Annual Statements Open main menu

CALIX, INC - Quarter Report: 2017 September (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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, 2017
OR 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission File Number: 001-34674

Calix, Inc.
(Exact Name of Registrant as Specified in Its Charter)

Delaware
 
68-0438710
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
1035 N. McDowell Blvd., Petaluma, CA 94954
(Address of Principal Executive Offices) (Zip Code)
(707) 766-3000
(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) 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
 
o
 
 
Accelerated Filer
 
x
 
 
 
 
Non-accelerated filer
 
o
(Do not check if a smaller reporting company)
 
Smaller Reporting Company
 
o
 
 
 
 
 
 
 
 
Emerging Growth Company
 
o
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act). 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 November 2, 2017, there were 50,394,757 shares of the Registrant’s common stock, par value $0.025 outstanding.


Table of Contents

Calix, Inc.
Form 10-Q
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

PART I. FINANCIAL INFORMATION
 
ITEM 1.
Financial Statements
CALIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value) 
 
 
September 30,
2017
 
December 31,
2016
 
 
(Unaudited)
 
 (See Note 1)
ASSETS
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
64,184

 
$
50,359

Marketable securities
 
6,598

 
27,748

Accounts receivable, net
 
44,227

 
51,336

Inventory
 
36,321

 
44,545

Deferred cost of revenue
 
22,859

 
34,763

Prepaid expenses and other current assets
 
11,504

 
10,571

Total current assets
 
185,693

 
219,322

Property and equipment, net
 
16,997

 
17,984

Goodwill
 
116,175

 
116,175

Other assets
 
777

 
1,994

 
 
$
319,642

 
$
355,475

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
 
Accounts payable
 
$
29,576

 
$
23,827

Accrued liabilities
 
59,401

 
69,715

Deferred revenue
 
28,228

 
27,854

Line of credit
 
30,000

 

Total current liabilities
 
147,205

 
121,396

Long-term portion of deferred revenue
 
21,173

 
20,237

Other long-term liabilities
 
881

 
878

Total liabilities
 
169,259

 
142,511

Commitments and contingencies (See Note 7)
 

 

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.025 par value; 5,000 shares authorized; no shares issued and outstanding as of September 30, 2017 and December 31, 2016
 

 

Common stock, $0.025 par value; 100,000 shares authorized; 55,712 shares issued and 50,382 shares outstanding as of September 30, 2017, and 54,722 shares issued and 49,392 shares outstanding as of December 31, 2016
 
1,393

 
1,368

Additional paid-in capital
 
843,811

 
836,563

Accumulated other comprehensive loss
 
(344
)
 
(656
)
Accumulated deficit
 
(654,491
)
 
(584,325
)
Treasury stock, 5,330 shares as of September 30, 2017 and December 31, 2016
 
(39,986
)
 
(39,986
)
Total stockholders’ equity
 
150,383

 
212,964

 
 
$
319,642

 
$
355,475

See accompanying notes to condensed consolidated financial statements.

3

Table of Contents

CALIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Revenue:
 
 
 
 
 
 
 
 
Products
 
$
106,442

 
$
114,029

 
$
305,395

 
$
305,853

Services
 
22,385

 
7,158

 
67,073

 
21,134

Total revenue
 
128,827

 
121,187

 
372,468

 
326,987

Cost of revenue:
 
 
 
 
 
 
 
 
Products (1)
 
55,494

 
60,662

 
171,166

 
159,856

Services (1)
 
28,700

 
6,981

 
78,969

 
18,099

Total cost of revenue
 
84,194

 
67,643

 
250,135

 
177,955

Gross profit
 
44,633

 
53,544

 
122,333

 
149,032

Operating expenses:
 
 
 
 
 
 
 
 
Research and development (1)
 
32,633

 
28,119

 
99,391

 
75,925

Sales and marketing (1)
 
18,448

 
20,575

 
59,306

 
58,850

General and administrative (1)
 
10,203

 
8,615

 
30,161

 
32,940

Amortization of intangible assets
 

 

 

 
1,701

Restructuring charges
 
612

 

 
2,268

 

Litigation settlement gain
 

 
(4,500
)
 

 
(4,500
)
Total operating expenses
 
61,896

 
52,809

 
191,126

 
164,916

Income (loss) from operations
 
(17,263
)
 
735

 
(68,793
)
 
(15,884
)
Interest and other income (expense), net:
 
 
 
 
 
 
 
 
Interest income (expense), net
 
(60
)
 
80

 
88

 
274

Other income (expense), net
 
(305
)
 
30

 
(386
)
 
145

Income (loss) before provision for income taxes
 
(17,628
)
 
845

 
(69,091
)
 
(15,465
)
Provision for income taxes
 
225

 
209

 
1,075

 
454

Net income (loss)
 
$
(17,853
)

$
636

 
$
(70,166
)
 
$
(15,919
)
Net income (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
$
(0.35
)
 
$
0.01

 
$
(1.40
)
 
$
(0.33
)
Diluted
 
$
(0.35
)
 
$
0.01

 
$
(1.40
)
 
$
(0.33
)
Weighted-average number of shares used to compute
 


 


 
 
 
 
net income (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
50,336

 
48,773

 
49,960

 
48,578

Diluted
 
50,336

 
49,309

 
49,960

 
48,578

 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(17,853
)
 
$
636

 
$
(70,166
)
 
$
(15,919
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Unrealized gains (losses) on available-for-sale
 
 
 
 
 
 
 
 
marketable securities, net
 
4

 
(9
)
 
3

 
97

Foreign currency translation adjustments, net
 
116

 
(87
)
 
309

 
(128
)
Total other comprehensive income, net of tax
 
120

 
(96
)
 
312

 
(31
)
Comprehensive income (loss)
 
$
(17,733
)
 
$
540

 
$
(69,854
)
 
$
(15,950
)
                                                                                     
 
 
 
 
 
 
 
 
 (1)  Includes stock-based compensation as follows:
 
 
 
 
 
 
 
 
Cost of revenue:
 
 
 
 
 
 
 
 
Products
 
$
137

 
$
120

 
$
349

 
$
338

Services
 
69

 
54

 
200

 
146

Research and development
 
1,215

 
1,573

 
3,663

 
3,719

Sales and marketing
 
816

 
1,661

 
2,581

 
3,323

General and administrative
 
759

 
1,269

 
2,521

 
2,840

See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

CALIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
Operating activities:
 
 
 
 
Net loss
 
$
(70,166
)
 
$
(15,919
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
 
Stock-based compensation
 
9,314

 
10,366

Depreciation and amortization
 
7,632

 
6,282

Amortization of intangible assets
 
813

 
4,991

Loss on retirement of property and equipment
 
148

 

Amortization of premium (discount) related to available-for-sale securities
 
(7
)
 
337

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
7,109

 
(10,104
)
Inventory
 
8,224

 
7,477

Deferred cost of revenue
 
11,904

 
(9,800
)
Prepaid expenses and other assets
 
(320
)
 
(6,058
)
Accounts payable
 
5,543

 
(356
)
Accrued liabilities
 
(10,132
)
 
13,974

Deferred revenue
 
1,310

 
4,383

Other long-term liabilities
 
3

 
(313
)
Net cash provided by (used in) operating activities
 
(28,625
)
 
5,260

Investing activities:
 
 
 
 
Purchases of property and equipment
 
(6,786
)
 
(5,364
)
Purchases of marketable securities
 
(8,732
)
 

Sales of marketable securities
 
5,051

 

Maturities of marketable securities
 
24,841

 
20,170

Net cash provided by investing activities
 
14,374

 
14,806

Financing activities:
 
 
 
 
Proceeds from exercise of stock options
 
29

 
14

Proceeds from employee stock purchase plan
 
673

 
2,905

Payments for repurchases of common stock
 

 
(12,809
)
Taxes paid for awards vested under equity incentive plan
 
(2,743
)
 
(1,787
)
Proceeds from line of credit
 
68,534

 

Repayment of line of credit
 
(38,534
)
 

Payments to originate the line of credit
 
(186
)
 

Net cash provided by (used in) financing activities
 
27,773

 
(11,677
)
Effect of exchange rate changes on cash and cash equivalents
 
303

 
(251
)
Net increase in cash and cash equivalents
 
13,825

 
8,138

Cash and cash equivalents at beginning of period
 
50,359

 
23,626

Cash and cash equivalents at end of period
 
$
64,184

 
$
31,764

See accompanying notes to condensed consolidated financial statements.

5

Table of Contents

CALIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Company and Basis of Presentation
Company
Calix, Inc. (together with its subsidiaries, “Calix,” the “Company,” “our,” “we,” or “us”) was incorporated in August 1999, and is a Delaware corporation. The Company is a leading global provider of broadband communications access platforms, systems and software for fiber- and copper-based network architectures and a pioneer in software defined access and cloud products focused on access networks and the subscriber. Calix’s portfolio combines Access eXtensible Operating System (“AXOS”), a software platform for access, with Calix Cloud, the Company’s innovative cloud products for network data analytics and subscriber experience assurance. Together they enable communications service providers (“CSPs”) to transform their networks and enhance how they connect to their residential and business subscribers. The Company enables CSPs to provide a wide range of revenue-generating services, from basic voice and data to advanced broadband services, over legacy and next-generation access networks. The Company focuses solely on CSP access networks, the portion of the network that governs available bandwidth and determines the range and quality of services that can be offered to subscribers.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements, including the accounts of Calix, Inc. and its wholly-owned subsidiaries, have been prepared in accordance with the requirements of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. generally accepted accounting principles (“GAAP”) can be condensed or omitted. In the opinion of management, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of the Company’s financial position and operating results. All significant intercompany balances and transactions have been eliminated in consolidation. The Condensed Consolidated Balance Sheet at December 31, 2016 has been derived from the audited financial statements at that date.
The results of the Company’s operations can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year or any future periods. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
The Company’s fiscal year begins on January 1st and ends on December 31st. Quarterly periods are based on a 4-4-5 calendar with the first, second and third quarters ending on the 13th Saturday of each fiscal period. As a result, the Company had five more days in the nine months ended September 30, 2017 than in the nine months ended September 24, 2016. The preparation of financial statements in conformity with GAAP for interim financial reporting requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Prior Period Recast
The Company’s revenue from services for the three and nine months ended September 30, 2017 represents more than 10% of its total revenue; hence, the services revenue and the associated cost of revenue are presented separately in the accompanying Condensed Consolidated Statements of Comprehensive Income (Loss). Services include professional services, customer support, software maintenance, extended warranty subscriptions, training and managed services. Accordingly, revenue and cost of revenue for the three and nine months ended September 24, 2016 are recast solely to conform with the current period presentation. The recast does not affect total revenue, total cost of revenue, gross profit, operating expenses or net income (loss).
2. Significant Accounting Policies
The Company’s significant accounting policies are disclosed in its Annual Report on Form 10-K for the year ended December 31, 2016. The Company’s significant accounting policies did not change during the nine months ended September 30, 2017, except for those impacted by the newly adopted accounting standards below.
Newly Adopted Accounting Standards
Stock-Based Compensation
In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 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 for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The Company adopted ASU 2016-09 in the first quarter of 2017 and had the following impact:
a.
Accounting for Income Taxes - The primary impact of the adoption was the recognition of excess tax benefits and tax deficiencies through the statement of operations when the awards vest or are settled rather than through paid-in capital. The new guidance eliminates the requirement to delay the recognition of excess tax benefits until it reduces current taxes payable and requires the

6

Table of Contents

recognition of excess tax benefits and tax deficiencies in the period they arise. The Company adopted this guidance on a modified retrospective basis beginning on January 1, 2017, and the adoption had a cumulative-effect adjustment to the beginning balance of deferred tax asset and was fully offset by the corresponding valuation allowance as of January 1, 2017. The adoption had no cumulative-effect adjustment on January 1, 2017 accumulated deficit as the Company’s net operating loss carryforwards are offset by a full valuation allowance.
b.
Classification of Excess Tax Benefits on the Statement of Cash Flows - ASU 2016-09 requires all tax-related cash flows resulting from share-based payments to be reported as operating activities on the statement of cash flows, a change from the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. The Company adopted this guidance prospectively beginning on January 1, 2017. The adoption of ASU 2016-09 as it relates to this matter had no impact to the Company’s consolidated financial statements.
c.
Forfeitures - The Company has historically recognized stock-based compensation expense net of estimated forfeitures on all unvested awards and elected to continuously do so with the adoption of this new guidance. Hence, the adoption of ASU 2016-09 as it relates to this matter had no impact to the Company’s consolidated financial statements.
d.
Minimum Statutory Tax Withholding Requirements - ASU 2016-09 allows companies to withhold an amount up to the employee’s maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award. The Company adopted this guidance using a modified retrospective approach. The adoption had no impact on the January 1, 2017 accumulated deficit as the Company had no outstanding liability awards that would otherwise qualify for equity classification under this new guidance.
e.
Classification of Employee Taxes Paid on the Statement of Cash Flows When an Employer Withholds Shares for Tax-Withholding Purposes - ASU 2016-09 clarifies that all cash payments made to taxing authorities on the employees’ behalf for withheld shares should be presented as financing activities on the statement of cash flows. The Company has historically presented the taxes paid related to net share settlement of equity awards as a financing activity on the statements of cash flows. Hence, the adoption of ASU 2016-09 as it relates to this matter had no impact to the Company’s consolidated financial statements.
Inventory
In July 2015, the FASB issued Accounting Standards Update No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”), which requires measurement of inventory at lower of cost and net realizable value, versus lower of cost or market. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company adopted ASU 2015-11 prospectively beginning on January 1, 2017. The adoption of this standard had no material impact on the Company’s consolidated financial statements.
Recent Accounting Pronouncements Not Yet Adopted
Leases
In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires recognition of an asset and liability for lease arrangements longer than twelve months. ASU 2016-02 will be effective for the Company beginning in the first quarter of 2019. Early application is permitted, and it is required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Company is not planning to early adopt, and accordingly, it will adopt the new standard effective January 1, 2019. The Company intends to elect the available practical expedients on adoption. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial statements. The Company expects its assets and liabilities to increase as the new standard requires recognition of right-of-use assets and lease liabilities for operating leases, but does not expect any material impact on its income (loss) from operations or net income (loss) as a result of the adoption of this standard.
Revenue from Contracts with Customers
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. Additionally, it supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40, Other Assets and Deferred Costs-Contracts with Customers. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the previous guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. On August 12, 2015, the FASB issued Accounting Standards Update No. 2015-14, Revenue from Contracts with Customers (Topic 606), Deferral of the Effective Date (“ASU 2015-14”) to defer the effective date of ASU 2014-09 by one year. ASU 2015-14 permits early adoption of the new revenue standard, but not before its original effective date. In April 2016, the FASB issued Accounting Standards Update No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”) which further clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in ASU 2014-09. In May 2016, the FASB issued Accounting Standards Update No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”) which addresses narrow-scope improvements to the guidance on collectibility, non-cash consideration, and completed contracts at transition and provides a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers.

7

Table of Contents

The new standard permits adoption either by using (i) a full retrospective approach for all periods presented in the period of adoption or (ii) a modified retrospective approach with the cumulative effect of initially applying the new standard recognized at the date of initial application and providing certain additional disclosures. The Company will adopt the new standard effective January 1, 2018 using the modified retrospective transition method applied to those contracts which are not completed as of that date.
The Company has reached preliminary conclusions on key accounting assessments related to the standard and is in the process of evaluating the impact of the new standard on its accounting policies, processes and system requirements. The Company has assigned internal resources in addition to the engagement of third party service providers to assist in its evaluation. Additionally, the Company expects to make investments in new systems or enhancement of existing systems to enable timely and accurate reporting under the new standard. While the Company continues to perform further assessment of all potential impacts under the new standard, the Company expects the timing of revenue recognition to be accelerated for certain performance obligations related to certain revenue arrangements which are currently deferred until customer acceptance. Depending on the outcome of the Company’s final evaluation, the timing of when revenue is recognized could change significantly for those revenue arrangements under the new standard.
In connection with the adoption of the new revenue standard, the Company will also adopt ASC 340-40, Other Assets and Deferred Costs - Contracts with Customers, with respect to capitalization and amortization of incremental costs of obtaining a contract effective January 1, 2018. As a result, the Company may need to capitalize additional costs of obtaining a contract, including sales commissions, as the guidance requires the capitalization of all incremental costs incurred to obtain a contract with a customer that it would not have incurred if the contract had not been obtained, provided it expects to recover the costs. The Company expects that sales commissions as a result of obtaining customer contracts are recoverable, and as a result, the Company will defer certain sales commissions and amortize them over the period that the related revenue is recognized.
While the Company continues to assess all the potential impacts of the new standard, including the areas described above, and anticipates this standard could have a material impact on its consolidated financial statements, the Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its consolidated financial statements at this time.
Concentration of Customer Risk
The Company had one customer that accounted for more than 10% of its total revenue for the three months ended September 30, 2017 and two customers that each accounted for more than 10% of its total revenue for the nine months ended September 30, 2017. These two customers each accounted for more than 10% of the Company’s total revenue for the three and nine months ended September 24, 2016. These two customers together represented 41% and 43% of the Company’s total revenue for the three and nine months ended September 30, 2017, respectively, and 37% and 34% for the three and nine months ended September 24, 2016, respectively. One of these two customers represented more than 10% of the Company’s accounts receivable as of September 30, 2017 and each of these two customers represented more than 10% of the Company’s accounts receivable as of December 31, 2016.
3. Cash, Cash Equivalents and Marketable Securities
The Company has invested its excess cash primarily in money market funds and highly liquid marketable securities such as corporate debt instruments, commercial paper and U.S. government agency securities. The Company considers all investments with maturities of three months or less when purchased to be cash equivalents. Marketable securities represent highly liquid corporate debt instruments, commercial paper and U.S. government agency securities with maturities greater than 90 days at date of purchase. Marketable securities with maturities greater than one year are classified as current because management considers all marketable securities to be available for current operations.
Cash equivalents are stated at amounts that approximate fair value based on quoted market prices. Marketable securities are recorded at their fair values.
The Company’s investments have been classified and accounted for as available-for-sale. Such investments are recorded at fair value and unrealized holding gains and losses are reported as a separate component of accumulated other comprehensive income (loss) in the stockholders’ equity until realized. Realized gains and losses on sales of marketable securities, if any, are determined on the specific identification method and are reclassified from accumulated other comprehensive income (loss) to results of operations as other income (expense).
The Company, to date, has not determined that any of the unrealized losses on its investments are considered to be other-than-temporary. The Company reviews its investment portfolio to determine if any security is other-than-temporarily impaired, which would require the Company to record an impairment charge in the period any such determination is made. In making this judgment, the Company evaluates, among other things: the duration and extent to which the fair value of a security is less than its cost; the financial condition of the issuer and any changes thereto; and the Company’s intent and ability to hold its investment for a period of time sufficient to allow for any anticipated recovery in market value, or whether the Company will more likely than not be required to sell the security before recovery of its amortized cost basis. The Company has evaluated its investments as of September 30, 2017 and has determined that no investments with unrealized losses are other-than-temporarily impaired. No investments have been in a continuous loss position for greater than one year.

8

Table of Contents

Cash, cash equivalents and marketable securities consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Cash and cash equivalents:
 
 
 
 
Cash
 
$
55,058

 
$
34,340

Money market funds
 
9,126

 
15,020

Commercial paper
 

 
999

Total cash and cash equivalents
 
64,184

 
50,359

Marketable securities:
 


 


Corporate debt securities
 

 
17,272

Commercial paper
 
2,400

 
6,275

U.S. government agency securities
 
4,198

 
4,201

Total marketable securities
 
6,598

 
27,748

 
 
$
70,782

 
$
78,107

The carrying amounts of the Company’s money market funds approximate their fair values due to their nature, duration and short maturities.
As of September 30, 2017, all marketable securities were due in one year or less; and the amortized cost and fair value of marketable securities were as follows (in thousands):
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Commercial paper
 
$
2,401

 
$

 
$
(1
)
 
$
2,400

U.S. government agency securities
 
4,200

 

 
(2
)
 
4,198

 
 
$
6,601

 
$

 
$
(3
)
 
$
6,598

As of December 31, 2016, the amortized cost and fair value of marketable securities were as follows (in thousands):
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Corporate debt securities
 
$
17,279

 
$
1

 
$
(8
)
 
$
17,272

Commercial paper
 
6,275

 

 

 
6,275

U.S. government agency securities
 
4,200

 
1

 

 
4,201

 
 
$
27,754

 
$
2

 
$
(8
)
 
$
27,748

4. Fair Value Measurements
The Company measures its cash equivalents and marketable securities at fair value on a recurring basis. Fair value is an exit price, representing the amount 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 liability. The Company utilizes the following three-tier value hierarchy which prioritizes the inputs used in measuring fair value:
Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 – Observable inputs other than quoted prices included in Level 1 for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-driven valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3 – Unobservable inputs to the valuation derived from fair valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

9

Table of Contents

The following table sets forth the Company’s financial assets measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016, based on the three-tier fair value hierarchy (in thousands):
As of September 30, 2017
 
Level 1

Level 2

Total
Money market funds
 
$
9,126

 
$

 
$
9,126

Commercial paper
 

 
2,400

 
2,400

U.S. government agency securities
 

 
4,198

 
4,198

 
 
$
9,126

 
$
6,598


$
15,724

 

As of December 31, 2016
 
Level 1
 
Level 2
 
Total
Money market funds
 
$
15,020

 
$

 
$
15,020

Corporate debt securities
 

 
17,272

 
17,272

Commercial paper
 

 
7,274

 
7,274

U.S. government agency securities
 

 
4,201

 
4,201

 
 
$
15,020

 
$
28,747

 
$
43,767

The fair values of money market funds classified as Level 1 were derived from quoted market prices as active markets for these instruments exist. The fair values of corporate debt securities, commercial paper and U.S. government agency securities classified as Level 2 were derived from quoted market prices for similar instruments indexed to prevailing market yield rates. The Company has no level 3 financial assets. The Company did not have any transfers between Level 1 and Level 2 of the fair value hierarchy during the nine months ended September 30, 2017 and September 24, 2016.
5. Goodwill
Goodwill was recorded as a result of the Company’s acquisitions of Occam Networks, Inc. (“Occam”) in February 2011 and Optical Solutions, Inc. in February 2006. This goodwill is not deductible for tax purposes, and there have been no adjustments to goodwill since the acquisition dates.
Goodwill is not amortized but instead is subject to an annual impairment test or more frequently if events or changes in circumstances indicate that it may be impaired. The Company evaluates goodwill on an annual basis at the end of the second quarter of each year. Management has determined that the Company operates as a single reporting unit and, therefore, evaluates goodwill impairment at the enterprise level. Management assessed qualitative factors to determine whether it was more likely than not (that is, a likelihood of more than 50 percent) that the fair value of the Company was less than its carrying amount, including goodwill, as of July 1, 2017. In assessing the qualitative factors, management considered the impact of these key factors: macro-economic conditions, industry and market environment, overall financial performance of the Company, cash flow from operating activities, market capitalization and stock price. Management concluded that the fair value of the Company was more likely than not greater than its carrying amount as of July 1, 2017. As such, it was not necessary to perform the two-step goodwill impairment test at the time.
There have been no significant events or changes in circumstances subsequent to the 2017 annual impairment test that would more likely than not indicate that the carrying value of goodwill may have been impaired as of September 30, 2017. Therefore, there was no impairment to the carrying value of the Company’s goodwill as of September 30, 2017.
6. Balance Sheet Details
Accounts receivable, net consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Accounts receivable
 
$
45,630

 
$
52,792

Allowance for doubtful accounts
 
(550
)
 
(518
)
Product return reserve
 
(853
)
 
(938
)
 
 
$
44,227

 
$
51,336

Inventory consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Raw materials
 
$
1,082

 
$
1,827

Finished goods
 
35,239

 
42,718

 
 
$
36,321

 
$
44,545


10

Table of Contents

Property and equipment, net consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Test equipment
 
$
46,580

 
$
43,580

Computer equipment and software
 
33,652

 
30,306

Furniture and fixtures
 
2,890

 
2,831

Leasehold improvements
 
6,759

 
6,898

Total
 
89,881

 
83,615

Accumulated depreciation and amortization
 
(72,884
)
 
(65,631
)
 
 
$
16,997

 
$
17,984

Accrued liabilities consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Accrued compensation and related benefits
 
$
23,890

 
$
19,541

Accrued professional and consulting fees
 
12,222

 
8,205

Accrued warranty and retrofit
 
8,454

 
12,214

Advance customer payments
 
5,211

 
20,726

Accrued excess and obsolete inventory at contract manufacturers
 
1,819

 
1,327

Accrued customer rebates
 
828

 
1,931

Accrued restructuring charges
 
195

 

Accrued other
 
6,782

 
5,771

 
 
$
59,401

 
$
69,715

Advance customer payments as of September 30, 2017 and December 31, 2016 primarily included $3.4 million and $20.3 million, respectively, which the Company received as payments in advance of completion of final customer acceptance of the products and services provided in connection with turnkey network improvement projects for a customer.
Deferred revenue consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Current:
 
 
 
 
Products and services
 
$
24,512

 
$
24,472

Extended warranty
 
3,716

 
3,382

 
 
28,228

 
27,854

Long-term:
 
 
 
 
Products and services
 
18

 
22

Extended warranty
 
21,155

 
20,215

 
 
21,173

 
20,237

 
 
$
49,401

 
$
48,091

Deferred cost of revenue consisted of costs incurred for products and services for which revenue has been deferred or not yet earned.

11

Table of Contents

7. Commitments and Contingencies
Lease Commitments
The Company leases office space under non-cancelable operating leases. Certain of the Company’s operating leases contain renewal options and rent acceleration clauses. Future minimum payments under the non-cancelable operating leases consisted of the following as of September 30, 2017 (in thousands):
Period
 
Minimum Future Lease Payments
Remainder of 2017
 
$
756

2018
 
2,794

2019
 
1,082

2020
 
738

2021
 
286

Thereafter
 
19

 
 
$
5,675

The Company leases its primary office space in Petaluma, California under a lease agreement (“Petaluma Lease”) that expires February 2019. On January 28, 2013, the Company entered into an amendment to its Petaluma Lease ("Amendment") to extend the lease term to February 2019. In connection with the Petaluma Lease and the Amendment, the Company received lease incentives of $1.2 million and $0.4 million, respectively, which can be used for leasehold improvements or be applied as credits to rent payments. The Company capitalized the full amount of the lease incentives upon inception of the respective agreement and these incentives are being amortized to reduce rent expense over the extended lease term. As of September 30, 2017, total unamortized lease incentive is not significant. Payments under the Company’s operating leases that escalate over the term of the lease are recognized as rent expense on a straight-line basis.
The above table also includes future minimum lease payments primarily for our facilities in Minneapolis, Minnesota; Nanjing, China; Richardson, Texas; and San Jose, and Santa Barbara, California, which expire at various dates through 2022.
For the three and nine months ended September 30, 2017, total rent expense of the Company was $0.9 million and $2.7 million, respectively. For the three and nine months ended September 24, 2016, total rent expense of the Company was $0.9 million and $2.6 million, respectively.
Purchase Commitments
The Company’s primary contract manufacturers place orders for component inventory in advance based upon the Company’s build forecasts in order to reduce manufacturing lead times and ensure adequate component supply. The components are used by the contract manufacturers to build the products included in the build forecasts. The Company generally does not take ownership of the components held by contract manufacturers. The Company places purchase orders with its contract manufacturers in order to fulfill its monthly finished product inventory requirements. The Company incurs a liability when the contract manufacturer has converted the component inventory to a finished product and takes ownership of the inventory when transferred to the designated shipping warehouse. In the event of termination of services with a contract manufacturer, the Company may be required to purchase the remaining components inventory held by the contract manufacturer as well as any outstanding orders pursuant to the contractual provisions with such contract manufacturer. As of September 30, 2017, the Company had approximately $62.6 million of outstanding purchase commitments for inventories to be delivered by its suppliers, including contract manufacturers, within one year.
The Company has from time to time, and subject to certain conditions, reimbursed its primary contract manufacturer for component inventory purchases when this inventory has been rendered excess or obsolete, for example due to manufacturing and engineering change orders resulting from design changes, manufacturing discontinuation of parts by its suppliers, or in cases where inventory levels greatly exceed projected demand. The estimated excess and obsolete inventory liabilities related to such manufacturing and engineering change orders and other factors, which are included in accrued liabilities in the accompanying balance sheets, were $1.8 million and $1.3 million as of September 30, 2017 and December 31, 2016, respectively. The Company records these amounts in cost of products and services in the accompanying Condensed Consolidated Statements of Comprehensive Income (Loss).
Contingencies
The Company evaluates the circumstances regarding outstanding and potential litigation and other contingencies on a quarterly basis to determine whether there is at least a reasonable possibility that a loss exists requiring accrual or disclosure, and if so, whether an estimate of the possible loss or range of loss can be made, or whether such an estimate cannot be made. When a loss is probable and reasonably estimable, the Company accrues for such amount based on its estimate of the probable loss considering information available at the time. When a loss is reasonably possible, the Company discloses the estimated possible loss or range of loss in excess of amounts accrued if material. Except as otherwise disclosed below, the Company does not believe that there was a reasonable possibility that a material loss may have been incurred during the period presented with respect to the matters disclosed.

12

Table of Contents

Accrued Warranty and Retrofit
The Company provides a standard warranty for its hardware products. Hardware generally has a one-, three- or five-year standard warranty from the date of shipment. Under certain circumstances, the Company also provides fixes on specifically identified performance failures for products that are outside of the standard warranty period and recognizes estimated costs related to retrofit activities upon identification of such product failures. The Company accrues for potential warranty and retrofit claims based on the Company’s historical product failure rates and historical costs incurred in correcting product failures along with other relevant information related to any specifically identified product failures. The Company’s warranty and retrofit accruals are based on estimates of losses that are probable based on information available. The adequacy of the accrual is reviewed on a periodic basis and adjusted, if necessary, based on additional information as it becomes available. Changes in the Company’s warranty and retrofit reserves in the periods as indicated were as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Balance at beginning of period
 
$
9,265

 
$
9,152

 
$
12,214

 
$
9,564

Provision for warranty and retrofit charged to cost of revenue
 
2,057

 
3,180

 
5,661

 
6,292

Utilization of reserve
 
(2,868
)
 
(948
)
 
(9,421
)
 
(4,073
)
Adjustments to pre-existing reserve
 

 
(11
)
 

 
(410
)
Balance at end of period
 
$
8,454

 
$
11,373

 
$
8,454

 
$
11,373

Litigation
From time to time, the Company is involved in various legal proceedings arising from the normal course of business activities.
The Company is not currently a party to any legal proceedings that, if determined adversely to the Company, in management’s opinion, are currently expected to individually or in the aggregate have a material adverse effect on the Company’s business, operating results or financial condition taken as a whole.
Indemnifications
The Company from time to time enters into contracts that require it to indemnify various parties against claims from third parties. These contracts primarily relate to (i) certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company’s use of the applicable premises, (ii) agreements with the Company’s officers, directors and certain employees, under which the Company may be required to indemnify such persons for liabilities arising out of their relationship with the Company, (iii) contracts under which the Company may be required to indemnify customers against third-party claims that a Company product infringes a patent, copyright or other intellectual property right and (iv) procurement or license agreements, under which the Company may be required to indemnify licensors or vendors for certain claims that may be brought against them arising from the Company’s acts or omissions with respect to the supplied products or technology.
Because any potential obligation associated with these types of contractual provisions are not quantified or stated, the overall maximum amount of the obligation cannot be reasonably estimated. Historically, the Company has not been required to make payments under these obligations, and no liabilities have been recorded for these obligations in the accompanying Condensed Consolidated Balance Sheets.

13

Table of Contents

8. Net Income (Loss) Per Common Share
The following table sets forth the computation of basic and diluted net income (loss) per common share for the periods indicated (in thousands, except per share data):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Numerator:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(17,853
)
 
$
636

 
$
(70,166
)
 
$
(15,919
)
Denominator:
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding used to compute basic net income (loss) per share
 
50,336

 
48,773

 
49,960

 
48,578

Effect of dilutive common stock equivalents
 

 
536

 

 

Weighted-average common shares outstanding used to compute diluted net income (loss) per share
 
50,336

 
49,309

 
49,960

 
48,578

Net income (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
$
(0.35
)
 
$
0.01

 
$
(1.40
)
 
$
(0.33
)
Diluted
 
$
(0.35
)
 
$
0.01

 
$
(1.40
)
 
$
(0.33
)
Potentially dilutive shares, weighted average

5,741

 
3,951

 
5,704

 
5,794

Potentially dilutive shares have been excluded from the computation of diluted net loss per common share when their effect is antidilutive. These antidilutive shares were primarily from stock options, restricted stock units and performance restricted stock units. For each of the periods presented where the Company reported a net loss, the effect of all potentially dilutive securities would be antidilutive, and as a result diluted net loss per common share is the same as basic net loss per common share.
9. Stockholders’ Equity
Equity Incentive Plans
As of September 30, 2017, the Company currently maintains two equity incentive plans, the 2002 Stock Plan and the 2010 Equity Incentive Award Plan (together, the “Plans”). These plans were approved by the stockholders and are described in the Company’s Annual Report on Form 10-K filed with the SEC on February 28, 2017. The Company also maintains a Long Term Incentive Program under the 2010 Equity Incentive Award Plan. Under the Long Term Incentive Program, certain key employees of the Company are eligible for equity awards based on the Company’s stock price performance. To date, awards granted under the Plans consist of stock options, restricted stock units (“RSUs”) and performance restricted stock units (“PRSUs”).
Stock Options
During the three and nine months ended September 30, 2017, 1,565,000 shares of stock options were granted with a weighted-average grant date fair value of $3.45 per share, of which 1,165,000 shares with a weighted-average grant date fair value of $3.43 per share were performance-based stock option awards which were granted by the Company to its executives. These performance-based stock option awards contain a one-year performance period and a subsequent three-year service period. The performance target is based on a combination of the Company’s revenue and non-GAAP operating income during the performance period and accounted for as a performance condition. After the one-year performance period, if the performance target is met and subject to certification by the Compensation Committee of the Company’s board of directors, each performance-based stock option award shall vest with respect to 25% of the earned shares on February 6, 2018 and 6.25% of the earned shares on the quarterly anniversary thereafter, subject to the executive’s continuous service with the Company from the grant date through the respective vesting dates. If the performance target is not met, all performance-based stock options granted under this award shall be immediately forfeited and canceled without vesting of any shares.
During the three months ended September 30, 2017, no stock options were exercised. During the nine months ended September 30, 2017, 5,000 shares of stock options were exercised at a weighted-average exercise price of $5.99 per share. As of September 30, 2017, unrecognized stock-based compensation expense of $3.4 million related to stock options, net of estimated forfeitures, is expected to be recognized over a weighted-average period of 2.3 years.
Restricted Stock Units
During the three months ended September 30, 2017, 92,266 shares of RSUs were granted with a weighted-average grant date fair value of $6.34 per share. During the nine months ended September 30, 2017, 505,236 shares of RSUs were granted with a weighted-average grant date fair value of $6.75 per share. During the three months ended September 30, 2017, 107,107 shares of RSUs vested, net of shares withheld for statutory income tax purposes, and were converted to an equivalent number of shares of common stock. During the nine months ended September 30, 2017, 670,095 shares of RSUs vested, net of shares withheld for statutory income tax purposes, and were converted to an equivalent number of shares of common stock. Taxes withheld from employees of $0.1 million were remitted to the relevant taxing authorities during the three months ended September 30, 2017. Taxes withheld from employees of $1.8 million were remitted to the relevant taxing

14

Table of Contents

authorities during the nine months ended September 30, 2017. As of September 30, 2017, unrecognized stock-based compensation expense of $10.2 million related to RSUs, net of estimated forfeitures, was expected to be recognized over a weighted-average period of 2.2 years.
Performance Restricted Stock Units
In 2016, the Company granted PRSUs to its executives with a one-year performance period and a subsequent two-year service period. The performance target for these particular performance-based awards is based on the Company’s revenue during the performance period and accounted for as a performance condition. After the one-year performance period, if the performance target is met and subject to certification by the Compensation Committee of the Company’s board of directors, each PRSU award shall vest with respect to 50% of the PRSUs subject to the award in February 2017, 25% in February 2018 and 25% in February 2019, subject to the executive’s continuous service with the Company from the grant date through the respective vesting dates. If the performance target is not met, all PRSUs granted under this award shall be immediately forfeited and canceled without vesting of any shares.
During the three months ended September 30, 2017no PRSUs vested. During the nine months ended September 30, 2017, 325,000 shares of PRSUs vested and were converted into 195,656 shares of common stock, net of shares withheld for statutory income tax purposes. Taxes withheld from employees of $0.9 million were remitted to the relevant taxing authorities during the nine months ended September 30, 2017. As of September 30, 2017, unrecognized stock-based compensation expense of $0.3 million related to PRSUs, net of estimated forfeitures, is expected to be recognized over a weighted-average period of 10.3 months.
Employee Stock Purchase Plans
The Company’s Amended and Restated Employee Stock Purchase Plan (“Restated ESPP”) allows employees to purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their annual compensation subject to certain Internal Revenue Code limitations. In addition, no participant may purchase more than 2,000 shares of common stock in each offering period.
The offering periods under the Restated ESPP were six-month periods commencing on November 2nd and May 2nd of each year, effective November 2, 2015. In July 2016, the Compensation Committee of the Company’s board of directors approved a change in those six-month period commencement dates to May 15th and November 15th of each year, effective May 15, 2017. The ending date of the Restated ESPP offering period which commenced on November 2, 2016 was extended until May 14, 2017 as a result of this change. The price of common stock purchased under the Restated ESPP is 85 percent of the lower of the fair market value of the common stock on the commencement date and the end date of each six-month offering period. As of September 30, 2017, there were 3,000,217 shares available for issuance under the Restated ESPP.
During the three months ended September 30, 2017, no shares were purchased under the Restated ESPP. During the nine months ended September 30, 2017, 119,011 shares were purchased under the Restated ESPP. As of September 30, 2017, unrecognized stock-based compensation expense of $0.2 million related to the Restated ESPP is expected to be recognized over a remaining service period of 1.5 months.
On March 30, 2017, the Company’s board of directors, upon recommendation of the Compensation Committee, approved the adoption of the Calix, Inc. 2017 Nonqualified Employee Stock Purchase Plan (“Nonqualified ESPP”). The Nonqualified ESPP was approved by our stockholders on May 17, 2017, with the initial offering period commencing July 1, 2017. Under the Nonqualified ESPP, eligible employees can purchase shares of the Company’s common stock through payroll deductions of up to 25 percent of their annual compensation. Eligible employees have the right to (a) purchase the maximum number of whole shares of common stock that can be purchased with the elected payroll deductions during each offering period for which the employee is enrolled at a purchase price equal to the closing price of the Company’s common stock on the last day of such offering period and (b) receive an equal number of shares of the Company’s common stock that are subject to a risk of forfeiture in the event the employee terminates employment within the one year period immediately following the purchase date. The Nonqualified ESPP provides two six-month offering periods, from January 1 through June 30 and July 1 through December 31 of each year. The maximum number of shares of common stock currently authorized for issuance under the Nonqualified ESPP is 1,000,000 shares, with a maximum of 500,000 shares allocated per purchase period. As of September 30, 2017, unrecognized stock-based compensation expense of $1.2 million related to the Nonqualified ESPP is expected to be recognized over a remaining service period of 1.3 years.
Stock-Based Compensation Expense
Stock-based compensation expense associated with stock options, RSUs, PRSUs and purchase rights under the Restated ESPP and Nonqualified ESPP is measured at the grant date based on the fair value of the award, and is recognized, net of forfeitures, as expense over the remaining requisite service period on a straight-line basis.
The fair value of stock option and employee stock purchase right under the Restated ESPP is estimated at the grant date using the Black-Scholes option valuation model.
The fair value of RSUs and Nonqualified ESPP is based on closing market price of the Company’s common stock on the date of grant.
Stock-based compensation expense associated with PRSUs with graded vesting features and which contain both a performance and a service condition is measured based on the closing market price of the Company’s common stock on the date of grant, and is recognized, net of forfeitures, as expense over the requisite service period using the graded vesting attribution method.
Stock-based compensation expense associated with performance-based stock options with graded vesting features and which contain both a performance and a service condition is measured based on fair value of stock option estimated at the grant date using the Black-

15

Table of Contents

Scholes option valuation model, and is recognized, net of forfeitures, as expense over the requisite service period using the graded vesting attribution method.
Compensation expense associated with PRSUs and performance-based stock option awards with graded vesting features and which contain both a performance and a service condition is only recognized if the Company has determined that it is probable that the performance condition will be met. The Company reassesses the probability of vesting at each reporting period and adjusts compensation expense based on its probability assessment. In February 2017, the Compensation Committee of the Company’s board of directors determined that the performance condition related to PRSUs granted to executives in 2016 was met based on the Company’s actual revenue recognized during 2016. The probability of meeting the performance condition related to performance-based stock option awards granted to executives in August 2017 was assessed to be unlikely as of September 30, 2017; as such, no stock-based compensation expense was recognized for these performance-based stock option awards as of September 30, 2017.
The fair value of PRSUs with a market condition is estimated on the date of award using a Monte Carlo simulation model to estimate the total shareholder return of the Company’s stock in relation to the peer group over each performance period. Compensation cost on PRSUs with a market condition is not adjusted for subsequent changes in the Company’s stock performance or the level of ultimate vesting.
10. Accumulated Other Comprehensive Loss
The table below summarizes the changes in accumulated other comprehensive loss by component for the periods indicated (in thousands):
 
Three Months Ended
 
September 30, 2017
 
September 24, 2016
 
Unrealized Gains and Losses on Available-for-Sale Marketable Securities
 
Foreign Currency Translation Adjustments
 
Total
 
Unrealized Gains and Losses on Available-for-Sale Marketable Securities
 
Foreign Currency Translation Adjustments
 
Total
Balance at beginning of period
$
(7
)
 
$
(457
)
 
$
(464
)
 
$
12

 
$
(142
)
 
$
(130
)
Other comprehensive income (loss)
4

 
116

 
120

 
(9
)
 
(87
)
 
(96
)
Balance at end of period
$
(3
)
 
$
(341
)
 
$
(344
)
 
$
3

 
$
(229
)
 
$
(226
)
 
Nine Months Ended
 
September 30, 2017
 
September 24, 2016
 
Unrealized Gains and Losses on Available-for-Sale Marketable Securities
 
Foreign Currency Translation Adjustments
 
Total
 
Unrealized Gains and Losses on Available-for-Sale Marketable Securities
 
Foreign Currency Translation Adjustments
 
Total
Balance at beginning of period
$
(6
)
 
$
(650
)
 
$
(656
)
 
$
(94
)
 
$
(101
)
 
$
(195
)
Other comprehensive income (loss)
3

 
309

 
312

 
97

 
(128
)
 
(31
)
Balance at end of period
$
(3
)
 
$
(341
)
 
$
(344
)
 
$
3

 
$
(229
)
 
$
(226
)
Realized gains and losses on sales of available-for-sale marketable securities, if any, are reclassified from accumulated other comprehensive loss to “Other income (expense)” in the accompanying Condensed Consolidated Statements of Comprehensive Income (Loss).
11. Credit Facility
The Company entered into a credit agreement with Bank of America, N.A. on July 29, 2013 (as amended on December 23, 2015, the “Credit Agreement”). The Credit Agreement provided for a revolving facility in the aggregate principal amount of up to $50.0 million, with any borrowings limited to a maximum consolidated leverage ratio of consolidated funded indebtedness to consolidated EBITDA (as defined in the Credit Agreement). On August 7, 2017, the Company contemporaneously terminated the Credit Agreement in connection with entering into a loan and security agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”).
The Loan Agreement provides for a senior secured revolving credit facility with SVB, pursuant to which SVB agreed to make revolving advances available to the Company in a principal amount of up to $30.0 million based on a customary accounts receivable borrowing base, subject to certain exceptions for accounts originating outside the United States and certain specific accounts. The credit facility includes a $10.0 million sublimit for the issuance of letters of credit. The letters of credit issued under the Loan Agreement will reduce, on a dollar-for-dollar basis, the amount available under the credit facility. Additionally, the Company can borrow up to $5.0 million on a non-formula revolver until January 15, 2018, which will reduce, on a dollar-for-dollar basis, the amount available under the credit facility so that at no time will more than $30.0 million in principal amount be outstanding under the Loan Agreement. The credit facility matures and all outstanding amounts become due and payable on August 7, 2019. Subject to certain exceptions, the Company will also be required to pay to SVB a fee of $0.3 million if it terminates the credit facility prior to August 7, 2018. The credit facility is secured by substantially all of the

16

Table of Contents

Company’s assets, including the Company’s intellectual property. Loans under the credit facility will bear interest through maturity at a variable annual rate based upon an annual rate of either a prime rate or a LIBOR rate, plus an applicable margin between 0.50% to 1.50% for prime rate advances and between 2.00% and 3.00% for LIBOR advances based on the Company’s maintenance of an applicable liquidity ratio. As of September 30, 2017, the Company was in compliance with these requirements. The credit facility includes affirmative and negative covenants applicable to the Company and its subsidiaries. Furthermore, the Loan Agreement requires the Company to maintain a liquidity ratio at minimum levels set forth in more detail in the Loan Agreement. The credit facility also includes events of default, the occurrence and continuation of which would provide SVB with the right to demand immediate repayment of any principal and unpaid interest under the credit facility, and to exercise remedies against the Company and the collateral securing the loans under the credit facility. As of September 30, 2017, the outstanding balance on the line of credit was $30 million.
12. Income Taxes
The following table presents the provision for income taxes from continuing operations and the effective tax rates for the periods indicated (in thousands, except percentages):
 
 
Three Months Ended
 
Nine Months Ended

 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Provision for income taxes
 
$
225

 
$
209

 
$
1,075

 
$
454

Effective tax rate
 
(1.3
)%
 
24.7
%
 
(1.6
)%
 
(2.9
)%
The income tax provision for the three and nine months ended September 30, 2017 and September 24, 2016 consisted primarily of foreign income taxes. The effective tax rate for the three and nine months ended September 30, 2017 and September 24, 2016 was determined using an estimated annual effective tax rate adjusted for discrete items, if any, that occurred during the respective periods. The Company’s effective tax rate for the three and nine months ended September 30, 2017 and September 24, 2016 is impacted by the change in foreign income tax expense.
Deferred tax assets are recognized if realization of such assets is more likely than not. The Company has established and continues to maintain a full valuation allowance against its net deferred tax assets, with the exception of certain foreign deferred tax assets, as the Company does not believe that realization of those assets is more likely than not.
The Company’s effective tax rate may be subject to fluctuation during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of forecasted pre-tax earnings in the various jurisdictions in which it operates, valuation allowances against deferred tax assets, the recognition or de-recognition of tax benefits related to uncertain tax positions, and changes in or the interpretation of tax laws in jurisdictions where it conducts business.
13. Restructuring Charges
The Company adopted a restructuring plan in March 2017. This restructuring plan realigns the Company’s business, increasing its focus towards its investments in software defined access and cloud products, while reducing its cost structure in its traditional systems business. The Company began to take action under this plan beginning in March 2017 and recognized $0.6 million and $2.3 million of restructuring charges for the three and nine months ended September 30, 2017, respectively, consisting primarily of severance and other one-time termination benefits. Restructuring charges are presented separately under operating expenses in the accompanying Condensed Consolidated Statements of Comprehensive Income (Loss).
The following table summarizes the activities related to the restructuring charges pursuant to the above restructuring plan (in thousands):
 
 
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
Liability at beginning of period
 
$
600

 
$

Restructuring charges for the period
 
612

 
2,268

Cash payments
 
(1,017
)
 
(2,073
)
Liability at end of period
 
$
195

 
$
195

The Company currently estimates that this plan will result in pre-tax restructuring charges totaling up to $4.0 million with approximately up to $1.7 million of additional charges expected to be recognized during the fourth quarter of 2017. These charges are primarily cash-based.
ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities and Exchange Act of 1934, as amended. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections of earnings, revenue or other financial items, any statement of or concerning the

17

Table of Contents

following: the plans and objectives of management for future operations, proposed new products or licensing, product development, anticipated customer demand or capital expenditures, future economic and/or market conditions or performance, and assumptions underlying any of the above. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “believes,” “intends,” “plans,” “anticipates,” “estimates,” “projects,” “potential,” or “continue” or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including those identified in the Risk Factors discussed in Part II, Item 1A, in the discussion below, as well as in other sections of this report and in our Annual Report on Form 10-K for the year ended December 31, 2016. All forward-looking statements and reasons why results may differ included in this Quarterly Report on Form 10-Q are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.
Overview
We are a leading global provider of broadband communications access platforms, systems and software for fiber- and copper-based network architectures and a pioneer in software defined access and cloud products focused on access networks and the subscriber. Calix’s portfolio combines AXOS, a software platform for access, with Calix Cloud, innovative cloud products for network data analytics and subscriber experience assurance. Together, they enable CSPs to transform their networks and enhance how they connect to their residential and business subscribers. We enable CSPs to provide a wide range of revenue-generating services, from basic voice and data to advanced broadband services, over legacy and next-generation access networks. We focus solely on CSP access networks, the portion of the network that governs available bandwidth and determines the range and quality of services that can be offered to subscribers. We believe that continued innovation and investment in advanced platforms and systems are important elements of our growth strategy. Our most advanced systems operate on AXOS, a network operating system and software platform built for the specific needs of the access network that allows for all software functions in the access network to be developed and run without dependence on underlying hardware and associated silicon chipsets.
We market our access systems and related software to CSPs globally through our direct sales force as well as a number of resellers. At the end of the third quarter of 2017, over 24 million ports of the Calix portfolio have been deployed at a growing number of CSPs worldwide. Our customers range from smaller, regional CSPs to some of the world’s largest CSPs. We have enabled over 1,300 customers to deploy gigabit passive optical network, Active Ethernet and point-to-point Ethernet fiber access networks.
Our revenue was $128.8 million and $372.5 million for the three and nine months ended September 30, 2017, respectively, compared to $121.2 million and $327.0 million for the three and nine months ended September 24, 2016, respectively. Our revenue levels and continued revenue growth will depend on our ability to continue to sell our access systems and software to existing customers and to attract new customers, particularly larger CSPs, globally. During the three months ended September 30, 2017, we continued to see growth in our services business to meet customer demand for turnkey solutions that include professional services together with the supply of equipment and materials, including projects that are funded by the Federal Communication Commission’s (FCC) current Connect America Fund program, CAF2. Specifically, during the nine months ended September 30, 2017, we completed a significant turnkey network improvement project that we had commenced in 2015, and continued work underway on previously-awarded CAF2 projects including completion of a large majority of these projects. Revenue for such projects is generally recognized only when all project requirements are completed, which typically requires longer periods depending on the nature and scope of the project. Similarly, some of the costs incurred by us for such projects, including labor and related costs, are deferred and recognized to cost of revenue when the associated revenue is recognized.
Revenue fluctuations result from many factors, including: increases or decreases in customer orders for our products and services, contractual terms with customers that result in delayed revenue recognition and varying budget cycles and seasonal buying patterns of our customers. More specifically, our customers tend to spend less in the first quarter as they are finalizing their annual budgets, and in certain regions, customers are also challenged by winter weather conditions that inhibit fiber deployment in outside plants. Our revenue levels are also dependent upon our customers’ timing of purchases and capital expenditure plans, including expenditure plans for turnkey solutions projects, which are generally non-recurring in nature. As of September 30, 2017, we had deferred product revenue of approximately $16.8 million related to ongoing work in turnkey network improvement projects that will be recognized upon acceptance by the customer or upon agreed milestones. The timing of recognition of deferred revenue may cause significant fluctuations in our revenue and operating results from period to period.
Cost of revenue is strongly correlated to revenue and tends to fluctuate due to all of the above factors that could impact revenue. Factors that impacted our cost of revenue for the three and nine months ended September 30, 2017, and that may impact cost of revenue in future periods, also include: changes in the mix of products delivered, customer location and regional mix, changes in product warranty and incurrence of retrofit costs, changes in the cost of our inventory and inventory write-downs. Cost of services revenue has been impacted, and is expected to continue to be impacted in future periods, by increases in the pace of professional services activity due to customer requirements and project deadlines, the timing of completion of project requirements, higher than anticipated costs associated with delivery of professional services for which project pricing is typically set at the outset of the project, charges related to cost overruns on services projects and inefficiencies associated with delays resulting from third party dependencies and incremental costs to rework. Cost of revenue also includes fixed expenses related to our internal operations, which could impact our cost of revenue as a percentage of revenue if there are large fluctuations in revenue.
Cost of revenue has a direct impact on gross profit and gross margins. During the three and nine months ended September 30, 2017, our gross profit and gross margin continued to be negatively impacted by an increase in our services revenue, which carries negative gross

18

Table of Contents

margin, as a mix of total revenue. We have continued to incur higher costs related to our professional services business for turnkey network improvement projects, largely associated with projects initiated in 2016. Overall, our gross profit and gross margin fluctuate based on timing of factors such as new product introductions or upgrades to existing products, changes in customer mix, changes in the mix of products demanded and sold (and any related write-downs of existing inventory), increases in mix of revenue towards professional services, increases in mix of revenue from channel sales rather than direct sales or other unfavorable customer or product mix, shipment volumes and any related volume discounts, changes in our product and services costs, pricing decreases or discounts, customer rebates and incentive programs due to competitive pressure. The timing of our recognition of deferred revenue and related deferred costs related to turnkey professional services projects could also result in lower gross profit and gross margin in the periods that such revenue is recognized, and the relative size of these projects could cause large fluctuations in our gross profit from period to period. Moreover, to the extent that deferred costs related to the professional services portion of turnkey projects is determined to be unrecoverable, we incur a charge to cost of service revenue in the period such cost is determined to be unrecoverable. In connection with our recoverability assessment as of September 30, 2017, we wrote down our deferred costs by $3.3 million. See the risk factor titled “An increase in revenue mix towards services will adversely affect our gross margins” below in the “Risk Factors” section of this Quarterly Report on Form 10-Q.
Our operating expenses have fluctuated based on the following factors: changes in headcount and personnel costs which comprise a significant portion of our operating expenses, timing of variable compensation expenses due to fluctuations in order volumes, timing of research and development expenses including investments in innovative solutions, such as next generation solutions and new customer segments, prototype builds and outsourced development projects, fluctuations in stock-based compensation expenses due to timing of equity grants or other factors affecting vesting, changes in acquisition-related expenses and timing of litigation-related costs. During the three and nine months ended September 30, 2017 as compared with the corresponding periods in 2016, our total operating expense increased due to increases in headcount and outside contractors, primarily for research and development and, to a lesser extent, as a result of severance-related expenses incurred in the three and nine months ended September 30, 2017. In March 2017, we adopted a restructuring plan to realign our business to increase focus towards investments in software defined access and cloud products and to reduce costs in our traditional systems business, which we expect will result in revised pre-tax restructuring charges estimated to be up to $4.0 million in 2017, of which we incurred $2.3 million during the nine months ended September 30, 2017. We anticipate that our operating expenses will be relatively consistent over the next several quarters in absolute dollars, but will decline as a percentage of revenue over time.
Our net loss was $17.9 million and $70.2 million for the three and nine months ended September 30, 2017, respectively, compared to a net income of $0.6 million and net loss of $15.9 million for the three and nine months ended September 24, 2016, respectively. Since our inception we have incurred significant losses and, as of September 30, 2017, we had an accumulated deficit of $654.5 million. Further, as a result of the fluctuations described above and a number of other factors, many of which are outside our control, our quarterly operating results fluctuate from period to period. Comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance.
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. To the extent there are material differences between these estimates and actual results, our financial statements may be affected. Our management evaluates its estimates, assumptions and judgments on an ongoing basis.
Our critical accounting policies and estimates are described under “Critical Accounting Policies and Estimates” in “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, 2016. During the nine months ended September 30, 2017, there have been no significant changes in our critical accounting policies and estimates.
Recent Accounting Pronouncements
See Note 2 to the unaudited condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein by reference.
Results of Operations
Comparison of the Three and Nine Months Ended September 30, 2017 and September 24, 2016
Revenue
Our revenue is comprised of the following:
Products — includes revenue from the sale of access systems, premises equipment, software licenses and cloud-based software products.
Services — includes revenue from professional services, customer support, software maintenance, extended warranty subscriptions, training and managed services.

19

Table of Contents

The following table sets forth our revenue (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Products
 
$
106,442

 
$
114,029

 
$
(7,587
)
 
(7
)%
 
$
305,395

 
$
305,853

 
$
(458
)
 
 %
Services
 
22,385

 
7,158

 
15,227

 
213
 %
 
67,073

 
21,134

 
45,939

 
217
 %
 
 
$
128,827

 
$
121,187

 
$
7,640

 
6
 %
 
$
372,468

 
$
326,987

 
$
45,481

 
14
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Percent of total revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Products
 
83
%
 
94
%
 
 
 
 
 
82
%
 
94
%
 
 
 
 
Services
 
17
%
 
6
%
 
 
 
 
 
18
%
 
6
%
 
 
 
 
 
 
100
%
 
100
%
 
 
 
 
 
100
%
 
100
%
 
 
 
 
Our revenue increased by $7.6 million, or 6%, for the three months ended September 30, 2017 and $45.5 million, or 14%, for the nine months ended September 30, 2017 as compared with the corresponding periods in 2016. This was mainly due to an increase in services revenue by $15.2 million, or 213%, for the three months ended September 30, 2017 and $45.9 million, or 217%, for the nine months ended September 30, 2017, primarily driven by the completion of services associated with a significant turnkey network improvement project substantially completed during the first quarter of 2017 and the completion of a number of sites from previously-awarded CAF2 projects. Our product revenue decreased by $7.6 million for the three months ended September 30, 2017 as compared with the corresponding period in 2016 mainly due to lower shipment levels to one of our large Tier 2 customers relative to the prior year period. During the three and nine months ended September 30, 2017, revenue generated in the United States was $117.5 million and $332.1 million or 91% and 89%, respectively, of our total revenue, compared to $111.8 million and $298.8 million, or 92% and 91% of our total revenue, for the same periods in 2016. International revenue was $11.3 million and $40.3 million, or 9% and 11% of our total revenue, for the three and nine months ended September 30, 2017, respectively, compared to $9.4 million and $28.1 million, or 8% and 9% of our total revenue, for the same periods in 2016.
We had one customer that accounted for more than 10% of our total revenue during the three months ended September 30, 2017. See Note 2 to the unaudited condensed consolidated financial statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for more details on concentration of revenue for the periods presented.
Cost of Revenue, Gross Profit and Gross Margin
The following table sets forth our cost of revenue (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Products
 
$
55,494

 
$
60,662

 
$
(5,168
)
 
(9
)%
 
$
171,166

 
$
159,856

 
$
11,310

 
7
%
Services
 
28,700

 
6,981

 
21,719

 
311
 %
 
78,969

 
18,099

 
60,870

 
336
%
 
 
$
84,194

 
$
67,643

 
$
16,551

 
24
 %
 
$
250,135

 
$
177,955

 
$
72,180

 
41
%
Our cost of revenue increased by $16.6 million and $72.2 million during the three and nine months ended September 30, 2017, respectively, as compared with the corresponding periods in 2016. This was primarily attributable to an increase in cost of service revenue by $21.7 million and $60.9 million during those respective periods, as we experienced higher levels of service activities, as well as higher costs attributed to rework, delays, unanticipated costs and overruns (including third party costs) for our turnkey network improvement projects. Our product cost of revenue also decreased by $5.2 million for the three months ended September 30, 2017 as compared with the corresponding period in 2016 mainly due to lower shipments as described above, and increased by $11.3 million for the nine months ended September 30, 2017 as compared to the year ago period mainly due to product mix. Our warranty and retrofit costs primarily related to certain retrofit charges for two specific product families also decreased by approximately $1.1 million and $0.6 million during the three and nine months ended September 30, 2017, respectively, as compared with the corresponding periods in 2016. This is partly offset by increases in our inventory write-downs attributed to slow moving inventories by $0.5 million and $0.8 million during those respective periods.

20

Table of Contents

The following table sets forth our gross profit and gross margin (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
Gross profit:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Products
 
$
50,948

 
$
53,367

 
$
(2,419
)
 
(5
)%
 
$
134,229

 
$
145,997

 
$
(11,768
)
 
(8
)%
Services
 
(6,315
)
 
177

 
(6,492
)
 
(3,668
)%
 
(11,896
)
 
3,035

 
(14,931
)
 
(492
)%
Total gross profit
 
$
44,633

 
$
53,544

 
$
(8,911
)
 
(17
)%
 
$
122,333

 
$
149,032

 
$
(26,699
)
 
(18
)%
Gross margin:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Products
 
48
 %
 
47
%
 
 
 
 
 
44
 %
 
48
%
 
 
 
 
Services
 
(28
)%
 
2
%
 
 
 
 
 
(18
)%
 
14
%
 
 
 
 
Total gross margin
 
35
 %
 
44
%
 
 
 
 
 
33
 %
 
46
%
 
 
 
 
Gross profit decreased to $44.6 million and $122.3 million during the three and nine months ended September 30, 2017, respectively, from $53.5 million and $149.0 million during the corresponding periods in 2016. Gross margin decreased to 35% and 33% during the three and nine months ended September 30, 2017, respectively, from 44% and 46% during the corresponding periods in 2016. The decrease in gross profit and gross margin during the three and nine months ended September 30, 2017 was primarily due to an increase in revenue mix toward service revenue as we continued to grow our professional services business, an increased level of activities in our turnkey network improvement projects and higher costs attributed to rework and overruns. The rework costs and overruns generally relate to projects that were started in 2016 that incurred higher than anticipated costs, project delays, third party dependencies, quality issues associated with subcontracted work, rework to meet customer requirements and longer than anticipated time to complete. The large majority of these 2016 projects were completed by the end of the third quarter of 2017. Looking forward, we expect to continue to drive efficiencies in our delivery of professional services for turnkey network improvement projects.
The decrease within the products category was partly attributed to product and regional mix as well as higher inventory write-downs, partly offset by lower warranty and retrofit charges as described above.
Operating Expenses
Research and Development Expenses
The following table sets forth our research and development expenses (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
Research and development
 
$
32,633

 
$
28,119

 
$
4,514

 
16
%
 
$
99,391

 
$
75,925

 
$
23,466

 
31
%
Percent of total revenue
 
25
%
 
23
%
 
 
 
 
 
27
%
 
23
%
 
 
 
 
The increase in research and development expenses by $4.5 million during the three months ended September 30, 2017 as compared with the corresponding period in 2016 was primarily due to an increase in expenses for outside contractors by $4.5 million and expenditures relating to prototype and expendable equipment used for research and development activities by $0.4 million primarily for development services including investments in next generation technologies to pursue broader growth opportunities. Our personnel for research and development also increased during the three months ended September 30, 2017 as compared with the corresponding period in 2016 which resulted in higher compensation and employee benefits (other than bonuses) of $0.6 million. The increase was partly offset by lower employee bonuses of $0.7 million during the three months ended September 30, 2017 as compared with the corresponding period in 2016.
The increase in research and development expenses by $23.5 million during the nine months ended September 30, 2017 as compared with the corresponding period in 2016 was primarily due to an increase in expenses for outside contractors by $13.2 million and expenditures relating to prototype and expendable equipment used for research and development activities by $2.7 million primarily for development services including investments in next generation technologies to pursue broader growth opportunities. Our personnel for research and development also increased during the nine months ended September 30, 2017 as compared with the corresponding period in 2016 which resulted in higher compensation and employee benefits (other than bonuses) of $7.6 million. The increase was partly offset by lower employee bonuses of $0.7 million during the nine months ended September 30, 2017 as compared with the corresponding period in 2016.
We increased our research and development efforts to grow our product portfolio and to make strategic investments in innovative solutions, including next generation platforms and new market segments. We intend to continue to moderate our investments in research and development as our next generations systems and software platforms are brought to market.

21

Table of Contents

Sales and Marketing Expenses
The following table sets forth our sales and marketing expenses (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
Sales and marketing
 
$
18,448

 
$
20,575

 
$
(2,127
)
 
(10
)%
 
$
59,306

 
$
58,850

 
$
456

 
1
%
Percent of total revenue
 
14
%
 
17
%
 
 
 
 
 
16
%
 
18
%
 
 
 
 
The decrease in sales and marketing expenses by $2.1 million during the three months ended September 30, 2017 as compared with the corresponding period in 2016 was primarily due to lower compensation and employee benefits of $1.1 million arising from changes in personnel as a result of our restructuring plan and lower stock-based compensation expense of $0.8 million.
Sales and marketing expenses were relatively flat during the nine months ended September 30, 2017 as compared with the corresponding period in 2016.
We expect to continue our investments in sales and marketing in order to extend our market reach and grow our business in support of our key strategic initiatives.
General and Administrative Expenses
The following table sets forth our general and administrative expenses (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
General and administrative
 
$
10,203

 
$
8,615

 
$
1,588

 
18
%
 
$
30,161

 
$
32,940

 
$
(2,779
)
 
(8
)%
Percent of total revenue
 
8
%
 
7
%
 
 
 
 
 
8
%
 
10
%
 
 
 
 
The increase in general and administrative expenses by $1.6 million for the three months ended September 30, 2017 as compared with the corresponding period in 2016 was due to higher professional services expense of $2.0 million primarily related to outside consulting services for the implementation of a new SaaS-based enterprise resource planning (“ERP”) infrastructure, which was partially offset by a lower stock-based compensation expense of $0.5 million.
The decrease in general and administrative expenses by $2.8 million for the nine months ended September 30, 2017 as compared with the corresponding period in 2016 included legal fees and expenses related to the Occam litigation of $6.4 million that did not recur in 2017 as the litigation was settled in 2016. The decrease was partially offset by increases in professional services expense of $2.6 million primarily related to outside consulting services in 2017 for the implementation of the new ERP infrastructure, recoveries of legal fees and expenses in 2016 that did not recur in 2017, compensation and employee benefits of $1.3 million due to increase in headcount and severance benefits of $0.5 million related to our separation agreement with our former Chief Financial Officer. We expect that general and administrative expenses will continue at current levels until the implementation of the new ERP infrastructure is completed, which is expected to occur in mid-2018.
Amortization of Intangible Asset
The intangible asset related to customer relationships had reached completion of its amortization period during the first quarter of 2016.
Restructuring Charges
In connection with a restructuring plan we adopted in March 2017, we recognized approximately $0.6 million and $2.3 million of restructuring charges during the three and nine months ended September 30, 2017, respectively, consisting primarily of severance and other one-time termination benefits. See Note 13, “Restructuring Charges” of the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for further details regarding this restructuring plan.
Litigation Settlement Gain
During the three and nine months ended September 24, 2016, we recognized a litigation settlement gain of $4.5 million as a reduction to operating expense. This litigation settlement gain consisted of a litigation settlement accrual of $4.5 million in partial recovery of out-of-pocket costs related to the Occam litigation.

22

Table of Contents

Provision for Income Taxes
The following table sets forth our provision for income taxes (dollars in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
 
September 30,
2017
 
September 24,
2016
 
Variance
in
Dollars
 
Variance
in
Percent
Provision for income taxes
 
$
225

 
$
209

 
$
16

 
8
%
 
$
1,075

 
$
454

 
$
621

 
137
%
Effective tax rate
 
(1.3
)%
 
24.7
%
 
 
 
 
 
(1.6
)%
 
(2.9
)%
 
 
 
 
The income tax provision for the three and nine months ended September 30, 2017 and September 24, 2016 consisted primarily of foreign income taxes. The effective tax rate for the three and nine months ended September 30, 2017 and September 24, 2016 was determined using an estimated annual effective tax rate adjusted for discrete items, if any, that occurred during the respective periods. Our effective tax rate for the three and nine months ended September 30, 2017 and September 24, 2016 is impacted by the change in foreign income tax expense.
Deferred tax assets are recognized if realization of such assets is more likely than not. We have established and continue to maintain a full valuation allowance against our net deferred tax assets, with the exception of certain foreign deferred tax assets, as we do not believe that realization of those assets is more likely than not.
Our effective tax rate may be subject to fluctuation during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of forecasted pre-tax earnings in the various jurisdictions in which we operate, valuation allowances against deferred tax assets, the recognition or de-recognition of tax benefits related to uncertain tax positions, and changes in or the interpretation of tax laws in jurisdictions where we conduct business.
Liquidity and Capital Resources
We have historically funded our operations and investing activities primarily through cash generated from operations and sales of our common stock. At September 30, 2017, we had cash, cash equivalents and marketable securities of $70.8 million, which consisted of deposits held at banks, money market mutual funds held at major financial institutions and highly liquid marketable securities such as commercial paper and U.S. government agency securities. This includes $5.8 million of cash held by our foreign subsidiaries, primarily in China. As of September 30, 2017, our liability for taxes that would be payable as a result of repatriation of undistributed earnings of our foreign subsidiaries to the United States was not significant and limited to withholding taxes considering our existing net operating loss carryovers.
Operating Activities
During the nine months ended September 30, 2017, cash used in operating activities increased as we continued to invest in research and development to pursue broader market and customer opportunities. Furthermore, during this period we continued to experience losses due to higher costs, delays, overruns and other inefficiencies associated with our professional services business for turnkey network improvement projects (including CAF2 projects). As described below, these turnkey network improvement projects generally involve greater working capital needs at the outset as services and products are supplied, while revenue and cash collections occur after projects are accepted or agreed-upon milestones are reached. Net cash used in operations of $28.6 million for the nine months ended September 30, 2017 consisted of a net loss of $70.2 million, partially offset by $23.6 million of cash flow increases reflected in the net change in assets and liabilities and $17.9 million of non-cash charges. Cash flow increases resulting from the net change in assets and liabilities primarily consisted of a decrease in deferred cost of revenue of $11.9 million mainly due to recognition of associated costs related to turnkey network improvement projects that are either accepted or for which agreed-upon milestones are reached, partly offset by an increase in deferred revenue of $1.3 million attributed to additional deferral of revenue related to turnkey network improvement projects, a decrease in inventories of $8.2 million primarily due to higher inventory turnover, a decrease in accounts receivable of $7.1 million mainly due to collection from one of our customers for turnkey improvement projects and an increase in accounts payable of $5.5 million primarily due to the timing of inventory receipts and payments to our manufacturers. This was partially offset by a decrease in accrued expenses and other liabilities of $10.1 million primarily due to a decrease in customer advance payments for turnkey services projects for one of our customers and partly due to the timing of our payments of payroll, sales commissions and other expenses. Non-cash charges primarily consisted of stock-based compensation of $9.3 million, depreciation and amortization of $7.6 million and amortization of intangible assets of $0.8 million.
Net cash provided by operations of $5.3 million for the nine months ended September 24, 2016 consisted of a net loss of $15.9 million and $0.8 million of cash flow decreases reflected in the net change in assets and liabilities, more than offset by $22.0 million of non-cash charges. Cash flow decreases resulting from the net change in assets and liabilities primarily consisted of an increase in accounts receivable of $10.1 million mainly due to higher revenue in 2016, an increase in prepaid expenses and other assets of $6.1 million mainly due to litigation settlement gain accrual, a net decrease in deferred revenue and deferred cost of revenue of $5.4 million as a result of revenue and cost recognition for previous shipments related to certain turnkey projects and Rural Utility Service (“RUS”) funded contracts and a decrease in accounts payable of $0.4 million primarily due to the timing of inventory receipts and payments to our manufacturers. This was partially offset by an increase in accrued expenses and other liabilities of $13.7 million primarily due to the timing of our payments of payroll, sales commissions and other expenses and a decrease in inventories of $7.5 million primarily due to higher inventory turnover. Non-cash charges primarily consisted of stock-based compensation of $10.4 million, depreciation and amortization of $6.3 million and amortization of intangible assets of $5.0 million.

23

Table of Contents

Investing Activities
Net cash provided by investing activities of $14.4 million for the nine months ended September 30, 2017 consisted of net sales and maturities of marketable securities of $21.2 million partially offset by capital expenditures of $6.8 million for purchases of test equipment, computer equipment and software.
Our cash provided by investing activities of $14.8 million for the nine months ended September 24, 2016 consisted of maturities of marketable securities of $20.2 million partially offset by capital expenditures of $5.4 million for purchases of test equipment, computer equipment and software.
Financing Activities
Net cash provided by financing activities of $27.8 million for the nine months ended September 30, 2017 primarily consisted of net proceeds from our line of credit of $30.0 million and the proceeds from the issuance of common stock under our Amended and Restated Employee Stock Purchase Plan (“Restated ESPP”) of $0.7 million, partially offset by the payment of payroll taxes for the vesting of awards under our 2010 Equity Incentive Award Plan of $2.7 million and payments to originate the line of credit of $0.2 million.
Net cash used in financing activities of $11.7 million for the nine months ended September 24, 2016 consisted of the repurchases of common stock of $12.8 million and the payment of payroll taxes for the vesting of awards under our 2010 Equity Incentive Award Plan of $1.8 million, partially offset by the proceeds from the issuance of common stock under the Restated ESPP of $2.9 million.
Stock Repurchase Program
On April 26, 2015, our board of directors approved a program to repurchase up to $40 million of our common stock from time to time. This stock repurchase program commenced in May 2015. During the nine months ended September 24, 2016, we repurchased 1,789,287 shares of common stock for $12.8 million at an average price of $7.16 per share. In March 2016, we completed purchases under the $40 million stock repurchase program and repurchased a total of 5,329,817 shares of common stock from May 2015 to March 2016 at an average price of $7.50 per share.
Working Capital and Capital Expenditure Needs
We currently have no material cash commitments, except for contractual obligations under our Loan Agreement, normal recurring trade payables, expense accruals, operating leases and non-cancelable firm purchase commitments. Our working capital needs related to turnkey network improvement arrangements have been substantial, and are expected to remain substantial, as under such arrangements we generally purchase substantial equipment, components and materials and pay our subcontractors at the outset and through the course of a project, but we may not receive payment from our customers until completion and acceptance of the associated services, which may be one or more quarters later. We believe that our outsourced approach to manufacturing provides us significant flexibility in both managing inventory levels and financing our inventory. In the event that our revenue plan does not meet our expectations, we may eliminate or curtail expenditures to mitigate the impact on our working capital.
On August 7, 2017, we entered into the Loan Agreement for a senior secured revolving credit facility with SVB which provides for a revolving credit facility of up to $30.0 million based on a customary accounts receivable borrowing base, subject to certain exceptions for accounts originating outside the United States and certain specific accounts. The credit facility matures and all outstanding amounts become due and payable on August 7, 2019. As of September 30, 2017, we borrowed $30.0 million under this line of credit. Please refer to Note 11, “Credit Facility” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more details on this credit facility.
We believe, based on our current operating plan and operating cash flows, our existing cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for at least the next twelve months. In addition, we may also use our existing credit facility from time to time to support our working capital needs. Our future capital requirements will depend on many factors including our rate of revenue growth, timing of customer payments and payment terms, particularly of larger customers, the timing and extent of spending to support development efforts, particularly research and development related to growth initiatives such as our software defined access portfolio, our ability to manage product cost efficiencies and maintain product margin levels, the timing, extent and size of turnkey professional services projects and our ability to develop operational efficiencies and successfully scale that business, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the acquisition of new capabilities or technologies and the continued market acceptance of our products. If we are unable to generate positive operating income and positive cash flows from operations, our liquidity, results of operations and financial condition will be adversely affected. If we are unable to generate cash flows to support our operational needs, we may need to seek other sources of liquidity, including borrowings, to support our working capital needs. In addition, we may choose to seek other sources of liquidity even if we believe we have generated sufficient cash flows to support our operational needs. There is no assurance that any other sources of liquidity may be available to us on acceptable terms or at all. If we are unable to generate sufficient cash flows or obtain other sources of liquidity, we will be forced to limit our development activities, reduce our investment in growth initiatives and institute cost-cutting measures, all of which would adversely impact our business and growth.
Contractual Obligations and Commitments
Our principal commitments as of September 30, 2017 consist of our contractual obligations under the Loan Agreement, operating leases for office space and non-cancelable outstanding purchase obligations. The following table summarizes our contractual obligations at September 30, 2017 (in thousands):

24

Table of Contents

 
 
Payments Due by Period
 
 
Total
 
Less Than 1 Year
 
1-3 Years
 
3-5 Years
Line of credit, including interest (1)
 
$
33,239

 
$
1,749

 
$
31,490

 
$

Operating lease obligations (2)
 
5,675

 
2,989

 
2,196

 
490

Non-cancelable purchase commitments (3)
 
62,579

 
62,579

 

 

Total
 
$
68,254

 
$
65,568

 
$
2,196

 
$
490

(1) Line of credit contractual obligations include projected interest payments over the term of the Loan Agreement, assuming interest rate in effect for the outstanding borrowings as of September 30, 2017 and payment of the borrowings on August 7, 2019, the contractual maturity date of the credit facility. See Note 11, “Credit Facility” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussions regarding our contractual obligations relating to our line of credit.
(2) Future minimum operating lease obligations in the table above include primarily payments for our office space in Petaluma, California, and for our facilities in Minneapolis, Minnesota; Nanjing, China; Richardson, Texas; and San Jose and Santa Barbara, California, which expire at various dates through 2022. See Note 7, “Commitments and Contingencies” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion regarding our operating leases.
(3) Represents outstanding purchase commitments for inventory to be delivered by our suppliers, including contract manufacturers. See Note 7, “Commitments and Contingencies” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion regarding our outstanding purchase commitments.
Off-Balance Sheet Arrangements
As of September 30, 2017 and December 31, 2016, we did not have any off-balance sheet arrangements.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
The primary objectives of our investment activity are to preserve principal, provide liquidity and maximize income without significantly increasing risk. By policy, we do not enter into investments for trading or speculative purposes. At September 30, 2017, we had cash, cash equivalents and marketable securities of $70.8 million, which was held primarily in cash, money market funds and highly liquid marketable securities such as corporate debt instruments, commercial paper and U.S. government agency securities. Due to the nature of these money market funds and highly liquid marketable securities, we believe that we do not have any material exposure to changes in the fair value of our cash equivalents and marketable securities as a result of changes in interest rates.
Our exposure to interest rate risk also relates to the amount of interest we must pay on our borrowings under our new revolving credit facility pursuant to our Loan Agreement with SVB. Borrowings under the Loan Agreement will bear interest through maturity at a variable annual rate based upon an annual rate of either a prime rate or a LIBOR rate, plus an applicable margin between 0.50% to 1.50% for prime rate advances and between 2.00% and 3.00% for LIBOR advances based on the Company’s maintenance of an applicable liquidity ratio. As of September 30, 2017, we had $30 million outstanding borrowings under the Loan Agreement.
Foreign Currency Exchange Risk
Our primary foreign currency exposures are described below.
Economic Exposure
The direct effect of foreign currency fluctuations on our sales and expenses has not been material because our sales and expenses are primarily denominated in U.S. dollars (“USD”). However, we are indirectly exposed to changes in foreign currency exchange rates to the extent of our use of foreign contract manufacturers whom we pay in USD. Increases in the local currency rates of these vendors in relation to USD could cause an increase in the price of products that we purchase. Additionally, if the USD strengthens relative to other currencies, such strengthening could have an indirect effect on our sales to the extent it raises the cost of our products to non-U.S. customers and thereby reduces demand. A weaker USD could have the opposite effect. The precise indirect effect of currency fluctuations is difficult to measure or predict because our sales are influenced by many factors in addition to the impact of such currency fluctuations.
Translation Exposure
Our sales contracts are primarily denominated in USD and, therefore, the majority of our revenue is not subject to foreign currency risk. We are directly exposed to changes in foreign exchange rates to the extent such changes affect our expenses related to our foreign assets and liabilities with our subsidiaries in Brazil, China and the United Kingdom, whose functional currencies are the Brazilian Real (“BRL”), Chinese Renminbi (“RMB”) and British Pounds Sterling (“GBP”), respectively.
Our operating expenses are incurred primarily in the United States, with a small portion of expenses incurred in Brazil associated with sales and marketing expenses, in China associated with our research and development operations that are maintained there and in the United Kingdom for our sales and services operations there. Our operating expenses are generally denominated in the functional currencies of our

25

Table of Contents

subsidiaries in which the operations are located. The percentages of our operating expenses denominated in the following currencies for the indicated periods were as follows:
 
 
Nine Months Ended
 
 
September 30,
2017
 
September 24,
2016
USD
 
90
%
 
88
%
RMB
 
7
%
 
7
%
GBP
 
3
%
 
4
%
BRL
 
%
 
1
%
 
 
100
%
 
100
%
If USD had appreciated or depreciated by 10%, relative to RMB, GBP and BRL, our operating expenses for the first nine months of 2017 would have decreased or increased by approximately $2.0 million, or approximately 1%. We do not currently enter into forward exchange contracts to hedge exposure denominated in foreign currencies or any derivative financial instruments. In the future, we may consider entering into hedging transactions to help mitigate our foreign currency exchange risk.
Foreign exchange rate fluctuations may also adversely impact our financial position as the assets and liabilities of our foreign operations are translated into USD in preparing our Condensed Consolidated Balance Sheets. The effect of foreign exchange rate fluctuations on our consolidated financial position for the nine months ended September 30, 2017 was a net translation gain of approximately $0.3 million. This gain is recognized as an adjustment to stockholders’ equity through accumulated other comprehensive loss.
Transaction Exposure
We have certain assets and liabilities, primarily receivables and accounts payable (including inter-company transactions) that are denominated in currencies other than the relevant entity’s functional currency. In certain circumstances, changes in the functional currency value of these assets and liabilities create fluctuations in our reported consolidated financial position, cash flows and results of operations. Transaction gains and losses on these foreign currency denominated assets and liabilities are recognized each period within other income (expense), net in our Condensed Consolidated Statements of Comprehensive Income (Loss). During the nine months ended September 30, 2017, the net loss we recognized related to these foreign exchange assets and liabilities was insignificant.
ITEM 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Based on their evaluation as of September 30, 2017, our Chief Executive Officer and Chief Financial Officer, with the participation of our management, have concluded that our disclosure controls and procedures (as defined in Rules 13a–15(e) and 15d–15(e) under the Exchange Act) were effective at the reasonable assurance level.
Limitations on the Effectiveness of Controls
Our disclosure controls and procedures provide our Chief Executive Officer and Chief Financial Officer reasonable assurance that our disclosure controls and procedures will achieve their objectives. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting can or will prevent all human error. Our management recognizes that a control system, no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Furthermore, the design of a control system must reflect the fact that there are internal resource constraints, and the benefit of controls must be weighed relative to their corresponding costs. Because of the limitations in all control systems, no evaluation of controls can provide complete assurance that all control issues and instances of error, if any, within our company are detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur due to human error or mistake. Additionally, controls, no matter how well designed, could be circumvented by the individual acts of specific persons within the organization. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated objectives under all potential future conditions.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

26

Table of Contents

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings
For a description of our material pending legal proceedings, please refer to Note 7 “Commitments and Contingencies – Litigation” of the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which is incorporated by reference.
ITEM 1A. Risk Factors
We have identified the following additional risks and uncertainties that may affect our business, financial condition and/or results of operations. The risks described below include any material changes to and supersede the description of the risk factors disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission on February 28, 2017. Investors should carefully consider the risks described below, together with the other information set forth in this Quarterly Report on Form 10-Q, before making any investment decision. The risks described below are not the only ones we face. Additional risks not currently known to us or that we currently believe are immaterial may also significantly impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and investors may lose all or part of their investment.
Risks Related to Our Business and Industry
Our markets are rapidly changing, which makes it difficult to predict our future revenue and plan our expenses appropriately.
We compete in markets characterized by rapid technological change, changing needs of communications service providers, or CSPs, evolving industry standards and frequent introductions of new products and services. We invest significant amounts to pursue innovative technologies that we believe would be adopted by CSPs. In addition, on an ongoing basis we expect to reposition our product and service offerings and introduce new products and services as we encounter rapidly changing CSP requirements and increasing competitive pressures. We may not be successful in doing so in a timely and responsive manner, or at all. As a result, it is difficult to forecast our future revenue and plan our operating expenses appropriately, which makes it difficult to predict our future operating results.
We have a history of losses, and we may not be able to generate positive operating income and positive cash flows in the future.
We have experienced net losses in each year of our existence. For the years ended December 31, 2016, 2015 and 2014, we incurred net losses of $27.4 million, $26.3 million, and $20.8 million, respectively. For the first nine months of 2017, we incurred a net loss of $70.2 million. As of September 30, 2017 and December 31, 2016, we had an accumulated deficit of $654.5 million and $584.3 million, respectively.
We expect to continue to incur significant expenses and cash outlays for research and development, growth of our services operations, investments in innovative technologies, expansion of our product portfolio, sales and marketing, customer support and general and administrative functions as we expand our business and operations and target new customer segments, primarily larger CSPs including cable multiple system operators, or MSOs. Given our growth rate and the intense competitive pressures we face, we may be unable to control our operating costs.
We cannot guarantee that we will achieve profitability in the future. We will have to generate and sustain significant and consistent increased revenue, while continuing to control our expenses, in order to achieve and then maintain profitability. We may also incur significant losses in the future for a number of reasons, including the risks discussed in this “Risk Factors” section and other factors that we cannot anticipate. We have incurred higher than expected costs associated with the growth of our professional services business and, if we are unable to scale that business and attain operational efficiencies, we will continue to incur losses. If we are unable to generate positive operating income and positive cash flows from operations, our liquidity, gross margins, results of operations and financial condition will be adversely affected. If we are unable to generate cash flows to support our operational needs, we may need to seek other sources of liquidity, including additional borrowings, to support our working capital needs. In addition, we may choose to seek other sources of liquidity even if we believe we have generated sufficient cash flows to support our operational needs. There is no assurance that any other sources of liquidity may be available to us on acceptable terms or at all. If we are unable to generate sufficient cash flows or obtain other sources of liquidity, we will be forced to limit our development activities, reduce our investment in growth initiatives and institute cost-cutting measures, all of which would adversely impact our business and growth.
The U.S. federal government has called for potentially substantial changes to U.S. tax policies and laws. We are unable to predict what U.S. tax reform may be enacted in the future or what effect such changes would have on our business. Any significant change in our future effective tax rate could have a material impact on our business, financial condition, results of operations, or cash flows.
Our quarterly and annual operating results may fluctuate significantly, which may make it difficult to predict our future performance and could cause the market price of our stock to decline.
A number of factors, many of which are outside of our control, may cause or contribute to significant fluctuations in our quarterly and annual operating results. These fluctuations may make financial planning and forecasting difficult. Comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. If our

27

Table of Contents

revenue or operating results fall below the expectations of investors or securities analysts, or below any guidance we may provide to the market, the market price of our stock would likely decline. Moreover, we may experience delays in recognizing revenue under applicable revenue recognition rules. For example, revenue associated with large turnkey network improvement projects, which include projects that are funded by the CAF2 program, is generally deferred until customer acceptance is received and may be subject to delays, rework requirements and unexpected costs, among other uncertainties. Certain government-funded contracts, such as those funded by U.S. Department of Agriculture’s RUS, also include acceptance and administrative requirements that delay revenue recognition. The extent of these delays and their impact on our revenue can fluctuate considerably depending on the number and size of purchase orders under these contracts for a given time period. In addition, unanticipated decreases in our available liquidity due to fluctuating operating results could limit our growth and delay implementation of our expansion plans.
In addition to the other risk factors listed in this “Risk Factors” section, factors that have in the past and may continue to contribute to the variability of our operating results include:
our ability to predict our revenue and reduce and control product costs;
our ability to increase our sales to larger CSPs globally;
the capital spending patterns of CSPs and any decrease or delay in capital spending by CSPs due to macro-economic conditions, regulatory uncertainties or other reasons;
the impact of government-sponsored programs on our customers;
intense competition;
our ability to develop new products or enhancements that support technological advances and meet changing CSP requirements;
our ability to achieve market acceptance of our products and CSPs’ willingness to deploy our new products;
the concentration of our customer base;
the length and unpredictability of our sales cycles and timing of orders;
our focus on CSPs with limited revenue potential;
our lack of long-term, committed-volume purchase contracts with our customers;
our exposure to the credit risks of our customers;
fluctuations in our gross margins;
the interoperability of our products with CSP networks;
our dependence on sole-, single- and limited-source suppliers;
our ability to manage our relationships with our third-party vendors, including contract manufacturers, ODMs, logistics providers, component suppliers and development partners;
our ability to forecast our manufacturing requirements and manage our inventory;
our products’ compliance with industry standards;
our ability to expand our international operations;
our ability to protect our intellectual property and the cost of doing so;
the quality of our products, including any undetected hardware defects or bugs in our software;
our ability to estimate future warranty obligations due to product failure rates;
our ability to obtain necessary third-party technology licenses at reasonable costs;
the regulatory and physical impacts of climate change and other natural events;
the attraction and retention of qualified employees and key management personnel;
our ability to build and sustain the proper information technology infrastructure; and
our ability to maintain proper and effective internal controls.
Our gross margins may fluctuate over time, and our current level of gross margins may not be sustainable.
Our current level of gross margins may not be sustainable and may be adversely affected by numerous factors, including:
changes in customer, geographic or product mix, including the mix of configurations within each product group;
increased price competition, including the impact of customer discounts and rebates;
our ability to reduce and control product costs;
an increase in revenue mix toward services, which typically have lower margins;
changes in component pricing;
changes in contract manufacturer rates;
charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand;
introduction of new products;
our ability to scale our services business in order to gain desired efficiencies;
changes in shipment volume;
changes in or increased reliance on distribution channels;
potential liabilities associated with increased reliance on third-party vendors;
increased expansion efforts into new or emerging markets;
increased warranty costs;
excess and obsolete inventory and inventory holding charges;
expediting costs incurred to meet customer delivery requirements; and

28

Table of Contents

potential costs associated with contractual liquidated damages obligations.
An increase in revenue mix towards services will adversely affect our gross margins.
Customers are demanding greater professional and support services for our products, which usually have a lower gross margin than product purchases. In particular, we have experienced increased demand for professional services associated with network improvement projects, which typically are turnkey projects whereby we supply products and related professional services such as network planning, product installation, testing and network turn up. Revenue recognized from such professional services may be delayed because of the timing of completion and acceptance of a project or milestone, including third-party delays that may be outside our control. Additionally, if we are unable to meet project deadlines for professional and support services due to our suppliers’ inability to meet our demands for components or for any other reasons, we will incur additional costs, including higher premiums to source necessary components, additional costs and expedited fees to meet project deadlines, all of which would negatively impact our gross margins. We also rely upon third-party subcontractors to assist with some of our services projects, which generally result in higher costs and increased risk of cost overruns, including expenditures for costly rework, which would also negatively impact our gross margins. Furthermore, we incurred ramp up costs to grow our professional service business to meet customer demand, but we may not achieve the desired efficiencies and scale in our professional services business, which will have an adverse impact on our gross margins. Increases in professional services as a proportion of our revenue mix have resulted in lower overall gross margins and may continue to result in lower overall gross margins in future periods. This negative impact on gross margins is exacerbated in periods where we experience accelerated levels of activity to meet project requirements and customer deadlines. Moreover, the increase in our professional services projects has resulted in increased deferred costs, including costs directly associated with the delivery of the professional services for the arrangement, that are recognized as cost of revenue only when all revenue recognition criteria are met for the arrangement. In the event some or all of such deferred costs are deemed unrecoverable, including as a result of cost overruns, we will incur additional charges to cost of revenue in the period such deferred costs are determined to be unrecoverable. Any charge to cost of revenue for deferred costs determined to be unrecoverable would negatively impact our gross margins.
Our business is dependent on the capital spending patterns of CSPs, and any decrease or delay in capital spending by CSPs in response to economic conditions, uncertainties associated with the implementation of regulatory reform, or otherwise would reduce our revenue and harm our business.
Demand for our products depends on the magnitude and timing of capital spending by CSPs as they construct, expand, upgrade and maintain their access networks. Any future economic downturn may cause a slowdown in telecommunications industry spending, including in the specific geographies and markets in which we operate. In response to reduced consumer spending, challenging capital markets or declining liquidity trends, capital spending for network infrastructure projects of CSPs could be delayed or canceled. In addition, capital spending is cyclical in our industry, sporadic among individual CSPs and can change on short notice. As a result, we may not have visibility into changes in spending behavior until nearly the end of a given quarter.
CSP spending on network construction, maintenance, expansion and upgrades is also affected by reductions in their budgets, delays in their purchasing cycles, access to external capital (such as government grants and loan programs or the capital markets), and seasonality and delays in capital allocation decisions. For example, our CSP customers tend to spend less in the first quarter as they are still finalizing their annual budgets and in certain regions customers are also challenged by winter weather conditions that inhibit fiber deployment in outside plants. Also, softness in demand across any of our customer markets, including due to macro-economic conditions beyond our control or uncertainties associated with the implementation of regulatory reform, has in the past and could in the future lead to unexpected slowdown in capital expenditures by service providers.
Many factors affecting our results of operations are beyond our control, particularly in the case of large CSP orders and network infrastructure deployments involving multiple vendors and technologies where the achievement of certain thresholds for acceptance is subject to the readiness and performance of the CSP or other providers and changes in CSP requirements or installation plans. Further, CSPs may not pursue infrastructure upgrades that require our access systems and software. Infrastructure improvements may be delayed or prevented by a variety of factors including cost, regulatory obstacles (including uncertainties associated with the implementation of regulatory reforms), mergers, lack of consumer demand for advanced communications services and alternative approaches to service delivery. Reductions in capital expenditures by CSPs, particularly CSPs that are significant customers, may have a material negative impact on our revenue and results of operations and slow our rate of revenue growth. As a consequence, our results for a particular period may be difficult to predict, and our prior results are not necessarily indicative of results in future periods.
Government-sponsored programs could impact the timing and buying patterns of CSPs, which may cause fluctuations in our operating results.
We sell to CSPs, which include U.S.-based Independent Operating Companies (“IOCs”), which have revenue that is particularly dependent upon interstate and intrastate access charges and federal and state subsidies. The FCC and some states may consider changes to such payments and subsidies, and these changes could reduce IOC revenue. Furthermore, many IOCs use or expect to use government-supported loan programs or grants, such as RUS loans and grants, to finance capital spending. Changes to these programs, including uncertainty from government and administrative change, could reduce the ability of IOCs to access capital and thus reduce our revenue opportunities.
Many of our customers were awarded grants or loans under government stimulus programs such as the Broadband Stimulus (“BBS”) programs under the American Recovery and Reinvestment Act of 2009 (“ARRA”) and the funds distributed under the FCC’s Connect America Fund (“CAF”) program, and have purchased and will continue to purchase products from us or other suppliers while such programs

29

Table of Contents

and funding are available. However, customers may substantially curtail future purchases of products as ARRA funding winds down or because all purchases have been completed.
In addition, any changes in government regulations and subsidies could cause our customers to change their purchasing decisions, which could have an adverse effect on our operating results and financial condition.
We face intense competition that could reduce our revenue and adversely affect our financial results.
The market for our products is highly competitive, and we expect competition from both established and new companies to increase. Our competitors include companies such as ADTRAN, Inc., Alcatel-Lucent S.A. (now part of Nokia), Arris Group, Inc., Ciena Corporation, Huawei Technologies Co. Ltd., ZTE Corporation and DASAN Zhone Solutions, Inc., among others.
Our ability to compete successfully depends on a number of factors, including:
the successful development of new products;
our ability to anticipate CSP and market requirements and changes in technology and industry standards;
our ability to differentiate our products from our competitors’ offerings based on performance, cost-effectiveness or other factors;
our ongoing ability to successfully integrate acquired product lines and customer bases into our business;
our ability to meet increased customer demand for professional services associated with network improvement projects;
our ability to gain customer acceptance of our products; and
our ability to market and sell our products.
The broadband access equipment market has undergone and continues to undergo consolidation, as participants have merged, made acquisitions or entered into partnerships or other strategic relationships with one another to offer more comprehensive solutions than they individually had offered. Examples include our acquisitions of Occam in February 2011 and Ericsson’s fiber access assets in November 2012; Adtran’s acquisition of Nokia Siemens’s broadband access line business in May 2012; Arris’ acquisitions of BigBand Networks in October 2011, Motorola Mobility’s Home Unit from Google in December 2012 and Pace plc in January 2016; Nokia’s acquisition of Alcatel-Lucent in January 2016; and the merger of DASAN Zhone Solutions with DASAN Network Solutions in September 2016. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry.
Many of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do and are better positioned to acquire and offer complementary products and services. Many of our competitors have broader product lines and can offer bundled solutions, which may appeal to certain customers. Our competitors may also invest additional resources in developing more compelling product offerings. Potential customers may also prefer to purchase from their existing suppliers rather than a new supplier, regardless of product performance or features, because the products that we and our competitors offer require a substantial investment of time and funds to install.
Some of our competitors may offer substantial discounts or rebates to win new customers or to retain existing customers. If we are forced to reduce prices in order to secure customers, we may be unable to sustain gross margins at desired levels or achieve profitability. Competitive pressures could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which could reduce our revenue and adversely affect our financial results.
Product development is costly and if we fail to develop new products or enhancements that meet changing CSP requirements, we could experience lower sales.
Our industry is characterized by rapid technological advances, frequent new product introductions, evolving industry standards and unanticipated changes in subscriber requirements. Our future success will depend significantly on our ability to anticipate and adapt to such changes, and to offer, on a timely and cost-effective basis, products and features that meet changing CSP demands and industry standards. We intend to continue making significant investments in developing new products and enhancing the functionality of our existing products. Developing our products is expensive and complex and involves uncertainties. We may not have sufficient resources to successfully manage lengthy product development cycles. For the years ended December 31, 2016, 2015, and 2014, our research and development expenses were $106.9 million or 23% of our revenue, $89.7 million or 22% of our revenue, and $80.3 million or 20% of our revenue, respectively. For the first nine months of 2017, our research and development expenses were $99.4 million or 27% of our revenue. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts, including increased reliance on third-party development partners, to maintain our competitive position. These investments may take several years to generate positive returns, if ever. In addition, we may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements. If we fail to meet our development targets, demand for our products will decline.
In addition, the introduction of new or enhanced products also requires that we manage the transition from older products to these new or enhanced products in order to minimize disruption in customer ordering patterns, fulfill ongoing customer commitments and ensure that adequate supplies of new products are available for delivery to meet anticipated customer demand. If we fail to maintain compatibility with other software or equipment found in our customers’ existing and planned networks, we may face substantially reduced demand for our products, which would reduce our revenue opportunities and market share. Moreover, as customers complete infrastructure deployments, they may require greater levels of service and support than we have provided in the past. We may not be able to provide products, services and support to compete effectively for these market opportunities. If we are unable to anticipate and develop new products or enhancements to our existing products on a timely and cost-effective basis, we could experience lower sales, which would harm our business.

30

Table of Contents

Our new products are early in their life cycles and subject to uncertain market demand. If our customers are unwilling to install our new products or deploy our new services, or we are unable to achieve market acceptance of our new products, our business and financial results will be harmed.
Our new products are early in their life cycles and subject to uncertain market demand. They also may face obstacles in manufacturing, deployment and competitive response. Potential customers may choose not to invest the additional capital required for initial system deployment of new products. In addition, demand for new products is dependent on the success of our customers in deploying and selling advanced services to their subscribers. Our products support a variety of advanced broadband services, such as high-speed Internet, Internet protocol television, mobile broadband, high-definition video and online gaming. If subscriber demand for such services does not grow as expected or declines or our customers are unable or unwilling to deploy and market these services, demand for our products may decrease or fail to grow at rates we anticipate.
Our customer base is concentrated, and there are a limited number of potential customers for our products. The loss of any of our key customers, a decrease in purchases by our key customers or our inability to grow our customer base would adversely impact our revenue and results of operations and any delays in payment by a key customer could negatively impact our cash flows and working capital.
Historically, a large portion of our sales has been to a limited number of customers. For example, one customer accounted for 21%, 22% and 23% of our revenue for the years ended December 31, 2016, 2015 and 2014, respectively, and another customer accounted for 15% of our revenue for the year ended December 31, 2016. However, we cannot anticipate the level of purchases in the future by these customers. Customer purchases may be delayed or impacted due to financial difficulties, spending cuts or corporate consolidations. For example, one of our key customers recently completed a large acquisition, which may disrupt its normal expenditure plans, including possible delays or reduction in purchases of our products and services. Any decrease or delay in purchases and/or capital expenditure plans of any of our key customers, or our inability to grow our sales with existing customers, may have a material negative impact on our revenue and results of operations.
We anticipate that a large portion of our revenue will continue to depend on sales to a limited number of customers. In addition, some larger customers may demand discounts and rebates or desire to purchase their access systems and software from multiple providers. As a result of these factors, our future revenue opportunities may be limited, our margins could be reduced, and our profitability may be adversely impacted. The loss of, or reduction in, orders from any key customer would significantly reduce our revenue and harm our business. Furthermore, delays in payment and/or extended payment terms from any of our key or larger customers could have a material negative impact on our cash flows and working capital to support our business operations.
Furthermore, in recent years, the CSP market has undergone substantial consolidation. Industry consolidation generally has negative implications for equipment suppliers, including a reduction in the number of potential customers, a decrease in aggregate capital spending and greater pricing leverage on the part of CSPs over equipment suppliers. Continued consolidation of the CSP industry and among the ILEC and IOC customers, who represent a large part of our business, could make it more difficult for us to grow our customer base, increase sales of our products and maintain adequate gross margins.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.
The timing of our revenue is difficult to predict. Our sales efforts often involve educating CSPs about the use and benefits of our products. CSPs typically undertake a significant evaluation process, which frequently involves not only our products but also those of our competitors and results in a lengthy sales cycle. Sales cycles for larger customers are relatively longer and require considerably more time and expense. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce sales. In addition, product purchases are frequently subject to budget constraints, multiple approvals and unplanned administrative, processing and other delays. The timing of revenue related to sales of products and services that have installation requirements may be difficult to predict due to interdependencies that may be beyond our control, such as CSP testing and turn-up protocols or other vendors’ products, services or installations of equipment upon which our products and services rely. In addition, larger projects may have longer periods between project commencement and completion and recognition of revenue. Such delays may result in fluctuations in our quarterly revenue. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, we may not achieve our revenue forecasts and our financial results would be adversely affected.
Our focus on CSPs with relatively small networks limits our revenue from sales to any one customer and makes our future operating results difficult to predict.
A large portion of our sales efforts continue to be focused on CSPs with relatively small networks, MSOs and selected international CSPs. Our current and potential customers generally operate small networks with limited capital expenditure budgets. Accordingly, we believe the potential revenue from the sale of our products to any one of these customers is limited. As a result, we must identify and sell products to new customers each quarter to continue to increase our sales. In addition, the spending patterns of many of our customers are characterized by small and sporadic purchases. As a consequence, we have limited backlog and will likely continue to have limited visibility into future operating results.

31

Table of Contents

We do not have long-term, committed-volume purchase contracts with our customers, and therefore have no guarantee of future revenue from any customer.
We typically have not entered into long-term, committed-volume purchase contracts with our customers, including our key customers which account for a material portion of our revenue. As a result, any of our customers may cease to purchase our products at any time. In addition, our customers may attempt to renegotiate terms of sale, including price and quantity. If any of our key customers stop purchasing our access platforms, systems and software for any reason, our business and results of operations would be harmed.
Our efforts to increase our sales to CSPs globally, including MSOs, may be unsuccessful.
Our sales and marketing efforts have been focused on CSPs in North America. Part of our long-term strategy is to increase sales to CSPs globally, including MSOs. We have devoted and continue to devote substantial technical, marketing and sales resources to the pursuit of these larger CSPs, who have lengthy equipment qualification and sales cycles, without any assurance of generating sales. In particular, sales to these larger CSPs may require us to upgrade our products to meet more stringent performance criteria and interoperability requirements, develop new customer-specific features or adapt our product to meet international standards. For example, we have been invited by a large CSP to engage in initial testing and laboratory trials for our NG-PON2 technology along with our partner Ericsson. We have invested and expect to continue to invest considerable time, effort and expenditures, including investment in product research and development, related to this opportunity without any assurance that our efforts will produce orders or revenue. If we are unable to successfully increase our sales to larger CSPs, our operating results, financial condition, cash flows and long-term growth may be negatively impacted.
We are exposed to the credit risks of our customers; if we have inadequately assessed their creditworthiness, we may have more exposure to accounts receivable risk than we anticipate. Failure to collect our accounts receivable in amounts that we anticipate could adversely affect our operating results and financial condition.
In the course of our sales to customers, we may encounter difficulty collecting accounts receivable and could be exposed to risks associated with uncollectible accounts receivable. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability or unwillingness of our customers to make required payments. However, these allowances are based on our judgment and a variety of factors and assumptions.
We perform credit evaluations of our customers’ financial condition. However, our evaluation of the creditworthiness of customers may not be accurate if they do not provide us with timely and accurate financial information, or if their situations change after we evaluate their credit. While we attempt to monitor these situations carefully, adjust our allowances for doubtful accounts as appropriate and take measures to collect accounts receivable balances, we have written down accounts receivable and written off doubtful accounts in prior periods and may be unable to avoid additional write-downs or write-offs of doubtful accounts in the future. Such write-downs or write-offs could negatively affect our operating results for the period in which they occur, and could harm our financial condition.
Our products must interoperate with many software applications and hardware products found in our customers’ networks. If we are unable to ensure that our products interoperate properly, our business would be harmed.
Our products must interoperate with our customers’ existing and planned networks, which often have varied and complex specifications, utilize multiple protocol standards, include software applications and products from multiple vendors and contain multiple generations of products that have been added over time. As a result, we must continually ensure that our products interoperate properly with these existing and planned networks. To meet these requirements, we must undertake development efforts that require substantial capital investment and employee resources. We may not accomplish these development goals quickly or cost-effectively, if at all. If we fail to maintain compatibility with other software or equipment found in our customers’ existing and planned networks, we may face substantially reduced demand for our products, which would reduce our revenue opportunities and market share.
We have entered into interoperability arrangements with a number of equipment and software vendors for the use or integration of their technology with our products. These arrangements give us access to and enable interoperability with various products that we do not otherwise offer. If these relationships fail, we may have to devote substantially more resources to the development of alternative products and processes and our efforts may not be as effective as the combined solutions under our current arrangements. In some cases, these other vendors are either companies that we compete with directly or companies that have extensive relationships with our existing and potential customers and may have influence over the purchasing decisions of those customers. Some of our competitors have stronger relationships with some of our existing and other potential interoperability partners, and as a result, our ability to have successful interoperability arrangements with these companies may be harmed. Our failure to establish or maintain key relationships with third-party equipment and software vendors may harm our ability to successfully sell and market our products.
The quality of our support and services offerings is important to our customers, and if we fail to continue to offer high quality support and services, we could lose customers, which would harm our business.
Once our products are deployed within our customers’ networks, they depend on our support organization to resolve any issues relating to those products. A high level of support is critical for the successful marketing and sale of our products. Furthermore, our services to customers have increasingly broadened to include network design and services to deploy our products within our customers’ networks, such as our professional services associated with turnkey network improvement projects for our customers. If we do not effectively assist our customers in deploying our products, succeed in helping them quickly resolve post-deployment issues or provide effective ongoing support, it could adversely affect our ability to sell our products to existing customers and harm our reputation with potential new customers. As a result, our failure to maintain high quality support and services could result in the loss of customers, which would harm our business.

32

Table of Contents

Our products are highly technical and may contain undetected hardware defects or software bugs, which could harm our reputation and adversely affect our business.
Our products are highly technical and, when deployed, are critical to the operation of many networks. Our products have contained and may contain undetected defects, bugs or security vulnerabilities. Some defects in our products may only be discovered after a product has been installed and used by customers, and may in some cases only be detected under certain circumstances or after extended use. Any errors, bugs, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty and retrofit costs, any of which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach of warranty. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
Our estimates regarding future warranty or product obligations may change due to product failure rates, shipment volumes, field service obligations and rework costs incurred in correcting product failures. If our estimates change, the liability for warranty or product obligations may be increased, impacting future cost of revenue.
Our products are highly complex, and our product development, manufacturing and integration testing may not be adequate to detect all defects, errors, failures and quality issues. Quality or performance problems for products covered under warranty could adversely impact our reputation and negatively affect our operating results and financial position. The development and production of new products with high complexity often involves problems with software, components and manufacturing methods. If significant warranty or other product obligations arise due to reliability or quality issues arising from defects in software, faulty components or improper manufacturing methods, our operating results and financial position could be negatively impacted by:
cost associated with fixing software or hardware defects;
high service and warranty expenses;
high inventory obsolescence expense;
delays in collecting accounts receivable;
payment of liquidated damages for performance failures; and
declining sales to existing customers.
We do not have manufacturing capabilities, and therefore we depend upon a small number of outside contract manufacturers. We do not have supply contracts with all of these contract manufacturers; consequently, our operations could be disrupted if we encounter problems with any of these contract manufacturers.
We do not have internal manufacturing capabilities, and rely upon a small number of contract manufacturers to build our products. In particular, we rely on Flex Ltd. for the manufacture of most of our products. Our reliance on a small number of contract manufacturers makes us vulnerable to possible capacity constraints and reduced control over component availability, delivery schedules, manufacturing yields and costs.
We do not have supply contracts with some of our contract manufacturers. Consequently, these contract manufacturers are not obligated to supply products to us for any specific period, in any specific quantity or at any certain price. In addition, we have limited control over our contract manufacturers’ quality systems and controls, and therefore may not be able to ensure levels of quality manufacture suitable for our customers.
The revenue that Flex and other contract manufacturers generate from our orders represent a relatively small percentage of those manufacturers’ overall revenue. As a result, fulfilling our orders may not be considered a priority if such manufacturers are constrained in their ability to fulfill all of their customer obligations in a timely manner. In addition, a substantial part of our manufacturing is done in our contract manufacturer facilities that are located outside of the United States. We believe that the location of these facilities outside of the United States increases supply risk, including the risk of supply interruptions or reductions in manufacturing quality or controls. Moreover, regulatory changes or government actions relating to export or import regulations, economic sanctions or related legislation, or the possibility of such changes or actions, may create uncertainty or result in changes to or disruption in our operations with our contract manufacturers.
If Flex or any of our other contract manufacturers were unable or unwilling to continue manufacturing our products in required volumes and at high quality levels, we would have to identify, qualify and select acceptable alternative contract manufacturers. An alternative contract manufacturer may not be available to us when needed or may not be in a position to satisfy our production requirements at commercially reasonable prices and quality. Any significant interruption in manufacturing would require us to reduce our supply of products to our customers, which in turn would reduce our revenue and harm our relationships with our customers.
We and our business partners, including our contract manufacturers and suppliers, depend on sole-source, single-source and limited-source suppliers for some key components. If we and our business partners are unable to source these components on a timely basis, we will not be able to deliver our products to our customers.
We and our business partners, including our contract manufacturers and suppliers, depend on sole-source, single-source and limited-source suppliers for some key components of our products. For example, certain of our application-specific integrated circuit processors and resistor networks are purchased from sole-source suppliers.

33

Table of Contents

Any of the sole-source, single-source and limited-source suppliers upon whom we or our business partners rely could stop producing our components, cease operations or enter into exclusive arrangements with our competitors. In addition, purchase volumes of such components may be too low for Calix to be considered a priority customer by these suppliers. As a result, these suppliers could stop selling to us and our business partners at commercially reasonable prices, or at all. Any such interruption or delay may force us and our business partners to seek similar components from alternative sources, which may not be available. Switching suppliers could also require that we redesign our products to accommodate new components, and could require us to re-qualify our products with our customers, which would be costly and time-consuming. Any interruption in the supply of sole-source, single-source or limited-source components for our products would adversely affect our ability to meet scheduled product deliveries to our customers, could result in lost revenue or higher expenses and would harm our business.
We utilize domestic and international third-party vendors to assist in the design, development and manufacture of certain of our products, and to provide logistics services in the distribution of our products. If these vendors fail to provide these services, we could incur additional costs and delays or lose revenue.
From time to time we enter into original design manufacturer (“ODM”), original equipment manufacturer (“OEM”) and development agreements for the design, development and/or manufacture of certain of our products in order to enable us to offer products on an accelerated basis. For example, a third party assisted in the design and currently manufactures portions of our E-series systems and nodes family. We also rely upon limited third party vendors for logistics services to distribute our products. If any of these third-party vendors stop providing their services, for any reason, we would have to obtain similar services from alternative sources, which may not be available on commercially reasonable terms, if at all. We also have limited control over disruptions that may occur at the facilities of these third party partners, such as supply interruptions or manufacturing quality that may occur at ODM and OEM facilities and strikes or systems failures that may interrupt transportation and logistics services. In addition, switching development firms or manufacturers could require us to extend our development timeline and/or re-qualify our products with our customers, which would also be costly and time-consuming. Any interruption in the development, supply or distribution of our products would adversely affect our ability to meet scheduled product deliveries to our customers, could result in lost revenue or higher costs, which would negatively impact our margins and operating results and harm our business.
If we fail to forecast our manufacturing requirements accurately or fail to properly manage our inventory with our contract manufacturers, we could incur additional costs, experience manufacturing delays and lose revenue.
We bear inventory risk under our contract manufacturing arrangements and our ODM and OEM agreements. Lead times for the materials and components that we order through our manufacturers vary significantly and depend on numerous factors, including the specific supplier, contract terms and market demand for a component at a given time. Lead times for certain key materials and components incorporated into our products are currently lengthy, requiring our manufacturers to order materials and components several months in advance of manufacture.
If we overestimate our production requirements, our manufacturers may purchase excess components and build excess inventory. If our manufacturers, at our request, purchase excess components that are unique to our products or build excess products, we could be required to pay for these excess parts or products and their storage costs. Historically, we have reimbursed our primary contract manufacturers for a portion of inventory purchases when our inventory has been rendered excess or obsolete. Examples of when inventory may be rendered excess or obsolete include manufacturing and engineering change orders resulting from design changes or in cases where inventory levels greatly exceed projected demand. If we incur payments to our manufacturers associated with excess or obsolete inventory, this would have an adverse effect on our gross margins, financial condition and results of operations.
We have experienced unanticipated increases in demand from customers, which resulted in delayed shipments and variable shipping patterns. If we underestimate our product requirements, our manufacturers may have inadequate component inventory, which could interrupt manufacturing of our products and result in delays or cancellation of sales.
As the market for our products evolves, changing customer requirements may adversely affect the valuation of our inventory.
Customer demand for our products can change rapidly in response to market and technology developments. Demand can be affected not only by customer- or market-specific issues, but also by broader economic and/or geopolitical factors. We may, from time to time, adjust inventory valuations downward in response to our assessment of demand from our customers for specific products or product lines.
If we fail to comply with evolving industry standards, sales of our existing and future products would be adversely affected.
The markets for our products are characterized by a significant number of standards, both domestic and international, which are evolving as new technologies are developed and deployed. As we expand into adjacent markets and increase our international footprint, we are likely to encounter additional standards. Our products must comply with these standards in order to be widely marketable. In some cases, we are compelled to obtain certifications or authorizations before our products can be introduced, marketed or sold in new markets or to customers that we have not historically served. For example, our ability to maintain Operations System Modification for Intelligent Network Elements (“OSMINE”) certification for our products will affect our ongoing ability to continue to sell our products to Tier 1 CSPs.
In addition, our ability to expand our international operations and create international market demand for our products may be limited by regulations or standards adopted by other countries that may require us to redesign our existing products or develop new products suitable for sale in those countries. Although we believe our products are currently in compliance with domestic and international standards and regulations in countries in which we currently sell, we may not be able to design our products to comply with evolving standards and regulations in the future. This ongoing evolution of standards may directly affect our ability to market or sell our products. Further, the cost of

34

Table of Contents

complying with the evolving standards and regulations or the failure to obtain timely domestic or foreign regulatory approvals or certification could prevent us from selling our products where these standards or regulations apply, which would result in lower revenue and lost market share.
We may be unable to successfully expand our international operations. In addition, we may be subject to a variety of international risks that could harm our business.
We currently generate most of our sales from customers in North America and have limited experience marketing, selling and supporting our products and services outside North America or managing the administrative aspects of a worldwide operation. Our ability to expand our international operations is dependent on our ability to create or maintain international market demand for our products. In addition, as we expand our operations internationally, our support organization will face additional challenges including those associated with delivering support, training and documentation in languages other than English. If we invest substantial time and resources to expand our international operations and are unable to do so successfully and in a timely manner, our business, financial condition and results of operations will suffer.
In the course of expanding our international operations and operating overseas, we will be subject to a variety of risks, including:
differing regulatory requirements, including tax laws, trade laws, data privacy laws, labor regulations, tariffs, export quotas, custom duties or other trade restrictions;
liability or damage to our reputation resulting from corruption or unethical business practices in some countries;
exposure to effects of fluctuations in currency exchange rates if, over time, international customer contracts are increasingly denominated in local currencies;
longer collection periods and difficulties in collecting accounts receivable;
greater difficulty supporting and localizing our products;
different or unique competitive pressures as a result of, among other things, the presence of local equipment suppliers;
challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement appropriate systems, policies and compensation, benefits and compliance programs;
limited or unfavorable intellectual property protection;
risk of change in international political or economic conditions, terrorist attacks or acts of war; and
restrictions on the repatriation of earnings.
We engage resellers to promote, sell, install and support our products to some customers in North America and internationally. Their failure to do so or our inability to recruit or retain appropriate resellers may reduce our sales and thus harm our business.
We engage some value added resellers (“VARs”), who provide sales and support services for our products. In particular, the non-exclusive reseller agreement entered into with Ericsson in 2012 has provided us with an extensive global reseller channel. More recently we have partnered with Ericsson on larger customer opportunities. We compete with other telecommunications systems providers for our VARs’ business and many of our VARs, including Ericsson, are free to market competing products. Our use of VARs and other third-party support partners and the associated risks of doing so are likely to increase as we expand sales outside of North America. If Ericsson or any other VAR promotes a competitor’s products to the detriment of our products or otherwise fails to market our products and services effectively, we could lose market share. In addition, the loss of a key VAR or the failure of VARs to provide adequate customer service could have a negative effect on customer satisfaction and could cause harm to our business. If we do not properly recruit and train VARs to sell, install and service our products, our business, financial condition and results of operations may suffer.
The results of the United Kingdom’s referendum on withdrawal from the European Union may have a negative effect on global economic conditions, financial markets and our business.
In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union in a national referendum. The referendum was advisory, and the terms of any withdrawal are subject to a negotiation period that could last at least two years after the government of the United Kingdom formally initiated the withdrawal process in March 2017. Nevertheless, the referendum has created significant uncertainty about the future relationship between the United Kingdom and the European Union, including with respect to the laws and regulations that will apply as the United Kingdom determines which European Union laws to replace or replicate in the event of a withdrawal. The referendum has also given rise to calls for the governments of other European Union member states to consider withdrawal. These developments, or the perception that any of them could occur, have had and may continue to have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global market liquidity and restrict the ability of key market participants to operate in certain financial markets. Any of these factors could depress economic activity and restrict our access to capital, or the access to capital of our customers or partners, which could have a material adverse effect on our business, financial condition and results of operations and reduce the price of our securities.
We may have difficulty evolving and scaling our business and operations to meet customer and market demand, which could result in lower profitability or cause us to fail to execute on our business strategies.
In order to grow our business, we believe we will need to continually evolve and scale our business and operations to meet customer and market demand. Evolving and scaling our business and operations places increased demands on our management as well as our financial and operational resources to effectively:
manage organizational change;

35

Table of Contents

manage a larger organization;
accelerate and/or refocus research and development activities;
expand our manufacturing, supply chain and distribution capacity;
increase our sales and marketing efforts;
broaden our customer-support and services capabilities;
maintain or increase operational efficiencies;
scale support operations in a cost-effective manner;
implement appropriate operational and financial systems; and
maintain effective financial disclosure controls and procedures.
If we cannot evolve and scale our business and operations effectively, we may not be able to execute our business strategies in a cost-effective manner and our business, financial condition, profitability and results of operations would be adversely affected.
We may not be able to protect our intellectual property, which could impair our ability to compete effectively.
We depend on certain proprietary technology for our success and ability to compete. We rely on intellectual property laws as well as nondisclosure agreements, licensing arrangements and confidentiality provisions to establish and protect our proprietary rights. U.S. patent, copyright and trade secret laws afford us only limited protection, and the laws of some foreign countries do not protect proprietary rights to the same extent. Our pending patent applications may not result in issued patents, and our issued patents may not be enforceable. Any infringement of our proprietary rights could result in significant litigation costs. Further, any failure by us to adequately protect our proprietary rights could result in our competitors offering similar products, resulting in the loss of our competitive advantage and decreased sales.
Despite our efforts to protect our proprietary rights, attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we may be unable to protect our proprietary rights against unauthorized third-party copying or use. Furthermore, policing the unauthorized use of our intellectual property is difficult and costly. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs, diversion of resources and harm to our business.
We could become subject to litigation regarding intellectual property rights that could harm our business.
We may be subject to intellectual property infringement claims that are costly to defend and could limit our ability to use some technologies in the future. Third parties may assert patent, copyright, trademark or other intellectual property rights to technologies or rights that are important to our business. Such claims may originate from non-practicing entities, patent holding companies or other adverse patent owners who have no relevant product revenue, and therefore, our own issued and pending patents may provide little or no deterrence to suit from these entities.
We have received in the past and expect that in the future we may receive communications from competitors and other companies alleging that we may be infringing their patents, trade secrets or other intellectual property rights; offering licenses to such intellectual property; threatening litigation or requiring us to act as a third-party witness in litigation. In addition, we have agreed, and may in the future agree, to indemnify our customers for expenses or liabilities resulting from certain claimed infringements of patents, trademarks or copyrights of third parties. Such indemnification may require us to be financially responsible for claims made against our customers, including costs of litigation and damages awarded, which could negatively impact our results of operations. Any claims asserting that our products infringe the proprietary rights of third parties, with or without merit, could be time-consuming, result in costly litigation and divert the efforts of our engineering teams and management. These claims could also result in product shipment delays or require us to modify our products or enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available to us on acceptable terms, if at all.
Our use of open source software could impose limitations on our ability to commercialize our products.
We incorporate open source software into our products. Although we closely monitor our use of open source software, the terms of many open source software licenses have not been interpreted by the courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to sell our products. In such event, we could be required to make our proprietary software generally available to third parties, including competitors, at no cost, to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event re-engineering cannot be accomplished on a timely basis or at all, any of which could adversely affect our revenue and operating expenses.
If we are unable to obtain necessary third-party technology licenses, our ability to develop new products or product enhancements may be impaired.
While our current licenses of third-party technology generally relate to commercially available off-the-shelf technology, we may from time to time be required to license additional technology from third parties to develop new products or product enhancements. These third-party licenses may be unavailable to us on commercially reasonable terms, if at all. Our inability to obtain necessary third-party licenses may force us to obtain substitute technology of lower quality or performance standards or at greater cost, or may increase the time-to-market of our products or product enhancements, any of which could harm the competitiveness of our products and result in lost revenue.

36

Table of Contents

Our ability to incur debt and the use of our funds could be limited by borrowing base restrictions and restrictive covenants in our loan and security agreement for our revolving credit facility.
The Loan and Security Agreement we entered into in August 2017 with Silicon Valley Bank (“Loan Agreement”) provides for a revolving credit facility based on a customary accounts receivable borrowing base, subject to certain exceptions and exclusions, such that borrowings available to us are limited by eligible accounts receivable (as defined in the Loan Agreement). If our financial position deteriorates our borrowing capacity under the credit facility may be reduced. In addition, the Loan Agreement includes affirmative and negative covenants and requires that we maintain a specified minimum liquidity ratio. The negative covenants also include, among others, restrictions on our and our subsidiaries’ transferring collateral, making changes to the nature of our business or the business of the applicable subsidiary, incurring additional indebtedness, engaging in mergers or acquisitions, paying dividends or making other distributions, making investments, engaging in transactions with affiliates, making payments in respect of subordinated debt, creating liens and selling assets, in each case subject to certain exceptions. Failure to maintain these restrictive covenants and requirements can limit the amount of borrowings that are available to us, increase the cost of borrowings under the facility or require us to make immediate payments to reduce borrowings. The Loan Agreement covenants may also affect our ability to obtain future financing and to pursue attractive business opportunities and our flexibility in planning for, and reacting to, changes in business conditions. These covenants could place us at a disadvantage compared to some of our competitors, who may have fewer restrictive covenants and may not be required to operate under these restrictions.
Our failure or the failure of our manufacturers to comply with environmental and other legal regulations could adversely impact our results of operations.
The manufacture, assembly and testing of our products may require the use of hazardous materials that are subject to environmental, health and safety regulations, or materials subject to laws restricting the use of conflict minerals. Our failure or the failure of our contract manufacturers, ODMs and OEMs to comply with any of these requirements could result in regulatory penalties, legal claims or disruption of production. In addition, our failure or the failure of our manufacturers to properly manage the use, transportation, emission, discharge, storage, recycling or disposal of hazardous materials could subject us to increased costs or liabilities. Existing and future environmental regulations and other legal requirements may restrict our use of certain materials to manufacture, assemble and test products. Any of these consequences could adversely impact our results of operations by increasing our expenses and/or requiring us to alter our manufacturing processes.
Regulatory and physical impacts of climate change and other natural events may affect our customers and our contract manufacturers, resulting in adverse effects on our operating results.
As emissions of greenhouse gases continue to alter the composition of the atmosphere, affecting large-scale weather patterns and the global climate, any new regulation of greenhouse gas emissions may result in additional costs to our customers and our contract manufacturers. In addition, the physical impacts of climate change and other natural events, including changes in weather patterns, drought, rising ocean and temperature levels, earthquakes and tsunamis may impact our customers, suppliers and contract manufacturers, and our operations. These potential physical effects may adversely affect our revenue, costs, production and delivery schedules, and cause harm to our results of operations and financial condition.
We have in the past pursued, and may in the future continue to pursue, acquisitions which involve a number of risks and uncertainties. If we are unable to address and resolve these risks and uncertainties successfully, such acquisitions could disrupt our business and result in higher costs than we anticipate.
We acquired Occam Networks in 2011 and Ericsson’s fiber access assets in 2012. We may in the future acquire other businesses, products or technologies to expand our product offerings and capabilities, customer base and business. We have evaluated and expect to continue to evaluate a wide array of potential strategic transactions. We have limited experience making such acquisitions or integrating these businesses after such acquisitions. Unanticipated costs to us from these historical transactions as well as both anticipated and unanticipated costs to us related to any future transactions could exceed amounts that are covered by insurance and could have a material adverse impact on our financial condition and results of operations. For example, the Occam acquisition resulted in litigation with defense costs that were in excess of available directors and officers liability insurance coverage, including costs for which coverage was denied by our insurance carriers. In addition, the anticipated benefit of any acquisitions may never materialize or the process of integrating acquired businesses, products or technologies may create unforeseen operating difficulties and expenditures.
Some of the areas where we have experienced and may in the future experience acquisition-related risks include:
expenses and distractions, including diversion of management time related to litigation;
expenses and distractions related to potential claims resulting from any possible future acquisitions, whether or not they are completed;
retaining and integrating employees from acquired businesses;
issuance of dilutive equity securities or incurrence of debt;
integrating various accounting, management, information, human resource and other systems to permit effective management;
incurring possible write-offs, impairment charges, contingent liabilities, amortization expense of intangible assets or impairment of goodwill and intangible assets with finite useful lives;
difficulties integrating and supporting acquired products or technologies;
unexpected capital expenditure requirements;
insufficient revenue to offset increased expenses associated with acquisitions; and
opportunity costs associated with committing capital to such acquisitions.

37

Table of Contents

If our goodwill or intangible assets with finite useful lives become impaired, we may be required to record a significant charge to earnings. We review our goodwill and intangible assets with finite useful lives for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a sustained or significant decline in stock price and market capitalization. We test goodwill for impairment at least annually. If the carrying values of such assets were deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the estimated fair value would be recognized. Any such impairment could materially and adversely affect our financial condition and results of operations.
Foreign acquisitions would involve risks in addition to those mentioned above, including those related to integration of operations across different cultures and languages, currency risks and the particular economic, political and regulatory risks associated with specific countries. We may not be able to address these risks and uncertainties successfully, or at all, without incurring significant costs, delays or other operating problems.
Our inability to address or anticipate any of these risks and uncertainties could disrupt our business and could have a material impact on our financial condition and results of operations.
Our use of and reliance upon development resources in China may expose us to unanticipated costs or liabilities.
We operate a wholly foreign owned enterprise in Nanjing, China, where a dedicated team of engineers performs product development, quality assurance, cost reduction and other engineering work. We also outsource a portion of our software development to a team of software engineers based in Shenyang, China. Our reliance upon development resources in China may not enable us to achieve meaningful product cost reductions or greater resource efficiency. Further, our development efforts and other operations in China involve significant risks, including:
difficulty hiring and retaining appropriate engineering resources due to intense competition for such resources and resulting wage inflation;
the knowledge transfer related to our technology and exposure to misappropriation of intellectual property or confidential information, including information that is proprietary to us, our customers and third parties;
heightened exposure to changes in the economic, security and political conditions of China;
fluctuation in currency exchange rates and tax risks associated with international operations;
development efforts that do not meet our requirements because of language, cultural or other differences associated with international operations, resulting in errors or delays; and
uncertainty with regards to actions the Trump administration may take with respect to international trade agreements and U.S. tax provisions related to international commerce that could adversely affect our international operations.
Difficulties resulting from the factors above and other risks related to our operations in China could expose us to increased expense, impair our development efforts, harm our competitive position and damage our reputation.
Our customers are subject to government regulation, and changes in current or future laws or regulations that negatively impact our customers could harm our business.
The FCC has jurisdiction over all of our U.S. customers. FCC regulatory policies that create disincentives for investment in access network infrastructure or impact the competitive environment in which our customers operate may harm our business. For example, future FCC regulation affecting providers of broadband Internet access services could impede the penetration of our customers into certain markets or affect the prices they may charge in such markets. Similarly, changes to regulatory tariff requirements or other regulations relating to pricing or terms of carriage on communication networks could slow the development or expansion of network infrastructures. Consequently, such changes could adversely affect the sale of our products and services. Furthermore, many of our customers are subject to FCC rate regulation of interstate telecommunications services and are recipients of CAF capital incentive payments, which are intended to subsidize broadband and telecommunications services in areas that are expensive to serve. Changes to these programs, rules and regulations that could affect the ability of IOCs to access capital, and which could in turn reduce our revenue opportunities, remain possible.
In addition, many of our customers are subject to state regulation of intrastate telecommunications services, including rates for such services, and may also receive funding from state universal service funds. Changes in rate regulations or universal service funding rules, either at the U.S. federal or state level, could adversely affect our customers’ revenue and capital spending plans. Moreover, various international regulatory bodies have jurisdiction over certain of our non-U.S. customers. Changes in these domestic and international standards, laws and regulations, or judgments in favor of plaintiffs in lawsuits against CSPs based on changed standards, laws and regulations could adversely affect the development of broadband networks and services. This, in turn, could directly or indirectly adversely impact the communications industry in which our customers operate.
Many jurisdictions, including international governments and regulators, are also evaluating, implementing and enforcing regulations relating to cyber security, privacy and data protection, which can affect the market and requirements for networking and communications equipment. To the extent our customers are adversely affected by laws or regulations regarding their business, products or service offerings, our business, financial condition and results of operations would suffer.
Privacy concerns relating to our products and services could affect our business practices, damage our reputation and deter customers from purchasing our products and services.
Government and regulatory authorities in the United States and around the world have implemented and are continuing to implement laws and regulations concerning data protection. For example, in July 2016, the European Commission adopted the EU-U.S. Privacy Shield to

38

Table of Contents

replace Safe Harbor as a compliance mechanism for the transfer of personal data from the European Union to the United States. In addition, the General Data Protection Regulation adopted by the EU Parliament goes into effect in May 2018 to harmonize data privacy laws across Europe. The interpretation and application of these data protection laws and regulations are often uncertain and in flux, and it is possible that they may be interpreted and applied in a manner that is inconsistent with our data practices. Complying with these various laws could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business.
Concerns about or regulatory actions involving our practices with regard to the collection, use, disclosure, or security of customer information or other privacy related matters, even if unfounded, could damage our reputation and adversely affect operating results. While we strive to comply with all data protection laws and regulations, the failure or perceived failure to comply may result in inquiries and other proceedings or actions against us by government entities or others, or could cause us to lose customers, which could potentially have an adverse effect on our business.
We are subject to cybersecurity and privacy risks.
Our information systems and data centers (including third-party data centers) contain sensitive information that help us operate our business efficiently, interface with and provide software solutions to customers, maintain financial accuracy and accurately produce our financial statements. In addition, we host sensitive data in data centers, including subscriber data, in the course of providing services and solutions to customers. Malicious hackers may attempt to gain access to our network or data centers; steal proprietary information related to our business, products, employees, and customers; or interrupt our systems and services or those of our customers or others. The theft, loss, or misuse of personal data collected, used, stored or transferred by us to run our business could result in significantly increased security and remediation costs or costs related to defending legal claims. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure, we could be subject to cyberattacks, transaction errors, processing inefficiencies, the loss of customers, business disruptions or the loss of or damage to intellectual property through security breaches. If our data management systems, including those of our third-party data centers, do not effectively and securely collect, store, process and report relevant data for the operation of our business, whether due to cyberattacks, equipment malfunction or constraints, software deficiencies or human error, our ability to effectively plan, forecast and execute our business plan and comply with laws and regulations will be impaired, perhaps materially. Any such impairment could materially and adversely affect our financial condition, results of operations, cash flows, the timeliness with which we internally and externally report our operating results and our business and reputation.
While we have applied multiple layers of security to control access to our information technology systems and use encryption and authentication technologies to secure the transmission and storage of data, these security measures may be compromised as a result of third-party security breaches, employee error, malfeasance, faulty password management or other irregularity, and result in persons obtaining unauthorized access to our data or accounts. Third parties may attempt to fraudulently induce employees into disclosing user names, passwords or other sensitive information, which may in turn be used to access our information technology systems.
While we seek to apply best practice policies and devote significant resources to network security, data encryption and other security measures to protect our information technology and communications systems and data, these security measures cannot provide absolute security. We or our third-party hosting providers may experience a system breach and be unable to protect sensitive data. The costs to us to eliminate or alleviate network security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant, and our efforts to address these problems may not be successful and could result in unexpected interruptions, delays and cessation of service which may harm our business operations.
Although our systems have been designed around industry-standard architectures to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, cyberattacks, viruses, denial-of-service attacks, human error, hardware or software defects or malfunctions, and similar events or disruptions. Some of our systems are not fully redundant, and our disaster recovery planning is not sufficient for all eventualities. Our systems are also subject to break-ins, sabotage and intentional acts of vandalism. Despite any precautions we may take, the occurrence of a natural disaster, a decision by any of our third-party hosting providers to close a facility we use without adequate notice for financial or other reasons, a data breach or other unanticipated problems at our hosting facilities could cause system interruptions and delays which may result in loss of critical data and lengthy interruptions in our services.
We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in additional international markets.
Our products are subject to U.S. export and trade controls and restrictions. International shipments of certain of our products may require export licenses or are subject to additional requirements for export. In addition, the import laws of other countries may limit our ability to distribute our products, or our customers’ ability to buy and use our products, in those countries. Changes in our products or changes in export and import regulations or duties may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations, duties or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could negatively impact our ability to sell, profitably or at all, our products to existing or potential international customers.
If we lose any of our key personnel, or are unable to attract, train and retain qualified personnel, our ability to manage our business and continue our growth would be negatively impacted.
Our success depends, in large part, on the continued contributions of our key management, engineering, sales and marketing personnel, many of whom are highly skilled and would be difficult to replace. None of our senior management or key technical or sales personnel is

39

Table of Contents

bound by a written employment contract to remain with us for a specified period. In addition, we do not currently maintain key person life insurance covering our key personnel. If we lose the services of any key personnel, our business, financial condition and results of operations may suffer.
Competition for skilled personnel, particularly those specializing in engineering and sales, is intense. We cannot be certain that we will be successful in attracting and retaining qualified personnel, or that newly hired personnel will function effectively, both individually and as a group. In particular, we must continue to expand our direct sales force, including hiring additional sales managers, to grow our customer base and increase sales. If we are unable to effectively recruit, hire and utilize new employees, execution of our business strategy and our ability to react to changing market conditions may be impeded, and our business, financial condition and results of operations may suffer.
Volatility or lack of performance in our stock price may also affect our ability to attract and retain our key personnel. Our executive officers and employees hold a substantial number of shares of our common stock and vested stock options. Employees may be more likely to leave us if the shares they own or the shares underlying their equity awards decline in value, or if the exercise prices of stock options that they hold are significantly above the market price of our common stock. If we are unable to retain our employees, our business, operating results and financial condition will be harmed.
If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired, which would adversely affect our operating results, our ability to operate our business and our stock price.
Ensuring that we have adequate internal financial and accounting controls and procedures in place to produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We have in the past discovered, and may in the future, discover areas of our internal financial and accounting controls and procedures that need improvement.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our management does not expect that our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within our company will have been detected.
We are required to comply with Section 404 of the Sarbanes-Oxley Act (“SOX”), which requires us to expend significant resources in developing the required documentation and testing procedures. We cannot be certain that the actions we have taken and are taking to improve our internal controls over financial reporting will be sufficient to maintain effective internal controls over financial reporting in subsequent reporting periods or that we will be able to implement our planned processes and procedures in a timely manner. In addition, new and revised accounting standards and financial reporting requirements may occur in the future and implementing changes required by new standards, requirements or laws may require a significant expenditure of our management’s time, attention and resources which may adversely affect our reported financial results. If we are unable to produce accurate financial statements on a timely basis, investors could lose confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline and make it more difficult for us to finance our operations and growth.
We incur significant costs as a result of operating as a public company, which may adversely affect our operating results and financial condition.
As a public company, we incur significant accounting, legal and other expenses, including costs associated with our public company reporting requirements. We also anticipate that we will continue to incur costs associated with corporate governance requirements, including requirements and rules under SOX and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) among other rules and regulations implemented by the SEC, as well as listing requirements of the New York Stock Exchange (the “NYSE”). Furthermore, these laws and regulations could make it difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these requirements could also make it difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.
New laws and regulations as well as changes to existing laws and regulations affecting public companies, including the provisions of SOX and the Dodd-Frank Act and rules adopted by the SEC and the NYSE, would likely result in increased costs to us as we respond to their requirements. We continue to invest resources to comply with evolving laws and regulations, and this investment may result in increased general and administrative expense.
Risks Related to Ownership of Our Common Stock
Our stock price may continue to be volatile, and the value of an investment in our common stock may decline.
The trading price of our common stock has been, and is likely to continue to be, volatile, which means that it could decline substantially within a short period of time and could fluctuate widely in response to various factors, some of which are beyond our control. These factors include those discussed in the “Risk Factors” section of this Quarterly Report on Form 10-Q, and others such as:
quarterly variations in our results of operations or those of our competitors;
failure to meet any guidance that we have previously provided regarding our anticipated results;
changes in earnings estimates or recommendations by securities analysts;

40

Table of Contents

failure to meet securities analysts’ estimates;
announcements by us or our competitors of new products, significant contracts, commercial relationships, acquisitions or capital commitments;
developments with respect to intellectual property rights;
our ability to develop and market new and enhanced products on a timely basis;
our commencement of, or involvement in, litigation and developments relating to such litigation;
changes in governmental regulations; and
a slowdown in the communications industry or the general economy.
In recent years, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
If securities or industry analysts do not publish research or reports about our business or if they issue an adverse or misleading opinion regarding our stock, our stock price and trading volume could decline.
The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If any of the analysts who cover us issue an adverse or misleading opinion regarding our stock, our stock price would likely decline. If several of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable and may lead to entrenchment of our management and board of directors.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could have the effect of delaying or preventing changes in control or changes in our management or our board of directors. These provisions include:
a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;
no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;
the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquirer;
a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;
the requirement that a special meeting of stockholders may be called only by the chairman of the board of directors, the chief executive officer or the board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors; and
advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of us.
We are also subject to certain anti-takeover provisions under Delaware law. Under Delaware law, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction.
We may need additional capital in the future to finance our business.
We may need to raise additional capital to fund operations in the future. Although we believe that, based on our current level of operations and anticipated growth, our existing cash, cash equivalents, marketable securities and borrowings available under our Loan Agreement will provide adequate funds for ongoing operations, planned capital expenditures and working capital requirements for at least the next twelve months, our working capital needs and cash use have continued to increase to support our growth initiatives, and we may need additional capital if our current plans and assumptions change. If future financings involve the issuance of equity securities, our then-existing stockholders would suffer dilution. If we raise additional debt financing, we may be subject to restrictive covenants that limit our ability to conduct our business. If we are unable to generate positive operating income and positive cash flows from operations, our liquidity, results of operations and financial condition will be adversely affected. If we are unable to generate cash flows to support our operational needs, we may need to seek other sources of liquidity, including borrowings, to support our working capital needs. In addition, we may choose to seek other sources of liquidity even if we believe we have generated sufficient cash flows to support our operational needs. There is no assurance that any other sources of liquidity may be available to us on acceptable terms or at all. If we are unable to generate sufficient cash flows or

41

Table of Contents

obtain other sources of liquidity, we will be forced to limit our development activities, reduce our investment in growth initiatives and institute cost-cutting measures, all of which would adversely impact our business and growth.
We do not currently intend to pay dividends on our common stock and, consequently, our stockholders’ ability to achieve a return on their investment will depend on appreciation in the price of our common stock.
We do not currently intend to pay any cash dividends on our common stock for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Additionally, the terms of our credit facility restrict our ability to pay dividends under certain circumstances. Therefore, our stockholders are not likely to receive any dividends on our common stock for the foreseeable future.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Mine Safety Disclosures
Not applicable.
ITEM 5. Other Information
None.

42

Table of Contents

ITEM 6. Exhibits
Exhibit
Number
 
Description
 
 
10.1†
 
 
 
 
10.2*
 
 
 
 
10.3*
 
 
 
 
10.4*
 
 
 
 
10.5*
 
 
 
 
31.1
 
 
 
 
31.2
 
 
 
 
32.1
 
 
 
101.INS
 
XBRL Instance Document
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
† Confidential treatment has been requested for portions of this agreement.
* Indicates management contract or compensatory plan or arrangement.


43

Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
CALIX, INC.
(Registrant)
 
Date: November 8, 2017
By:
 
/s/ Carl Russo
 
 
 
Carl Russo
 
 
 
Chief Executive Officer
(Principal Executive Officer)
 
Date: November 8, 2017
By:
 
/s/ Cory Sindelar
 
 
 
Cory Sindelar
 
 
 
Chief Financial Officer
(Principal Financial Officer)
 
Date: November 8, 2017
By:
 
/s/ Sheila Cheung
 
 
 
Sheila Cheung
 
 
 
Vice President, Finance and Accounting
(Principal Accounting Officer)

44