Attached files
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EX-32.2 - EXHIBIT 32.2 - Sonus, Inc. | sons-ex32220160930.htm |
EX-32.1 - EXHIBIT 32.1 - Sonus, Inc. | sons-ex32120160930.htm |
EX-31.2 - EXHIBIT 31.2 - Sonus, Inc. | sons-ex31220160930.htm |
EX-31.1 - EXHIBIT 31.1 - Sonus, Inc. | sons-ex31120160930.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 30, 2016 | ||
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 001-34115
SONUS NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE | 04-3387074 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
4 Technology Park Drive, Westford, Massachusetts 01886
(Address of principal executive offices) (Zip code)
(978) 614-8100
(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 o
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 o
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 o | Accelerated filer x | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of October 24, 2016, there were 49,436,925 shares of the registrant's common stock, $0.001 par value, outstanding.
SONUS NETWORKS, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016
TABLE OF CONTENTS
Item | Page | |
PART I FINANCIAL INFORMATION | ||
PART II OTHER INFORMATION | ||
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, which are subject to a number of risks and uncertainties. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy, plans and objectives of management for future operations, plans for future cost reductions and plans for future product development and manufacturing are forward-looking statements. Without limiting the foregoing, the words "anticipates", "believes", "could", "estimates", "expects", "intends", "may", "plans", "seeks" and other similar language, whether in the negative or affirmative, are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We therefore caution you against relying on any of these forward-looking statements.
Important factors that could cause actual results to differ materially from those in these forward-looking statements are discussed in Part I, Items 2 and 3, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures About Market Risk," respectively, and Part II, Item 1A, "Risk Factors," of this Quarterly Report on Form 10-Q. Also, any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which this Quarterly Report on Form 10-Q was first filed. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.
References in this Quarterly Report on Form 10-Q to “Sonus,” “Sonus Networks,” “Company,” “we,” “us,” and “our” are to Sonus Networks, Inc. and its subsidiaries, collectively, unless the context requires otherwise.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
SONUS NETWORKS, INC.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
(unaudited)
September 30, 2016 | December 31, 2015 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 32,566 | $ | 50,111 | |||
Marketable securities | 49,829 | 58,533 | |||||
Accounts receivable, net of allowance for doubtful accounts of $0 at September 30, 2016 and $10 at December 31, 2015 | 44,169 | 51,533 | |||||
Inventory | 20,811 | 23,111 | |||||
Other current assets | 13,237 | 11,853 | |||||
Total current assets | 160,612 | 195,141 | |||||
Property and equipment, net | 13,077 | 13,620 | |||||
Intangible assets, net | 38,794 | 26,087 | |||||
Goodwill | 52,136 | 40,310 | |||||
Investments | 38,603 | 33,605 | |||||
Deferred income taxes | 1,797 | 1,879 | |||||
Other assets | 4,834 | 2,249 | |||||
$ | 309,853 | $ | 312,891 | ||||
Liabilities and Stockholders' Equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 4,331 | $ | 5,949 | |||
Accrued expenses | 22,990 | 31,963 | |||||
Current portion of deferred revenue | 37,896 | 38,716 | |||||
Current portion of long-term liabilities | 1,029 | 821 | |||||
Total current liabilities | 66,246 | 77,449 | |||||
Deferred revenue | 8,465 | 7,374 | |||||
Deferred income taxes | 2,806 | 2,282 | |||||
Contingent consideration - acquisition | 10,000 | — | |||||
Other long-term liabilities | 1,675 | 2,760 | |||||
Total liabilities | 89,192 | 89,865 | |||||
Commitments and contingencies (Note 15) | |||||||
Stockholders' equity: | |||||||
Preferred stock, $0.01 par value per share; 5,000,000 shares authorized, none issued and outstanding | — | — | |||||
Common stock, $0.001 par value per share; 120,000,000 shares authorized; 49,399,271 shares issued and outstanding at September 30, 2016; 49,473,789 shares issued and outstanding at December 31, 2015 | 49 | 49 | |||||
Additional paid-in capital | 1,249,095 | 1,240,803 | |||||
Accumulated deficit | (1,034,543 | ) | (1,023,242 | ) | |||
Accumulated other comprehensive income | 6,060 | 5,416 | |||||
Total stockholders' equity | 220,661 | 223,026 | |||||
$ | 309,853 | $ | 312,891 |
See notes to the unaudited condensed consolidated financial statements.
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SONUS NETWORKS, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Three months ended | Nine months ended | ||||||||||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||||||||||
Revenue: | |||||||||||||||
Product | $ | 38,601 | $ | 42,230 | $ | 108,719 | $ | 94,137 | |||||||
Service | 26,410 | 25,632 | 76,300 | 78,571 | |||||||||||
Total revenue | 65,011 | 67,862 | 185,019 | 172,708 | |||||||||||
Cost of revenue: | |||||||||||||||
Product | 12,285 | 13,158 | 35,230 | 36,075 | |||||||||||
Service | 9,140 | 8,992 | 27,572 | 27,277 | |||||||||||
Total cost of revenue | 21,425 | 22,150 | 62,802 | 63,352 | |||||||||||
Gross profit | 43,586 | 45,712 | 122,217 | 109,356 | |||||||||||
Operating expenses: | |||||||||||||||
Research and development | 18,230 | 19,335 | 53,005 | 58,642 | |||||||||||
Sales and marketing | 18,103 | 16,507 | 50,890 | 53,812 | |||||||||||
General and administrative | 8,998 | 11,074 | 26,656 | 30,742 | |||||||||||
Acquisition-related | 951 | — | 951 | 131 | |||||||||||
Restructuring | 1,620 | 158 | 1,620 | 1,306 | |||||||||||
Total operating expenses | 47,902 | 47,074 | 133,122 | 144,633 | |||||||||||
Loss from operations | (4,316 | ) | (1,362 | ) | (10,905 | ) | (35,277 | ) | |||||||
Interest income, net | 209 | 82 | 590 | 90 | |||||||||||
Other income, net | 803 | 133 | 916 | 183 | |||||||||||
Loss before income taxes | (3,304 | ) | (1,147 | ) | (9,399 | ) | (35,004 | ) | |||||||
Income tax provision | (427 | ) | (749 | ) | (1,902 | ) | (1,594 | ) | |||||||
Net loss | $ | (3,731 | ) | $ | (1,896 | ) | $ | (11,301 | ) | $ | (36,598 | ) | |||
Loss per share: | |||||||||||||||
Basic | $ | (0.08 | ) | $ | (0.04 | ) | $ | (0.23 | ) | $ | (0.74 | ) | |||
Diluted | $ | (0.08 | ) | $ | (0.04 | ) | $ | (0.23 | ) | $ | (0.74 | ) | |||
Shares used to compute loss per share: | |||||||||||||||
Basic | 49,402 | 49,625 | 49,436 | 49,512 | |||||||||||
Diluted | 49,402 | 49,625 | 49,436 | 49,512 |
See notes to the unaudited condensed consolidated financial statements.
5
SONUS NETWORKS, INC.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
Three months ended | Nine months ended | ||||||||||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||||||||||
Net loss | $ | (3,731 | ) | $ | (1,896 | ) | $ | (11,301 | ) | $ | (36,598 | ) | |||
Other comprehensive income (loss), net of tax: | |||||||||||||||
Foreign currency translation adjustments | 49 | 59 | 484 | 11 | |||||||||||
Unrealized (loss) gain on available-for sale marketable securities, net of tax | (112 | ) | 33 | 160 | 113 | ||||||||||
Reclassification adjustment for realized losses included in net loss | — | — | 18 | — | |||||||||||
Other comprehensive income (loss), net of tax | (63 | ) | 92 | 662 | 124 | ||||||||||
Comprehensive loss, net of tax | $ | (3,794 | ) | $ | (1,804 | ) | $ | (10,639 | ) | $ | (36,474 | ) |
See notes to the unaudited condensed consolidated financial statements.
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SONUS NETWORKS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Nine months ended | |||||||
September 30, 2016 | September 25, 2015 | ||||||
Cash flows from operating activities: | |||||||
Net loss | $ | (11,301 | ) | $ | (36,598 | ) | |
Adjustments to reconcile net loss to cash flows provided by operating activities: | |||||||
Depreciation and amortization of property and equipment | 5,914 | 9,646 | |||||
Amortization of intangible assets | 5,493 | 4,975 | |||||
Stock-based compensation | 15,464 | 16,902 | |||||
Loss on disposal of property and equipment | 29 | 112 | |||||
Gain on sale of domain name | (800 | ) | — | ||||
Deferred income taxes | 763 | 514 | |||||
Changes in operating assets and liabilities: | |||||||
Accounts receivable | 9,287 | 11,623 | |||||
Inventory | 2,756 | (2,076 | ) | ||||
Other operating assets | (798 | ) | 1,282 | ||||
Accounts payable | (2,904 | ) | (2,329 | ) | |||
Accrued expenses and other long-term liabilities | (12,032 | ) | (5,733 | ) | |||
Deferred revenue | (1,823 | ) | 3,379 | ||||
Net cash provided by operating activities | 10,048 | 1,697 | |||||
Cash flows from investing activities: | |||||||
Purchases of property and equipment | (3,637 | ) | (6,417 | ) | |||
Business acquisition, net of cash acquired | (20,669 | ) | (10,897 | ) | |||
Purchases of marketable securities | (62,468 | ) | (25,577 | ) | |||
Maturities/sales of marketable securities | 65,327 | 49,328 | |||||
Proceeds from the sale of domain name | 800 | — | |||||
Net cash (used in) provided by investing activities | (20,647 | ) | 6,437 | ||||
Cash flows from financing activities: | |||||||
Proceeds from sale of common stock in connection with employee stock purchase plan | 1,360 | 2,378 | |||||
Proceeds from exercise of stock options | 135 | 1,757 | |||||
Payment of tax withholding obligations related to net share settlements of restricted stock awards | (1,538 | ) | (2,314 | ) | |||
Repurchase of common stock | (7,130 | ) | (6,083 | ) | |||
Principal payments of capital lease obligations | (33 | ) | (62 | ) | |||
Net cash used in financing activities | (7,206 | ) | (4,324 | ) | |||
Effect of exchange rate changes on cash and cash equivalents | 260 | (194 | ) | ||||
Net (decrease) increase in cash and cash equivalents | (17,545 | ) | 3,616 | ||||
Cash and cash equivalents, beginning of year | 50,111 | 41,157 | |||||
Cash and cash equivalents, end of period | $ | 32,566 | $ | 44,773 | |||
Supplemental disclosure of cash flow information: | |||||||
Interest paid | $ | 27 | $ | 46 | |||
Income taxes paid | $ | 1,024 | $ | 833 | |||
Income tax refunds received | $ | 275 | $ | 312 | |||
Supplemental disclosure of non-cash investing activities: | |||||||
Capital expenditures incurred, but not yet paid | $ | 444 | $ | 556 | |||
Property and equipment acquired under capital lease | $ | 36 | $ | — | |||
Fair value of contingent consideration related to acquisition | $ | 10,000 | $ | — |
See notes to the unaudited condensed consolidated financial statements.
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SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)
(1) BASIS OF PRESENTATION
Business
Sonus Networks, Inc. (“Sonus” or the “Company”) is a leading provider of networked solutions for communications service providers (e.g., telecommunications, wireless and cable service providers) and enterprises to help them advance, protect and unify their communications and improve collaboration. Sonus helps many of the world's leading communications service providers and enterprises embrace the next generation of Session Initiation Protocol ("SIP") and 4G/LTE (Long Term Evolution)-based solutions, including Voice over IP ("VoIP") video and Unified Communications ("UC") through secure, reliable and scalable Internet Protocol ("IP") networks. Sonus' products include session border controllers ("SBCs"), diameter signaling controllers ("DSCs"), policy/routing servers, network intelligence applications ("VellOS") and are designed to provide network-wide security and other cloud network exchange services, media and signaling gateways and network analytics tools. Sonus products are supported by a global services team with experience in design, deployment and maintenance of some of the world's largest IP networks.
Sonus utilizes both direct and indirect sales channels to reach its target customers. Customers and prospective customers in the service provider space are traditional and emerging communications service providers, including long distance carriers, local exchange carriers, internet service providers, wireless operators, cable operators, international telephone companies and carriers that provide services to other carriers. Enterprise customers and target enterprise customers include financial institutions, retailers, state and local governments, and other multinational corporations.
Basis of Presentation
In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring items, necessary for their fair presentation with accounting principles generally accepted in the United States of America ("GAAP") and with the rules and regulations of the U.S. Securities and Exchange Commission ("SEC").
Interim results are not necessarily indicative of results for a full year or any future interim period. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2015 (the "Annual Report"), which was filed with the SEC on February 23, 2016.
For the year ended December 31, 2015, the Company reported its first, second and third quarters on a 4-4-5 basis, with the quarter ending on the Friday closest to the last day of each third month. Accordingly, the Company's first quarter ended on March 27, 2015, the second quarter ended on June 26, 2015 and the third quarter ended on September 25, 2015. Effective January 1, 2016, the Company is reporting its first, second and third quarters on a month-end basis, such that the first quarter ended on March 31, 2016, the second quarter ended on June 30, 2016 and the third quarter ended on September 30, 2016. The Company's fiscal year will continue to end on December 31.
During the preparation of the Company's consolidated financial statements for the three-month period ended June 26, 2015, the Company identified an error related to the historical foreign translation of depreciation expense on certain foreign fixed assets that resulted in a historical understatement of expense in prior fiscal years totaling $1.4 million on a cumulative basis. There is no tax effect on these expenses as the amounts were calculated in the appropriate foreign currencies. The Company does not believe this error is material to its previously issued historical consolidated financial statements for any of the periods impacted and accordingly, has not adjusted its historical financial statements. The Company recorded the cumulative impact of the adjustment in the three months ended June 26, 2015. This adjustment resulted in a one-time $1.4 million overstatement of depreciation expense. The Company does not believe this adjustment is material to its condensed consolidated financial statements for the periods presented.
On September 26, 2016 (the "Taqua Acquisition Date"), the Company acquired Taqua, LLC ("Taqua"), a leading supplier of IP communications systems, applications and services to mobile and fixed operators. The financial results of Taqua are included in the Company's condensed consolidated financial statements starting on the Taqua Acquisition Date.
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SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
On January 2, 2015 (the "Treq Asset Acquisition Date"), the Company acquired from Treq Labs, Inc. ("Treq") certain assets related to Treq's business of designing, developing, marketing, selling, servicing and maintaining software-defined networking ("SDN") technology, SDN controller software and SDN management software (the "SDN Business"). The financial results of the SDN Business are included in the Company's condensed consolidated financial statements starting on the Treq Asset Acquisition Date.
Significant Accounting Policies
The Company's significant accounting policies are disclosed in Note 2 to the Consolidated Financial Statements included in the Annual Report. There were no material changes to the significant accounting policies during either the three or nine months ended September 30, 2016.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of Sonus and its wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates and Judgments
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and judgments relied upon in preparing these consolidated financial statements include accounting for business combinations, revenue recognition for multiple element arrangements, inventory valuations, assumptions used to determine the fair value of stock-based compensation, intangible assets and goodwill valuations, including impairments, legal contingencies and recoverability of Sonus' net deferred tax assets and the related valuation allowances. Sonus regularly assesses these estimates and records changes in estimates in the period in which they become known. Sonus bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments, which include cash equivalents, marketable securities, investments, accounts receivable, accounts payable and other long-term liabilities, approximate their fair values.
Operating Segments
The Company operates in a single segment. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker in making decisions regarding resource allocation and assessing performance. To date, the chief operating decision maker has made such decisions and assessed performance at the company level, as one segment. The Company's chief operating decision maker is its President and Chief Executive Officer.
Recent Accounting Pronouncements
In August 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"), which amends the guidance in Accounting Standards Codification ("ASC") 230 on the classification of certain cash receipts and payments in the statement of cash flows. The primary purpose of ASU 2016-15 is to reduce the diversity in practice that has resulted from the lack of consistent principles on this topic. ASU 2016-15 adds or clarifies guidance on eight cash flow issues, including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or certain other debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows and application of
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SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
the predominance principle. ASU 2016-15 is effective for the Company beginning January 1, 2018 for both interim and annual reporting periods, with early adoption permitted. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively from the earliest date practicable if retrospective application would be impracticable. The Company is currently assessing the potential impact of the adoption of ASU 2016-15 on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which adds an impairment model that is based on expected losses rather than incurred losses. Under ASU 2016-13, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. ASU 2016-13 is effective for the Company beginning January 1, 2020 for both interim and annual reporting periods, with early adoption permitted. The Company does not expect the adoption of ASU 2016-13 will have a material impact on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"), which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for the Company beginning January 1, 2017 for both interim and annual reporting periods, with early adoption permitted. The Company is currently assessing the potential impact of the adoption of ASU 2016-09 on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) Section A - Leases: Amendments to the FASB Accounting Standards Codification ("ASU 2016-02"), its new standard on accounting for leases. ASU 2016-02 introduces a lessee model that brings most leases onto the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in ASC 606, the FASB's new revenue recognition standard (i.e., those related to evaluating when profit can be recognized). Furthermore, ASU 2016-02 addresses other concerns related to the current leases model. For example, ASU 2016-02 eliminates the current GAAP requirement for an entity to use bright-line tests in determining lease classification. ASU 2016-02 is effective for the Company for both interim and annual periods beginning January 1, 2019. The Company is currently assessing the potential impact of the adoption of ASU 2016-02 on its consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes ("ASU 2015-17"), which requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in the condensed consolidated balance sheet. Netting of deferred tax assets and deferred tax liabilities is still required under ASU 2015-17. The ASU is effective for the Company for its annual report of the year ending December 31, 2018 and for interim period reporting beginning January 1, 2019, with early adoption permitted. The Company elected to early-adopt ASU 2015-17 prospectively and accordingly, reclassified its net current deferred tax asset totaling $1.0 million to its noncurrent net deferred tax asset as of December 31, 2015. No prior periods were retrospectively adjusted. The early adoption of ASU 2015-17 did not have a material impact on the Company's consolidated financial statements.
In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments ("ASU 2015-16"), which eliminates the requirement to restate prior periods to reflect adjustments made to provisional amounts recognized in a business combination. Under ASU 2015-16, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, rather than retrospectively, as had previously been required. ASU 2015-16 also requires acquirers to present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 was effective for the Company as of January 1, 2016. The adoption of ASU 2015-16 did not have a material impact on the Company's consolidated financial statements.
In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory ("ASU 2015-11"), which simplifies the measurement of inventory by requiring entities to measure most inventory at the lower of cost and net realizable value, replacing the previous requirement to measure most inventory at the lower of cost or market. ASU 2015-11 does not apply to inventories that are measured by using either the last-in, first-out method or the retail inventory method. ASU 2015-11 is effective for the Company for both interim and annual reporting periods beginning January 1, 2017. The adoption of ASU 2015-11 is not expected to have a material impact on the Company's consolidated financial statements.
10
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern ("ASU 2014-15"), which provides guidelines for determining when and how to disclose going concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity's ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity's ability to continue as a going concern. ASU 2014-15 is effective for the Company for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The adoption of ASU 2014-15 is not expected to have a material impact on the Company's consolidated financial statements.
In June 2014, the FASB issued ASU 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) (“ASU 2014-12”). ASU 2014-12 clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense (measured as of the grant date without taking into account the effect of the performance target) related to an award for which transfer to the employee is contingent on the entity’s satisfaction of a performance target until it becomes probable that the performance target will be met. ASU 2014-12 does not contain any new disclosure requirements. ASU 2014-12 was effective for the Company as of January 1, 2016. The adoption of ASU 2014-12 did not have a material impact on the Company's consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), its final standard on revenue from contracts with customers. ASU 2014-09 outlines 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. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of 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. In applying the revenue model to contracts within its scope, an entity identifies the contract(s) with a customer, identifies the performance obligations in the contract, determines the transaction price, allocates the transaction price to the performance obligations in the contract and recognizes revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 applies to all contracts with customers that are within the scope of other topics in the FASB ASC. Certain of ASU 2014-09’s provisions also apply to transfers of nonfinancial assets, including in-substance nonfinancial assets that are not an output of an entity’s ordinary activities (i.e., property, plant and equipment; real estate; or intangible assets). Existing accounting guidance applicable to these transfers has been amended or superseded. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date ("ASU 2015-14"), which defers the original effective date of interim and annual reporting periods by one year. As a result, the Company will not be required to apply the new revenue standard until annual reporting periods beginning after December 15, 2017. In March 2016, the FASB issued ASU 2016-08, Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net) ("ASU 2016-08") to clarify certain aspects of the principal-versus-agent guidance in its new revenue recognition standard in response to feedback received from the FASB-International Accounting Standards Board joint revenue recognition transition resource group. ASU 2016-08 clarifies the implementation guidance on principal-versus-agent considerations regarding how an entity determines whether it is a principal or an agent for each specified good or service promised to the customer and how an entity determines the nature of each specified good or service. ASU 2016-08 also provides clarification regarding the application of the principal-versus-agent guidance. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing ("ASU 2016-10"), which amends certain aspects of the guidance in ASU 2014-09 on identifying performance obligations, including immaterial promised goods or services, shipping and handling activities and identifying when promises represent performance obligations; and licensing implementation guidance, including determining the nature of an entity's promise in granting a license, sales-based and usage-based royalties, restrictions of time, geographical location and use, and renewals of licenses that provide a right to use IP. In May 2016, the FASB issued ASU 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815) ("ASU 2016-11"), which rescinds certain SEC guidance from the Codification in response to announcements made by the SEC staff at the Emerging Issues Task Force's March 3, 2016 meeting, and which supersedes certain SEC observer comments on the topics of revenue and expense recognition for freight services in process, accounting for shipping and handling fees and costs, accounting for consideration given by a vendor to a customer and accounting for gas-balancing arrangements upon the adoption of ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, Revenue from
11
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
Contracts with Customers (Topic 606) ("ASU 2016-12"), which amends certain aspects of ASU 2014-09, including regarding collectability, the presentation of sales tax and other similar taxes collected from customers, non-cash consideration, contract modifications and completed contracts at transition. ASU 2016-08, ASU 2016-10, ASU 2016-11 and ASU 2016-12 are effective at the same time as ASU 2014-09 (as amended by ASU 2015-14). The Company is currently assessing the potential impact of the adoption of these ASUs on its consolidated financial statements.
(2) BUSINESS ACQUISITIONS
Taqua, LLC
On the Taqua Acquisition Date, the Company acquired Taqua, a privately-held company. Taqua enables the transformation of software-based service provider networks to deliver next-generation voice, video and messaging services, including VoIP, Voice over Wi-Fi ("VoWiFi") and Voice over Long-Term Evolution ("VoLTE"). The Company believes that the acquisition of Taqua will, among other things, accelerate the Company's mobile strategy by adding a Virtualized Mobile Core ("VMC") Platform and an IP Multimedia Subsystem ("IMS") Service Core and expand the Company's fixed portfolio by adding a Class 5 Softswitch (the T7000) for Network Transformation projects and a Multimedia Controller used in IP Peering applications (the T7100), both of which are complementary to Sonus' current product offerings. In consideration for the acquisition of Taqua, Sonus paid $19.9 million in cash to the sellers on the Taqua Acquisition Date, net of cash acquired. The Company also entered into an Earn-Out Agreement, dated as of September 26, 2016, with Taqua Holdings, LLC and Jeffrey L. Brawner, the seller representative in the transaction, under which there is the potential for additional cash payments of up to $65.0 million in the aggregate to the sellers if certain annual revenue thresholds are exceeded as measured annually through 2020. Based on historical sales and probability weighted cash flows related to forecasted sales, the Company recorded $10.0 million of contingent consideration as of the Taqua Acquisition Date. The Company determined that the estimated fair value of the earn-out at September 30, 2016 equaled its carrying value. Because there are unobservable inputs to the valuation methodology that are significant to the measurement of its fair value, namely, forecasted sales, the Company has categorized the earn-out at Level 3 within the fair value hierarchy. There were no changes to the estimated fair value of the earn-out between the Taqua Acquisition Date and September 30, 2016.
The transaction has been accounted for as a business combination and the financial results of Taqua have been included in the Company's condensed consolidated financial statements for the period subsequent to its acquisition.
As of September 30, 2016, the valuation of acquired assets, identifiable intangible assets and certain accrued liabilities is preliminary. The Company is in the process of investigating the facts and circumstances existing as of the Taqua Acquisition Date in order to finalize its valuation. Based on the preliminary purchase price allocation, the Company recorded $11.8 million of goodwill, which is primarily due to expected synergies between the combined companies and expanded market opportunities resulting from the expanded product offering portfolio. The goodwill is deductible for tax purposes.
12
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
A summary of the preliminary allocation of the purchase consideration for Taqua is as follows (in thousands):
Fair value of consideration transferred: | |||
Cash, net of cash acquired | $ | 19,919 | |
Contingent consideration estimate | 10,000 | ||
Fair value of total consideration | $ | 29,919 | |
Fair value of assets acquired and liabilities assumed: | |||
Current assets | 3,711 | ||
Property and equipment | 1,445 | ||
Intangible assets: | |||
Developed technology | 14,200 | ||
Customer relationships | 4,000 | ||
Goodwill | 11,826 | ||
Other noncurrent assets | 493 | ||
Current liabilities | (5,212 | ) | |
Long-term liabilities | (544 | ) | |
$ | 29,919 |
The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to value the acquired developed technology and customer relationship intangible assets. The preliminary valuation for each of these intangible assets was based on estimated projections of expected cash flows to be generated by the assets, discounted to the present value at discount rates commensurate with perceived risk. The valuation assumptions take into consideration the Company's estimates of technology attrition and revenue growth projections. The Company is amortizing the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives (see Note 6).
Taqua recorded $9.2 million of revenue for the nine months ended September 30, 2016 and $28.3 million of revenue for the year ended December 31, 2015. The Company has not disclosed the amount of revenue or earnings of Taqua since the Taqua Acquisition Date or pro forma financial information, as these amounts are not significant to the Company's consolidated financial statements.
Treq Labs, Inc.
On the Treq Asset Acquisition Date, the Company acquired from Treq the SDN Business. The SDN Business provides solutions that optimize networks for voice, video and UC for both enterprise and service provider customers. In consideration for the acquisition of the SDN Business, Sonus paid $10.1 million in cash on the Treq Asset Acquisition Date, and an additional consideration payment of $750,000 on each of July 2, 2015 and January 4, 2016. The Company also entered into an Earn-Out Agreement, dated as of January 2, 2015, with Treq and Karl F. May, the seller representative in the transaction (the "Earn-Out Agreement"), under which the Company agreed to issue up to an aggregate of 1.3 million shares of common stock over a three-year period subsequent to the Treq Asset Acquisition Date if aggregate revenue thresholds of at least $60 million are achieved by the SDN Business during that period, and up to an aggregate of an additional 2.2 million shares (3.5 million shares in total) if aggregate revenue thresholds of at least $150 million are achieved by the SDN Business during that period. If the initial revenue thresholds are not met, no shares will be issued. Based on historical and forecasted sales, no incremental contingent consideration was recorded either initially as of the Treq Asset Acquisition Date or through September 30, 2016. Any shares issued pursuant to the Earn-Out Agreement will be issued in reliance on the exemption from registration available under Section 4(a)(2) of the Securities Act of 1933, as amended (the "Securities Act"), and will be subsequently registered for resale under the Securities Act by the Company.
The transaction has been accounted for as a business combination. The Company finalized its valuation of the identifiable intangible assets in the second quarter of fiscal 2015. Based on the purchase price allocation, the Company recorded $1.0 million of goodwill, primarily due to expected synergies between the combined companies and expanded market opportunities.
13
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
The goodwill is deductible for tax purposes.
A summary of the purchase consideration for the SDN Business is as follows (in thousands):
Fair value of consideration transferred: | |||
Cash, net of cash acquired | $ | 11,647 | |
Fair value of assets acquired and liabilities assumed: | |||
Intangible assets: | |||
In-process research and development | $ | 9,100 | |
Developed technology | 1,500 | ||
Goodwill | 1,047 | ||
$ | 11,647 |
The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to value the acquired in-process research and development and developed technology intangible assets. The valuation for each of these intangible assets was based on estimated projections of expected cash flows to be generated by the assets, discounted to the present value at discount rates commensurate with perceived risk. The valuation assumptions take into consideration the Company's estimates of technology attrition and revenue growth projections. During the three months ended March 31, 2016, the Company began to record amortization expense in connection with the in-process research and development intangible assets related to a product that became generally available in that quarter and accordingly, reclassified the asset with a cost basis of $1.6 million to its developed technology intangible assets. During the three months ended September 25, 2015, the Company began to record amortization expense in connection with certain of the in-process research and development intangible assets related to a product that became generally available in that quarter and accordingly, reclassified the asset with a cost basis of $7.5 million to its developed technology intangible assets. Accordingly, as of March 31, 2016, the Company no longer had an in-process research and development intangible asset. The Company is amortizing the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives (see Note 6).
The Company has not disclosed the amount of revenue or earnings of the SDN Business since the Treq Asset Acquisition Date or pro forma financial information, as these amounts are not significant to the Company's consolidated financial statements.
Acquisition-Related Expenses
Acquisition-related expenses include those expenses related to acquisitions that would otherwise not have been incurred by the Company. These expenses include professional and services fees, such as legal, audit, consulting, paying agent and other fees, as well as cash payments to certain employees of acquired companies in connection with change of control agreements. The amounts recorded in the three and nine months ended September 30, 2016 relate to professional fees in connection with the acquisition of Taqua. The amounts recorded in the nine months ended September 25, 2015 relate to professional fees in connection with the acquisition of the SDN Business. The Company did not record acquisition-related expenses in the three months ended September 25, 2015.
The acquisition-related expenses included in the Company's results of operations for the three and nine months ended September 30, 2016 and September 25, 2015 are as follows (in thousands):
Three months ended | Nine months ended | ||||||||||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||||||||||
Professional and services fees | $ | 951 | $ | — | $ | 951 | $ | 131 |
14
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
(3) EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares outstanding during the period. For periods in which the Company reports net income, diluted net income per share is determined by using the weighted average number of common and dilutive common equivalent shares outstanding during the period unless the effect is antidilutive.
The calculations of shares used to compute basic and diluted loss per share are as follows (in thousands):
Three months ended | Nine months ended | ||||||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||||||
Weighted average shares outstanding—basic | 49,402 | 49,625 | 49,436 | 49,512 | |||||||
Potential dilutive common shares | — | — | — | — | |||||||
Weighted average shares outstanding—diluted | 49,402 | 49,625 | 49,436 | 49,512 |
Options to purchase the Company's common stock, unvested shares of restricted stock, unvested shares of performance-based stock and shares in connection with future purchases under the Company's Amended and Restated 2000 Employee Stock Purchase Plan, as amended (the "ESPP"), totaling 8.2 million shares for the three and nine months ended September 30, 2016 and 8.6 million shares for the three and nine months ended September 25, 2015 have not been included in the computation of diluted loss per share because their effect would have been antidilutive.
(4) CASH EQUIVALENTS AND INVESTMENTS
The Company invests in debt instruments, primarily U.S. government-backed, municipal and corporate obligations, which management believes to be high quality (investment grade) credit instruments.
During the three months ended September 30, 2016, the Company sold $1.1 million of its available-for-sale securities that were impacted by the Money Market Reform Act, which became effective October 14, 2016 for institutional money markets, to avoid any negative impact on the Company's institutional money market investments. The Company recognized nominal gross gains from the sale of these securities. During the three months ended March 31, 2016, the Company sold $3.8 million of its available-for-sale securities and recognized gross losses aggregating $18,000. Accordingly, the Company's Other income, net, in its condensed consolidated statement of operations for the nine months ended September 30, 2016 includes a loss in the aggregate of approximately $18,000 related to the aforementioned sales. The Company did not sell any of its available-for-sale securities during the three or nine months ended September 25, 2015. Investments with continuous unrealized losses for one year or greater at September 30, 2016 were nominal. Since the Company currently does not intend to sell these securities and does not believe it will be required to sell any securities before they recover in value, it does not believe these declines are other-than-temporary.
On a quarterly basis, the Company reviews its marketable securities and investments to determine if there have been any events that could create a credit impairment. Based on its reviews, the Company does not believe that any impairment existed with its current holdings at September 30, 2016.
The amortized cost, gross unrealized gains and losses and fair value of the Company's marketable debt securities and investments at September 30, 2016 and December 31, 2015 were comprised of the following (in thousands):
15
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
September 30, 2016 | |||||||||||||||
Amortized cost | Unrealized gains | Unrealized losses | Fair value | ||||||||||||
Cash equivalents | $ | 12,389 | $ | — | $ | — | $ | 12,389 | |||||||
Marketable securities | |||||||||||||||
Municipal obligations | $ | 2,627 | $ | 3 | $ | — | $ | 2,630 | |||||||
U.S. government agency notes | 9,973 | 9 | — | 9,982 | |||||||||||
Corporate debt securities | 37,221 | 12 | (16 | ) | 37,217 | ||||||||||
$ | 49,821 | $ | 24 | $ | (16 | ) | $ | 49,829 | |||||||
Investments | |||||||||||||||
Municipal obligations | $ | 1,109 | $ | 1 | $ | — | $ | 1,110 | |||||||
U.S. government agency notes | 21,470 | 17 | (2 | ) | 21,485 | ||||||||||
Corporate debt securities | 16,011 | 11 | (14 | ) | 16,008 | ||||||||||
$ | 38,590 | $ | 29 | $ | (16 | ) | $ | 38,603 |
December 31, 2015 | |||||||||||||||
Amortized cost | Unrealized gains | Unrealized losses | Fair value | ||||||||||||
Cash equivalents | $ | 7,122 | $ | — | $ | — | $ | 7,122 | |||||||
Marketable securities | |||||||||||||||
Municipal obligations | $ | 3,910 | $ | — | $ | (1 | ) | $ | 3,909 | ||||||
U.S. government agency notes | 3,450 | — | (2 | ) | 3,448 | ||||||||||
Corporate debt securities | 46,736 | 2 | (56 | ) | 46,682 | ||||||||||
Commercial paper | 3,994 | — | — | 3,994 | |||||||||||
Certificates of deposit | 500 | — | — | 500 | |||||||||||
$ | 58,590 | $ | 2 | $ | (59 | ) | $ | 58,533 | |||||||
Investments | |||||||||||||||
Municipal obligations | $ | 2,165 | $ | — | $ | (4 | ) | $ | 2,161 | ||||||
U.S. government agency notes | 1,999 | — | (13 | ) | 1,986 | ||||||||||
Corporate debt securities | 29,541 | 2 | (85 | ) | 29,458 | ||||||||||
$ | 33,705 | $ | 2 | $ | (102 | ) | $ | 33,605 |
The Company's available-for-sale debt securities classified as Investments in the condensed consolidated balance sheets at September 30, 2016 and December 31, 2015 had maturity dates after one year but within approximately two years or less from the balance sheet date.
Fair Value Hierarchy
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. The three-tier fair value hierarchy is based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is as follows:
Level 1. Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.
16
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
Level 2. Level 2 applies to assets or liabilities for which there are inputs that are directly or indirectly observable in the marketplace, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets).
Level 3. Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.
The following table shows the fair value of the Company's financial assets at September 30, 2016 and December 31, 2015. These financial assets are comprised of the Company's available-for-sale debt securities and reported under the captions Cash and cash equivalents, Marketable securities and Investments in the condensed consolidated balance sheets (in thousands):
Fair value measurements at September 30, 2016 using: | |||||||||||||||
Total carrying value at September 30, 2016 | Quoted prices in active markets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | ||||||||||||
Cash equivalents | $ | 12,389 | $ | 12,389 | $ | — | $ | — | |||||||
Marketable securities | |||||||||||||||
Municipal obligations | $ | 2,630 | $ | — | $ | 2,630 | $ | — | |||||||
U.S. government agency notes | 9,982 | — | 9,982 | — | |||||||||||
Corporate debt securities | 37,217 | — | 37,217 | — | |||||||||||
$ | 49,829 | $ | — | $ | 49,829 | $ | — | ||||||||
Investments | |||||||||||||||
Municipal obligations | $ | 1,110 | $ | — | $ | 1,110 | $ | — | |||||||
U.S. government agency notes | 21,485 | — | 21,485 | — | |||||||||||
Corporate debt securities | 16,008 | — | 16,008 | — | |||||||||||
$ | 38,603 | $ | — | $ | 38,603 | $ | — |
Fair value measurements at December 31, 2015 using: | |||||||||||||||
Total carrying value at December 31, 2015 | Quoted prices in active markets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | ||||||||||||
Cash equivalents | $ | 7,122 | $ | 7,122 | $ | — | $ | — | |||||||
Marketable securities | |||||||||||||||
Municipal obligations | $ | 3,909 | $ | — | $ | 3,909 | $ | — | |||||||
U.S. government agency notes | 3,448 | — | 3,448 | — | |||||||||||
Corporate debt securities | 46,682 | — | 46,682 | — | |||||||||||
Commercial paper | 3,994 | — | 3,994 | — | |||||||||||
Certificates of deposit | 500 | — | 500 | — | |||||||||||
$ | 58,533 | $ | — | $ | 58,533 | $ | — | ||||||||
Investments | |||||||||||||||
Municipal obligations | $ | 2,161 | $ | — | $ | 2,161 | $ | — | |||||||
U.S. government agency notes | 1,986 | — | 1,986 | — | |||||||||||
Corporate debt securities | 29,458 | — | 29,458 | — | |||||||||||
$ | 33,605 | $ | — | $ | 33,605 | $ | — |
The Company's marketable securities and investments have been valued with the assistance of valuations provided by third-party pricing services, as derived from such services' pricing models. Inputs to the models may include, but are not
17
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
limited to, reported trades, executable bid and asked prices, broker/dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security. The Company is ultimately responsible for the condensed consolidated financial statements and underlying estimates. Accordingly, the Company assesses the reasonableness of the valuations provided by the third-party pricing services by reviewing actual trade data, broker/dealer quotes and other similar data, which are obtained from quoted market prices or other sources.
(5) INVENTORY
Inventory at September 30, 2016 and December 31, 2015 consists of the following (in thousands):
September 30, 2016 | December 31, 2015 | ||||||
On-hand final assemblies and finished goods inventories | $ | 17,319 | $ | 17,136 | |||
Deferred cost of goods sold | 4,942 | 5,975 | |||||
22,261 | 23,111 | ||||||
Less current portion | (20,811 | ) | (23,111 | ) | |||
Noncurrent portion (included in Other assets) | $ | 1,450 | $ | — |
(6) INTANGIBLE ASSETS AND GOODWILL
The Company's intangible assets at September 30, 2016 and December 31, 2015 consist of the following (dollars in thousands):
September 30, 2016 | Weighted average amortization period (years) | Cost | Accumulated amortization | Net carrying value | |||||||||
Developed technology | 6.92 | $ | 47,080 | $ | 14,952 | $ | 32,128 | ||||||
Customer relationships | 5.69 | 14,030 | 7,364 | 6,666 | |||||||||
Internal use software | 3.00 | 730 | 730 | — | |||||||||
6.59 | $ | 61,840 | $ | 23,046 | $ | 38,794 |
December 31, 2015 | Weighted average amortization period (years) | Cost | Accumulated amortization | Net carrying value | |||||||||
In-process research and development | * | $ | 1,600 | $ | — | $ | 1,600 | ||||||
Developed technology | 6.42 | 31,280 | 10,415 | 20,865 | |||||||||
Customer relationships | 5.57 | 10,030 | 6,408 | 3,622 | |||||||||
Internal use software | 3.00 | 730 | 730 | — | |||||||||
6.19 | $ | 43,640 | $ | 17,553 | $ | 26,087 |
________________
* An in-process research and development intangible asset has an indefinite life until the product is generally available, at which time such asset is reclassified to developed technology. As of September 30, 2016, all of the Company's in-process research and development intangible assets had been reclassified to developed technology and are being amortized over their respective estimated useful lives.
Amortization expense for intangible assets for the three and nine months ended September 30, 2016 and September 25, 2015 was as follows (in thousands):
18
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
Three months ended | Nine months ended | Statement of operations classification | |||||||||||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||||||||||||
Developed technology | $ | 1,455 | $ | 1,282 | $ | 4,537 | $ | 3,505 | Cost of revenue - product | ||||||||
Customer relationships | 319 | 414 | 956 | 1,308 | Sales and marketing | ||||||||||||
Internal use software | — | 41 | — | 162 | Cost of revenue - product | ||||||||||||
$ | 1,774 | $ | 1,737 | $ | 5,493 | $ | 4,975 |
During the three months ended September 30, 2016, the Company recorded intangible assets aggregating $18.2 million, comprised of $14.2 million related to developed technology, with an estimated useful life of 8 years, and $4.0 million related to customer relationships, with an estimated useful life of 6 years. The Company is amortizing these intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives. The Company did not record amortization expense for the Taqua intangible assets for the period from the Taqua Acquisition Date through September 30, 2016, as the amounts were immaterial to the Company's consolidated financial results.
The Company is recording amortization expense in connection with the in-process research and development intangible assets that arose from the acquisition of the SDN Business, of which $1.6 million had been reclassified to developed technology in the three months ended March 31, 2016 and $7.5 million had been reclassified to developed technology in the three months ended September 25, 2015, representing the cost basis of products that became generally available in the respective quarters. The Company has determined that the reclassified assets each have an estimated useful life of 7 years. The Company is amortizing the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives.
Estimated future amortization expense for the Company's intangible assets at September 30, 2016 is as follows (in thousands):
Years ending December 31, | |||
Remainder of 2016 | $ | 2,524 | |
2017 | 10,836 | ||
2018 | 7,747 | ||
2019 | 7,079 | ||
2020 | 4,507 | ||
Thereafter | 6,101 | ||
$ | 38,794 |
The changes in the carrying value of the Company's goodwill in the nine months ended September 30, 2016 were as follows (in thousands):
Balance at January 1, 2016 | |||
Goodwill | $ | 43,416 | |
Accumulated impairment losses | (3,106 | ) | |
40,310 | |||
Acquisition of Taqua | 11,826 | ||
Balance at September 30, 2016 | $ | 52,136 | |
Balance at September 30, 2016 | |||
Goodwill | $ | 55,242 | |
Accumulated impairment losses | (3,106 | ) | |
$ | 52,136 |
19
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
The changes in the carrying value of the Company's goodwill in the nine months ended September 25, 2015 were as follows (in thousands):
Balance at January 1, 2015 | |||
Goodwill | $ | 42,369 | |
Accumulated impairment losses | (3,106 | ) | |
39,263 | |||
Acquisition of SDN Business | 1,047 | ||
Balance at September 25, 2015 | $ | 40,310 | |
Balance at September 25, 2015 | |||
Goodwill | $ | 43,416 | |
Accumulated impairment losses | (3,106 | ) | |
$ | 40,310 |
(7) ACCRUED EXPENSES
Accrued expenses at September 30, 2016 and December 31, 2015 consist of the following (in thousands):
September 30, 2016 | December 31, 2015 | ||||||
Employee compensation and related costs | $ | 12,577 | $ | 22,180 | |||
Other | 10,413 | 9,783 | |||||
$ | 22,990 | $ | 31,963 |
(8) RESTRUCTURING ACCRUAL
2016 Restructuring Initiative
In July 2016, the Company announced a program to further accelerate its investment in new technologies as the communications industry migrates to a cloud-based architecture (the "2016 Restructuring Initiative"). The Company expects to record between $3 million and $4 million of restructuring expense through the third quarter of 2017 in connection with this action, resulting in expected annual savings of approximately $6 million to $8 million. The Company intends to utilize the entire savings to shift headcount toward new strategic initiatives, such as new products and an expanded go-to-market footprint in selected geographies and discrete vertical markets. In connection with this restructuring initiative, the Company recorded $1.2 million in the three months ended September 30, 2016. A summary of the 2016 Restructuring Initiative accrual activity for the nine months ended September 30, 2016 is as follows:
Balance at January 1, 2016 | Initiatives charged to expense | Adjustments for changes in estimate | Cash payments | Balance at September 30, 2016 | |||||||||||||||
Severance | $ | — | $ | 1,236 | $ | — | $ | (216 | ) | $ | 1,020 |
The Company expects that the amounts accrued under the 2016 Restructuring Initiative will be paid by end of the fourth quarter of 2017.
20
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
Taqua Restructuring Initiative
In connection with the acquisition of Taqua, the Company's management approved an immaterial restructuring plan in the third quarter of 2016 to eliminate certain redundant positions within the combined companies. On October 24, 2016, the Audit Committee of the Board of Directors of the Company approved a broader Taqua restructuring plan related to headcount and redundant facilities (both restructuring plans, the "Taqua Restructuring Initiative"). In connection with this initiative, the Company recorded $0.4 million in the three months ended September 30, 2016. The Company anticipates it will record additional future expense in connection with this initiative for headcount and redundant facilities aggregating approximately $1 million to $2 million. A summary of the Taqua Restructuring Initiative accrual activity for the nine months ended September 30, 2016 is as follows:
Balance at January 1, 2016 | Initiatives charged to expense | Adjustments for changes in estimate | Cash payments | Balance at September 30, 2016 | |||||||||||||||
Severance | $ | — | $ | 384 | $ | — | $ | — | $ | 384 |
The Company expects that the amounts accrued under the Taqua Restructuring Initiative will be paid by the end of the second quarter of 2017.
2015 Restructuring Initiative
To better align the Company's cost structure to its current revenue expectations, in April 2015, the Company announced a cost reduction review and restructuring initiative (the "2015 Restructuring Initiative"). A summary of the 2015 Restructuring Initiative accrual activity for the nine months ended September 30, 2016 is as follows (in thousands):
Balance at January 1, 2016 | Initiatives charged to expense | Adjustments for changes in estimate | Cash payments | Balance at September 30, 2016 | |||||||||||||||
Severance | $ | 749 | $ | — | $ | — | $ | (649 | ) | $ | 100 |
The Company expects that the remaining amounts accrued under the 2015 Restructuring Initiative will be paid by the end of 2016.
Balance Sheet Classification
At September 30, 2016, the Company's restructuring accruals aggregated $1.5 million, of which approximately $33,000 was included in Other long-term liabilities, with the remainder included in Accrued expenses in the condensed consolidated balance sheet. At December 31, 2015, all of the restructuring accrual was included in Accrued expenses, as there was no long-term portion.
(9) DEBT
The Company entered into a credit agreement by and among the Company, as Borrower, Bank of America, N.A. ("Bank of America"), as Administrative Agent, Swing Line Lender and L/C Issuer, and the other lenders from time to time party thereto on June 27, 2014 (the "Credit Agreement"), which agreement was amended by a First Amendment to Credit Agreement on June 26, 2015 (the "First Amendment") and further amended by a Second Amendment to Credit Agreement on June 13, 2016 (the "Second Amendment" and collectively with the Credit Agreement and the First Amendment, the "Amended Credit Agreement"). Certain terms of the Credit Agreement have been amended by the Second Amendment, including, among other things: (i) an increase of the commitments from $15 million to $20 million; (ii) an extension of the maturity date from June 30, 2016 to June 30, 2017; (iii) a reduction to the aggregate amount of cash and cash equivalents that the Loan Parties (as defined
21
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
below) are required to hold at any time from $85 million to $50 million; and (iv) a reduction of the commitment fee on the unused commitments available for borrowing from 0.15% to 0.1125%. The Amended Credit Agreement provides that the Company may select the interest rates under the credit facility from among the following options: (i) the Eurodollar Rate (which is defined as the rate per annum equal to the London Interbank Offered Rate plus 1.5% per annum) for a Eurodollar Rate Loan; and (ii) the highest of (a) the Federal Funds Rate plus 1/2 of 1%, (b) the rate of interest in effect on the borrowing date as publicly announced from time to time by Bank of America as its prime rate, and (c) the monthly Eurodollar Rate plus 1%.
The obligations of the Company under the Amended Credit Agreement are guaranteed by Sonus International, Inc., Sonus Federal, Inc. and Network Equipment Technologies, Inc. ("NET") (collectively with the Company, the "Loan Parties") pursuant to a Master Continuing Guaranty and are secured by the assets of the Loan Parties pursuant to a Security and Pledge Agreement.
The Amended Credit Agreement contains affirmative, negative and financial covenants customary for financings of this type. The negative covenants include limitations on liens, indebtedness, fundamental changes, dispositions, restricted payments, investments, transactions with affiliates, certain restrictive agreements and compliance with sanctions laws and regulations. The total revenues of the Loan Parties cannot be less than an aggregate of $50 million as of the last day of the Loan Parties' fiscal quarter, computed on a fiscal quarterly basis. The credit facility will become due on June 30, 2017, subject to acceleration upon certain specified events of default, including, without limitation, payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations of warranties, bankruptcy and insolvency-related defaults, defaults relating to judgments, an ERISA Event (as defined in the Amended Credit Agreement), the failure to pay specified indebtedness and a change of control default.
The Company did not have any amounts outstanding under the Amended Credit Agreement at either September 30, 2016 or December 31, 2015.
(10) COMMON STOCK REPURCHASES
On July 29, 2013, the Company announced that its Board of Directors had authorized a stock buyback program to repurchase up to $100 million of the Company's common stock from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares repurchased will be determined by the Company's management based on its evaluation of market conditions and other factors. The Company may elect to implement a 10b5-1 repurchase program, which would permit shares to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws. The Company has not implemented such a 10b5-1 repurchase program to date. The stock buyback program may be suspended or discontinued at any time. The stock buyback program is being funded using the Company's working capital. During the nine months ended September 30, 2016, the Company spent $7.1 million, including transaction fees, to repurchase and retire 0.9 million shares of its common stock under the stock buyback program. During the nine months ended September 25, 2015, the Company spent $6.1 million, including transaction fees, to repurchase and retire 0.4 million shares of its common stock under the stock buyback program. At September 30, 2016, the Company had $7.8 million remaining under the stock buyback program for future repurchases.
(11) STOCK-BASED COMPENSATION PLANS
Stock Incentive Plan
The Company's 2007 Stock Incentive Plan, as amended (the "2007 Plan"), provides for the award of options to purchase the Company's common stock ("stock options"), stock appreciation rights ("SARs"), restricted common stock awards ("RSAs"), restricted common stock units ("RSUs"), performance-based stock awards ("PSAs"), performance-based stock units ("PSUs") and other stock-based awards to employees, officers, directors (including those directors who are not employees or officers of the Company), consultants and advisors of the Company and its subsidiaries.
22
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
At its 2016 annual meeting of stockholders held on June 9, 2016 (the "2016 Annual Meeting"), the Company's stockholders approved (i) changing the name of the 2007 Plan to the Amended and Restated Stock Incentive Plan (the "Stock Plan") and (ii) other amendments to the Stock Plan including, among other things, to:
• | Increase the number of shares of the Company's common stock authorized for issuance under the Stock Plan by 800,000 shares; |
• | Extend the Stock Plan's termination date through the tenth anniversary of the 2016 Annual Meeting; |
• | Revise the rate at which RSAs, RSUs, PSAs and PSUs (collectively, "full value awards") are counted against the shares of common stock available for issuance under the Stock Plan from 1.61 shares for every one share subject to such award to 1.50 shares for every one share subject to such award. Shares of common stock subject to full value awards that were granted under any prior ratio that applied at the time such awards were granted will continue to return to the Stock Plan upon forfeiture of such awards at the respective previous ratio of 1.50, 1.57 and 1.61, as applicable; |
• | Increase the maximum number of shares of the Company's common stock with respect to which awards may be granted to any participant under the Stock Plan to 1,000,000 shares per calendar year; |
• | Increase the maximum number of shares of the Company's common stock with respect to which awards may be granted under the Stock Plan to any director who is not an employee of the Company at the time of grant to 100,000 shares per calendar year; and |
• | Prohibit stock options and SARs granted under the Stock Plan from (i) providing for the payment or accrual of dividend equivalents or (ii) containing any provision entitling the grantee to the automatic grant of additional stock options or SARs, as applicable, in connection with the exercise of the original stock option or SAR, as applicable. |
In June 2016, the Compensation Committee of the Company's Board of Directors (the "Compensation Committee") voted to change the standard vesting terms for awards of stock options, RSAs and RSUs granted after June 9, 2016 as follows:
• | Stock options will generally vest over a period of three years, with one-third of the stock options vesting on the first anniversary of the grant date and the remaining two-thirds vesting in equal monthly increments thereafter through the third anniversary of the grant date. |
• | RSAs and RSUs (collectively, the "restricted stock grants") will generally vest over a period of three years, with one-third of the shares underlying the grant vesting on the first anniversary of the grant date and the remaining two-thirds vesting in equal increments semi-annually through the third anniversary of the grant date. |
The Company neither adjusted nor intends to adjust the vesting schedules of stock options or restricted stock grants awarded prior to June 9, 2016 to reflect the new three-year vesting schedules.
Executive Equity Arrangements
On April 1, 2016, the Company granted an aggregate of 131,250 PSUs with both market and service conditions to six of its executives (the "2016 PSUs"). The terms of the 2016 PSUs are such that up to one-third of the shares subject to the 2016 PSUs will vest on each of the first, second and third anniversaries of the date of grant (collectively, the "2016 PSU Vesting Dates") to the extent of achievement of the Company's total shareholder return ("TSR") compared to the TSR of the companies included in the NASDAQ Telecommunications Index for the same fiscal year, measured by the Compensation Committee after each of the 2016, 2017 and 2018 fiscal years, respectively (as used in this paragraph, each, a "Performance Period"). The shares determined to be earned will vest on the anniversary of the grant date following each Performance Period. Shares subject to the 2016 PSUs that fail to be earned will be forfeited. The 2016 PSUs include a market condition that requires the use of a Monte Carlo simulation approach to model future stock price movements based upon the risk-free rate of return, the volatility of each entity, and the pair-wise covariance between each entity. These results were then used to calculate the grant date fair values of the 2016 PSUs. Because the 2016 PSUs have market conditions, the Company is required to record expense
23
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
for the 2016 PSUs through the final 2016 PSU Vesting Date of April 1, 2019, regardless of the number of shares that are ultimately earned. In June 2016, one executive separated from the Company and forfeited his unvested 2016 PSUs; these forfeited unvested 2016 PSUs are reported as such in the performance-based units table below.
On March 16, 2015, the Company granted an aggregate of 131,250 PSUs with both market and service conditions to eight of its executives (the "2015 PSUs"). In 2015, subsequent to the grant date, two executives separated from the Company and, in accordance with their respective employment agreements with the Company, the Company accelerated the vesting of certain unvested 2015 PSUs. The terms of the 2015 PSUs are such that up to one-third of the shares subject to the 2015 PSUs will vest on each of the first, second and third anniversaries of the date of grant (collectively, the "2015 PSU Vesting Dates") to the extent of achievement of the Company's TSR compared to the TSR of the companies included in the NASDAQ Telecommunications Index for the same Performance Period, measured by the Compensation Committee at the end of each of the 2015, 2016 and 2017 fiscal years, respectively (as used in this paragraph, each, a "Performance Period"). The shares determined to be earned will vest on the anniversary of the grant date following each Performance Period. Shares subject to the 2015 PSUs that fail to be earned will be forfeited. The 2015 PSUs include a market condition that required the use of a Monte Carlo simulation approach to calculate the grant date fair values of the 2015 PSUs. Because the 2015 PSUs have market conditions, the Company is required to record expense for the 2015 PSUs through the final 2015 PSU Vesting Date of March 16, 2018, regardless of the number of shares that are ultimately earned, if any. In February 2016, the Compensation Committee determined that the performance metrics for the 2015 PSUs were not achieved for the 2015 Performance Period. Accordingly, 37,081 shares in the aggregate, representing one-third of the 2015 PSUs held by the then-remaining six executives, were forfeited, and are reported as such in the performance-based units table below. In June 2016, one executive separated from the Company and forfeited his unvested 2015 PSUs; these forfeited unvested 2015 PSUs are reported as such in the performance-based units table below.
In connection with the October 2016 separation of one executive from the Company and the terms of his employment agreement, as amended, the vesting schedules of certain of his stock options, RSAs and PSUs were accelerated to October 3, 2016. Accordingly, the Company accelerated the expense recognition in connection with these accelerated grants, resulting in incremental stock-based compensation expense of $1.9 million recorded in the three months ended September 30, 2016. The Company recorded all such incremental expense in the three months ended September 30, 2016, as any expense attributable to the period in the fourth quarter of 2016 was immaterial to the Company's consolidated financial results.
Stock Options
The activity related to the Company's outstanding stock options during the nine months ended September 30, 2016 is as follows:
Number of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (years) | Aggregate Intrinsic Value (in thousands) | |||||||||
Outstanding at January 1, 2016 | 6,352,208 | $ | 15.99 | |||||||||
Granted | 161,090 | $ | 8.41 | |||||||||
Exercised | (19,578 | ) | $ | 6.87 | ||||||||
Forfeited | (155,787 | ) | $ | 14.80 | ||||||||
Expired | (569,905 | ) | $ | 16.99 | ||||||||
Outstanding at September 30, 2016 | 5,768,028 | $ | 15.74 | 5.51 | $ | 294 | ||||||
Vested or expected to vest at September 30, 2016 | 5,666,592 | $ | 15.78 | 5.46 | $ | 282 | ||||||
Exercisable at September 30, 2016 | 4,619,681 | $ | 15.82 | 5.01 | $ | 238 |
The grant date fair values of options to purchase common stock granted in the three and nine months ended September 30, 2016 were estimated using the Black-Scholes valuation model with the following assumptions:
24
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
Three months ended | Nine months ended | ||
September 30, 2016 | September 30, 2016 | ||
Risk-free interest rate | 1.13% | 1.00% - 1.60% | |
Expected dividends | — | — | |
Weighted average volatility | 51.6% | 54.8% | |
Expected life (years) | 5.0 | 5.0-10.0 |
Additional information regarding the Company's stock options for the three and nine months ended September 30, 2016 is as follows:
Three months ended | Nine months ended | ||||||
September 30, 2016 | September 30, 2016 | ||||||
Weighted average grant date fair value of stock options granted | $ | 4.01 | $ | 4.46 | |||
Total intrinsic value of stock options exercised (in thousands) | $ | 27 | $ | 38 | |||
Cash received from the exercise of stock options (in thousands) | $ | 120 | $ | 135 |
Restricted Stock Awards and Units
The activity related to the Company's RSAs for the nine months ended September 30, 2016 is as follows:
Shares | Weighted Average Grant Date Fair Value | |||||
Unvested balance at January 1, 2016 | 1,512,783 | $ | 13.48 | |||
Granted | 1,535,902 | $ | 7.79 | |||
Vested | (701,774 | ) | $ | 12.82 | ||
Forfeited | (318,102 | ) | $ | 10.25 | ||
Unvested balance at September 30, 2016 | 2,028,809 | $ | 9.91 |
The activity related to the Company's RSUs for the nine months ended September 30, 2016 is as follows:
Shares | Weighted Average Grant Date Fair Value | |||||
Unvested balance at January 1, 2016 | 95,361 | $ | 16.05 | |||
Granted | 53,400 | $ | 7.58 | |||
Vested | (35,193 | ) | $ | 16.05 | ||
Forfeited | (3,349 | ) | $ | 16.05 | ||
Unvested balance at September 30, 2016 | 110,219 | $ | 11.95 |
The total fair value of shares of restricted stock granted under RSAs and RSUs that vested during the nine months ended September 30, 2016 was $9.6 million.
Performance-Based Stock Units
The activity related to the Company's PSUs for the nine months ended September 30, 2016 is as follows:
25
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
Shares | Weighted Average Grant Date Fair Value | |||||
Unvested balance at January 1, 2016 | 111,250 | $ | 14.68 | |||
Granted | 131,250 | $ | 9.39 | |||
Vested | — | $ | — | |||
Forfeited | (66,665 | ) | $ | 12.77 | ||
Unvested balance at September 30, 2016 | 175,835 | $ | 10.58 |
Employee Stock Purchase Plan
The Company's ESPP provides for six-month offering periods with the purchase price of the stock equal to 85% of the lesser of the market price on the first or last day of the offering period. The maximum number of shares of common stock an employee may purchase during each offering period is 500, subject to certain adjustments pursuant to the ESPP.
Stock-Based Compensation
The condensed consolidated statements of operations include stock-based compensation for the three and nine months ended September 30, 2016 and September 25, 2015 as follows (in thousands):
Three months ended | Nine months ended | ||||||||||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||||||||||
Product cost of revenue | $ | 95 | $ | 81 | $ | 259 | $ | 238 | |||||||
Service cost of revenue | 331 | 378 | 985 | 1,155 | |||||||||||
Research and development | 1,298 | 1,349 | 3,687 | 4,152 | |||||||||||
Sales and marketing | 3,048 | 1,282 | 5,292 | 4,150 | |||||||||||
General and administrative | 1,636 | 2,183 | 5,241 | 7,207 | |||||||||||
$ | 6,408 | $ | 5,273 | $ | 15,464 | $ | 16,902 |
There is no income tax benefit for employee stock-based compensation expense for the nine months ended September 30, 2016 or September 25, 2015 due to the valuation allowance recorded.
At September 30, 2016, there was $25.2 million, net of expected forfeitures, of unrecognized stock-based compensation expense related to unvested stock options, awards, units and ESPP shares. This expense is expected to be recognized over a weighted average period of approximately two years.
(12) MAJOR CUSTOMERS
The following customers contributed 10% or more of the Company's revenue in at least one of the three or nine month periods ended September 30, 2016 and September 25, 2015:
Three months ended | Nine months ended | ||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||
AT&T Inc. | 12% | 15% | 13% | 14% | |||
Inteliquent | * | 14% | * | * | |||
CenturyLink | * | 11% | * | * |
_______________________
* Represents less than 10% of revenue
26
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
At September 30, 2016, two customers accounted for 10% or more of the Company's accounts receivable balance, representing approximately 28% of the Company's accounts receivable balance. At December 31, 2015, one customer accounted for 10% or more of the Company's accounts receivable balance, representing approximately 11% of the Company's accounts receivable balance. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company maintains an allowance for doubtful accounts and such losses have been within management's expectations.
(13) GEOGRAPHIC INFORMATION
The Company's classification of revenue by geographic area is determined by the location to which the product is shipped or where the services are performed. The following table summarizes revenue by geographic area as a percentage of total revenue:
Three months ended | Nine months ended | ||||||||||
September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | ||||||||
United States | 70 | % | 77 | % | 69 | % | 71 | % | |||
Europe, Middle East and Africa | 14 | 11 | 13 | 12 | |||||||
Japan | 7 | 5 | 10 | 10 | |||||||
Other Asia Pacific | 5 | 4 | 5 | 4 | |||||||
Other | 4 | 3 | 3 | 3 | |||||||
100 | % | 100 | % | 100 | % | 100 | % |
International revenue, both as a percentage of total revenue and absolute dollars, may vary from one period to the next, and accordingly, historical data may not be indicative of future periods.
(14) INCOME TAXES
The Company's income tax provisions for the nine months ended September 30, 2016 and September 25, 2015 reflect the Company's estimates of the effective rates expected to be applicable for the respective full years, adjusted for any discrete events, which are recorded in the period that they occur. These estimates are reevaluated each quarter based on the Company's estimated tax expense for the full year. The estimated effective rates for the nine months ended September 30, 2016 and September 25, 2015 do not include any benefit for the Company's domestic losses, as the Company has concluded that a valuation allowance on any domestic benefit is required. Included in the Company's provision for the nine months ended September 30, 2016 is a discrete charge of $0.7 million related to an uncertain tax position of the Company's subsidiary in France.
(15) COMMITMENTS AND CONTINGENCIES
On April 6, 2015, Ming Huang, a purported shareholder of the Company, filed a Class Action Complaint (Civil Action No. 3:15-02407), alleging violations of the federal securities laws (the "Complaint") in the United States District Court for the District of New Jersey (the "District of New Jersey"), against the Company and two of its officers, Raymond P. Dolan, the Company's President and Chief Executive Officer, and Mark T. Greenquist, the Company's former Chief Financial Officer (collectively, the "Defendants"). On September 21, 2015, in response to motions subsequently filed with the District of New Jersey by four other purported shareholders of the Company seeking status as lead plaintiff, the District of New Jersey appointed Richard Sousa as lead plaintiff (the "Plaintiff"). The Plaintiff claims to represent purchasers of the Company's common stock during the period from October 23, 2014 to March 24, 2015, and seeks unspecified damages. The principal allegation contained in the Complaint is that the Defendants made misleading forward-looking statements concerning the Company's fiscal first quarter of 2015 financial performance. On September 22, 2015, the Company filed a Motion to Transfer
27
SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)
(the “Motion to Transfer”) this case to the United States District Court for the District of Massachusetts. The Plaintiff filed his opposition to the Motion to Transfer on October 5, 2015, and the Company filed a reply to the Motion to Transfer on October 13, 2015. On March 21, 2016, the District of New Jersey granted the Company's Motion to Transfer. Thus, this case will now be litigated in the United States District Court for the District of Massachusetts (Civil Action No. 1:16-cv-10657-GAO). On May 4, 2016, the Plaintiff filed an amended complaint (the "Amended Complaint"), which is now the operative complaint in this litigation. On June 20, 2016, the Company and the other Defendants filed a Motion to Dismiss the Amended Complaint (the "Motion to Dismiss") and on July 25, 2016, the Plaintiff filed an opposition to the Motion to Dismiss. The Company filed its reply to the Plaintiff's opposition to the Motion to Dismiss on August 15, 2016. The Company believes that the Defendants have meritorious defenses to the allegations made in the Amended Complaint and does not expect the results of this suit to have a material effect on its business or consolidated financial statements. The Company is also fully cooperating with an SEC inquiry regarding the development and issuance of the Company's first quarter 2015 revenue and earnings guidance. At this time, it is not possible to predict the outcome of the SEC's inquiry, including whether or not any proceedings will be initiated or, if so, when or how the matter will be resolved and therefore an estimate of the possible range of loss, if any, cannot be made.
In addition, the Company is often a party to disputes and legal proceedings that it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material effect on the Company's business or consolidated financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of the financial condition and results of operations of Sonus Networks, Inc. should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2015, which was filed with the U.S. Securities and Exchange Commission on February 23, 2016.
Overview
We are a leading provider of networked solutions for communications service providers (e.g., telecommunications, wireless and cable service providers) and enterprises to help them advance, protect and unify their communications and improve collaboration. We help many of the world's leading communications service providers and enterprises embrace the next generation of Session Initiation Protocol ("SIP") and 4G/LTE (Long Term Evolution)-based solutions, including Voice over IP ("VoIP") video and Unified Communications ("UC") through secure, reliable and scalable Internet Protocol ("IP") networks. Our products include session border controllers ("SBCs"), diameter signaling controllers ("DSCs"), policy/routing servers and network intelligence applications ("VellOS") and are designed to provide network-wide security and other cloud network exchange services, media and signaling gateways and network analytics tools. Our products are supported by a global services team with experience in design, deployment and maintenance of some of the world's largest IP networks.
Our solutions enable our customers to seamlessly link and leverage multivendor, multiprotocol communications systems and applications across their networks, around the world and in a rapidly changing ecosystem of IP-enabled devices, such as smartphones and tablets. Our solutions help our customers realize the intended value and benefits of UC platforms by allowing disparate communications environments, commonplace in most enterprises today, to work seamlessly together. Likewise, our solutions facilitate the evolution to cloud-based delivery of UC solutions.
We utilize both direct and indirect sales channels to reach our target customers. Customers and prospective customers in the service provider space are traditional and emerging communications service providers, including long distance carriers, local exchange carriers, internet service providers, wireless operators, cable operators, international telephone companies and carriers that provide services to other carriers. Enterprise customers and target enterprise customers include financial institutions, retailers, state and local governments, and other multinational corporations. We collaborate with our customers to identify and develop new, advanced services and applications that can help to reduce costs, improve productivity and generate
28
new revenue.
We have traditionally sold our products principally through a global direct sales force, with additional sales support from regional channel partners throughout the world. Our channel partner program, the Sonus Partner Assure Program, addresses service provider and enterprise market opportunities. We also have a two-tier distribution channel model.
For the year ended December 31, 2015, we reported our first, second and third quarters on a 4-4-5 basis, with the quarter ending on the Friday closest to the last day of each third month. Accordingly, our first quarter ended on March 27, 2015, our second quarter ended on June 26, 2015 and our third quarter ended on September 25, 2015. Effective January 1, 2016, we are reporting our first, second and third quarters on a month-end basis, such that our first quarter ended on March 31, 2016, our second quarter ended on June 30, 2016 and our third quarter ended on September 30, 2016. Our fiscal year will continue to end on December 31.
On September 26, 2016 (the "Taqua Acquisition Date"), we acquired Taqua, LLC ("Taqua"), a leading supplier of IP communications systems, applications and services to mobile and fixed operators. Taqua enables the transformation of software-based service provider networks to deliver next-generation voice, video and messaging services, including VoIP, Voice over Wi-Fi ("VoWiFi") and Voice over Long-Term Evolution ("VoLTE"). We believe that the acquisition of Taqua will, among other things, accelerate our mobile strategy by adding a Virtualized Mobile Core ("VMC") Platform and an IP Multimedia Subsystem ("IMS") Service Core and expand our fixed portfolio by adding a Class 5 Softswitch (the T7000) for Network Transformation projects and a Multimedia Controller used in IP Peering applications (the T7100), both of which are complementary to our current product offerings. In consideration for the acquisition of Taqua, we paid $19.9 million in cash to the sellers on the Taqua Acquisition Date, net of cash acquired. We also entered into an Earn-Out Agreement, dated as of September 26, 2016, with Taqua Holdings, LLC and Jeffrey L. Brawner, the seller representative in the transaction, under which there is the potential for additional cash payments to the sellers if certain annual revenue thresholds are exceeded as measured annually through 2020. Based on historical sales and probability weighted cash flows related to forecasted sales, we recorded $10.0 million of contingent consideration as of the Taqua Acquisition Date. The financial results of Taqua are included in our condensed consolidated financial statements starting on the Taqua Acquisition Date.
On January 2, 2015 (the "Treq Asset Acquisition Date"), we acquired from Treq Labs, Inc. ("Treq") certain assets related to its business of designing, developing, marketing, selling, servicing and maintaining software-defined networking ("SDN") technology, SDN controller software and SDN management software (the "SDN Business") for $10.1 million in cash on the Treq Asset Acquisition Date, and an additional consideration payment of $750,000 paid on each of July 2, 2015 and January 4, 2016. We also entered into an Earn-Out Agreement under which we agreed to issue to the sellers up to an aggregate of 1.3 million shares of common stock over a three-year period subsequent to the Treq Asset Acquisition Date if aggregate revenue thresholds of at least $60 million are achieved by the SDN Business during that period, and up to an aggregate of an additional 2.2 million shares (3.5 million shares in total) if aggregate revenue thresholds of at least $150 million are achieved by the SDN Business during that period. If the initial revenue thresholds are not met, no shares will be issued. Based on historical and forecasted sales, no incremental contingent consideration was recorded initially as of the Treq Asset Acquisition Date or through September 30, 2016. The SDN Business provides solutions that optimize networks for voice, video and UC for both enterprise and service provider customers. The financial results of the SDN Business are included in our condensed consolidated financial statements starting on the Treq Asset Acquisition Date.
On July 27, 2016, we announced that Anthony Scarfo ("Mr. Scarfo") was stepping down as Executive Vice President, Services, Product Management and Corporate Development, effective immediately. Mr. Scarfo remained with the Company in an advisory role to assist in the transition of his duties until October 3, 2016. In connection with Mr. Scarfo's separation from the Company, and in accordance with his employment agreement, as amended, we accelerated the vesting of certain of his unvested stock options, restricted stock awards ("RSAs") and performance-based stock units ("PSUs"). This acceleration resulted in incremental stock-based compensation expense aggregating $1.9 million in the three and nine months ended September 30, 2016, which is included as a component of Sales and marketing expense in our condensed consolidated statements of operations.
On June 9, 2016, Mark T. Greenquist ("Mr. Greenquist") tendered his resignation as our Chief Financial Officer, principal financial officer and principal accounting officer, effective June 15, 2016. Effective June 15, 2016, Susan M. Villare, our Vice President of Financial Planning and Analysis, has been fulfilling the roles of our Chief Financial Officer, principal financial officer and principal accounting officer on an interim basis, until a successor for Mr. Greenquist is identified.
In connection with the acquisition of Taqua, our management approved an immaterial restructuring plan in the third quarter of 2016 to eliminate certain redundant positions within the combined companies. On October 24, 2016, the Audit Committee of our Board of Directors approved a broader Taqua restructuring plan related to headcount and redundant facilities
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(both restructuring plans, the "Taqua Restructuring Initiative"). In addition to the $0.4 million of expense recorded in the three months ended September 30, 2016, we expect to record future expense through the end of the second quarter of 2017 of approximately $1 million to $2 million in the aggregate in connection with this initiative, of which approximately $1 million is related to headcount and $1 million is related to facilities, all of which will require cash payments.
On July 27, 2016, we announced a restructuring program to further accelerate our investment in new technologies as the communications industry migrates to a cloud-based architecture (the "2016 Restructuring Initiative"). The Audit Committee approved such restructuring program on July 25, 2016. We expect to record between $3 million and $4 million of restructuring expense over the next twelve months in connection with this action, resulting in expected annual savings of approximately $6 million to $8 million. We intend to utilize the entire savings to shift headcount towards new strategic initiatives (e.g., new products, expanded go-to-market footprint in selected geographies and discrete vertical markets).
Our strategy is designed to capitalize on our technology and market lead and to build a premier franchise in multimedia infrastructure solutions. We are currently focusing our major efforts on the following aspects of our business, which enable next generation communications, including SIP- and 4G/LTE-based networks:
• | expanding our communications network solutions to address emerging UC-, IP- and cloud-based enterprise and service providers; |
• | embracing the principles outlined by 3GPP, 4GPP2 and LTE architectures and delivering the industry's most advanced IMS (IP Multimedia Subsystem)-ready SBC and DSC product suites; |
• | leveraging our TDM (time division multiplexing)-to-IP gateway technology leadership with service providers to accelerate adoption of SIP-enabled UC services; |
• | expanding and broadening our customer base by targeting the enterprise market for SIP trunking and access solutions; |
• | providing an environment for our customers to enable real-time communication to embed into their presence on the worldwide web; |
• | expanding our global sales distribution, marketing and support capabilities; |
• | actively contributing to the SIP standards definition and adoption process; |
• | pursuing strategic transactions and alliances; |
• | successfully implementing our cost reduction initiatives; and |
• | delivering sustainable profitability by continuing to improve our overall performance. |
We reported losses from operations of $4.3 million for the three months ended September 30, 2016 and $1.4 million for the three months ended September 25, 2015. We reported losses from operations of $10.9 million for the nine months ended September 30, 2016 and $35.3 million for the nine months ended September 25, 2015.
We reported net losses of $3.7 million for the three months ended September 30, 2016 and $1.9 million for the three months ended September 25, 2015. We reported net losses of $11.3 million for the nine months ended September 30, 2016 and $36.6 million for the nine months ended September 25, 2015.
Our revenue was $65.0 million in the three months ended September 30, 2016 and $67.9 million in the three months ended September 25, 2015. Our revenue was $185.0 million in the nine months ended September 30, 2016 and $172.7 million in the nine months ended September 25, 2015.
Our gross profit was $43.6 million in the three months ended September 30, 2016 and $45.7 million in the three months ended September 25, 2015. Our gross profit was $122.2 million in the nine months ended September 30, 2016 and $109.4 million in the nine months ended September 25, 2015. Our gross profit as a percentage of revenue ("total gross margin") was 67.0% in the three months ended September 30, 2016 and 67.4% in the three months ended September 25, 2015. Our total gross margin was 66.1% in the nine months ended September 30, 2016 and 63.3% in the nine months ended September 25, 2015.
Our operating expenses were $47.9 million in the three months ended September 30, 2016, compared to $47.1 million in the three months ended September 25, 2015. Our operating expenses were $133.1 million in the nine months ended September 30, 2016 and $144.6 million in the nine months ended September 25, 2015.
We recorded stock-based compensation expense of $6.4 million in the three months ended September 30, 2016, compared to $5.3 million in the three months ended September 25, 2015, and $15.5 million in the nine months ended September 30, 2016, compared to $16.9 million in the nine months ended September 25, 2015. These amounts are included as components of both Cost of revenue and Operating expenses in our condensed consolidated statements of operations.
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See "Results of Operations" in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") for a discussion of these changes in our revenue and expenses.
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 have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment. If actual results differ significantly from management's estimates and projections, there could be a material effect on our condensed consolidated financial statements. The significant accounting policies that we believe are the most critical include the following:
• | Revenue recognition; |
• | Valuation of inventory; |
• | Loss contingencies and reserves; |
• | Stock-based compensation; |
• | Business combinations; |
• | Goodwill and intangible assets; and |
• | Accounting for income taxes. |
For a further discussion of our critical accounting policies and estimates, please refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. There were no significant changes to our critical accounting policies from December 31, 2015 through September 30, 2016.
Results of Operations
Three and nine months ended September 30, 2016 and September 25, 2015
Revenue. Revenue for the three and nine months ended September 30, 2016 and September 25, 2015 was as follows (in thousands, except percentages):
Three months ended | Increase (decrease) from prior year | |||||||||||||
September 30, 2016 | September 25, 2015 | $ | % | |||||||||||
Product | $ | 38,601 | $ | 42,230 | $ | (3,629 | ) | (8.6 | )% | |||||
Service | 26,410 | 25,632 | 778 | 3.0 | % | |||||||||
Total revenue | $ | 65,011 | $ | 67,862 | $ | (2,851 | ) | (4.2 | )% |
Nine months ended | Increase (decrease) from prior year | |||||||||||||
September 30, 2016 | September 25, 2015 | $ | % | |||||||||||
Product | $ | 108,719 | $ | 94,137 | $ | 14,582 | 15.5 | % | ||||||
Service | 76,300 | 78,571 | (2,271 | ) | (2.9 | )% | ||||||||
Total revenue | $ | 185,019 | $ | 172,708 | $ | 12,311 | 7.1 | % |
Product revenue is comprised of sales of our communication infrastructure products. The decrease in product revenue in the three months ended September 30, 2016 compared to the three months ended September 25, 2015 was primarily the result of a decrease in sales of our GSX-related products, partially offset by an increase in sales of our signaling products. Sales of our SBC products were essentially flat compared to the three months ended September 25, 2015.
The increase in product revenue in the nine months ended September 30, 2016 compared to the nine months ended September 25, 2015 was primarily the result of growth in the sales of our SBC products, in particular, our SBC 7000 and SBC
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5000 products. Sales of our SBC 7000 and SBC 5000 products increased approximately 28% in the aggregate in the nine months ended September 30, 2016 compared to the nine months ended September 25, 2015.
In the three months ended September 30, 2016, approximately 32% of our total product revenue was from indirect sales through our channel partner program, compared to approximately 22% in the three months ended September 25, 2015. Approximately 26% of our total product revenue was from indirect sales through our channel partner program in the nine months ended September 30, 2016, compared to approximately 24% in the nine months ended September 25, 2015.
In the three months ended September 30, 2016, our product revenue from sales to enterprise customers was approximately 21% of our total product revenue, compared to approximately 20% in the three months ended September 25, 2015. Our product revenue from sales to enterprise customers was approximately 20% of our total product revenue in the nine months ended September 30, 2016, compared to approximately 19% in the nine months ended September 25, 2015. These sales were made both through our direct sales team and indirect sales channel partners.
We expect that our product revenue in 2016 will increase from 2015 levels, primarily due to our expanding product portfolio and continued focus on additional new product offerings to address the emerging UC and IP-based markets, such as SBC, in both the enterprise and service provider markets.
Service revenue is primarily comprised of hardware and software maintenance and support (“maintenance revenue”) and network design, installation and other professional services (“professional services revenue”).
Service revenue for the three and nine months ended September 30, 2016 and September 25, 2015 was comprised of the following (in thousands, except percentages):
Three months ended | Increase from prior year | |||||||||||||
September 30, 2016 | September 25, 2015 | $ | % | |||||||||||
Maintenance | $ | 22,263 | $ | 22,024 | $ | 239 | 1.1 | % | ||||||
Professional services | 4,147 | 3,608 | 539 | 14.9 | % | |||||||||
$ | 26,410 | $ | 25,632 | $ | 778 | 3.0 | % |
Nine months ended | Decrease from prior year | |||||||||||||
September 30, 2016 | September 25, 2015 | $ | % | |||||||||||
Maintenance | $ | 64,290 | $ | 65,618 | $ | (1,328 | ) | (2.0 | )% | |||||
Professional services | 12,010 | 12,953 | (943 | ) | (7.3 | )% | ||||||||
$ | 76,300 | $ | 78,571 | $ | (2,271 | ) | (2.9 | )% |
Our maintenance revenue increased slightly in the three months ended September 30, 2016 compared to the three months ended September 25, 2015, primarily due to customer mix, including customer renewals, and the timing of product shipments with related maintenance revenue. Our maintenance revenue decreased in the nine months ended September 30, 2016 compared to the nine months ended September 25, 2015, primarily due to customer mix, including customer renewals, and the timing of product shipments with related maintenance.
The increase in our professional services revenue in the three months ended September 30, 2016 compared to the three months ended September 25, 2015 was primarily due to higher revenue from projects completed in the current year period compared to the same prior year period.
The decrease in our professional services revenue in the nine months ended September 30, 2016 compared to the nine months ended September 25, 2015 primarily reflects lower project-related revenue in the current year period compared to the same prior year period.
The timing of the completion of projects for revenue recognition, customer payments and maintenance contracts may cause our service revenue to fluctuate from one period to the next. We expect that our service revenue in fiscal 2016 will decrease slightly from fiscal 2015 levels as a result of customer merger activities and lower project-related service work.
The following customers contributed 10% or more of our revenue in at least one of the three or nine month periods ended
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September 30, 2016 and September 25, 2015:
Three months ended | Nine months ended | ||||||
Customer | September 30, 2016 | September 25, 2015 | September 30, 2016 | September 25, 2015 | |||
AT&T Inc. | 12% | 15% | 13% | 14% | |||
Inteliquent | * | 14% | * | * | |||
CenturyLink | * | 11% | * | * |
_______________________
* Represents less than 10% of revenue
International revenue was approximately 30% of revenue in the three months ended September 30, 2016 and approximately 23% of revenue in the three months ended September 25, 2015. International revenue was approximately 31% of revenue in the nine months ended September 30, 2016 and approximately 29% in the nine months ended September 25, 2015. Due to the timing of project completions, we expect that the domestic and international components as a percentage of our revenue will fluctuate from quarter to quarter and year to year.
Our deferred product revenue was $8.8 million at September 30, 2016 and $12.5 million at December 31, 2015. Our deferred service revenue was $37.6 million at September 30, 2016 and $33.6 million at December 31, 2015. Our deferred revenue balance may fluctuate as a result of the timing of revenue recognition, customer payments, maintenance contract renewals, contractual billing rights and maintenance revenue deferrals included in multiple element arrangements.
Cost of Revenue/Gross Margin. Our cost of revenue consists primarily of amounts paid to third-party manufacturers for purchased materials and services, royalties, manufacturing and professional services personnel and related costs, and provision for inventory obsolescence. Our cost of revenue and gross margins for the three and nine months ended September 30, 2016 and September 25, 2015 were as follows (in thousands, except percentages):
Three months ended | Increase (decrease) from prior year | |||||||||||||
September 30, 2016 | September 25, 2015 | $ | % | |||||||||||
Cost of revenue | ||||||||||||||
Product | $ | 12,285 | $ | 13,158 | $ | (873 | ) | (6.6 | )% | |||||
Service | 9,140 | 8,992 | 148 | 1.6 | % | |||||||||
Total cost of revenue | $ | 21,425 | $ | 22,150 | $ | (725 | ) | (3.3 | )% | |||||
Gross margin | ||||||||||||||
Product | 68.2 | % | 68.8 | % | ||||||||||
Service | 65.4 | % | 64.9 | % | ||||||||||
Total gross margin | 67.0 | % |