter of 2016 may continue into fiscal 2017. As our revenue is still primarily driven by the long-haul portion of the optical transport market, our current challenges with timing of customer builds and buying patterns in the long-haul market as well as competitive challenges in sub-sea will continue to have an impact on our overall revenue. Despite these challenges, we continue to be well positioned to continue to generate revenue from capacity additions to previously deployed 100G long-haul footprint and increasing market adoption of the Cloud Xpress family of DCI products. Over time, we expect to achieve cross-sell synergies from selling metro solutions into the traditional Infinera customer base and also expect sales of long-haul and sub-sea footprint to increase as we release products enabled by our Infinite Capacity Engine, a new optical engine subsystem that will be built with our 4th generation PIC technology and our next generation FlexCoherent Processor. As we grow our business in the DCI and metro markets, we believe this will help us broaden our overall market. In light of the current revenue challenges, we are balancing aggressive cost management while ensuring that we invest sufficiently to take advantage of our significant market opportunities across our end markets. Looking further out, our expectation is that with sustained revenue growth, we can further leverage our vertically-integrated manufacturing model, which combined with our expanding portfolio of purpose built products, continued long-haul capacity adds into deployed networks and expense management, can result in improved profitability and cash flow.
Our goal is to be the preeminent provider of optical transport networking systems to Service Providers around the world. Our long-term revenue growth will depend on the timely introduction of next-generation technologies into our product portfolio, continued acceptance of our products, diversification of our customer base, growth of communications traffic and the continued proliferation of bandwidth-intensive services, which are expected to drive the need for increased levels of bandwidth.
Our near-term quarter-over-quarter revenue may be impacted by several factors including general economic and market conditions, time-to-market development and market acceptance of new products, customer spending cycles and technology requirements, timing of large product deployments, and customer consolidation.
We maintain a broad customer base across multiple verticals and geographies, with several customers capable of spending significantly in a given quarter. However, in a period where multiple key customers slow spend, our business may be harmed if our customers do not generate as much revenue as we forecast, stop purchasing from us, or substantially reduce their orders to us. We experienced a slowdown in spending from multiple key customers during the three months ended September 24, 2016, which resulted in revenue declining substantially compared to the prior quarter and the corresponding period in 2015. For the three months ended September 24, 2016, two customers individually accounted for 16% and 12% of our total revenue, respectively, and for the corresponding period in 2015, two customers individually accounted for 26% and 16% our total revenue, respectively. For the nine months ended September 24, 2016, two customers individually accounted for 16% and 10% of our total revenue, respectively, and two customers individually accounted for 18% and 15% of our total revenue, respectively, for the corresponding period in 2015.
We are headquartered in Sunnyvale, California, with employees located throughout the Americas, Europe and the Asia Pacific region. We primarily sell our products through our direct sales force but also sell indirectly through resellers. We derived 86% and 93% of our revenue from direct sales to customers during each of the three and nine months ended September 24, 2016, respectively, and 93% and 94% of our revenue for each of the three and nine months ended September 26, 2015, respectively. Our indirect sales rose to $26.5 million, or 14% of revenue during the three months ended September 24, 2016 compared to $15.8 million, or 7% in the corresponding period of 2015 largely due to strong gains in revenue generated through partnerships with certain key international partners. While we expect to continue generating a substantial majority of our revenue from direct sales in the near future, we are working to expand our indirect sales programs by expanding relationships with key international partners and offering more channel friendly offerings such as the Cloud Xpress platform and XTM-Series products.
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.

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An accounting policy is deemed to be critical if it requires a significant accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes that there have been no significant changes during the nine months ended September 24, 2016 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 26, 2015.
Results of Operations
The results of operations for the three and nine months ended September 24, 2016 reflects the inclusion of the Transmode business, which was acquired on August 20, 2015. The following sets forth, for the periods presented, certain unaudited condensed consolidated statements of operations information (in thousands, except percentages):
 
 
Three Months Ended
 
 
 
 
 
September 24, 2016
 
September 26, 2015
 
 
 
 
 
Amount    
 
  % of total  
revenue
 
Amount    
 
  % of total  
revenue
 
Change    
 
% Change 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
156,188

 
84
%
 
$
202,365

 
87
%
 
$
(46,177
)
 
(23
)%
Services
29,264

 
16
%
 
30,107

 
13
%
 
(843
)
 
(3
)%
Total revenue
$
185,452

 
100
%
 
$
232,472

 
100
%
 
$
(47,020
)
 
(20
)%
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
91,064

 
49
%
 
$
117,154

 
50
%
 
$
(26,090
)
 
(22
)%
Services
9,786

 
5
%
 
12,513

 
5
%
 
(2,727
)
 
(22
)%
Total cost of revenue
$
100,850

 
54
%
 
$
129,667

 
55
%
 
$
(28,817
)
 
(22
)%
Gross profit
$
84,602

 
45.6
%
 
$
102,805