Edgar Filing: INFINERA CORP

INFN-9.28-2013-10Q

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 28, 2013



¨	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, 2013, 119,560,318 shares of the registrant’s Common Stock, $0.001 par value, were issued and outstanding.

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INFINERA CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE FISCAL QUARTER ENDED SEPTEMBER 28, 2013

INDEX



		Page
PART I. FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (Unaudited)	3

	Condensed Consolidated Balance Sheets – As of September 28, 2013 and December 29, 2012	3

	Condensed Consolidated Statements of Operations – Three and nine months ended September 28, 2013 and September 29, 2012	4

	Condensed Consolidated Statements of Comprehensive Income (Loss) – Three and nine months ended September 28, 2013 and September 29, 2012	5

	Condensed Consolidated Statements of Cash Flows – Nine months ended September 28, 2013 and September 29, 2012	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	30

Item 4.	Controls and Procedures	30

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	32

Item 1A.	Risk Factors	33

Item 6.	Exhibits	50

	Signature Page	51

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PART I. FINANCIAL INFORMATION


Item 1.	Condensed Consolidated Financial Statements

INFINERA CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par values)

(Unaudited)



	September 28, 2013			December 29, 2012
ASSETS
Current assets:
Cash and cash equivalents	$	137,629		$	104,666
Short-term investments	151,821			76,146
Accounts receivable, net of allowance for doubtful accounts of $147 in 2013 and $94 in 2012	87,180			107,039
Other receivables	616			2,909
Inventory	123,505			127,809
Deferred inventory costs	1,244			1,029
Prepaid expenses and other current assets	18,924			9,899
Total current assets	520,919			429,497
Property, plant and equipment, net	79,062			80,343
Deferred inventory costs, non-current	19			100
Long-term investments	52,871			2,874
Cost-method investment	9,000			9,000
Long-term restricted cash	3,724			3,868
Deferred tax asset	—			805
Other non-current assets	5,238			1,683
Total assets	$	670,833		$	528,170
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	29,218		$	61,428
Accrued expenses	21,290			25,483
Accrued compensation and related benefits	24,621			22,325
Accrued warranty	12,854			7,262
Deferred revenue	25,202			26,744
Deferred tax liability	—			805
Total current liabilities	113,185			144,047
Long-term debt, net	107,350			—
Accrued warranty, non-current	10,308			9,220
Deferred revenue, non-current	3,097			3,210
Other long-term liabilities	18,158			15,557
Commitments and contingencies (Note 14)
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 28, 2013 and December 29, 2012 Issued and outstanding shares – 119,491 as of September 28, 2013 and 112,461 as of December 29, 2012	119			112
Additional paid-in capital	1,016,397			930,618
Accumulated other comprehensive loss	(3,474		)	(2,228		)
Accumulated deficit	(594,307		)	(572,366		)
Total stockholders’ equity	418,735			356,136
Total liabilities and stockholders’ equity	$	670,833		$	528,170

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

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INFINERA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Revenue:
Product	$	120,807		$	98,853		$	348,769		$	269,087
Ratable product and related support and services	525			450			1,553			1,504
Services	20,688			12,911			54,708			39,782
Total revenue	142,020			112,214			405,030			310,373
Cost of revenue:
Cost of product	66,645			66,510			222,126			181,851
Cost of ratable product and related support and services	40			102			204			459
Cost of services	6,964			4,102			19,973			13,762
Total cost of revenue	73,649			70,714			242,303			196,072
Gross profit	68,371			41,500			162,727			114,301
Operating expenses:
Research and development	32,528			27,912			93,935			90,573
Sales and marketing	17,720			19,285			52,921			55,304
General and administrative	11,678			12,508			32,976			35,912
Total operating expenses	61,926			59,705			179,832			181,789
Income (loss) from operations	6,445			(18,205		)	(17,105		)	(67,488		)
Other income (expense), net:
Interest income	232			175			636			678
Interest expense	(2,578		)	—			(3,427		)	—
Other gain (loss), net:	(444		)	(617		)	(805		)	(892		)
Total other income (expense), net	(2,790		)	(442		)	(3,596		)	(214		)
Income (loss) before income taxes	3,655			(18,647		)	(20,701		)	(67,702		)
Provision for income taxes	308			434			1,240			1,540
Net income (loss)	$	3,347		$	(19,081	)	$	(21,941	)	$	(69,242	)
Net income (loss) per common share
Basic	$	0.03		$	(0.17	)	$	(0.19	)	$	(0.63	)
Diluted	$	0.03		$	(0.17	)	$	(0.19	)	$	(0.63	)
Weighted average shares used in computing net income (loss) per common share
Basic	118,740			111,579			116,653			110,216
Diluted	124,679			111,579			116,653			110,216

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

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INFINERA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)



	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Net income (loss)	$	3,347		$	(19,081	)	$	(21,941	)	$	(69,242	)
Other comprehensive income (loss):
Unrealized gain (loss) on auction rate securities classified as available-for-sale investments	—			82			—			(143		)
Reclassification of realized gain on auction rate securities	—			—			(166		)	—
Unrealized gain (loss) on all other available-for-sale investments	44			69			(64		)	189
Foreign currency translation adjustment	(98		)	614			(1,016		)	352
Tax related to available-for-sale investment	—			(18		)	—			(19		)
Net change in accumulated other comprehensive income (loss)	(54		)	747			(1,246		)	379
Comprehensive income (loss)	$	3,293		$	(18,334	)	$	(23,187	)	$	(68,863	)

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

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INFINERA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Nine Months Ended
	September 28, 2013			September 29, 2012
Cash Flows from Operating Activities:
Net loss	$	(21,941	)	$	(69,242	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	18,574			17,274
(Recovery of) provision for other receivables	(88		)	—
Provision for doubtful accounts	53			94
Amortization of debt discount and issuance costs	2,552			—
Amortization of premium on investments	870			1,610
Stock-based compensation expense	23,802			31,684
Non-cash tax benefit	—			(18		)
Other gain	(243		)	(479		)
Changes in assets and liabilities:
Accounts receivable	19,805			(11,021		)
Other receivables	2,131			(2,228		)
Inventory	(3,603		)	(28,774		)
Prepaid expenses and other assets	(8,398		)	33
Deferred inventory costs	(160		)	4,877
Accounts payable	(30,624		)	(1,048		)
Accrued liabilities and other expenses	1,640			3,690
Deferred revenue	(1,655		)	(6,683		)
Accrued warranty	6,680			2,434
Net provided by (cash used) in operating activities	9,395			(57,797		)
Cash Flows from Investing Activities:
Purchase of available-for-sale investments	(206,528		)	(50,134		)
Proceeds from sale of available-for-sale investments	2,850			6,694
Proceeds from maturities and calls of investments	77,143			95,368
Purchase of property and equipment	(13,605		)	(22,238		)
Reimbursement of manufacturing capacity advance	—			50
Change in restricted cash	110			(564		)
Net cash provided by (used in) investing activities	(140,030		)	29,176
Cash Flows from Financing Activities:
Proceeds from issuance of debt, net	144,469			—
Proceeds from issuance of common stock	21,551			11,280
Repurchase of common stock	(1,541		)	(875		)
Net cash provided by financing activities	164,479			10,405
Effect of exchange rate changes on cash	(881		)	358
Net change in cash and cash equivalents	32,963			(17,858		)
Cash and cash equivalents at beginning of period	104,666			94,458
Cash and cash equivalents at end of period	$	137,629		$	76,600
Supplemental disclosures of cash flow information:
Cash paid for income taxes	$	1,536		$	755
Supplemental schedule of non-cash financing activities:
Non-cash settlement for manufacturing capacity advance	$	—		$	275
Transfer of inventory to fixed assets	$	6,672		$	738

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

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INFINERA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


1.	Basis of Presentation and Significant Accounting Policies

Infinera Corporation (“Infinera” or 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 29, 2012.

The Company has made estimates and judgments affecting the amounts reported in its condensed consolidated financial statements and the accompanying notes. The Company’s actual results may differ materially from these estimates. The accounting estimates that require most significant, difficult, and subjective judgment include revenue recognition, stock-based compensation, inventory valuation, allowances for sales returns, allowances for doubtful accounts, accrued warranty, fair value measurement of the liability component of the convertible senior notes, cash equivalents, fair value measurement of investments, other-than-temporary impairments, derivative instruments and accounting for income taxes.

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 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 29, 2012.

There have been no material changes in the Company’s significant accounting policies for the nine months ended September 28, 2013 as compared to those disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2012.


2.	Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2013-02, Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The Company adopted the guidance for ASU 2013-02 beginning in its fiscal quarter ended March 30, 2013. Other than requiring additional disclosures, the Company’s adoption of ASU 2013-02 did not have an impact on the Company’s financial position, results of operations or cash flow.

In July 2013, the FASB issued Accounting Standards Update 2013-11, Income Taxes – Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry forward, a Similar Tax Loss, or a Tax Credit Carry forwards Exists (“ASU 2013-11”). ASU 2013-11 requires entities to present the unrecognized tax benefits in the financial statements as a liability and not combine it with deferred tax assets to the extent a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. ASU 2013-11 is effective for annual and interim periods for fiscal years beginning on or after December 15, 2013. The Company is currently evaluating ASU 2013-11 and does not expect its adoption to have an impact on the Company’s financial position, results of operations or cash flow.


3.	Fair Value Measurements and Other-Than-Temporary Impairments

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.

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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 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, derivative instruments and debt securities at fair value and classifies its securities 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, corporate bonds, and foreign currency exchange forward contracts within Level 2 of the fair value hierarchy as follows:

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, and result in the classification of these securities as Level 2 of the fair value hierarchy.

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, and result in the classification of these securities as Level 2 of the fair value hierarchy.

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. Since 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. As a result, the Company classifies its corporate bonds as Level 2 of the fair value hierarchy.

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. As a result, the Company classifies its derivative instruments as Level 2 of the fair value hierarchy.

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The Company classified its auction rate securities (“ARS”) within Level 3 of the fair value hierarchy. The Company’s ARS were classified within Level 3 because they were valued, in part, by using inputs that were unobservable in the market and were significant to the valuation. During the first quarter of 2013, the Company disposed of its remaining $3.1 million (par value) ARS, with $0.1 million of ARS called at par value and $3.0 million of ARS tendered at 95% of par value. As of September 28, 2013, none of the Company’s existing securities were classified as Level 3 securities.

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 28, 2013								As of December 29, 2012
	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	$	72,386	$	—	$	—	$	72,386	$	25,560	$	—	$	—	$	25,560
Certificates of deposit	—		2,640		—		2,640		—		2,160		—		2,160
Commercial paper	—		88,720		—		88,720		—		14,843		—		14,843
Corporate bonds	—		109,540		—		109,540		—		57,467		—		57,467
U.S. treasuries	7,806		—		—		7,806		15,020		—		—		15,020
ARS	—		—		—		—		—		—		2,873		2,873
Total assets	$	80,192	$	200,900	$	—	$	281,092	$	40,580	$	74,470	$	2,873	$	117,923
Liabilities
Foreign currency exchange forward contracts	$	—	$	64	$	—	$	64	$	—	$	112	$	—	$	112

During the three and nine months ended September 28, 2013, there were no transfers of assets or liabilities between Level 1 and Level 2 financial assets.

The Company’s remaining Level 3 financial assets were disposed during the first quarter of 2013. The following tables present a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable (Level 3) inputs (in thousands):



	Nine Months Ended
	December 29, 2012		Total Net Gains Included in Other Comprehensive Loss		Calls				Sold				September 28, 2013
ARS – available-for-sale	$	2,873	$	—	$	(92	)	⁽¹⁾	$	(2,781	)	⁽²⁾	$	—



	Three Months Ended
	June 30, 2012		Total Net Gains Included in Other Comprehensive Loss			Calls		September 29, 2012
ARS – available-for-sale	$	2,796	$	83	⁽³⁾	$	—	$	2,879



	Nine Months Ended
	December 31, 2011		Total Net Gains Included in Other Comprehensive Loss			Calls				September 29, 2012
ARS – available-for-sale	$	7,675	$	143	⁽³⁾	$	(4,939	)	⁽⁴⁾	$	2,879


⁽¹⁾	Amount represents the fair market value of the securities called at par value. Realized gains for the nine months ended September 28, 2013 were not significant.


⁽²⁾	Amount represents the fair market value of the securities sold at 95% par value. Realized gains for the nine months ended September 28, 2013 were $0.2 million.


⁽³⁾	Amount represents the change in the non-credit loss related other-than-temporary impairments (“OTTI”) recorded in Accumulated other comprehensive loss in the accompanying condensed consolidated balance sheets.

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⁽⁴⁾	Amount represents the fair market value of the securities called. Realized gains on these calls for the nine months ended September 29, 2012 were $0.5 million.

Investments at fair value were as follows (in thousands):



	September 28, 2013
	Adjusted Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Money market funds	$	72,386	$	—	$	—		$	72,386
Certificates of deposit	2,640		—		—			2,640
Commercial paper	88,713		13		(6		)	88,720
Corporate bonds	109,598		36		(94		)	109,540
U.S. treasuries	7,803		3		—			7,806
Total available-for-sale investments	$	281,140	$	52	$	(100	)	$	281,092



	December 29, 2012
	Adjusted Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Money market funds	$	25,560		$	—	$	—		$	25,560
Certificates of deposit	2,160			—		—			2,160
Commercial paper	14,848			—		(5		)	14,843
Corporate bonds	57,451			22		(6		)	57,467
U.S. treasuries	15,015			5		—			15,020
ARS	2,707		⁽¹⁾	166		—			2,873
Total available-for-sale investments	$	117,741		$	193	$	(11	)	$	117,923


⁽¹⁾	Amount represents the par value less $0.4 million of credit-related OTTI recognized through earnings in prior years.

As of September 28, 2013, the Company’s available-for-sale investments in certificates of deposit, commercial paper, corporate bonds, and U.S. treasuries have a contractual maturity term of no more than 18 months. Proceeds from sales, maturities and calls of available-for-sale investments were $80.0 million for the nine months ended September 28, 2013, and $102.1 million for the nine months ended September 29, 2012. Net realized gains (losses) on short-term and long-term investments were $0.2 million for the nine months ended September 28, 2013 and were $0.5 million for the nine months ended September 29, 2012. The specific identification method is used to account for gains and losses on available-for-sale investments.

Other-Than-Temporary Impairments

As a result of the Company’s disposal of $3.1 million ARS (par value) during the first quarter of 2013, it recorded an approximately $0.2 million gain, which was recognized as Other gain (loss) in the Company’s condensed consolidated statements of operations.

A roll-forward of amortized cost, cumulative OTTI recognized in earnings and Accumulated other comprehensive loss is as follows (in thousands):



	Amortized Cost			Cumulative OTTI in Earnings			Unrealized Gain			OTTI Loss in Accumulated Other Comprehensive Loss			Accumulated Other Comprehensive Income (Loss)
Balance at December 29, 2012	$	2,707		$	(394	)	$	784		$	(618	)	$	166
Call on investments	(87		)	13			(25		)	20			(5		)
Investments sold	(2,620		)	381			(759		)	598			(161		)
Balance at September 28, 2013	$	—		$	—		$	—		$	—		$	—

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4.	Cost-method Investment

As of September 28, 2013, the Company’s investment in a privately-held company was $9.0 million. This investment is accounted for as a cost-basis investment, 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 the entity. The Company’s cost-method investment is carried at historical cost in its condensed consolidated financial statements and measured at fair value on a nonrecurring basis. If the Company believes that the carrying value of the cost basis investment 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. The Company regularly evaluates the carrying value of this cost-method investment for impairment. As of September 28, 2013, no event had occurred that would adversely affect the carrying value of this investment, therefore, the fair value of the cost-method investment is not estimated. The Company did not record any impairment charges for this cost-method investment during the three and nine months ended September 28, 2013 and September 29, 2012.


5.	Derivative Instruments

Foreign Currency Exchange Forward Contracts

The Company enters into foreign currency exchange forward contracts to manage its exposure to fluctuations in foreign exchange rates that arise primarily from its Euro denominated receivables and Euro denominated restricted cash balance amounts that are pledged as collateral for certain stand-by and commercial letters of credit. Gains and losses on these contracts are intended to offset the impact of foreign exchange rate changes on the underlying foreign currency denominated accounts receivables and restricted cash, and therefore, do not subject the Company to material balance sheet risk. The forward contracts are with one high-quality institution and the Company consistently monitors the creditworthiness of the counterparty. None of the Company’s derivative instruments contain credit-risk related contingent features, any rights to reclaim cash collateral or any obligation to return cash collateral. The forward contracts entered into during the three and nine months ended September 28, 2013 were denominated in Euros and typically had maturities of no more than 30 days. The contracts are settled for U.S. dollars at maturity at rates agreed to at inception of the contracts.

As of September 28, 2013, the Company did not designate foreign currency exchange forward contracts related to Euro denominated receivables and restricted cash as hedges for accounting purposes, and accordingly changes in the fair value of these instruments are included in Other gain (loss), net in the accompanying condensed consolidated statements of operations. For the three months ended September 28, 2013 and September 29, 2012, the before-tax effect of foreign currency exchange forward contracts for Euro denominated receivables and restricted cash not designated as hedging instruments was a loss of $1.2 million and a loss of $0.2 million, respectively, included in Other gain (loss), net in the condensed consolidated statements of operations. For the nine months ended September 28, 2013 and September 29, 2012, the before-tax effect of foreign currency exchange forward contracts for Euro denominated receivables and restricted cash not designated as hedging instruments was a loss of $1.4 million and a loss of $0.4 million, respectively, included in Other gain (loss), net in the condensed consolidated statement of operations.

The fair value of derivative instruments not designated as hedging instruments in the Company’s condensed consolidated balance sheets was as follows (in thousands):



	As of September 28, 2013					As of December 29, 2012
	Gross Notional⁽¹⁾		Other Accrued Liabilities			Gross Notional⁽¹⁾		Other Accrued Liabilities
Foreign currency exchange forward contracts
Related to Euro denominated receivables	$	23,255	$	(60	)	$	22,882	$	(105	)
Related to restricted cash	1,363		(4		)	1,495		(7		)
	$	24,618	$	(64	)	$	24,377	$	(112	)


⁽¹⁾	Represents the face amounts of forward contracts that were outstanding as of the period noted.

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6.	Balance Sheet Details

The following table provides details of selected balance sheet items (in thousands):



	September 28, 2013			December 29, 2012
Inventory
Raw materials	$	12,154		$	13,003
Work in process	45,681			57,281
Finished goods ⁽¹⁾	65,670			57,525
Total inventory	$	123,505		$	127,809
Property, plant and equipment, net:
Computer hardware	$	9,362		$	9,024
Computer software	16,728			15,834
Laboratory and manufacturing equipment	143,680			120,543
Furniture and fixtures	1,348			1,285
Leasehold improvements	34,952			33,370
Construction in progress	6,969			17,513
Subtotal	$	213,039		$	197,569
Less accumulated depreciation and amortization	(133,977		)	(117,226		)
Total property, plant and equipment, net	$	79,062		$	80,343
Accrued expenses:
Loss contingency related to non-cancelable purchase commitments	$	3,948		$	5,401
Professional and other consulting fees	1,969			3,703
Taxes payable	2,642			3,588
Royalties	999			1,516
Accrued rebate and customer prepay liability	1,059			1,284
Accrued interest on convertible senior notes	875			—
Other accrued expenses	9,798			9,991
Total accrued expenses	$	21,290		$	25,483


⁽¹⁾	Included in finished goods inventory at September 28, 2013 and December 29, 2012 were $14.0 million and $12.2 million, respectively, of inventory at customer locations for which product acceptance had not occurred.

The following table sets forth the Company's outstanding standby letters of credit (in thousands):



	September 28,		December 29,
	2013		2012

Value added tax license	$	1,395	$	1,536
Customer proposal guarantee	1,353		1,373
Property leases	699		699
Total standby letters of credit	$	3,447	$	3,608

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7.	Comprehensive Loss

Other comprehensive loss includes certain changes in equity that are excluded from net loss. The following table sets forth the changes in accumulated other comprehensive loss by component for the nine months ended September 28, 2013 (in thousands):



	Unrealized Gain on Auction Rate Securities			Unrealized Gain on Other Available-for-Sale Securities			Foreign Currency Translation			Accumulated Tax Effect			Total
Balance at December 29, 2012	$	166		$	16		$	(1,650	)	$	(760	)	$	(2,228	)
Other comprehensive loss before reclassifications	—			(64		)	(1,016		)	—			(1,080		)
Amounts reclassified from accumulated other comprehensive loss	(166		)	—			—			—			(166		)
Net current-period other comprehensive loss	(166		)	(64		)	(1,016		)	—			(1,246		)
Balance at September 28, 2013	$	—		$	(48	)	$	(2,666	)	$	(760	)	$	(3,474	)

The following table provides details about reclassifications out of accumulated other comprehensive loss for the nine months ended September 28, 2013 (in thousands):



Details about Accumulated Other Comprehensive Loss Components	Amount Reclassified from Accumulated Other Comprehensive Loss			Affected Line Item in the Statement Where Net Loss is Presented
Unrealized gain on auction rate securities	$	(166	)	Other gain (loss), net
	—			Provision for income taxes
Total reclassifications for the period	$	(166	)	Total, net of income tax


8.	Basic and Diluted Net Income (Loss) Per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed using net income (loss) and the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period. Potentially dilutive common shares include the assumed exercise of outstanding stock options, assumed vesting of outstanding restricted stock units (“RSUs”) and performance stock units (“PSUs”), assumed exercise of outstanding warrants, assumed conversion of convertible senior notes and assumed issuance of stock under the Company’s employee stock purchase plan (“ESPP”) using the treasury stock method. When there is a loss, these potentially diluted common shares are anti-dilutive and therefore, excluded from the diluted net loss calculation. The Company includes the common shares underlying PSUs in the calculation of diluted net income per share when they become contingently issuable and excludes such shares when they are not contingently issuable.

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 28, 2013		September 29, 2012			September 28, 2013			September 29, 2012
Numerator:
Net income (loss)	$	3,347	$	(19,081	)	$	(21,941	)	$	(69,242	)
Denominator:
Basic weighted average common shares outstanding	118,740		111,579			116,653			110,216
Effect of dilutive securities:
Employee equity plans	5,939		—			—			—
Diluted weighted average common shares outstanding	124,679		111,579			116,653			110,216

Net income (loss) per common share
Basic	$	0.03	$	(0.17	)	$	(0.19	)	$	(0.63	)
Diluted	$	0.03	$	(0.17	)	$	(0.19	)	$	(0.63	)

The number of shares outstanding used in the computation of basic and diluted net income (loss) per share does not include the effect of the following potential outstanding common stock. The effects of these potentially outstanding shares were not included in the calculation of diluted net income (loss) per share because the effect would have been anti-dilutive or the performance condition of the award has not been met (in thousands):



	Three Months Ended		Nine Months Ended
	September 28, 2013	September 29, 2012	September 28, 2013	September 29, 2012
Stock options	408	9,348	6,603	9,348
RSUs	89	6,818	6,559	6,818
PSUs	211	1,405	721	1,405
ESPP	675	966	675	966
Warrants to purchase common stock	—	93	—	93
Total	1,383	18,630	14,558	18,630

In the three and nine months ended September 28, 2013, the Company excluded the convertible senior notes in the calculation of diluted earnings per share because the average market price was below the conversion price. The Company would include the dilutive effects of the convertible senior notes in the future if the average market price is above the conversion price. Upon conversion of the Notes, it is the Company’s intention to pay cash equal to the lesser of the aggregate principal amount and 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 unless their effect is anti-dilutive. See Note 9, “Convertible Senior Notes,” to the Notes to Condensed Consolidated Financial Statements for more information.


9.	Convertible Senior Notes

In May 2013, the Company issued $150.0 million of 1.75% convertible senior notes due June 1, 2018 (the “Notes”). The Notes 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 and the conversion value of the Notes being converted and cash, shares of common stock or a combination of cash and shares of

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common stock, at the Company’s election, for any remaining conversion obligation. 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 cancelled, extinguished or forfeited. Holders may convert their Notes under the following circumstances:

•

during any fiscal quarter commencing after the fiscal quarter ending on September 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 will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its Notes in connection with such make-whole fundamental change.

The Notes consisted of the following (in thousands):



	Other Non- Current Assets			Long-term Debt			Additional Paid- in Capital
Principal amount	$	—		$	150,000		$	—
Debt discount	—			(45,000		)	—
Equity component	—			—			45,000
Debt issuance cost	3,872			—			(1,659		)
Initial transaction amounts	$	3,872		$	105,000		$	43,341
Amortization of debt issuance cost	(202		)	—			—
Amortization of debt discount	—			2,350			—
Net carrying amount at September 28, 2013	$	3,670		$	107,350		$	43,341

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. The remaining debt discount amount to be amortized over the remaining five years until maturity of the Notes was $42.7 million as of September 28, 2013.

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

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component were recorded as Other non-current assets and will be amortized to interest expense over the term of the Notes. The issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity. Additionally, the Company recorded a deferred tax liability of $17.0 million in connection with the Notes, along with 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 28, 2013
Contractual interest expense	$	656	$	875
Amortization of debt issuance costs	152		202
Amortization of debt discount	1,770		2,350
	$	2,578	$	3,427

The effective interest rate of the liability component was 1.75%. The excess of the principal amount of the liability component over its carrying amount is amortized, using an effective interest rate of 5.12%, to interest expense over the term of the Notes.

As of September 28, 2013, the fair value of the Notes was $173.6 million. The fair value was determined based on the quoted bid price of the Notes in an over-the-counter market on September 27, 2013. The Notes are classified as Level 2 of the fair value hierarchy. Based on the closing price of the Company’s common stock of $11.40 on September 27, 2013, the if-converted value of the Notes was less than their principal amount.


10.	Stockholders’ Equity

Stock-based Compensation Plans

The Company’s stock-based compensation plans include stock options, RSUs, PSUs and employee stock purchases under the Company’s ESPP. As of September 28, 2013, there were a total of 16.8 million shares available for grant under the Company’s 2007 Equity Incentive Plan. The following tables summarize the Company’s equity award activity and related information (in thousands, except per share data):



	Number of Options		Average Exercise Price Per Share		Aggregate Intrinsic Value
Outstanding at December 29, 2012	9,008		$	7.13	$	5,726
Options exercised	(1,988	)	$	6.53	$	6,848
Options canceled	(417	)	$	7.96
Outstanding at September 28, 2013	6,603		$	7.26	$	27,954
Vested and expected to vest as of September 28, 2013	6,592				$	27,916
Exercisable at September 28, 2013	6,187		$	7.22	$	26,493

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	Number of Restricted Stock Units		Weighted- Average Grant Date Fair Value Per Share		Aggregate Intrinsic Value
Outstanding at December 29, 2012	6,703		$	8.01	$	38,873
RSUs granted	3,258		$	7.36
RSUs released	(2,903	)	$	8.27	$	23,389
RSUs canceled	(499	)	$	7.67
Outstanding at September 28, 2013	6,559		$	7.60	$	74,768
Expected to vest at September 28, 2013	6,375				$	72,679



	Number of Performance Stock Units		Weighted- Average Grant Date Fair Value Per Share		Aggregate Intrinsic Value
Outstanding at December 29, 2012	1,368		$	10.53	$	7,933
PSUs granted	552		$	6.70
PSUs released	(684	)	$	10.53	$	4,284
PSUs canceled	(515	)	$	11.31
Outstanding at September 28, 2013	721		$	7.04	$	8,214
Expected to vest at September 28, 2013	490				$	5,587

The aggregate intrinsic value of unexercised options, unreleased RSUs and unreleased PSUs is calculated as the difference between the closing price of the Company’s common stock of $11.40 at September 27, 2013 and the exercise prices of the underlying equity awards. The aggregate intrinsic value of the options which have been exercised and RSUs released is calculated as the difference between the fair market value of the common stock at the date of exercise or release and the exercise price of the underlying equity awards.

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 28, 2013. 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	1,420	1.02
RSUs	32,616	2.26
PSUs	2,183	1.70

Employee Stock Options

The ranges of estimated values of stock options and performance-based stock options granted, as well as ranges of assumptions used in calculating these values were based on estimates as follows:

Three Months Ended

Nine Months Ended

Employee and Director Stock Options

September 28,

2013

September 29,

2012

September 28,

2013

September 29,

2012

Volatility

N/A

65% - 68%

Risk-free interest rate

N/A

0.7%-1.0%

Expected life

N/A

4.0 - 5.3 years

Estimated fair value

N/A

$3.75 - $3.76

Stock-based compensation expense (in thousands)

665

2,553

2,190

7,121

_________________

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N/A	Not applicable because the Company did not grant any options to employees for the periods presented.

Employee Stock Purchase Plan

The fair value of the ESPP shares was estimated at the date of grant using the following assumptions:



	Three Months Ended				Nine Months Ended
Employee Stock Purchase Plan	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Volatility	49%		54%		46% - 49%		54% - 57%
Risk-free interest rate	0.10%		0.17%		0.10% - 0.14%		0.16% - 0.17%
Expected life	0.5 years		0.5 years		0.5 years		0.5 years
Estimated fair value	$	3.00	$	1.73	$1.87 - $3.00		$1.73 - $2.63
Stock-based compensation expense (in thousands)	$	777	$	895	$	2,050	$	2,653

Restricted Stock Units

During the three and nine months ended September 28, 2013, the Company granted RSUs to members of the Company’s board of directors and employees to receive an aggregate of 0.4 million shares and 3.3 million shares of the Company’s common stock, respectively, at no cost. 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 28, 2013 and September 29, 2012 was approximately $5.5 million and $18.2 million, respectively, and $6.9 million and $20.6 million, respectively.

Performance Stock Units

Pursuant to the Company’s 2007 Equity Incentive Plan, during 2009, the Company granted PSUs primarily to members of the Company’s board of directors and executive officers. The number of shares to be issued upon vesting of PSUs range from 0.5 to 2.0 times the number of PSUs granted depending on the relative performance of the Company’s common stock price compared to the NASDAQ Composite Index over a three-year or four-year period. During the nine months ended September 28, 2013, the Company released 0.5 million shares of PSUs based on a payout of 0.5 times of the target number of PSUs.

Pursuant to the Company’s 2007 Equity Incentive Plan, during 2012, the Company granted 0.5 million shares of PSUs to certain of the Company’s executive officers. These PSUs will only vest upon the achievement of certain specific revenue and operating profit criteria and are subject to each named executive officer’s continued service to the Company. If the financial performance metrics are not met within the time limits specified in the award agreements, the PSUs will be canceled. During the nine months ended September 28, 2013, the Company released 0.2 million shares of PSUs upon achievement of certain performance goals.

Pursuant to the Company’s 2007 Equity Incentive Plan, during the three and nine months ended September 29, 2013, the Company granted zero and 0.6 million shares of PSUs, respectively, to certain of the Company’s executive officers. The number of shares to be issued upon vesting of PSUs range from 0 to 1.5 times the number of PSUs granted depending on the relative performance of the Company’s common stock price compared to the NASDAQ Telecom Composite Index over the span of one, two and three years of total shareholder returns.

Amortization of stock-based compensation related to PSUs in the three months ended September 28, 2013 was approximately $0.5 million. Amortization of stock-based compensation related to PSUs in the nine months ended September 28, 2013 was approximately $0.1 million, including $1.5 million of expense offset by a $1.4 million decrease in fair value for one award classified as a liability award, in accordance with Accounting Standard Codification 718, Compensation – Stock Compensation. Amortization of stock-based compensation related to PSUs in the three and nine months ended September 28, 2012 was approximately $1.0 million and $2.8 million, respectively.

Common Stock Warrants

During the first quarter of 2013, warrants to purchase 92,592 shares of common stock were net exercised. The aggregate consideration for such exercises was approximately $0.5 million. As of September 28, 2013, there were no warrants of common stock outstanding.

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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 28, 2013		December 29, 2012
Stock-based compensation effects in inventory	$	3,656	$	4,891
Stock-based compensation effects in deferred inventory cost	$	16	$	42
Stock-based compensation effects in fixed assets	$	152	$	171



	Three Months Ended				Nine Months Ended
	September 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Stock-based compensation effects in net income (loss) before income taxes
Cost of revenue	$	422	$	683	$	1,382	$	1,975
Research and development	2,434		3,439		8,175		10,454
Sales and marketing	1,853		2,685		5,659		7,648
General and administration	1,807		2,804		4,167		7,732
	6,516		9,611		19,383		27,809
Cost of revenue – amortization from balance sheet ⁽¹⁾	1,127		1,706		4,419		3,875
Total stock-based compensation expense	$	7,643	$	11,317	$	23,802	$	31,684

_________________


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


11.	Income Taxes

Provision for income taxes for the three and nine months ended September 28, 2013 was $0.3 million and $1.2 million, respectively, or 8.4% and negative 6.0%, respectively, on a pre-tax income of $3.7 million and a pre-tax loss of $20.7 million, respectively. This compared to a tax provision of $0.4 million and $1.5 million, respectively, or negative 2.3% and negative 2.3%, respectively, on a pre-tax loss of $18.6 million and $67.7 million, respectively, for the three and nine months ended September 29, 2012. The difference between the Company’s effective tax rates and the federal statutory rate of 35% is primarily attributable to unbenefited U.S. losses, foreign taxes provided on the income of the Company’s foreign subsidiaries, non-deductible stock-based compensation expense, and various discrete items. The lower tax expense in 2013 relates to a release of transfer pricing reserves following a statute of limitations expiration.

The realization of tax benefits of deferred tax assets is dependent upon future levels of taxable income, of an appropriate character, in the periods the items are scheduled to be deductible or taxable. Based on the available objective evidence, management believes it is more likely than not that the domestic net deferred tax assets will not be realizable. Accordingly, the Company has provided a full valuation allowance against its domestic deferred tax assets, net of deferred tax liabilities, as of September 28, 2013 and December 29, 2012. In determining future taxable income, the Company makes assumptions to forecast federal, state and international operating income, the reversal of taxable temporary differences, and the implementation of any feasible and prudent tax planning strategies. The assumptions require significant judgment regarding the forecasts of future taxable income and are consistent with the Company’s forecasts used to manage its business. The Company intends to maintain the remaining valuation allowance until sufficient positive evidence exists to support a reversal of, or decrease, in the valuation allowance.


12.	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. The Company’s chief executive officer 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.

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The Company has one business activity, and there are no segment managers who are held accountable for operations, operating results and plans for levels or components below the consolidated unit level. 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 28, 2013		September 29, 2012		September 28, 2013		September 29, 2012
Americas:
United States	$	103,113	$	79,094	$	270,437	$	215,782
Other Americas	2,024		3,716		6,544		9,223
	105,137		82,810		276,981		225,005
Europe, Middle East and Africa	32,262		27,515		103,022		76,944
Asia Pacific	4,621		1,889		25,027		8,424
Total revenue	$	142,020	$	112,214	$	405,030	$	310,373

Property, plant and equipment, net



	September 28, 2013		December 29, 2012
United States	$	76,271	$	78,309
Other Americas	364		198
Europe, Middle East and Africa	995		24
Asia Pacific	1,432		1,812
Total property, plant and equipment, net	$	79,062	$	80,343


13.	Guarantees

Product Warranties

Upon delivery of products, the Company provides for the estimated cost to repair or replace products or the related components that may be returned under hardware warranties. In general, hardware warranty periods range from one to five years. 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 estimates its hardware warranty obligations based on the Company’s historical experience of known product failure rates, use of materials to repair or replace defective products, and service delivery costs incurred in correcting product failures. In addition, from time to time, specific hardware warranty accruals may be made if unforeseen technical problems arise with specific products. Management periodically assesses the adequacy of the Company’s 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 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Beginning balance	$	19,701		$	13,702		$	16,482		$	12,865
Charges to operations	5,220			4,241			16,646			10,065
Utilization	(2,645		)	(1,684		)	(6,783		)	(5,488		)
Change in estimate ⁽¹⁾	886			(960		)	(3,183		)	(2,143		)
Balance at the end of the period	$	23,162		$	15,299		$	23,162		$	15,299


⁽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 and the impact of these changes on the Company’s estimate of expected future returns and changes in the estimated cost of replacing failed units using either repaired or new units.


14.	Litigation and Contingencies

Legal Matters

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. A complete description of the Company’s legal proceedings can be found in “Item 3. Legal Proceedings” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2012 filed with the SEC on March 5, 2013. Any updates to the information contained in the Company’s Annual Report on Form 10-K are set forth below.

Cheetah Patent Infringement Litigation

A hearing was held on July 16, 2013, during which the parties presented evidence to the U.S. District Court for the Eastern District of Texas Texarkana Division regarding the interpretation of various claim terms of U.S. patent nos. 6,795,605 and 7,142,347. On July 24, 2013, the Court issued an order regarding claim construction, in which the Court agreed with some of the Company’s proposed claim constructions.

In addition to the ongoing Cheetah litigation, on June 10, 2013, the Company filed a Petition for Inter Partes Review to challenge the validity of Cheetah’s U.S. patent no. 6,888,661 (the “‘661 Patent”) in a separate proceeding before the United States Patent and Trademark Office. Cheetah has sued Finisar Corporation for infringement of the ‘661 Patent in the U.S. District Court for the Eastern District of Michigan.

Based on the information available at this time, the Company concluded that the likelihood of a loss with respect to the Cheetah litigation is probable and reasonably estimable. Accordingly, the Company accrued an insignificant amount during the third quarter of 2013 which did not have a material adverse effect on the Company’s business, consolidated financial position, results of operations, or cash flows. Factors that the Company considered in the determination of the likelihood of a loss and the estimate that loss in respect to this matter included the merits of the case, the nature of the litigation (including the complex and technical nature of patent litigation), the length of time the matter has been pending, the lift of the stay by the court, the status of the plaintiff as a non-operating entity and the likelihood of the plaintiff accepting the estimated amount. However, the outcome of such legal matters is inherently unpredictable and subject to significant uncertainties.

Cambrian Science Patent Infringement Litigation

On June 17, 2013, the U.S. District Court for the Central District of California issued an order regarding claim construction, in which the Court agreed with some of the Company’s proposed claim constructions.

Based on the information available at this time, the Company concluded that the likelihood of a loss with respect to this suit is less than reasonably possible and therefore, a range of loss cannot be provided. As a result, the Company has made no provision for this lawsuit in its financial statements. Factors that the Company considered in the determination of the likelihood of a loss in respect to this matter included the merits of the case, the nature of the litigation (including the complex and technical nature of patent litigation), the length of time the matter has been pending, and the status of the plaintiff as a non-operating entity, and the Company’s intention to vigorously defend this case.

Loss Contingencies

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 28, 2013, the Company has not accrued or recorded any such material liabilities.

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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 any expectation of earnings, revenues, gross margins, expenses or 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; statements concerning new products or services, including future PIC capacity and new product costs, delivery dates and revenues; 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 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 29, 2012 filed on March 5, 2013. 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

Infinera was founded in December 2000 with a unique vision for optical networking. Prior to Infinera, communications service provider optical networks were built from fairly commoditized products, broadly known as wavelength division multiplexing (“WDM”) systems. Continued growth in bandwidth demand and the rise of cloud services have increased the need for the delivery of a highly-interconnected and high-capacity transport network. To address the increasing demand for cloud-based services and data center connectivity, we introduced the Infinera Intelligent Transport Network™ in June 2013. We believe the Intelligent Transport Network helps carriers increase revenues with the timely delivery of reliable, differentiated services while reducing operating costs through scale, multi-layer convergence and automation.

Essential to our strategy is the use of photonic integrated circuits (“PICs”) to deliver massive bandwidth in a very small power and space footprint, allowing the integration of high-capacity switching into the same platform. Infinera believes PICs enable the most efficient solution for operators to scale their network bandwidth capacity. We introduced the DTN platform based on the 100Gigabits per second (“Gbps”) PIC in 2004 and since then have made significant enhancements by increasing reach and fiber capacity for the long-haul market, adding the Infinera MTC, a 19-inch DTN chassis option tailored for the metro core market, and adding a submarine version of the DTN platform for the Submarine Line Terminating Equipment market. In addition, we introduced our ATN metro access platform, extending the benefits of the Intelligent Transport Network to the edge of the network. In the second quarter of 2012, we started shipping the DTN-X platform, based on our third generation 500Gbps PIC. The DTN-X platform provides high-capacity 100Gbps coherent DWDM in the form of 500Gbps super-channels and integrates five terabits per second of optical transport network switching into a converged platform.

Our goal is to be the leading provider of Intelligent Transport Networks to communications service providers, internet content providers, cable operators, subsea network operators, and others. Our revenue growth will depend on the continued acceptance of our products, growth of communications traffic and the proliferation of bandwidth-intensive services, which increases the need for transport capacity. Our ability to increase our revenue and achieve profitability will be directly affected by the level of acceptance of our products in the long-haul and metro WDM markets and by our ability to cost-effectively develop and sell innovative products that leverage our technology advantages.

As of September 28, 2013, we have sold our network systems for deployment in the optical networks of 126 customers worldwide, including CenturyLink, Colt, Cox Communications, DANTE, Deutsche Telekom, Equinix, Interoute, KDDI, Level 3, NTT, OTE, Pacnet, Rostelecom, Telefonica, TeliaSonera International and Vodafone. Since the commencement of shipping our DTN-X platform in the second quarter of 2012, we have 35 customers who have purchased our DTN-X platform. We do not have long-term sales commitments from our customers. To date, a few of our customers have accounted for a significant portion of our revenue. Three customers each accounted for over 10% of our revenue in the three months ended September 28, 2013 and one customer accounted for over 10% of our revenue in the three months ended September 29, 2012. No customer

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accounted for over 10% of our revenue in the nine months ended September 28, 2013 and one customer accounted for over 10% of our revenue in the nine months ended September 29, 2012. Our business will be harmed if any of our key customers do not generate as much revenue as we forecast, stop purchasing from us, or substantially reduce their orders to us.

We are headquartered in Sunnyvale, California, with employees located throughout the Americas, Europe, and the Asia Pacific region. We expect to continue to add personnel in the United States and internationally to develop our products and provide additional geographic sales and technical support coverage. We primarily sell our products through our direct sales force, with a small portion sold indirectly through resellers. We derived 96% and 94% of our revenue from direct sales to customers in the three and nine months ended September 28, 2013, respectively, and 99% and 98% of our revenue for the three and nine months ended September 29, 2012, respectively. Our strategy is to leverage reseller channels where appropriate to expand our presence in certain geographies; however, we expect to continue generating a substantial majority of our revenue from direct sales.

Our near-term year-over-year and quarter-over-quarter revenue will likely be volatile and may be impacted by several factors including general economic and market conditions, time-to-market development of new products, acquisitions of new customers and the timing of large product deployments.

In May 2013, we issued $150.0 million of 1.75% convertible senior notes (the “Notes”) due June 1, 2018. We intend to use the net proceeds for working capital and other general corporate purposes. See Note 9, “Convertible Senior Notes,” to the Notes to Condensed Consolidated Financial Statements for more information.

In 2013, we intend to continue to focus our efforts on leveraging the DTN-X platform to win new network footprint and gain market share. These efforts will be balanced with a focus on product cost improvements and overall prudent financial management.

We expect to continue to make significant investments in the business, and management currently believes that operating expenses for 2013 will range from $247 million to $252 million, including stock-based compensation expense of approximately $30 million to $35 million.

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 U.S. GAAP. The preparation of these financial statements requires management to make estimates and assumptions that 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.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes that there have been no significant changes during the nine months ended September 28, 2013 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 29, 2012.

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Results of Operations

The following sets forth, for the periods presented, certain unaudited condensed consolidated statements of operations information (in thousands, except %):



	Three Months Ended
	September 28, 2013				September 29, 2012
	Amount		% of total revenue		Amount		% of total revenue		Change			% Change
Revenue:
Product	$	120,807	85	%	$	98,853	88	%	$	21,954		22	%
Ratable product and related support and services	525		—	%	450		—	%	75			17	%
Services	20,688		15	%	12,911		12	%	7,777			60	%
Total revenue	$	142,020	100	%	$	112,214	100	%	$	29,806		27	%
Cost of revenue:
Product	$	66,645	47	%	$	66,510	59	%	$	135		—	%
Ratable product and related support and services	40		—	%	102		—	%	(62		)	-61	%
Services	6,964		5	%	4,102		4	%	2,862			70	%
Total cost of revenue	$	73,649	52	%	$	70,714	63	%	$	2,935		4	%
Gross profit	$	68,371	48	%	$	41,500	37	%	$	26,871		65	%



	Nine Months Ended
	September 28, 2013				September 29, 2012
	Amount		% of total revenue		Amount		% of total revenue		Change			% Change
Revenue:
Product	$	348,769	86	%	$	269,087	87	%	$	79,682		30	%
Ratable product and related support and services	1,553		—	%	1,504		—	%	49			3	%
Services	54,708		14	%	39,782		13	%	14,926			38	%
Total revenue	$	405,030	100	%	$	310,373	100	%	$	94,657		30	%
Cost of revenue:
Product	$	222,126	55	%	$	181,851	59	%	$	40,275		22	%
Ratable product and related support and services	204		—	%	459		—	%	(255		)	-56	%
Services	19,973		5	%	13,762		4	%	6,211			45	%
Total cost of revenue	$	242,303	60	%	$	196,072	63	%	$	46,231		24	%
Gross profit	$	162,727	40	%	$	114,301	37	%	$	48,426		42	%

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The following table summarizes our revenue by geography and sales channel for the periods presented (in thousands, except %):



	Three Months Ended
	September 28, 2013				September 29, 2012
	Amount		% of total revenue		Amount		% of total revenue		Change		% Change
Total revenue by geography
Domestic	$	103,113	73	%	$	79,094	70	%	$	24,019	30	%
International	38,907		27	%	33,120		30	%	5,787		17