INFN-6.28-2014-10Q
Table of Contents


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 June 28, 2014
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 July 29, 2014, 123,670,547 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 JUNE 28, 2014
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)
 
June 28,
2014
 
December 28,
2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
83,307

 
$
124,330

Short-term investments
230,694

 
172,660

Accounts receivable, net of allowance for doubtful accounts of $41 in 2014 and $43 in 2013
120,686

 
100,643

Inventory
130,853

 
123,685

Prepaid expenses and other current assets
20,167

 
17,752

Total current assets
585,707

 
539,070

Property, plant and equipment, net
76,886

 
79,668

Long-term investments
37,086

 
64,419

Cost-method investment
9,000

 
9,000

Long-term restricted cash
4,404

 
3,904

Other non-current assets
5,571

 
4,865

Total assets
$
718,654

 
$
700,926

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
33,162

 
$
39,843

Accrued expenses
22,546

 
22,431

Accrued compensation and related benefits
28,742

 
33,899

Accrued warranty
13,860

 
12,374

Deferred revenue
29,657

 
32,402

Total current liabilities
127,967

 
140,949

Long-term debt, net
112,932

 
109,164

Accrued warranty, non-current
14,088

 
10,534

Deferred revenue, non-current
6,187

 
4,888

Other long-term liabilities
18,173

 
17,581

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 June 28, 2014 and December 28, 2013 Issued and outstanding shares – 123,615 as of June 28, 2014 and 119,887 as of December 28, 2013
124

 
120

Additional paid-in capital
1,046,375

 
1,025,661

Accumulated other comprehensive loss
(3,113
)
 
(3,486
)
Accumulated deficit
(604,079
)
 
(604,485
)
Total stockholders’ equity
439,307

 
417,810

Total liabilities and stockholders’ equity
$
718,654

 
$
700,926

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
 
Six Months Ended
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
Revenue:
 
 
 
 
 
 
 
Product
$
142,364

 
$
120,647

 
$
266,606

 
$
228,990

Services
23,035

 
17,738

 
41,608

 
34,020

Total revenue
165,399

 
138,385

 
308,214

 
263,010

Cost of revenue:
 
 
 
 
 
 
 
Cost of product
85,906

 
80,198

 
164,344

 
155,645

Cost of services
9,240

 
6,533

 
15,211

 
13,009

Total cost of revenue
95,146

 
86,731

 
179,555

 
168,654

Gross profit
70,253

 
51,654

 
128,659

 
94,356

Operating expenses:
 
 
 
 
 
 
 
Research and development
31,738

 
31,681

 
61,084

 
61,407

Sales and marketing
18,082

 
17,155

 
35,944

 
35,201

General and administrative
12,381

 
11,426

 
24,635

 
21,298

Total operating expenses
62,201

 
60,262

 
121,663

 
117,906

Income (loss) from operations
8,052

 
(8,608
)
 
6,996

 
(23,550
)
Other income (expense), net:
 
 
 
 
 
 
 
Interest income
337

 
207

 
673

 
404

Interest expense
(2,728
)
 
(849
)
 
(5,405
)
 
(849
)
Other gain (loss), net
(264
)
 
(158
)
 
(993
)
 
(361
)
Total other income (expense), net
(2,655
)
 
(800
)
 
(5,725
)
 
(806
)
Income (loss) before income taxes
5,397

 
(9,408
)
 
1,271

 
(24,356
)
Provision for income taxes
617

 
601

 
865

 
932

Net income (loss)
$
4,780

 
$
(10,009
)
 
$
406

 
$
(25,288
)
Net income (loss) per common share
 
 
 
 
 
 
 
Basic
$
0.04

 
$
(0.09
)
 
$ 0.00

 
$
(0.22
)
Diluted
$
0.04

 
$
(0.09
)
 
$ 0.00

 
$
(0.22
)
Weighted average shares used in computing net income (loss) per common share
 
 
 
 
 
 
 
Basic
123,128

 
116,911

 
122,240

 
115,609

Diluted
126,758

 
116,911

 
126,112

 
115,609

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
 
Six Months Ended
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
Net income (loss)
$
4,780

 
$
(10,009
)
 
$
406

 
$
(25,288
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Reclassification of realized gain on auction rate securities
—

 
—

 
—

 
(166
)
Unrealized gain (loss) on all other available-for-sale investments
13

 
(99
)
 
62

 
(108
)
Foreign currency translation adjustment
87

 
(802
)
 
331

 
(918
)
Tax related to available-for-sale investment
—

 
—

 
(20
)
 
—

Net change in accumulated other comprehensive income (loss)
100

 
(901
)
 
373

 
(1,192
)
Comprehensive income (loss)
$
4,880

 
$
(10,910
)
 
$
779

 
$
(26,480
)
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)
 
 
Six Months Ended
 
June 28,
2014
 
June 29,
2013
Cash Flows from Operating Activities:
 
 
 
Net income (loss)
$
406

 
$
(25,288
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
Depreciation and amortization
12,813

 
12,621

Amortization of debt discount and issuance costs
4,092

 
630

Amortization of premium on investments
1,747

 
450

Stock-based compensation expense
13,476

 
16,159

Other gain
(22
)
 
(291
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
(20,043
)
 
10,332

Inventory
(8,107
)
 
791

Prepaid expenses and other assets
(3,389
)
 
(2,238
)
Accounts payable
(6,428
)
 
(23,980
)
Accrued liabilities and other expenses
(3,318
)
 
(220
)
Deferred revenue
(1,448
)
 
4,440

Accrued warranty
5,040

 
3,219

Net cash used in operating activities
(5,181
)
 
(3,375
)
Cash Flows from Investing Activities:
 
 
 
Purchase of available-for-sale investments
(158,496
)
 
(130,828
)
Proceeds from sale of available-for-sale investments
9,824

 
2,850

Proceeds from maturities and calls of investments
116,290

 
62,647

Purchase of property and equipment
(9,985
)
 
(9,431
)
Change in restricted cash
(491
)
 
(6
)
Net cash used in investing activities
(42,858
)
 
(74,768
)
Cash Flows from Financing Activities:
 
 
 
Proceeds from issuance of debt, net
—

 
144,469

Proceeds from issuance of common stock
8,401

 
12,496

Minimum tax withholding paid on behalf of employees for net share settlement
(1,619
)
 
(1,499
)
Net cash provided by financing activities
6,782

 
155,466

Effect of exchange rate changes on cash
234

 
(778
)
Net change in cash and cash equivalents
(41,023
)
 
76,545

Cash and cash equivalents at beginning of period
124,330

 
104,666

Cash and cash equivalents at end of period
$
83,307

 
$
181,211

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for income taxes, net of refunds
$
482

 
$
1,148

Cash paid for interest
$
1,313

 
$
—

Supplemental schedule of non-cash financing activities:
 
 
 
Transfer of inventory to fixed assets
$
978

 
$
4,684

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 (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 28, 2013.
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, allowances for sales returns, allowances for doubtful accounts, accrued warranty, fair value measurement of the liability component of the convertible senior notes, fair value measurement of cash equivalents, investments and derivative instruments, other-than-temporary impairments and accounting for income taxes. 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 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 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 28, 2013.
There have been no material changes in the Company’s significant accounting policies for the six months ended June 28, 2014 as compared to those disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2013.
2.
Recent Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board ("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 reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. ASU 2013-11 is effective for annual and interim periods for fiscal years beginning on or after December 15, 2013. The Company's adoption of ASU 2013-11 during the first quarter of 2014 had no impact on the Company’s financial position, results of operations or cash flow.
In May 2014, the FASB issued Accounting Standards Update 2014-09, "Revenue from Contracts from Customers" ("ASU 2014-09"). ASU 2014-09 provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. ASU 2014-09 will require an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update creates a five-step model that requires entities to exercise judgment when considering the terms of the contract(s) which include (i) identifying the contract(s) with the customer, (ii) identifying the separate performance obligations in the contract, (iii) determining the transaction price, (iv) allocating the transaction price to the separate performance obligations, and (v) recognizing revenue when each performance obligation is satisfied. ASU 2014-09 will be effective for the Company’s first quarter of 2017. The Company has the option to apply the provisions of ASU 2014-09 either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of applying this ASU recognized at the date of initial application. Early adoption is not permitted. The Company is currently evaluating the method and impact the adoption of ASU 2014-09 will have on the Company's condensed consolidated financial statements.

7

In June 2014, the FASB issued Accounting Standards Update No. 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period" ("ASU 2014-12"). ASU 2014-12 requires that a performance target that affects vesting and could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC 718, Compensation—Stock Compensation, as it relates to such awards. ASU 2014-12 is effective for us in our first quarter of fiscal 2017 with early adoption permitted using either of two methods: (i) prospective to all awards granted or modified after the effective date; or (ii) retrospective to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter, with the cumulative effect of applying ASU 2014-12 as an adjustment to the opening retained earnings balance as of the beginning of the earliest annual period presented in the financial statements. The Company is currently evaluating the impact of the pending adoption on ASU 2014-12 on our condensed consolidated financial statements.
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.
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 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.
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

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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.
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.

As of June 28, 2014, 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 June 28, 2014
 
As of December 28, 2013
 
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
$
16,741

 
$
—

 
$
—

 
$
16,741

 
$
51,749

 
$
—

 
$
—

 
$
51,749

Certificates of deposit
—

 
3,560

 
—

 
3,560

 
—

 
3,840

 
—

 
3,840

Commercial paper
—

 
82,673

 
—

 
82,673

 
—

 
85,860

 
—

 
85,860

Corporate bonds
—

 
186,006

 
—

 
186,006

 
—

 
150,595

 
—

 
150,595

U.S. treasuries
8,838

 
—

 
—

 
8,838

 
4,804

 
—

 
—

 
4,804

Foreign currency exchange forward contracts
—

 
—

 
—

 
—

 
—

 
29

 
—

 
29

Total assets
$
25,579

 
$
272,239

 
$
—

 
$
297,818

 
$
56,553

 
$
240,324

 
$
—

 
$
296,877

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
$
—

 
$
62

 
$
—

 
$
62

 
$
—

 
$
26

 
$
—

 
$
26

During the three and six months ended June 28, 2014, there were no transfers of assets or liabilities between Level 1 and Level 2.

Investments at fair value were as follows (in thousands): 
 
June 28, 2014
 
Adjusted Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized 
Losses
 
Fair Value    
Money market funds
$
16,741

 
$
—

 
$
—

 
$
16,741

Certificates of deposit
3,560

 
—

 
—

 
3,560

Commercial paper
82,675

 
4

 
(6
)
 
82,673

Corporate bonds
186,069

 
29

 
(92
)
 
186,006

U.S. treasuries
8,835

 
5

 
(2
)
 
8,838

Total available-for-sale investments
$
297,880

 
$
38

 
$
(100
)
 
$
297,818

 

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December 28, 2013
 
Adjusted Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value    
Money market funds
$
51,749

 
$
—

 
$
—

 
$
51,749

Certificates of deposit
3,840

 
—

 
—

 
3,840

Commercial paper
85,870

 
2

 
(12
)
 
85,860

Corporate bonds
150,711

 
27

 
(143
)
 
150,595

U.S. treasuries
4,802

 
2

 
—

 
4,804

Total available-for-sale investments
$
296,972

 
$
31

 
$
(155
)
 
$
296,848

As of June 28, 2014, the Company’s available-for-sale investments have a contractual maturity term of no more than 18 months. Net realized gains (losses) on short-term and long-term investments for the three and six months ended June 28, 2014 were insignificant in both periods. Net realized gains (losses) on short-term and long-term investments were zero and $0.2 million for the three and six months ended June 29, 2013, respectively. The specific identification method is used to account for gains and losses on available-for-sale investments.
As of June 28, 2014 and December 28, 2013, the Company held $53.3 million and $64.6 million of cash in banks, respectively.
Other-Than-Temporary Impairments
As a result of the Company’s disposal of $3.1 million of its remaining auction rate securities (par value) during the first quarter of 2013, it recorded an approximately $0.2 million gain, which was recognized as other gain (loss), net in the Company’s condensed consolidated statements of operations.
A roll-forward of amortized cost, cumulative other-than-temporary impairments ("OTTI") recognized in earnings and accumulated other comprehensive loss for the six months ended June 29, 2013 were 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 June 29, 2013
$
—

 
$
—

 
 
$
—

 
$
—

 
$
—

4.
Cost-method Investment
As of June 28, 2014, the Company’s investment in a privately-held company was $9.0 million. This investment is accounted for as a cost-method 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 June 28, 2014, 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 six months ended June 28, 2014 and June 29, 2013.
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 and British pound denominated receivables and euro denominated restricted cash balance amounts that are pledged as collateral for certain stand-by and commercial

10

letters of credit. 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. The forward contracts are with one high-quality institution and the Company consistently monitors the creditworthiness of the counterparty. The forward contracts entered into during the three and six months ended June 28, 2014 were denominated in euros and British pounds, and had maturities of no more than 35 days. The contracts are settled for U.S. dollars at maturity at rates agreed to at inception of the contracts.
As of June 28, 2014, the Company did not designate foreign currency exchange forward contracts 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 June 28, 2014 and June 28, 2013, the before-tax effect of foreign currency exchange forward contracts and restricted cash was an insignificant loss and a loss of $0.7 million, respectively. For the six months ended June 28, 2014 and June 29, 2013, the before-tax effect of foreign currency exchange forward contracts and restricted cash was a loss of $0.4 million and a loss of $0.2 million, respectively.

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 June 28, 2014
 
As of December 28, 2013
 
Gross Notional(1)
 
Prepaid Expenses and Other Assets
 
Other
Accrued
   Liabilities   
 
Gross Notional(1)  
 
Prepaid Expenses and Other Assets
 
Other
Accrued
   Liabilities   
Foreign currency exchange forward contracts
 
 
 
 
 
 
 
 
 
 
 
Related to euro denominated receivables
$
12,458

 
—

 
$
(53
)
 
$
16,867

 
27

 
$
—

Related to British pound denominated receivables
1,266

 
—

 
(4
)
 
13,271

 
—

 
(26
)
Related to restricted cash
1,381

 
—

 
(6
)
 
1,391

 
2

 
—

 
$
15,105

 
$
—

 
$
(63
)
 
$
31,529

 
$
29

 
$
(26
)
 _________________
(1) 
Represents the face amounts of forward contracts that were outstanding as of the period noted.

11
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6.
Balance Sheet Details
The following table provides details of selected balance sheet items (in thousands):
 
June 28, 2014
 
December 28, 2013
Inventory:
 
 
 
Raw materials
$
11,160

 
$
14,311

Work in process
40,641

 
49,172

Finished goods (1)
79,052

 
60,202

Total inventory
$
130,853

 
$
123,685

Property, plant and equipment, net:
 
 
 
Computer hardware
$
8,270

 
$
9,692

Computer software(2)
17,578

 
16,988

Laboratory and manufacturing equipment
154,181

 
146,834

Furniture and fixtures
1,344

 
1,347

Leasehold improvements
36,687

 
35,913

Construction in progress
7,278

 
8,950

Subtotal
$
225,338

 
$
219,724

Less accumulated depreciation and amortization
(148,452
)
 
(140,056
)
Total property, plant and equipment, net
$
76,886

 
$
79,668

Accrued expenses:
 
 
 
Loss contingency related to non-cancelable purchase commitments
$
5,019

 
$
5,120

Professional and other consulting fees
1,131

 
1,411

Taxes payable
2,990

 
2,372

Royalties
1,804

 
1,540

Accrued rebate and customer prepay liability
566

 
3,807

Accrued interest on convertible senior notes
219

 
219

Other accrued expenses
10,817

 
7,962

Total accrued expenses
$
22,546

 
$
22,431

 _________________
(1) 
Included in finished goods inventory at June 28, 2014 and December 28, 2013 were $17.8 million and $9.2 million, respectively, of inventory at customer locations for which product acceptance had not occurred.

(2) 
Included in computer software at June 28, 2014 and December 28, 2013 were $7.9 million and $7.9 million, respectively, related to an enterprise resource planning ("ERP") system that the Company implemented during 2012. The unamortized ERP costs at June 28, 2014 and December 28, 2013 were $5.7 million and $6.3 million, respectively.
Restricted Cash
The Company’s long-term restricted cash balance is primarily comprised of certificates of deposit, of which the majority is not insured by the Federal Deposit Insurance Corporation. These amounts primarily collateralize the Company’s issuances of stand-by and commercial letters of credit. Additionally, the Company’s restricted cash balance includes a leave encashment fund for India employees and a corporate bank card deposit for employees in the United Kingdom.
The following table sets forth the Company's outstanding standby letters of credit (in thousands):
 
June 28, 2014
 
December 28, 2013
Value added tax license
$
1,451

 
$
1,430

Customer proposal guarantee
1,876

 
1,446

Property leases
699

 
699

Total standby letters of credit
$
4,026

 
$
3,575



12
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7.
Accumulated Comprehensive Loss
Other comprehensive loss includes certain changes in equity that are excluded from net income (loss). The following table sets forth the changes in accumulated other comprehensive loss by component for the six months ended June 28, 2014 (in thousands): 
 
 
Unrealized Gain
on Other
Available-for-Sale
Securities
 
Foreign
Currency Translation     
 
     Accumulated     
Tax Effect
 
Total        
Balance at December 28, 2013
 
$
(124
)
 
$
(2,602
)
 
$
(760
)
 
$
(3,486
)
Net current-period other comprehensive loss
 
62

 
331

 
(20
)
 
373

Balance at June 28, 2014
 
$
(62
)
 
$
(2,271
)
 
$
(780
)
 
$
(3,113
)
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 conversion of convertible senior notes from the conversion spread, and assumed issuance of stock under the Company’s employee stock purchase plan (“ESPP”) using the treasury stock method. 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 are anti-dilutive and therefore, excluded from the diluted net loss calculation.

13

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
 
Six Months Ended
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
4,780

 
$
(10,009
)
 
$
406

 
$
(25,288
)
Denominator:
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
123,128

 
116,911

 
122,240

 
115,609

Effect of dilutive securities:
 
 
 
 
 
 
 
Employee equity plans
3,630

 
—

 
3,872

 
—

Diluted weighted average common shares outstanding
126,758

 
116,911

 
126,112

 
115,609

 
 
 
 
 
 
 
 
Net income (loss) per common share
 
 
 
 
 
 
 
Basic
$
0.04

 
$
(0.09
)
 
$ 0.00

 
$
(0.22
)
Diluted
$
0.04

 
$
(0.09
)
 
$ 0.00

 
$
(0.22
)
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 their effect would have been anti-dilutive under the treasury stock method or the performance condition of the award has not been met (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Stock options
766

 
7,396

 
914

 
7,396

Restricted stock units
338

 
6,362

 
569

 
6,362

Performance stock units
—

 
721

 
—

 
721

Employee stock purchase plan shares
697

 
601

 
708

 
601

Total
1,801

 
15,080

 
2,191

 
15,080


In the three and six months ended June 28, 2014, the Company excluded the potential shares issued upon early conversion of the convertible senior notes in the calculation of diluted earnings per share because the market price was below the conversion price. In the future, the Company would include these dilutive effects of the convertible senior notes in the calculation of diluted net income per common share if the market price is above the conversion price. Upon conversion of the convertible senior 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 unless their effect is anti-dilutive.
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 common stock, at the Company’s election, for any remaining conversion obligation. The initial

14
Table of Contents

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 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 amounts recorded in connection with the issuance of the Notes and related amortization 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
(682
)
 
—

 
—

Amortization of debt discount
—

 
7,932

 
—

Net carrying amount at June 28, 2014
$
3,190

 
$
112,932

 
$
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 years until maturity of the Notes was $37.1 million as of June 28, 2014.

15
Table of Contents

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 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 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
 
Six Months Ended
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Contractual interest expense
$
656

 
$
219

 
$
1,313

 
$
219

Amortization of debt issuance costs
164

 
50

 
324

 
50

Amortization of debt discount
1,908

 
580

 
3,768

 
580

Total interest expense
$
2,728

 
$
849

 
$
5,405

 
$
849

The coupon rate was 1.75%. 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.
As of June 28, 2014, the fair value of the Notes was $160.1 million. The fair value was determined based on the quoted bid price of the Notes in an over-the-counter market on June 27, 2014. The Notes are classified as Level 2 of the fair value hierarchy. Based on the closing price of the Company’s common stock of $9.55 on June 27, 2014, the if-converted value of the Notes was less than their principal amount.
10.
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. As of June 28, 2014, there were a total of 17.5 million shares of common stock available for grant under the Company’s 2007 Equity Incentive Plan ("2007 Plan"). The following tables summarize the Company’s equity award activity and related information (in thousands, except per share data): 
 
Number of
Options
 
Weighted-Average
Exercise
Price
  Per Share  
 
  Aggregate  
Intrinsic
Value
Outstanding at December 28, 2013
6,367

 
$
7.26

 
$
17,452

Options granted
25

 
$
9.02

 
 
Options exercised
(456
)
 
$
5.87

 
$
1,379

Options canceled
(40
)
 
$
11.58

 


Outstanding at June 28, 2014
5,896

 
$
7.34

 
$
14,355

Vested and expected to vest as of June 28, 2014
5,893

 
 
 
$
14,347

Exercisable at June 28, 2014
5,770

 
$
7.34

 
$
14,102

 

16
Table of Contents

 
Number of
Restricted
Stock Units
 
Weighted-
Average
 Grant Date 
Fair Value
Per Share
 
  Aggregate  
Intrinsic
Value
Outstanding at December 28, 2013
6,583

 
$
7.72

 
$
64,443

RSUs granted
2,293

 
$
8.29

 


RSUs released
(2,441
)
 
$
7.66

 
$
20,824

RSUs canceled
(313
)
 
$
7.24

 


Outstanding at June 28, 2014
6,122

 
$
7.98

 
$
58,464

Expected to vest at June 28, 2014
5,880

 


 
$
56,151

 
 
Number of
Performance
Stock Units
 
Weighted-
Average
 Grant Date 
Fair Value
Per Share
 
  Aggregate  
Intrinsic
Value
Outstanding at December 28, 2013
721

 
$
7.04

 
$
7,054

PSUs granted
446

 
$
7.04

 

PSUs released
(255
)
 
$
6.36

 
$
2,097

PSUs canceled
(73
)
 
$
7.19

 

Outstanding at June 28, 2014
839

 
$
7.21

 
$
8,009

Expected to vest at June 28, 2014
625

 

 
$
5,969

The aggregate intrinsic value of unexercised options is calculated as the difference between the closing price of the Company’s common stock of $9.55 at June 27, 2014 and the exercise prices of the underlying options. The aggregate intrinsic value of the 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 options. The aggregate intrinsic value of unreleased RSUs and unreleased PSUs is calculated using the closing price of the Company's common stock of $9.55 at June 27, 2014. 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 June 28, 2014. 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
422

 
1.6
RSUs
35,613

 
2.4
PSUs
2,782

 
1.6
Employee Stock Options
The estimated values of stock options, as well as assumptions used in calculating these values were based on estimates as follows (expense amounts in thousands):
 
Three Months Ended
 
Six Months Ended
Employee and Director Stock Options
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Volatility
N/A
 
N/A
 
52%
 
N/A
Risk-free interest rate
N/A
 
N/A
 
1.3%
 
N/A
Expected life
N/A
 
N/A
 
4.3 years
 
N/A
Estimated fair value
N/A
 
N/A
 
$3.85
 
N/A
Total stock-based compensation expense
$127
 
$722
 
$515
 
$1,525
_________________

17
Table of Contents

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 (expense amounts in thousands):
 
Three Months Ended
 
Six Months Ended
Employee Stock Purchase Plan
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Volatility
49%
 
46%
 
49% - 51%
 
46%
Risk-free interest rate
0.02%
 
0.14%
 
0.02% - 0.11%
 
0.10%
Expected life
0.25 years
 
0.5 years
 
0.25 - 0.5 years
 
0.5 years
Estimated fair value
$2.05
 
$1.87
 
$2.05 - $2.57
 
$1.87
Total stock-based compensation expense
$843
 
$566
 
$1,634
 
$1,274
Restricted Stock Units
During the three and six months ended June 28, 2014, the Company granted RSUs to employees and members of the Company’s board of directors to receive an aggregate of 1.8 million shares and 2.3 million shares of the Company’s common stock, respectively. 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 six months ended June 28, 2014 and June 29, 2013 was approximately $5.3 million and $10.3 million, respectively, and $5.8 million and$12.7 million, respectively.

Performance Stock Units
Pursuant to the Company’s 2007 Plan, during fiscal 2012, the Company granted 0.5 million shares of PSUs to certain of its 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 three and six months ended June 28, 2014, the Company did not release any shares subject to these PSUs.
Pursuant to the Company’s 2007 Plan, during fiscal 2013, the Company granted 0.6 million shares of PSUs to certain of its 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. During the three and six months ended June 28, 2014, the Company released no shares and 0.3 million shares of PSUs, respectively, based on a payout of 1.5 times of the target number of PSUs.

The ranges of estimated values of the PSUs granted, as well as assumptions used in calculating these values were based on estimates as follows:
 
Year Ended
 
December 28, 2013
Infinera Volatility
55%
NASDAQ Telecom Composite Index Volatility
23%
Risk-free interest rate
0.42%
Correlation with NASDAQ Telecom Composite Index
0.56
Estimated fair value
$6.27 - $7.06
Pursuant to the Company's 2007 Plan, during the three and six months ended June 28, 2014, the Company granted 0.1 million shares and 0.4 million shares of PSUs, respectively, to certain of its 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 iShares North American Tech-Multimedia Networking ("IGN") Index over the span of one, two and three years of total shareholder returns.

18
Table of Contents


The ranges of estimated values of the PSUs granted, as well as assumptions used in calculating these values were based on estimates as follows:
 
Three Months Ended
 
Six Months Ended
 
June 28, 2014
Infinera Volatility
50%
 
49% - 50%
IGN Index Volatility
25%
 
25%
Risk-free interest rate
0.71%
 
0.66% - 0.71%
Correlation with IGN Index
0.60
 
0.60
Estimated fair value
$6.59 - $7.53
 
$6.59 - $7.60
Amortization of stock-based compensation related to PSUs in the three and six months ended June 28, 2014 was approximately $0.6 million and $1.0 million, respectively. Amortization of stock-based compensation related to PSUs in the three months ended June 29, 2013 was approximately $0.4 million. Amortization of stock-based compensation in the six months ended June 29, 2013 was a credit of approximately $0.4 million, including $1.0 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."
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):
 
June 28, 2014
 
December 28, 2013
Stock-based compensation effects in inventory
$
3,228

 
$
3,189

Stock-based compensation effects in deferred inventory cost
$
13

 
$
15

Stock-based compensation effects in fixed assets
$
132

 
$
145

 
 
Three Months Ended
 
Six Months Ended
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Stock-based compensation effects included in net income (loss) before income taxes
 
 
 
 
 
 
 
Cost of revenue
$
477

 
$
474

 
$
929

 
$
960

Research and development
2,080

 
2,622

 
4,218

 
5,741

Sales and marketing
1,815

 
1,807

 
3,535

 
3,806

General and administration
1,549

 
1,591

 
3,079

 
2,360

 
5,921

 
6,494

 
11,761

 
12,867

Cost of revenue – amortization from balance sheet (1)
883

 
1,690

 
1,715

 
3,292

Total stock-based compensation expense
$
6,804

 
$
8,184

 
$
13,476

 
$
16,159

_________________
(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 six months ended June 28, 2014 was $0.6 million and $0.9 million, respectively, on pre-tax income of $5.4 million and $1.3 million, respectively. This compared to a tax provision of $0.6 million and $0.9 million, respectively, on pre-tax losses of $9.4 million and $24.4 million, respectively, for the three and six months ended June 29, 2013. In all periods, the tax expense primarily represents foreign taxes of the Company's overseas subsidiaries compensated on a cost plus basis and remains relatively similar in all periods, regardless of the level of consolidated earnings. The Company does not provide for tax on U.S. income, nor benefit U.S. losses, because of its significant loss carryforward position and a corresponding full valuation allowance. 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

19

settlements with tax authorities. No significant releases are expected in the near future based on information available at this time.

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 June 28, 2014 and December 28, 2013. 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 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 ("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
 
Six Months Ended
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Americas:
 
 
 
 
 
 
 
United States
$
136,342

 
$
88,251

 
$
247,033

 
$
167,324

Other Americas
4,760

 
3,802

 
8,296

 
4,519

 
141,102

 
92,053

 
255,329

 
171,843

Europe, Middle East and Africa
19,234

 
31,954

 
44,847

 
70,760

Asia Pacific and Japan
5,063

 
14,378

 
8,038

 
20,407

Total revenue
$
165,399

 
$
138,385

 
$
308,214

 
$
263,010


Property, plant and equipment, net 
 
June 28,
2014
 
December 28,
2013
United States
$
74,157

 
$
76,850

Other Americas
283

 
319

Europe, Middle East and Africa
1,022

 
1,451

Asia Pacific and Japan
1,424

 
1,048

Total property, plant and equipment, net
$
76,886

 
$
79,668

13.
Guarantees
Product Warranties
Upon delivery of products, the Company provides for the estimated cost to repair or replace products including 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 or

20

replacement. The Company estimates its hardware warranty obligations based on the Company’s historical experience of known product failure rates, use of materials and labor 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
 
Six Months Ended
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Beginning balance
$
26,385

 
$
16,672

 
$
22,908

 
$
16,482

Charges to operations
6,800

 
6,178

 
12,360

 
10,346

Utilization
(2,370
)
 
(2,055
)
 
(5,612
)
 
(4,138
)
Change in estimate (1)
(2,867
)
 
(1,094
)
 
(1,708
)
 
(2,989
)
Balance at the end of the period
$
27,948

 
$
19,701

 
$
27,948

 
$
19,701

 _________________
(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 resulting impact of these changes on the Company’s estimate of expected future returns, as well as changes in the estimated cost and the mix of new versus used units related to replacement of failed 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.
Cambrian Science Patent Infringement Litigation
On July 12, 2011, the Company was notified by Level 3 that Cambrian Science Corporation (“Cambrian”) filed suit against Level 3 and six other defendants, including Cox Communications, Inc., XO Communications, LLC, Global Crossing Limited, 360Networks (USA), Inc., Integra Telecom, Inc. and IXC, Inc. dba Telekenex (collectively, the “Defendants”) in the U.S. District Court for the Central District of California alleging infringement of patent no. 6,775,312 (the “’312 Patent”) and requesting damages for such alleged infringement (the “Cambrian Claim”). The nature of the Cambrian Claim involves allegations of infringement of the ’312 Patent resulting from the Defendants’ use of certain products and systems in the Defendants’ networks, including our DTN platform. On August 24, 2011, Cambrian amended the complaint to name the Company as a defendant. The Company assumed the defense of the Cambrian Claim and filed an answer to Cambrian’s complaint on September 21, 2011, in which the Company denied infringement of the ‘312 Patent and raised other defenses. Cambrian filed a second amended complaint on October 6, 2011, which included many of the same allegations as in the original complaint. The Company filed its answer to the second amended complaint on October 21, 2011, in which the Company maintained the same denials and defenses as in the Company’s initial answer. On December 23, 2011, the Company filed a motion requesting that the court stay the case with respect to each of the above-noted customer Defendants. Cambrian filed its opposition to the Company’s motion on December 30, 2011. The Company’s request was denied in the court’s decision on March 7, 2012. The Company presented evidence on the appropriate meanings of relevant key words used in the patent claims during a claim construction hearing on November 20, 2012.

On June 17, 2013, the court issued an order regarding claim construction, in which the court agreed with almost all of the Company’s proposed claim constructions. On October 17, 2013, the parties met for a court-mandated mediation. On April 24, 2014, the Company filed two motions for summary judgment relating to non-infringement and Cambrian’s claim to an earlier date of invention. The court held a hearing on the summary judgment motions on June 9, 2014. On July 2, 2014, the court granted the Company's motion for summary judgment on non-infringement and entered a final judgment of non-infringement of the ‘312 Patent. Cambrian may appeal the court’s ruling of non-infringement to the Court of Appeals for the Federal Circuit. The Company is seeking to recover certain costs and attorney's fees from Cambrian.


21
Table of Contents

Based on the information available at this time, the Company has concluded that the likelihood of a loss with respect to this suit is reasonably possible. The Company has further concluded that the range of the reasonably possible loss is an insignificant amount and will not have a material adverse effect on the Company’s business, consolidated financial position, results of operations, or cash flows. Accordingly, the Company has accrued an insignificant amount, 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 of 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 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.
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 June 28, 2014, the Company has not accrued or recorded any such material liabilities other than for the accrual associated with the Cambrian lawsuit.

22
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 earnings, revenue, gross margin, expenses, cash flows and other financial items; any statements of the plans, strategies and objectives of management for future operations and personnel; factors that may affect our operating results; statements concerning new products or services, including future PIC capacity and new product costs, delivery dates and revenue; statements related to capital expenditures; statements related to future economic conditions, performance, market growth or our sales cycle; statements related to our convertible senior notes issued in May 2013; 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 28, 2013 filed on February 21, 2014. Such forward-looking statements speak only as of the date of this report. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.
Overview
We were founded in December 2000 with a unique vision for optical networking. Prior to this, communications service provider optical networks were built from fairly commoditized products, broadly known as wavelength division multiplexing (“WDM”) systems. Recent growth in bandwidth demand has increased the need for the delivery of high-capacity low-cost bandwidth throughout the network. We believe that in many cases, traditional point-to-point network architectures do not provide the required flexibility to meet this demand. It takes large amounts of low-cost bandwidth, pervasive Optical Transport Network (“OTN”) switching, and the intelligence of bandwidth management to manage these larger networks and deliver high-capacity services quickly and cost-effectively. We believe this can best be achieved with photonic integrated circuits (“PICs”) and that only through photonic integration can network operators efficiently scale their network bandwidth without significant increases in space, power or operational workload.
We provide optical transport networking equipment, software and services to telecommunications service providers, internet content providers, cable operators, and wholesale network operators, including subsea network operators (collectively, “Service Providers”) across the globe. Optical transport networks are deployed by Service Providers facing significant demands for transmission capacity prompted by increased use of high-speed Internet access, mobile broadband, high-definition video streaming services, business Ethernet services, cloud-based services and wholesale bandwidth services.
The Infinera Intelligent Transport Network is an architecture for Service Providers to address the increasing demand for cloud-based services and data center connectivity. This architectural approach helps Service Providers use time as a weapon to increase revenues with reliable, differentiated services while reducing operating costs through scale, multi-layer convergence and automation. The Infinera Intelligent Transport Network is based on platforms built with our unique PICs.
Traffic patterns in the optical network continue to grow to accommodate increased demands for transmission capacity prompted by increased use of high-speed Internet access, mobile broadband, streaming high-definition video services, business Ethernet services, cloud-based services and wholesale bandwidth services. We believe that the Infinera Intelligent Transport Network architecture is uniquely enabled to deliver improvements in these areas compared to competitive WDM systems that still rely on discrete optical components rather than PICs. We also believe that this enables Service Providers to deploy reliable, high-capacity, efficient optical network solutions

23
Table of Contents

that are easy to use and to improve the integration between the layers of Service Provider networks with the lowest total cost of ownership.
Our DTN platform currently supports 10 Gigabits per second ("Gbps") and 40 Gbps WDM transmission capacity combined with integrated switching capabilities. Our DTN-X platform supports 100 Gbps WDM transmission capacity with 500 Gbps super-channels and also integrates 5 Terabits per second of OTN switching capacity in a single bay. The DTN-X platform leverages the unique capabilities of our 500 Gbps PICs to deliver high-capacity Intelligent Transport Networks that reduce power, cooling and space, while simplifying transport network operations. Our ATN platform supports direct wavelength connectivity to DTN and DTN-X nodes, reducing equipment costs and providing unique network management capabilities across our Intelligent Transport Network.
As of June 28, 2014, we have sold our network systems for deployment in the optical networks of 133 customers worldwide, including CenturyLink, Colt, Cox Communications, DANTE, Deutsche Telekom, Equinix, Interoute, KDDI, Level 3, NTT, OTE, Pacnet, Rostelecom, Telefonica, TeliaSonera International Carrier, Vodafone and XO Communications. Since the commencement of shipping our DTN-X platform in the second quarter of 2012, we have 46 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. Two customers each accounted for over 10% of our revenue in the second quarter of 2014, and no customer accounted for over 10% of our revenue in the corresponding period in 2013. Two customers each accounted for over 10% of our revenue in the six months ended June 28, 2014, and one customer accounted for over 10% of our revenue in the corresponding period in 2013.
We are headquartered in Sunnyvale, California, with employees located throughout the Americas, Europe and the Asia Pacific region. We expect to continue to add personnel in the United States and internationally to develop our products and provide additional geographic sales and technical support coverage. We primarily sell our products through our direct sales force, with a small portion sold indirectly through resellers. We derived 97% and 98% of our revenue from direct sales to customers in the three and six months ended June 28, 2014, respectively, and 88% and 92% of our revenue for the three and six months ended June 28, 2013, respectively. Our strategy is to leverage channel partners where appropriate to expand our presence in certain geographies; however, we expect to continue generating a substantial majority of our revenue from direct sales.
In the remainder of 2014, our goal is to continue our growth in the 100 Gbps technology cycle with additional network builds to both new and existing customers. We also anticipate customers who deployed the DTN-X platform over the past two years to buy additional capacity for their networks, which if they do, will drive both additional revenue and also improve gross margin levels. Given the lower than expected research and development expenses incurred during the first half of fiscal 2014, we currently expect to ramp up our research and development spending levels in the second half of the fiscal year to allow us to execute on our future product roadmap, including additional features for our long-haul offerings and new products for adjacent markets. We anticipate generating positive cash flows over the remainder of the fiscal year.
Our year-over-year and quarter-over-quarter revenue will likely be volatile and may be impacted by several factors including general economic and market conditions, time-to-market development of new products, acquisitions of new customers and the timing of large product deployments.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our condensed consolidated financial statements, which we have prepared in accordance with the U.S. generally accepted accounting principles ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates, assumptions and judgments that can affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
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 six

24
Table of Contents

months ended June 28, 2014 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 28, 2013.

Results of Operations
The following sets forth, for the periods presented, certain unaudited condensed consolidated statements of operations information (in thousands, except percentages):
 
 
Three Months Ended
 
 
 
 
 
June 28, 2014
 
June 29, 2013
 
 
 
 
 
Amount    
 
  % of total  
revenue
 
Amount    
 
  % of total  
revenue
 
Change    
 
% Change 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
142,364

 
86
%
 
$
120,647

 
87
%
 
$
21,717

 
18
%
Services
23,035

 
14
%
 
17,738

 
13
%
 
5,297

 
30
%
Total revenue
$
165,399

 
100
%
 
$
138,385

 
100
%
 
$
27,014

 
20
%
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
85,906

 
52
%
 
$
80,198

 
58
%
 
$
5,708

 
7
%
Services
9,240

 
6
%
 
6,533

 
5
%
 
2,707

 
41
%
Total cost of revenue
$
95,146

 
58
%
 
$
86,731

 
63
%
 
$
8,415

 
10
%
Gross profit
$
70,253

 
42
%
 
$
51,654

 
37
%
 
$
18,599

 
36
%
 

 
Six Months Ended
 
 
 
 
 
June 28, 2014
 
June 29, 2013
 
 
 
 
 
Amount    
 
  % of total  
revenue
 
Amount    
 
  % of total  
revenue
 
Change    
 
% Change 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
266,606

 
87
%
 
$
228,990

 
87
%
 
$
37,616

 
16
%
Services
41,608

 
13
%
 
34,020

 
13
%
 
7,588

 
22
%
Total revenue
$
308,214

 
100
%
 
$
263,010

 
100
%
 
$
45,204

 
17
%
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
164,344

 
53
%
 
$
155,645

 
59
%
 
$
8,699

 
6
%
Services
15,211

 
5
%
 
13,009

 
5
%
 
2,202

 
17
%
Total cost of revenue
$
179,555

 
58
%
 
$
168,654

 
64
%
 
$
10,901

 
6
%
Gross profit
$
128,659

 
42
%
 
$
94,356

 
36
%
 
$
34,303

 
36
%
Revenue
Total revenue increased by $27.0 million, or 20%, during the three months ended June 28, 2014 compared to the corresponding period in 2013 and increased by $45.2 million, or 17%, during the six months ended June 28, 2014 compared to the corresponding period in 2013.
Total product revenue increased by $21.7 million, or 18%, during the three months ended June 28, 2014 compared to the corresponding period in 2013 as a result of growth across multiple customer verticals. We continue to see customers adding new routes and additional capacity to their existing networks. In addition, we continue to win opportunities with new customers wanting to adopt our platforms.
Total product revenue increased by $37.6 million, or 16%, during the six months ended June 28, 2014 compared to the corresponding period in 2013. This increase was driven by relatively stronger demand across our customer base as they continue to deploy our products to meet the growing bandwidth needs of their networks.
Total services revenue increased by $5.3 million, or 30%, during the three months ended June 28, 2014 compared to the corresponding period in 2013. Total services revenue increased by $7.6 million, or 22%, during the six months ended June 28, 2014 compared to the corresponding period in 2013. The increase in both the quarter

25
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and year-to-date periods of fiscal 2014 was due to higher levels of deployment services as customers build out new networks utilizing our teams’ expertise as well as higher on-going support services as we continue to grow our installed base.

The following table summarizes our revenue by geography and sales channel for the periods presented (in thousands, except percentages):
 
 
Three Months Ended
 
 
 
 
 
June 28, 2014
 
June 29, 2013
 
 
 
 
 
Amount
 
% of total revenue
 
Amount
 
% of total revenue
 
Change
 
% Change
Total revenue by geography
 
 
 
 
 
 
 
 
 
 
 
Domestic
$
136,342

 
82
%
 
$
88,251

 
64
%
 
$
48,091

 
54
 %
International
29,057

 
18
%
 
50,134

 
36
%
 
(21,077
)
 
(42
)%
 
$
165,399

 
100
%
 
$
138,385

 
100
%
 
$
27,014

 
20
 %
Total revenue by sales channel
 
 
 
 
 
 
 
 
 
 
 
Direct
$
160,310

 
97
%
 
$
122,234

 
88
%
 
$
38,076

 
31
 %
Indirect
5,089

 
3
%
 
16,151

 
12
%
 
(11,062
)
 
(68
)%
 
$
165,399

 
100
%
 
$
138,385

 
100
%
 
$
27,014

 
20
 %
 
Six Months Ended
 
 
 
 
 
June 28, 2014
 
June 29, 2013
 
 
 
 
 
Amount
 
% of total revenue
 
Amount
 
% of total revenue
 
Change
 
% Change
Total revenue by geography
 
 
 
 
 
 
 
 
 
 
 
Domestic
$
247,033

 
80
%
 
$
167,324

 
64
%
 
$
79,709

 
48
 %
International
61,181

 
20
%
 
95,686

 
36
%
 
(34,505
)
 
(36
)%
 
$
308,214

 
100
%
 
$
263,010

 
100
%
 
$
45,204

 
17
 %
Total revenue by sales channel
 
 
 
 
 
 
 
 
 
 
 
Direct
$
300,784

 
98
%
 
$
243,082

 
92
%
 
$
57,702

 
24
 %
Indirect
7,430

 
2
%
 
19,928

 
8
%
 
(12,498
)
 
(63
)%
 
$
308,214

 
100
%
 
$
263,010

 
100
%
 
$
45,204

 
17
 %

International revenue decreased by $21.1 million to 18% of total revenue for the three months ended June 28, 2014 from 36% of total revenue in the corresponding period in 2013. International revenue decreased by $34.5 million to 20% of total revenue for the six months ended June 28, 2014 from 36% of total revenue in the corresponding period in 2013. In absolute dollars, international revenue declined as we experienced strong demand led by Europe in the first half of 2013, which we have not been able to duplicate in the first half of 2014. In addition, as a percentage of total revenue, international revenue decreased during the three and six months ended June 28, 2014 due to strong demand within North America.
We believe that our DTN-X platform is well positioned as existing customers continue to build out their networks and as we gain new opportunities to deploy our networks with new customers. We continue to see strong demand across our customer base including both new customers as well as growth with existing customers. As a result, we currently expect that these dynamics will drive our revenue slightly higher in the third quarter of 2014 on a sequential basis and represent significant year-over-year growth.
Cost of Revenue and Gross Margin
Gross margin increased to 42% in the three months ended June 28, 2014 from 37% in the corresponding period of 2013. The increase was primarily driven by customers adding an increased volume of capacity to the DTN-X networks they have built over the last few years.
Gross margin increased to 42% in the six months ended June 28, 2014 from 36% in the corresponding period of 2013. This increase was primarily due to improvements in revenue mix, including both the mix of customers as well as the ratio of new network builds to capacity adds to existing networks.

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Based on our current outlook, we expect that gross margin in the third quarter of 2014 will decline slightly as compared to the prior quarter as we anticipate a significant number of new network builds.
Operating Expenses
The following tables summarize our operating expenses for the periods presented (in thousands, except percentages): 
 
Three Months Ended
 
 
 
 
 
June 28, 2014
 
June 29, 2013
 
 
 
 
 
Amount    
 
  % of total  
revenue
 
Amount    
 
  % of total  
revenue
 
Change    
 
% Change  
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
31,738

 
19
%
 
$
31,681

 
23
%
 
$
57

 
0.2
%
Sales and marketing
18,082

 
11
%
 
17,155

 
13
%
 
927