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Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549 
 
FORM 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2017
OR
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: 001-37771
 
Acacia Communications, Inc.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
27-0291921
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
Three Mill and Main Place, Suite 400
Maynard, Massachusetts 01754
(Address of principal executive offices)
(978) 938-4896
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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
 
  
Accelerated filer
 ☐
 
 
 
 
 
 
Non-accelerated filer
 
☒  (Do not check if a small reporting company)
  
Small reporting company
 ☐
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 ☒
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.            ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐   No  ☒ 
As of July 28, 2017, the registrant had 39,228,125 shares of common stock issued and outstanding.


Table of Contents

ACACIA COMMUNICATIONS, INC.
Table of Contents
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
EX-31.1
 
(CERTIFICATION OF THE CEO PURSUANT TO SECTION 302)
 
 
EX-31.2
 
(CERTIFICATION OF THE CFO PURSUANT TO SECTION 302)
 
 
EX-32.1
 
(CERTIFICATION OF THE CEO PURSUANT TO SECTION 906)
 
 
EX-32.2
 
(CERTIFICATION OF THE CFO PURSUANT TO SECTION 906)
 
 


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, and these statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance.  In some cases, forward-looking statements can be identified by terms such as “may,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions that concern our expectations, strategy, plans or intentions.  Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:
our expectations regarding our expenses and revenue, our ability to maintain and expand gross profit, the sufficiency of our cash resources and needs for additional financing;
our anticipated growth strategies;
our expectations regarding competition;
the anticipated trends and challenges in our business and the market in which we operate;
our expectations regarding, and the capacity and stability of, our supply chain and manufacturing;
the scope, progress, expansion, and costs of developing and commercializing our products;
the size and growth of the potential markets for our products and the ability to serve those markets;
the timing, rate and degree of introducing any of our products into the market and the market acceptance of any of our products;
our ability to establish and maintain development partnerships;
our ability to attract or retain key personnel;
our expectations regarding federal, state and foreign regulatory requirements, including export controls, tax law changes and interpretations, economic sanctions and anti-corruption regulations;
regulatory developments in the United States and foreign countries, including under export control laws or regulations that could impede our ability to sell our products to certain customers or customers in certain foreign jurisdictions; and
our ability to obtain and maintain intellectual property protection for our products.
The foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.
The forward-looking statements in this Quarterly Report on Form 10-Q are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are subject to a number of risks, uncertainties and assumptions described in the “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, investors in our common stock should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements.
Although we may elect to update forward-looking statements in the future, we specifically disclaim any obligation to do so, even if our estimates change, and readers should not rely on those forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q.


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PART I—FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements (Unaudited).
ACACIA COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(Unaudited)

 
June 30, 2017
 
December 31, 2016
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
106,127

 
$
206,402

Marketable securities - short-term
176,293

 
104,004

Accounts receivable
82,911

 
108,127

Inventory
41,686

 
31,681

Prepaid expenses and other current assets
18,750

 
12,076

Deferred product costs
371

 
85

Total current assets
426,138

 
462,375

Marketable securities - long-term
60,486

 

Restricted cash
37

 
1,630

Property and equipment, net
25,765

 
25,124

Deferred tax asset
37,472

 
23,533

Other assets
8,864

 
4,274

Total assets
$
558,762

 
$
516,936

 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
35,224

 
$
49,430

Accrued liabilities
31,098

 
29,863

Deferred revenue
1,530

 
1,375

Total current liabilities
67,852

 
80,668

Other long-term liabilities
1,932

 
1,473

Total liabilities
69,784

 
82,141

 
 
 
 
Commitments and contingencies (Note 10)


 


 
 
 
 
Stockholders' equity:
 

 
 

Preferred stock, $0.0001 par value; 5,000 shares authorized; none issued and outstanding at June 30, 2017 and December 31, 2016

 

Common stock, $0.0001 par value; 150,000 shares authorized; 39,059 and 37,998 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively
4

 
4

Additional paid-in capital
309,717

 
295,893

Accumulated other comprehensive loss
(30
)
 
(16
)
Retained earnings
179,287

 
138,914

Total stockholders' equity
488,978

 
434,795

Total liabilities and stockholders' equity
$
558,762

 
$
516,936

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

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ACACIA COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Revenue
$
78,898

 
$
116,192

 
$
193,565

 
$
200,681

Cost of revenue
53,516

 
62,240

 
111,883

 
111,323

Gross profit
25,382

 
53,952

 
81,682

 
89,358

Operating expenses:
 
 
 
 
 

 
 

Research and development
22,734

 
21,839

 
40,462

 
37,253

Sales, general and administrative
9,368

 
8,649

 
18,059

 
12,703

Gain on disposal of property and equipment
(47
)
 

 
(47
)
 

Total operating expenses
32,055

 
30,488

 
58,474

 
49,956

(Loss) income from operations
(6,673
)
 
23,464

 
23,208

 
39,402

Other income (expense), net:
 
 
 
 
 

 
 

Interest income, net
827

 
20

 
1,272

 
28

Change in fair value of preferred stock warrant liability

 
(3,609
)
 

 
(3,361
)
Other expense
(1
)
 
(58
)
 
(39
)
 
(78
)
Total other income (expense), net
826

 
(3,647
)
 
1,233

 
(3,411
)
(Loss) income before (benefit) provision for income taxes
(5,847
)
 
19,817

 
24,441

 
35,991

(Benefit) provision for income taxes
(10,511
)
 
2,219

 
(15,932
)
 
3,796

Net income
$
4,664

 
$
17,598

 
$
40,373

 
$
32,195

Accretion of redeemable convertible preferred stock

 
(636
)
 

 
(1,722
)
Undistributed earnings attributable to participating securities

 
(6,455
)
 

 
(17,467
)
Net income attributable to common stockholders - basic and diluted
$
4,664

 
$
10,507

 
$
40,373

 
$
13,006

Net income per share attributable to common stockholders:
 
 
 
 
 

 
 

Basic
$
0.12

 
$
0.51

 
$
1.05

 
$
0.95

Diluted
$
0.11

 
$
0.43

 
$
0.97

 
$
0.77

Weighted-average shares used to compute net income per share attributable to common stockholders:
 
 
 
 
 

 
 

Basic
38,756

 
20,760

 
38,546

 
13,751

Diluted
41,582

 
24,373

 
41,639

 
16,927


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

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ACACIA COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
4,664

 
$
17,598

 
$
40,373

 
$
32,195

Other comprehensive income (loss):
 
 
 
 
 

 
 

Changes in unrealized gain (loss) on marketable securities, net of income taxes of $13 and $(2) for the three and six months ended June 30, 2017, respectively
22

 

 
(14
)
 

Comprehensive income
$
4,686

 
$
17,598

 
$
40,359

 
$
32,195


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

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ACACIA COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS’ EQUITY
(in thousands)
(Unaudited)
 
 
Redeemable Convertible Preferred Stock
 
 
 
 
 
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Loss
 
 
 
 
 
 
 
Common Stock
 
 
 
Retained Earnings
 
 
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
Total
Balance at December 31, 2015
24,177

 
$
70,780

 
 
6,669

 
$
1

 
$

 
$

 
$
8,015

 
$
8,016

Accretion of preferred stock issuance costs
 

 
94

 
 
 

 
 

 
(94
)
 
 

 
 

 
(94
)
Accretion to redemption value
 

 
1,628

 
 
 

 
 

 
(950
)
 
 

 
(678
)
 
(1,628
)
Conversion of redeemable convertible preferred stock into common stock upon initial public offering
(24,177
)
 
(72,502
)
 
 
24,177

 
2

 
72,500

 
 
 
 
 
72,502

Reclassification of preferred stock warrant liability into additional paid-in capital upon conversion to common stock warrants
 
 
 
 
 
 
 
 
 
6,615

 
 
 
 
 
6,615

Issuance of common stock in relation to initial public offering, net of offering costs incurred of $3,824
 
 
 
 
 
4,570

 
1

 
93,932

 
 
 
 
 
93,933

Vesting of restricted common stock
 

 
 

 
 
43

 
 

 
 

 
 

 
 

 

Exercise of common stock options
 

 
 

 
 
200

 

 
283

 
 

 
 

 
283

Stock-based compensation expense
 

 
 

 
 
 

 
 

 
9,461

 
 

 
 

 
9,461

Net income
 

 
 

 
 
 

 
 

 
 

 
 

 
32,195

 
32,195

Balance at June 30, 2016

 
$

 
 
35,659

 
$
4

 
$
181,747

 
$

 
$
39,532

 
$
221,283

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016

 
$

 
 
37,998

 
$
4

 
$
295,893

 
$
(16
)
 
$
138,914

 
$
434,795

Vesting of restricted common stock
 

 
 

 
 
51

 
 

 
 

 
 

 
 

 

Exercise of common stock options
 

 
 

 
 
523

 

 
1,903

 
 

 
 

 
1,903

Vesting of restricted stock units
 

 
 

 
 
457

 

 


 
 

 
 

 

Common stock issued under employee stock purchase plan
 
 
 
 
 
30

 

 
1,179

 
 
 
 
 
1,179

Stock-based compensation expense
 

 
 

 
 
 

 
 

 
10,742

 
 

 
 

 
10,742

Unrealized losses on marketable securities, net of tax of $(2)
 

 
 

 
 
 

 
 

 
 

 
(14
)
 
 

 
(14
)
Net income
 

 
 

 
 
 

 
 

 
 

 
 

 
40,373

 
40,373

Balance at June 30, 2017

 
$

 
 
39,059

 
$
4

 
$
309,717

 
$
(30
)
 
$
179,287

 
$
488,978


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

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ACACIA COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

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(Unaudited) 
 
Six Months Ended June 30,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 

 
 

Net income
$
40,373

 
$
32,195

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation
5,841

 
3,820

Gain on disposal of property and equipment
(47
)
 

Stock-based compensation
10,742

 
9,461

Deferred income taxes
(13,939
)
 
(454
)
Other non-cash charges
158

 

Change in fair value of preferred stock warrant liability

 
3,361

Changes in operating assets and liabilities:


 
 

Accounts receivable
25,216

 
(36,629
)
Inventory
(10,005
)
 
4,656

Prepaid expenses and other current assets
(6,435
)
 
(1,026
)
Deferred product costs
(286
)
 
1,994

Restricted cash
1,593

 

Other assets
(4,560
)
 
(109
)
Accounts payable
(12,364
)
 
22,929

Accrued liabilities
925

 
2,826

Deferred revenue
155

 
(672
)
Other long-term liabilities
459

 
568

Net cash provided by operating activities
37,826

 
42,920

 


 


CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Purchases of property and equipment
(8,006
)
 
(8,033
)
Purchases of marketable securities
(233,246
)
 

Sales and maturities of marketable securities
100,300

 

Deposits
(30
)
 
(23
)
Net cash used in investing activities
(140,982
)
 
(8,056
)
 


 


CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Payment of capital lease obligation

 
(34
)
Proceeds from initial public offering, net of underwriting discounts and commissions

 
97,757

Payment of public offering costs
(201
)
 
(1,471
)
Proceeds from the issuance of common stock under stock-based compensation plans
3,082

 
283

Net cash provided by financing activities
2,881

 
96,535

 


 


Net (decrease) increase in cash and cash equivalents
(100,275
)
 
131,399

Cash and cash equivalents—Beginning of period
206,402

 
27,610

Cash and cash equivalents—End of period
$
106,127

 
$
159,009

 


 


Supplemental cash flow disclosures:
 

 
 

Cash paid for income taxes, net of refunds
$
833

 
$
2,819

 


 


Supplemental disclosure of non-cash investing and financing activities:
 

 
 

Capital expenditures incurred but not yet paid
$
140

 
$
1,474

Public offering costs incurred but not yet paid
$

 
$
528

Accretion of redemption value on redeemable convertible preferred stock
$

 
$
1,628

Accretion of redeemable convertible preferred stock issuance costs
$

 
$
94

Conversion of redeemable convertible preferred stock into common stock
$

 
$
72,502

Reclassification to additional paid-in capital of fair value of preferred stock warrant liability upon conversion to common stock warrants
$

 
$
6,615

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

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Acacia Communications, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
 
1. NATURE OF THE BUSINESS AND OPERATIONS
 
Acacia Communications, Inc. was incorporated on June 2, 2009, as a Delaware corporation. Acacia Communications, Inc. and its wholly-owned subsidiaries (the “Subsidiaries”) are collectively referred to as the Company. The Company is a leading provider of high-speed coherent interconnect products that are designed to improve the capacity, performance, intelligence and cost of communications networks relied upon by cloud infrastructure operators and content and communications service providers. The Company’s products include a series of low-power coherent digital signal processors and silicon photonic integrated circuits integrated into families of optical interconnect modules with transmission speeds ranging from 100 to 400 gigabits per second for use in long-haul, metro and inter-data center markets. The Company is also developing optical interconnect modules that will enable transmission speeds of one terabit (1,000 gigabits) per second and above.
The Company is headquartered in Maynard, Massachusetts, and has established wholly-owned subsidiaries in North America, Europe and Asia as part of the Company’s global expansion.
On May 18, 2016, the Company closed its initial public offering (“IPO”), in which the Company issued and sold 4,570,184 shares of common stock and certain selling stockholders sold an additional 604,816 shares, inclusive of the underwriters’ option to purchase additional shares that was exercised in full.  The price per share to the public was $23.00.  The Company received aggregate proceeds of approximately $97.8 million from the IPO, net of underwriters’ discounts and commissions, before deduction of offering expenses of approximately $4.3 million. The Company received no proceeds from the sale of shares by the selling stockholders.  Upon the closing of the IPO, all shares of the Company’s outstanding redeemable convertible preferred stock (the “preferred stock”) automatically converted into 24,177,495 shares of common stock.  
On October 13, 2016, the Company closed a follow-on public offering in which the Company issued and sold 1,210,302 shares of common stock and certain selling stockholders sold an additional 3,289,698 shares.  The underwriters’ option to purchase up to an additional 675,000 shares from certain of the selling stockholders was not exercised.  The price per share to the public was $100.00.  The Company received aggregate proceeds of $116.8 million from the follow-on offering, net of underwriters’ discounts and commissions, before deduction of offering expenses of approximately $1.2 million.  The Company received no proceeds from the sale of shares by the selling stockholders.

2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The unaudited condensed consolidated financial statements include the accounts of Acacia Communications, Inc. and its Subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for annual financial statements.  For further information, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, which was filed with the SEC on February 23, 2017. There have been no significant changes in the Company’s accounting policies from those disclosed in the Annual Report on Form 10-K that have had a material impact on the Company’s condensed consolidated financial statements.
The unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2016, and in management’s opinion, include all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s condensed consolidated balance sheet as of June 30, 2017, its condensed consolidated income statements for the three and six months ended June 30, 2017 and 2016, its condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2017 and 2016, its condensed consolidated statements of redeemable convertible preferred stock and stockholders’ equity for the six months ended June 30, 2017 and 2016, and its condensed consolidated statements of cash flows for the six months ended June 30, 2017 and 2016. All intercompany balances and transactions have been eliminated in consolidation.  The financial data and the other financial information disclosed in the notes to these condensed consolidated financial statements related to these three- and six-month periods are also unaudited. The results of operations for the three and six months ended June 30, 2017 are not necessarily indicative of the results to be expected for the full fiscal year or any other period.

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Use of Estimates
The preparation of unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Recently Issued Accounting Pronouncements
In May 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting ("ASU 2017-09"). ASU 2017-09 provides clarity about which changes to terms or conditions of a share-based payment award require modification accounting. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. The amendments in ASU 2017-09 are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted, and is required to be applied on a prospective basis for awards modified on or after the adoption date. The Company does not expect any material impact of this guidance on its condensed consolidated financial statements due to the infrequency of share-based payment award modifications.
In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Topic 310-20): Premium Amortization on Purchased Callable Debt Securities (“ASU 2017-08”).  ASU 2017-08 amends the amortization period for certain purchased callable debt securities held at a premium to the earliest call date in order to reduce diversity in practice and provide more decision-useful information. The amendments in ASU 2017-08 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted, and is required to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company does not anticipate that this guidance will have a material impact on its condensed consolidated financial statements because all of the Company's callable debt securities held at a premium are already amortized to the earliest call date.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 320): Restricted Cash (“ASU 2016-18”).  ASU 2016-18 will require amounts generally described as restricted cash or restricted cash equivalents to be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.  The amendments in ASU 2016-18 are effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, and must be applied using a retrospective approach with earlier adoption permitted. The Company expects its condensed consolidated statements of cash flows to be impacted by the amount of restricted cash held by the Company in each period.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”).  ASU 2016-16 requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs.  The amendments in ASU 2016-16 are effective for fiscal years beginning after December 15, 2017, and must be applied using a modified retrospective approach with earlier adoption permitted for annual reporting periods for which financial statements have not yet been issued. The Company does not anticipate that this guidance will have a material impact on its condensed consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 is intended to provide more decision-useful information about expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date.  The main provisions include presenting financial assets measured at amortized cost at the amount expected to be collected, which is net of an allowance for credit losses, and recording credit losses related to available-for-sale securities through an allowance for credit losses.  The amendments in ASU 2016-13 are effective for fiscal years beginning after December 15, 2019, and must be applied using a modified retrospective approach with earlier adoption permitted for fiscal years beginning after December 15, 2018. The Company is currently evaluating the impact of this guidance on its condensed consolidated financial statements.

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In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 will require lessees to recognize a right-of-use asset and lease liability on the balance sheet for virtually all leases. For the income statement, ASU 2016-02 retains a dual model requiring leases to be classified as either operating or financing leases. Operating leases will result in straight-line expense, and financing leases will have a front-loaded expense pattern with an interest expense component. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, and must be applied using a modified retrospective approach with earlier adoption permitted. The Company is currently evaluating the impact of this guidance on its condensed consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which affects any entity that either enters into contracts with customers to transfer goods and services or enters into contracts for the transfer of nonfinancial assets. ASU 2014-09 will replace most existing revenue recognition guidance in GAAP when it becomes effective. 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 currently effective 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. The new guidance is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application.  ASU 2014-09 was initially to be effective for annual periods beginning after December 15, 2016, including interim periods within that period. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers, which delays the effective date of ASU 2014-09 by one year and allows for early adoption as of the original effective date. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, which clarifies certain principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies certain guidance related to identifying performance obligations and licensing.  In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which addresses improvements to the guidance on collectability, noncash consideration and completed contracts at transition.  In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, which addresses clarifications and corrections in various areas, including contract costs and disclosures.  
The Company has commenced its evaluation of the impact that ASU 2014-09 may have on its condensed consolidated financial statements, including evaluation of the disclosure requirements under the new standard.  Although its evaluation is ongoing, the Company does not anticipate that the adoption of this standard will have a significant impact on its condensed consolidated financial statements as, upon adoption, most revenue will continue to be recognized at a point-in-time when control transfers which is similar to the current revenue recognition model.  The Company plans to adopt this guidance on January 1, 2018, using the modified retrospective adoption method applied to those contracts that were not completed as of that date. As the Company continues its evaluation, it is also identifying and preparing to implement changes to accounting policies, business processes and internal controls to support the new accounting and disclosure requirements.

3. FINANCIAL INSTRUMENTS
 
The following tables set forth the Company’s cash, cash equivalents and short- and long-term marketable securities as of June 30, 2017 and December 31, 2016 (in thousands):
 
June 30, 2017
 
 
 
Gross Unrealized
 
 
 
 
 
 
 
Amortized Cost
 
Gains
 
Losses(1)
 
Estimated Fair Value
 
Cash and Cash Equivalents
 
Marketable Securities
Cash
$
76,213

 
$

 
$

 
$
76,213

 
$
76,213

 
$

Money market funds
5,018

 

 

 
5,018

 
5,018

 

Repurchase agreements
20,000

 

 

 
20,000

 
20,000

 

U.S. treasury bonds
12,192

 

 
(3
)
 
12,189

 

 
12,189

Commercial paper
55,322

 

 
(1
)
 
55,321

 
2,996

 
52,325

Certificates of deposit
23,448

 
6

 
(1
)
 
23,453

 
1,900

 
21,553

Asset-backed securities
35,021

 
4

 
(7
)
 
35,018

 

 
35,018

Corporate debt securities
115,735

 
18

 
(59
)
 
115,694

 

 
115,694

Total
$
342,949

 
$
28

 
$
(71
)
 
$
342,906

 
$
106,127

 
$
236,779

(1)
Losses represent marketable securities that were in loss positions for less than one year.

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December 31, 2016
 
 
 
Gross Unrealized
 
 
 
 
 
 
 
Amortized Cost
 
Gains
 
Losses(1)
 
Estimated Fair Value
 
Cash and Cash Equivalents
 
Marketable Securities
Cash
$
81,230

 
$

 
$

 
$
81,230

 
$
81,230

 
$

Money market funds
118,174

 

 

 
118,174

 
118,174

 

U.S. treasury bonds
15,017

 

 
(2
)
 
15,015

 

 
15,015

Commercial paper
49,673

 

 

 
49,673

 
5,997

 
43,676

Corporate debt securities
46,339

 
2

 
(27
)
 
46,314

 
1,001

 
45,313

Total
$
310,433

 
$
2

 
$
(29
)
 
$
310,406

 
$
206,402

 
$
104,004

(1)
Losses represent marketable securities that were in loss positions for less than one year.

The proceeds from the sales and maturities of marketable securities, which were primarily reinvested and resulted in realized gains and losses, were as follows (in thousands):
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
Proceeds from the sales and maturities of marketable securities
$
61,400

 
$
100,300

Realized gains
$
3

 
$
4

Realized losses
$

 
$

 
The contractual maturities of short-term and long-term marketable securities held at June 30, 2017 and December 31, 2016 are as follows (in thousands):
 
June 30, 2017
 
December 31, 2016
 
Amortized Cost Basis
 
Aggregate Fair Value
 
Amortized Cost Basis
 
Aggregate Fair Value
Due within one year
$
176,332

 
$
176,293

 
$
104,031

 
$
104,004

Due after 1 year through 2 years
60,491

 
60,486

 

 

Total
$
236,823

 
$
236,779

 
$
104,031

 
$
104,004


At June 30, 2017, the Company believed that the unrealized losses on its available-for-sale investments were temporary. The investments with unrealized losses consisted primarily of corporate debt securities. In making the determination that the decline in fair value of these securities was temporary, the Company considered various factors, including, but not limited to: the length of time each security was in an unrealized loss position; the extent to which fair value was less than cost; the financial condition and near-term prospects of the issuers; and the Company’s intent not to sell these securities and the assessment that it is more likely than not that the Company would not be required to sell these securities before the recovery of their amortized cost basis.
 
4. INVENTORY
Inventory consisted of the following as of June 30, 2017 and December 31, 2016 (in thousands):
 
June 30, 2017
 
December 31, 2016
Raw materials
$
24,003

 
$
14,385

Work-in-process
2,917

 
3,235

Finished goods
14,766

 
14,061

Inventory
$
41,686

 
$
31,681



5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following as of June 30, 2017 and December 31, 2016 (in thousands):

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June 30, 2017
 
December 31, 2016
Engineering laboratory equipment
$
35,364

 
$
31,096

Computer software
1,617

 
1,381

Computer equipment
3,677

 
2,572

Furniture and fixtures
2,908

 
408

Leasehold improvements
2,222

 
1,032

Construction in progress
1,672

 
5,954

Total property and equipment
47,460

 
42,443

Less: Accumulated depreciation
(21,695
)
 
(17,319
)
Property and equipment, net
$
25,765

 
$
25,124


Depreciation expense was $3.0 million and $2.1 million for the three months ended June 30, 2017 and 2016, respectively, and $5.8 million and $3.8 million for the six months ended June 30, 2017 and 2016, respectively.

6. ACCRUED LIABILITIES
Accrued liabilities consisted of the following as of June 30, 2017 and December 31, 2016 (in thousands):
 
June 30, 2017
 
December 31, 2016
Employee-related liabilities
$
5,551

 
$
6,235

Outsourced foundry services
346

 
1,811

Goods and services received not invoiced
7,977

 
9,024

Accrued income taxes
464

 
670

Accrued manufacturing related expenses
6,980

 
5,255

Warranty reserve
4,859

 
2,158

Other accrued liabilities
4,921

 
4,710

Accrued liabilities
$
31,098

 
$
29,863


7. FAIR VALUE MEASUREMENT
The Company measures certain financial assets and liabilities at fair value. Fair value is determined based upon the exit price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, as determined by either the principal market or the most advantageous market. Inputs used in the valuation techniques to derive fair values are classified based on a three-level hierarchy, as follows:
Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3—Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.
The Company considers all highly liquid investments purchased with a remaining maturity of three months or less to be cash equivalents. The Company’s cash equivalents consist of money market funds, repurchase agreements, commercial paper, certificates of deposit and corporate debt securities with an original maturity of three months or less.  The Company’s investments in money market funds, repurchase agreements, commercial paper, certificates of deposit, asset-backed securities, corporate bonds and U.S. government agency debt securities, which are classified as Level 2 within the fair value hierarchy, were initially valued at the transaction price and subsequently valued at each reporting date utilizing market-observable data. The market-observable data included reportable trades, benchmark yields, credit spreads, broker/dealer quotes, bids, offers, current spot rates and other industry and economic events.
The fair value of these assets measured on a recurring basis was determined using the following inputs as of June 30, 2017 and December 31, 2016 (in thousands):

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June 30, 2017
 
Quoted Prices in Active Markets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total Fair Value
Assets:
 

 
 

 
 

 
 

Money market funds
$

 
$
5,018

 
$

 
$
5,018

Repurchase agreements

 
20,000

 

 
20,000

U.S. treasury bonds

 
12,189

 

 
12,189

Commercial paper

 
55,321

 

 
55,321

Certificates of deposit

 
23,453

 

 
23,453

Asset-backed securities

 
35,018

 

 
35,018

Corporate debt securities

 
115,694

 

 
115,694

Total
$

 
$
266,693

 
$

 
$
266,693

  
 
December 31, 2016
 
Quoted Prices in Active Markets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total Fair Value
Assets:
 

 
 

 
 

 
 

Money market funds
$

 
$
118,174

 
$

 
$
118,174

U.S. treasury bonds

 
15,015

 

 
15,015

Commercial paper

 
49,673

 

 
49,673

Corporate debt securities

 
46,314

 

 
46,314

Total
$

 
$
229,176

 
$

 
$
229,176

There have been no transfers between fair value measurement levels during the three or six months ended June 30, 2017.
For certain other financial instruments, including accounts receivable, restricted cash, accounts payable, and other current liabilities, the carrying amounts approximate their fair value due to the relatively short maturity of these balances.
Preferred Stock Warrants
Prior to the closing of the Company’s IPO, the Company remeasured the fair value of its preferred stock warrants at each balance sheet date. Any changes in fair value were recognized as a component of other income (expense) in the condensed consolidated income statements. The valuation technique used to measure fair value for the Company’s preferred stock warrants, which were considered Level 3 fair value estimates within the fair value hierarchy, was the Black-Scholes option pricing model. The significant unobservable inputs used in the fair value measurement of the Company’s preferred stock warrants was the fair value of the Company’s series B and series C preferred stock. The Company also utilized risk-free interest rate, expected dividend yield, expected volatility and expected term as observable inputs with the fair value of the series B and series C preferred stock in determining the fair value of the preferred stock warrants. There is not a direct interrelationship between the unobservable inputs and the observable inputs.     
 
A summary of the changes in the Company’s preferred stock warrant liability measured at fair value using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2016 is as follows (in thousands):

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Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
Preferred stock warrant liability at beginning of period
$
3,006

 
$
3,254

Change in fair value
3,609

 
3,361

Reclassification of preferred stock warrant liability to additional paid-in capital upon conversion to common stock warrants
(6,615
)
 
$
(6,615
)
Preferred stock warrant liability at end of period
$

 
$


The warrants to purchase shares of preferred stock were converted into warrants to purchase shares of common stock upon the closing of the IPO.

8. STOCK COMPENSATION PLANS
The following table summarizes the classification of stock-based compensation in the condensed consolidated income statements for the three and six months ended June 30, 2017 and 2016 (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Cost of revenue
$
511

 
$
660

 
$
953

 
$
692

Research and development
3,779

 
5,389

 
6,771

 
5,578

Sales, general and administrative
1,820

 
3,122

 
3,018

 
3,191

Total stock-based compensation
$
6,110

 
$
9,171

 
$
10,742

 
$
9,461


The following table summarizes stock-based compensation expense by award type for the three and six months ended June 30, 2017 and 2016 (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Stock options
$
655

 
$
507

 
$
1,321

 
$
768

Restricted stock awards
29

 
18

 
58

 
47

Restricted stock units
5,126

 
8,495

 
8,812

 
8,495

Employee stock purchase plan
300

 
151

 
551

 
151

Total stock-based compensation
$
6,110

 
$
9,171

 
$
10,742

 
$
9,461

Stock Options
A summary of stock option activity under the Company’s equity incentive plans for the six months ended June 30, 2017 is as follows:
 
Number of Options
(in thousands)
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term
(in years)
 
Aggregate Intrinsic Value
(in thousands)
Outstanding at December 31, 2016
2,354

 
$
7.10

 
7.4
 
$
129,288

Granted

 


 
 
 
 

Exercised
(523
)
 
$
3.64

 
 
 
$
27,050

Cancelled
(8
)
 
$
8.42

 
 
 
 

Outstanding at June 30, 2017
1,823

 
$
8.08

 
7.1
 
$
62,255

Vested and expected to vest at:
 

 
 

 
 
 
 

June 30, 2017
1,823

 
$
8.08

 
7.1
 
$
62,255

December 31, 2016
2,354

 
$
7.10

 
7.4
 
$
129,288

Exercisable at:
 

 
 

 
 
 
 

June 30, 2017
819

 
$
3.54

 
6.2
 
$
31,079

December 31, 2016
975

 
$
1.78

 
6.1
 
$
58,458


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As of June 30, 2017 and December 31, 2016, there was $6.2 million and $7.6 million, respectively, of unrecognized compensation cost related to unvested common stock options, which is expected to be recognized over weighted-average periods of 2.6 years and 3.1 years, respectively.
The weighted-average grant date fair value of stock options granted during the three and six months ended June 30, 2016 was $22.35 and $8.97, respectively.  No stock options were granted by the Company during the three or six months ended June 30, 2017.
Restricted Stock Units
During the six months ended June 30, 2017, the Company granted 441,000 restricted stock units ("RSUs") to employees and executives under the 2016 Equity Incentive Plan that vest upon the satisfaction of a service condition, generally over four years.  The cost of any RSUs with only a service condition is determined using the fair value of the Company’s common stock on the date of grant, and compensation is recognized on a straight-line basis over the requisite vesting period.
During the six months ended June 30, 2017, the Company granted 436,000 RSUs to executive officers that include a market condition and a performance condition in addition to a service condition (“performance-based RSUs” or “PRSUs”).  Each PRSU represents the right to receive one share of the Company’s common stock when and if the applicable vesting conditions are satisfied.  The number of PRSUs that are subject to the service condition is determined based on the achievement of certain market and performance objectives over a two-year period running from January 1, 2017 through December 31, 2018 (the “Earned PRSUs”).  Thirty-three percent of any Earned PRSUs will vest on the later of (i) March 17, 2019 and (ii) the date that the number of Earned PRSUs is determined by the Compensation Committee after December 31, 2018. Thereafter, an additional 33% of the Earned PRSUs will vest on March 17, 2020 and the remaining 34% of the Earned PRSUs will vest on March 17, 2021. Vesting of Earned PRSUs is subject to the applicable officer’s continued provision of services to the Company through the applicable vesting date.  The number of PRSUs that become Earned PRSUs will be determined based on the extent to which the Company achieves (i) a revenue growth objective, based on the compound annual growth rate of the Company’s total revenue by measuring the Company’s revenue for fiscal year 2018 against the Company’s revenue for fiscal year 2016 (the “Revenue Growth Objective”), and/or (ii) a stock price objective during the two-year period (the “Stock Price Objective”). If neither the Revenue Growth Objective nor the Stock Price Objective is achieved, none of the PRSUs will become Earned PRSUs. Any PRSUs that do not become Earned PRSUs shall be forfeited once the number of Earned PRSUs is determined by the Compensation Committee after December 31, 2018.  
For the PRSUs, the related stock-based compensation expense is amortized using the accelerated method over the vesting period of four years. The Company estimates the fair value of the PRSUs using management’s best estimate of whether it is probable or not probable that the Revenue Growth Objective will be satisfied using the most currently available projections of future revenue performance, which is reassessed at each reporting period. Changes in the subjective and probability-based assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized in the Company’s condensed consolidated income statements.
The Company estimated the fair value of the PRSUs using a Monte Carlo valuation model on the date of grant, using the following assumptions:
Risk-free interest rate
1.3%
Expected dividend yield
None
Expected volatility
58.3%
Expected term (in years)
1.8
Grant date fair value of underlying shares
$55.02
As soon as practicable following each vesting date of RSUs, including PRSUs, the Company will issue to the holder of the RSUs the number of shares of common stock equal to the aggregate number of RSUs that have vested. Notwithstanding the foregoing, the Company may, in its sole discretion, in lieu of issuing shares of common stock to the holder of the RSUs, pay the holder an amount in cash equal to the fair market value of such shares of common stock. To date, the Company has not settled any vested RSUs with cash.
A summary of the changes in the Company’s RSUs during the six months ended June 30, 2017 is as follows:

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RSUs
(in thousands)
 
Weighted-Average Grant Date Fair Value
Outstanding at December 31, 2016
2,034

 
$
21.09

Granted
877

 
$
56.41

Vested
(457
)
 
$
16.36

Cancelled
(7
)
 
$
32.50

Outstanding at June 30, 2017
2,447

 
$
34.59

The granted amount includes the 436,000 PRSUs which is the maximum number that were granted to executives during the six months ended June 30, 2017.  
As of June 30, 2017 and December 31, 2016, there was $53.5 million and $32.1 million, respectively, of total unrecognized compensation cost related to unvested RSUs, which is expected to be recognized over weighted-average periods of 3.3 years and 3.4 years, respectively.

9. NET INCOME PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS
Basic and diluted net income per share attributable to common stockholders is presented in conformity with the two-class method required for participating securities. The Company considers its preferred stock to be participating securities. In the event a cash dividend is paid on common stock, the holders of preferred stock are also entitled to a proportionate share of any such dividend as if they were holders of common stock (on an as-if converted basis). The holders of the preferred stock do not have a contractual obligation to share in losses. In accordance with the two-class method, earnings allocated to these participating securities and the related number of outstanding shares of the participating securities, which include contractual participation rights in undistributed earnings, have been excluded from the computation of basic and diluted net income per share attributable to common stockholders.  As a result of the conversion of preferred stock on May 18, 2016, no earnings were allocated to participating securities during the three and six months ended June 30, 2017.
The following table sets forth the computation of the Company’s basic and diluted net income per share attributable to common stockholders (in thousands, except per share amounts):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Numerator:
 

 
 

 
 
 
 
Net income
$
4,664

 
$
17,598

 
$
40,373

 
$
32,195

Less: preferred stock accretion

 
(636
)
 

 
(1,722
)
Less: undistributed earnings attributable to participating
   securities

 
(6,455
)
 

 
(17,467
)
Net income attributable to common stockholders - basic and diluted
$
4,664

 
$
10,507

 
$
40,373

 
$
13,006

Denominator:
 

 
 

 
 

 
 

Weighted-average shares used to compute net income per
   share attributable to common stockholders - basic
38,756

 
20,760

 
38,546

 
13,751

Dilutive effect of stock options, unvested restricted stock
   and restricted stock units, preferred stock warrants, and
   employee stock purchase plan
2,826

 
3,613

 
3,093

 
3,176

Weighted-average shares used to compute net income per
   share attributable to common stockholders - diluted
41,582

 
24,373

 
41,639

 
16,927

Net income per share attributable to common stockholders
 

 
 

 
 

 
 

Basic
$
0.12

 
$
0.51

 
$
1.05

 
$
0.95

Diluted
$
0.11

 
$
0.43

 
$
0.97

 
$
0.77



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The following common stock equivalents (in thousands) were excluded from the computation of diluted net income per share for the periods presented because including them would have been antidilutive:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Options to purchase common stock
90

 
15

 
90

 
270

Unvested restricted stock units and awards
562

 
20

 
381

 
137

Preferred stock warrants

 
245

 

 
245

 
As discussed further in Note 8, in March 2017, the Company granted 436,000 PRSUs to executives that include market, performance and service conditions.  As the market and performance criteria associated with the vesting of those awards have not been satisfied as of June 30, 2017, the Company has excluded those shares from the table above and the calculation of diluted net income per share attributable to common stockholders.

10. COMMITMENTS AND CONTINGENCIES
Leases
The Company’s principal facilities are located in Maynard, Massachusetts and Holmdel, New Jersey and are leased by the Company under non-cancelable operating leases that expire in February 2025, with respect to the Massachusetts facility, and December 2021, with respect to the New Jersey facility. The Company also leases office space in various locations with expiration dates between 2018 and 2021. Several of the lease agreements include leasehold improvement incentives, escalating lease payments, renewal provisions and other provisions which require the Company to pay taxes, insurance and maintenance costs. All of the Company’s facility leases are accounted for as operating leases. Rent expense is recorded over each respective lease term on a straight-line basis. Rent expense was $1.2 million and $0.3 million for the three months ended June 30, 2017 and 2016, respectively, and $2.7 million and $0.6 million for the six months ended June 30, 2017 and 2016, respectively.
Future minimum lease payments due under these non-cancelable lease agreements as of June 30, 2017, are as follows (in thousands):
 
Amounts
Remaining 2017
$
1,674

2018
3,113

2019
3,047

2020
3,067

2021
3,039

Thereafter
7,387

Total
$
21,327


The Holmdel, New Jersey and Maynard, Massachusetts leases entered into during 2016 included tenant improvements which were partially funded by the Company.  Under these lease agreements, the Company will not have title to the tenant improvements.  Therefore, as the Company funded its portion of the improvements, it recorded a prepaid lease asset that will be amortized over the lease term.  As of June 30, 2017, the Company was committed to approximately $0.6 million of remaining tenant improvement costs related to these leases which is expected to be paid in the third quarter of 2017.
Warranties
The Company’s standard warranty obligation to its customers provides for repair or replacement of a defective product at the Company’s discretion for a period of time following purchase, generally between 12 and 24 months. Factors that affect the warranty obligation include product failure rates, material usage, and service delivery costs incurred in correcting product failures. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. The estimated cost associated with fulfilling the Company’s warranty obligation to customers is recorded in cost of revenue. Changes in the Company’s product warranty liability, which is included as a component of accrued liabilities on the condensed consolidated balance sheets, are set forth in the table below (in thousands). The reserves below do not include reserves established as a result of the manufacturing process quality issue described below under the heading "Manufacturing Process Quality Reserve."

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Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Warranty reserve, beginning of period
$
2,113

 
$
1,147

 
$
2,158

 
$
763

Provisions made to warranty reserve during the period
4,771

 
1,156

 
5,971

 
1,786

Charges against warranty reserve during the period
(2,025
)
 
(997
)
 
(3,270
)
 
(1,243
)
Warranty reserve, end of period
$
4,859

 
$
1,306

 
$
4,859

 
$
1,306

Manufacturing Process Quality Reserve
In May 2017, the Company announced a quality issue at one of its three contract manufacturers that affected a portion of the approximate 1,300 AC400 units and 5,100 CFP units manufactured by the contract manufacturer over an approximate four month period (the "Quality Issue"). As a result of the Quality Issue, the Company established reserves to cover anticipated costs, including cost estimates for product repairs, rework of component inventory with the contract manufacturer and rescreening costs. The Quality Issue warranty reserve of $2.8 million was recorded as a component of accrued liabilities in the Company's condensed consolidated balance sheets as of June 30, 2017. An additional $5.0 million was reserved against estimated affected inventory on-hand at the contract manufacturer and in-transit returns as of June 30, 2017. The Company's estimates of the Quality Issue costs are subject to change as customers return the potentially affected units and final testing is performed.
Legal Contingencies
On January 22, 2016, ViaSat, Inc. filed a suit against the Company alleging, among other things, breach of contract, breach of the implied covenant of good faith and fair dealing and misappropriation of trade secrets. On February 19, 2016, the Company responded to ViaSat’s suit and alleged counterclaims against ViaSat including, among other things, patent misappropriation, breach of contract, breach of the implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition, which ViaSat denied in its response filed March 16, 2016. The lawsuit is still pending and discovery is ongoing. The Company is continuing to evaluate ViaSat’s claims, but based on the information available to the Company today, the Company currently believes that this suit will not have a material adverse effect on the Company’s business or its condensed consolidated financial position, results of operations or cash flows. On July 28, 2017, the Company filed a suit against ViaSat asserting commercial disparagement, libel, slander of title, unfair competition, intentional interference with advantageous relations and intentional interference with contractual relations.
In addition, from time to time the Company may become involved in legal proceedings or be subject to claims arising in the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, the Company currently believes that the final outcome of these ordinary course matters will not have a material adverse effect on the Company’s business or its condensed consolidated financial position, results of operations or cash flows. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources and other factors.
Indemnification
In the ordinary course of business, the Company enters into various agreements containing standard indemnification provisions. The Company’s indemnification obligations under such provisions are typically in effect from the date of execution of the applicable agreement through the end of the applicable statute of limitations. During the three and six months ended June 30, 2017 and 2016, the Company did not experience any losses related to these indemnification obligations. The Company does not expect significant claims related to these indemnification obligations, and consequently, has concluded that the fair value of these obligations is not material. Accordingly, as of June 30, 2017 and December 31, 2016, no amounts have been accrued related to such indemnification provisions.

11. INCOME TAXES
The Company is subject to income tax in the United States as well as other tax jurisdictions in which it conducts business. Earnings from non-U.S. activities are subject to local country income tax. The Company does not provide for federal income taxes on the undistributed earnings of its foreign subsidiaries as such earnings are reinvested indefinitely.
 

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The Company’s tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter. In each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual tax rate changes, the Company makes a cumulative adjustment in that quarter. The Company’s quarterly tax provision, and its quarterly estimate of its annual effective tax rate, are subject to significant volatility due to several factors, including the Company’s ability to accurately predict its pre-tax income and loss in multiple jurisdictions, as well as the portions of stock-based compensation that will either not generate tax benefits or the tax benefit is unpredictable and reflected when realized by employees.
 
For the three months ended June 30, 2017, the Company recorded a benefit for income taxes of $10.5 million as compared to a tax provision of $2.2 million for the three months ended June 30, 2016, resulting in an effective tax rate of 179.8% and 11.2% for the three months ended June 30, 2017 and 2016, respectively. For the six months ended June 30, 2017, the Company recorded a benefit from income taxes of $15.9 million as compared to a tax provision of $3.8 million for the six months ended June 30, 2016, resulting in an effective tax rate of (65.2)% and 10.5% for the six months ended June 30, 2017 and 2016, respectively. The benefits for income taxes recorded in the three and six months ended June 30, 2017 are mainly due to the favorable effect of foreign statutory tax rates applicable to income earned outside the United States under the Company’s corporate structure and the recognition of excess tax benefits from the taxable compensation on share-based awards.   The Company’s historical provision for income taxes is not necessarily reflective of its future results of operations.    
 
As of June 30, 2017 and December 31, 2016, the Company identified $3.8 million and $3.1 million, respectively, of gross uncertain tax positions.  Included in those balances as of June 30, 2017 and December 31, 2016 are $1.9 million and $1.5 million, respectively, of tax benefits that, if recognized, would impact the effective tax rate.  These have been accrued for as long-term liabilities on the Company’s condensed consolidated balance sheets.  The Company’s existing tax positions will continue to generate an increase in unrecognized tax benefits in subsequent periods.   The Company’s policy is to record interest and penalties related to unrecognized tax benefits as income tax expense. During the three and six months ended June 30, 2017 and 2016, the amounts recorded related to the accrual of interest and penalties were immaterial in each period.  

12. SEGMENT INFORMATION AND GEOGRAPHIC DATA
The Company operates as one operating segment. Operating segments are defined as components of an enterprise for which separate financial information is regularly evaluated by the chief operating decision maker (“CODM”), which is the Company’s president and chief executive officer, in deciding how to allocate resources and assess performance. The Company’s CODM evaluates the Company’s financial information and resources and assesses the performance of these resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information can be found in the condensed consolidated financial statements.
Revenue by geographic region, based on ship-to destinations, was as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
United States
$
23,814

 
$
27,048

 
$
36,227

 
$
40,016

China
29,367

 
45,968

 
86,349

 
87,352

Germany
9,649

 
25,564

 
22,615

 
44,720

Thailand
5,115

 

 
16,719

 

Other
10,953

 
17,612

 
31,655

 
28,593

Total revenue
$
78,898

 
$
116,192

 
$
193,565

 
$
200,681


Total long-lived assets by geographic region consisted of the following as of June 30, 2017 and December 31, 2016 (in thousands):
 
June 30, 2017
 
December 31, 2016
United States
$
16,737

 
$
14,026

China
1,420

 
2,235

Thailand
7,249

 
8,070

Other
359

 
793

Total long-lived assets
$
25,765

 
$
25,124



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13. CONCENTRATIONS OF RISK
Customer Concentration
Customers with revenue equal to or greater than 10% of total revenue for the three and six months ended June 30, 2017 and 2016 were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
A
28
%
 
32
%
 
36
%
 
38
%
B
19
%
 
27
%
 
14
%
 
24
%
C
15
%
 
10
%
 
*

 
11
%
 
*
Less than 10% of revenue in the period indicated
Customers that accounted for equal to or greater than 10% of accounts receivable at June 30, 2017 and December 31, 2016 were as follows:
 
June 30, 2017
 
December 31, 2016
A
26
%
 
26
%
B
11
%
 
19
%
C
22
%
 
15
%
Supplier Concentration
The Company purchases a substantial portion of its inventory from contract manufacturers and component suppliers located in Japan, Canada, Thailand and the United States. For the three and six months ended June 30, 2017 and 2016, total inventory purchased from each of the suppliers was as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
W
11
%
 
*

 
30
%
 
*

X
20
%
 
46
%
 
23
%
 
44
%
Y
*

 
22
%
 
28
%
 
16
%
Z
12
%
 
20
%
 
17
%
 
20
%
 
*
Less than 10% of total inventory purchased in the period indicated

The Company also outsources certain engineering projects to a foundry located in the United States.  During the three months ended June 30, 2017 and 2016, the Company incurred 21% and 22%, respectively, of its total research and development costs with the U.S. foundry. During the six months ended June 30, 2017 and 2016, the Company incurred 12% and 18%, respectively, of its total research and development costs with the U.S. foundry.  

14. RELATED PARTIES
One of the members of the Company's Board of Directors, Vincent Roche, is also the President and Chief Executive Officer and a member of the board of directors of Analog Devices, Inc. (“ADI”).  The Company, through its contract manufacturers, periodically purchases supplies from ADI pursuant to purchase orders negotiated on an arm’s length basis between ADI and the Company’s contract manufacturers at prevailing prices.  These purchased supplies are used as content in certain of the Company’s manufactured products.  During the three and six months ended June 30, 2017 and 2016, the Company’s contract manufacturers made purchases from ADI of approximately $1.0 million, $2.2 million, $1.1 million, and $1.8 million, respectively.  


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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K filed with the SEC on February 23, 2017.  As discussed in the section titled “Special Note Regarding Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or if they prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements.  Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” under Part II, Item 1A below.
Company Overview
Our mission is to deliver high-speed coherent optical interconnect products that transform communications networks, relied upon by cloud infrastructure operators and content and communication service providers, through improvements in performance and capacity and a reduction in associated costs. By converting optical interconnect technology to a silicon-based technology, a process we refer to as the siliconization of optical interconnect, we believe we are leading a disruption that is analogous to the computing industry’s integration of multiple functions into a microprocessor. Our products include a series of low-power coherent digital signal processor application-specific integrated circuits, or DSP ASICs, and silicon photonic integrated circuits, or silicon PICs, which we have integrated into families of optical interconnect modules with transmission speeds ranging from 100 to 400 gigabits per second, or Gbps, for use in long-haul, metro and inter-data center markets. We are also developing optical interconnect modules that will enable transmission speeds of one terabit (1,000 gigabits) per second and above. Our modules perform a majority of the digital signal processing and optical functions in optical interconnects and offer low power consumption, high density and high speeds at attractive price points.
For the three and six months ended June 30, 2017 and 2016, we generated 73%, 70%, 80% and 80%, respectively, of our revenue from our five largest customers, the mix of customers varied across each period.  
Results of Operations
The following tables set forth the components of our condensed consolidated income statements for each of the periods presented and as a percentage of our revenue for those periods. The period-to-period comparison of operating results is not necessarily indicative of results for future periods.  

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Consolidated Income Statement Data:
 

 
 

 
 

 
 

Revenue
$
78,898

 
$
116,192

 
$
193,565

 
$
200,681

Cost of revenue(1)
53,516

 
62,240

 
111,883

 
111,323

Gross profit
25,382

 
53,952

 
81,682

 
89,358

Operating expenses:
 
 
 
 
 

 
 

Research and development(1)
22,734

 
21,839

 
40,462

 
37,253

Sales, general and administrative(1)
9,368

 
8,649

 
18,059

 
12,703

Gain on disposal of property and equipment
(47
)
 

 
(47
)
 

Total operating expenses
32,055

 
30,488

 
58,474

 
49,956

(Loss) income from operations
(6,673
)
 
23,464

 
23,208

 
39,402

Total other income (expense), net
826

 
(3,647
)
 
1,233

 
(3,411
)
(Loss) income before (benefit) provision for income taxes
(5,847
)
 
19,817

 
24,441

 
35,991

(Benefit) provision for income taxes
(10,511
)
 
2,219

 
(15,932
)
 
3,796

Net income
$
4,664

 
$
17,598

 
$
40,373

 
$
32,195

 
(1)
Stock-based compensation included in the condensed consolidated income statement data was as follows (in thousands):

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Table of Contents

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Cost of revenue
$
511

 
$
660

 
$
953

 
$
692

Research and development
3,779

 
5,389

 
6,771

 
5,578

Sales, general and administrative
1,820

 
3,122

 
3,018

 
3,191

Total stock-based compensation
$
6,110

 
$
9,171

 
$
10,742

 
$
9,461


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Revenue
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of revenue
68
 %
 
54
 %
 
58
 %
 
55
 %
Gross profit
32
 %
 
46
 %
 
42
 %
 
45
 %
Operating expenses:
 
 
 
 
 
 
 
Research and development
29
 %
 
19
 %
 
21
 %
 
19
 %
Sales, general and administrative
12
 %
 
7
 %
 
9
 %