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Table of Contents


 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 July 28, 2019
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 000-27999
 
Finisar Corporation
(Exact name of Registrant as specified in its charter)

Delaware
 
94-3038428
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
1389 Moffett Park Drive
 
 
Sunnyvale,
California
 
94089
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code:
408-548-1000

 
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 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, 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
 
Accelerated filer 
 
Non-accelerated filer 
 
Smaller reporting company
 
Emerging growth company
 
 
 
 
 
(Do not check if a smaller reporting 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 

Number of shares of the registrant's common stock, $.001 par value, outstanding as of August 30, 2019: 120,108,027



Table of Contents


INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended July 28, 2019
 
 
 
Page
 
 
 




2

Table of Contents

FORWARD LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We use words like “anticipates,” “believes,” “plans,” “expects,” “future,” “intends” and similar expressions to identify these forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events; however, our business and operations are subject to a variety of risks and uncertainties, and, consequently, actual results may materially differ from those projected by any forward-looking statements. As a result, you should not place undue reliance on these forward-looking statements since they may not occur.
Certain factors that could cause actual results to differ from those projected are discussed in “Part II. Other Information, Item 1A. Risk Factors.” We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events.


3

Table of Contents

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
FINISAR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
July 28, 2019
 
April 28, 2019
 
(Unaudited)
 
 
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
882,269

 
$
814,185

Short-term investments

 
100,000

Accounts receivable, net of allowance for doubtful accounts of $220 at July 28, 2019 and $216 at April 28, 2019
256,605

 
263,394

Inventories
320,555

 
299,028

Other current assets
40,179

 
44,224

Total current assets
1,499,608

 
1,520,831

Property, equipment and improvements, net
633,323

 
622,979

Purchased intangible assets, net
3,631

 
4,182

Goodwill
106,736

 
106,736

Other assets
62,413

 
15,462

Deferred tax assets
89,218

 
81,977

Total assets
$
2,394,929

 
$
2,352,167

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 
 
 
Accounts payable
$
119,628

 
$
132,440

Accrued compensation
33,343

 
31,804

Other accrued liabilities
66,163

 
49,495

Total current liabilities
219,134

 
213,739

Long-term liabilities:
 
 
 
Convertible debt
516,746

 
512,105

Other non-current liabilities
44,906

 
12,162

Total liabilities
780,786

 
738,006

Commitments and contingencies

 

Stockholders' equity:
 
 
 
Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding at July 28, 2019 and April 28, 2019

 

Common stock, $0.001 par value, 750,000 shares authorized
120

 
118

Additional paid-in capital
2,933,917

 
2,919,305

Accumulated other comprehensive loss
(54,483
)
 
(48,568
)
Accumulated deficit
(1,265,411
)
 
(1,256,694
)
Total stockholders' equity
1,614,143

 
1,614,161

Total liabilities and stockholders' equity
$
2,394,929

 
$
2,352,167

See accompanying notes.

4

Table of Contents

FINISAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
 
 
Three Months Ended
 
 
July 28, 2019
 
July 29, 2018
 
 
 
 
 
Revenues
 
$
285,028

 
$
317,336

Cost of revenues
 
197,627

 
236,156

Amortization of acquired developed technology
 
471

 
496

Impairment of long-lived assets
 
1,665

 

Gross profit
 
85,265

 
80,684

Operating expenses:
 
 
 
 
Research and development
 
52,151

 
63,059

Sales and marketing
 
12,107

 
12,480

General and administrative
 
13,234

 
12,643

Start-up costs
 
17,076

 
7,553

Amortization of purchased intangibles
 
230

 
640

Total operating expenses
 
94,798

 
96,375

Loss from operations
 
(9,533
)
 
(15,691
)
Interest income
 
4,424

 
5,155

Interest expense
 
(6,423
)
 
(9,386
)
Other expense, net
 
(2,132
)
 
(1,789
)
Loss before income taxes
 
(13,664
)
 
(21,711
)
Provision for (benefit from) income taxes
 
(4,947
)
 
(3,222
)
Net loss
 
$
(8,717
)
 
$
(18,489
)
Net loss per share:
 
 
 
 
Basic
 
$
(0.07
)
 
$
(0.16
)
Diluted
 
$
(0.07
)
 
$
(0.16
)
Shares used in computing net loss per share:
 
 
 
 
Basic
 
119,216

 
115,867

Diluted
 
119,216

 
115,867


See accompanying notes.

5

Table of Contents

FINISAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, in thousands)


 
 
Three Months Ended
 
 
July 28, 2019
 
July 29, 2018
Net loss
 
$
(8,717
)
 
$
(18,489
)
Other comprehensive income (loss), net of tax:
 
 
 
 
Change in cumulative foreign currency translation adjustment
 
(5,915
)
 
(29,696
)
Total other comprehensive income (loss), net of tax
 
(5,915
)
 
(29,696
)
Total comprehensive income (loss)
 
$
(14,632
)
 
$
(48,185
)

See accompanying notes.


6

Table of Contents

FINISAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited, in thousands)
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Accumulated
Deficit
 
Total
Finisar
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 28, 2019
118,006

 
$
118

 
$
2,919,305

 
$
(48,568
)
 
$
(1,256,694
)
 
$
1,614,161

Net loss

 

 

 

 
(8,717
)
 
(8,717
)
Other comprehensive loss, net

 

 

 
(5,915
)
 

 
(5,915
)
Issuance of shares pursuant to employee stock purchase plan and equity plans, net of tax withholdings
2,091

 
2

 
(2,749
)
 

 

 
(2,747
)
Stock-based compensation

 

 
17,361

 

 

 
17,361

Balance at July 28, 2019
120,097

 
$
120

 
$
2,933,917

 
$
(54,483
)
 
$
(1,265,411
)
 
$
1,614,143

 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 29, 2018
114,813

 
$
115

 
$
2,850,195

 
$
(14,660
)
 
$
(1,212,033
)
 
$
1,623,617

Cumulative effect of change in accounting principle

 

 

 

 
8,555

 
8,555

Net loss

 

 

 

 
(18,489
)
 
(18,489
)
Other comprehensive loss, net

 

 

 
(29,696
)
 

 
(29,696
)
Issuance of shares pursuant to employee stock purchase plan and equity plans, net of tax withholdings
2,347

 
2

 
4,377

 

 

 
4,379

Stock-based compensation

 

 
15,085

 

 

 
15,085

Balance at July 29, 2018
117,160

 
$
117

 
$
2,869,657

 
$
(44,356
)
 
$
(1,221,967
)
 
$
1,603,451



7

Table of Contents

FINISAR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Three Months Ended
 
July 28, 2019
 
July 29, 2018
Operating activities
 
 
 
Net loss
$
(8,717
)
 
$
(18,489
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation
22,592

 
24,799

Amortization
932

 
1,521

Stock-based compensation expense
15,722

 
15,141

Amortization of discount on held-to-maturity investments

 
(2,626
)
Impairment of long-lived assets
1,665

 
188

Amortization of discount on convertible debt
5,464

 
7,927

Deferred income tax (benefit) expense
(7,241
)
 
(7,282
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
6,789

 
(11,447
)
Inventories
(20,587
)
 
11,298

Other assets
3,248

 
8,472

Accounts payable
(7,121
)
 
9,851

Accrued compensation
1,539

 
2,824

Other accrued liabilities
2,828

 
17,639

Net cash provided by operating activities
17,113

 
59,816

Investing activities

 
 
Additions to property, equipment and improvements
(45,228
)
 
(104,902
)
Purchases of short-term investments

 
(659,709
)
Maturities of short-term investments
100,000

 
714,348

Net cash provided by (used in) investing activities
54,772

 
(50,263
)
Financing activities

 
 
Repayment of 2033 Notes
(1,054
)
 

Proceeds from the issuance of shares under equity plans and employee stock purchase plan
121

 
6,780

Shares repurchased for tax withholdings on vesting of restricted stock units
(2,868
)
 
(2,401
)
Net cash provided by (used in) financing activities
(3,801
)
 
4,379

Net increase in cash and cash equivalents
68,084

 
13,932

Cash and cash equivalents at beginning of period
814,185

 
312,257

Cash and cash equivalents at end of period
$
882,269

 
$
326,189

Supplemental disclosure of cash flow information
 
 
 
Cash paid for interest
$
1,438

 
$
2,085

Cash paid for taxes
$
1,306

 
$
2,699


See accompanying notes.

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FINISAR CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements as of July 28, 2019 and for the three month periods ended July 28, 2019 and July 29, 2018 have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”), and include the accounts of Finisar Corporation and its controlled subsidiaries (collectively, “Finisar” or the “Company”). Intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP and pursuant to the rules and regulations of the SEC have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Company's financial position as of July 28, 2019, its operating results for the three month periods ended July 28, 2019 and July 29, 2018, and its cash flows for the three month periods ended July 28, 2019 and July 29, 2018. Operating results for the three month period ended July 28, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending May 3, 2020. The condensed consolidated balance sheet as of April 28, 2019 has been derived from the audited consolidated financial statements as of that date, but does not include all the footnotes required by U.S. GAAP for complete financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the fiscal year ended April 28, 2019.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Merger Agreement
On November 8, 2018, the Company, II-VI Incorporated, a Pennsylvania corporation (“Parent”) and Mutation Merger Sub Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Subsidiary”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which, among other things, Merger Subsidiary will be merged with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Parent. The closing of the Merger is subject to various customary conditions.

2. Summary of Significant Accounting Policies
For a description of significant accounting policies, see Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included in the Company's annual report on Form 10-K for the fiscal year ended April 28, 2019. There have been no material changes to the Company's significant accounting policies since the filing of the annual report on Form 10-K, except for the adoption of a new lease accounting standard as described below.
Revenue
The following table presents the Company's revenues disaggregated by geography (based on the location of the entity purchasing the Company’s products) and market application:
 
Three Months Ended
(in thousands)
July 28, 2019
 
July 29, 2018
 
 
 
 
United States
$
86,067

 
$
110,400

China
75,722

 
79,713

Mexico
34,366

 
35,348

Rest of the world
88,873

 
91,875

Totals
$
285,028

 
$
317,336

 
 
 
 
Datacom
$
199,456

 
$
238,120

Telecom
85,572

 
$
79,216

Totals
$
285,028

 
$
317,336



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Effect of Adoption of New Accounting Standard
In February 2016, the FASB issued an accounting standards update which replaces then current lease accounting standard. The update requires lessees, among other items, to recognize a right-of-use ("ROU") asset and a lease liability for most leases. The update requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification determines whether lease expense is recognized based on an effective interest method (for finance leases) or on a straight-line (for operating leases) basis over the term of the lease. A lessee is also required to record a ROU asset and a lease liability for all leases with a term of greater than twelve months regardless of their classification. Leases with a term of twelve months or less will be accounted for similar to existing guidance for operating lease. The Company adopted this standard on April 29, 2019, applying a modified retrospective approach and using an option to apply it at the adoption date. The Company determines if an arrangement is a lease, or contains a lease, at inception, and classifies it as operating or finance. The Company does not have lease arrangements with residual value guarantees or material restrictive covenants. The Company's lease arrangements primarily consist of real property leases. ROU assets and corresponding lease liabilities are recognized based on the present value of the lease payments over the lease term. Lease terms may include options to extend when it is reasonably certain that the Company will exercise that option. As the implicit rate is not readily determinable in most of the Company's lease arrangements, the Company uses its estimated secured incremental borrowing rate based on information available at the lease commencement date in determining the present value of lease payments. All of the Company's lease arrangements are accounted for as operating leases. Certain of the Company's lease arrangements include non-lease components (e.g., common-area maintenance), and the Company accounts for non-lease components together with lease components for all such lease arrangements. Upon adoption, the Company made an accounting policy election not to record lease arrangements with an initial term of twelve months or less on its balance sheet. As part of its adoption, the Company elected a package of practical expedients for leases that commenced prior to the adoption date and did not reassess: (i) whether any expired or existing contracts are or contain leases; (ii) lease classification for any expired or existing leases; and (iii) initial direct costs capitalization for any existing leases. Upon adoption, the Company recognized ROU assets of $50.3 million as other assets, and corresponding lease liabilities of $14.9 million and $39.1 million as other accrued liabilities and other non-current liabilities, respectively.
As of July 28, 2019, the ROU assets balance was $47.0 million and corresponding lease liabilities were $14.5 million and $35.8 million as other accrued liabilities and other non-current liabilities, respectively. The Company's leases have remaining lease terms of approximately one to seven years, which may include extension options. As of July 28, 2019, the weighted average remaining lease term and the weighted average discount rate for the Company's leases were approximately 4.9 years and approximately 4%, respectively. Lease expense for the three month period ended July 28, 2019 was approximately $3.9 million. Lease payments under non-cancelable leases as of July 28, 2019, were as follows (in thousands):
 
Payments Due by Fiscal Year
 
 
 
2020 (remainder)
 
2021
 
2022
 
2023
 
2024
 
2025 and thereafter
 
Total
Lease payments (undiscounted)
$
11,344

 
$
12,404

 
$
9,697

 
$
8,480

 
$
4,812

 
$
7,837

 
$
54,574

Present value of lease payments
 
 
 
 
 
 
 
 
 
 
 
 
$
50,290


Cash outflows for operating leases were approximately $3.9 million for the three month period ended July 28, 2019.
Prior to the Company's adoption of the new lease accounting standard, future minimum lease payments under non-cancelable leases as of April 28, 2019 were as follows (in thousands):
 
Payments Due by Fiscal Year
 
 
 
2020
 
2021
 
2022
 
2023
 
2024
 
2025 and thereafter
 
Total
Lease payments (undiscounted)
$
9,990

 
$
7,797

 
$
7,513

 
$
5,873

 
$
2,484

 
$
3,915

 
$
37,572



Pending Adoption of New Accounting Standards
From time to time, new accounting pronouncements are issued by the FASB, or other standards setting bodies, that are adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes the impact of recently issued standards that are not yet effective will not have a material impact on its consolidated financial position, results of operations and cash flows upon adoption.

3. Earnings per Share
Basic net income (loss) per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Diluted net income (loss) per share has been computed using the weighted-average number of

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shares of common stock outstanding during the period plus dilutive potential shares of common stock from (1) stock options and restricted stock units (under the treasury stock method) and (2) convertible debt (under the treasury stock method) outstanding during the period.
The following table presents the calculation of basic and diluted net loss per share:
 
Three Months Ended
(in thousands, except per share amounts)
July 28, 2019
 
July 29, 2018
Numerator:
 
 
 
Net loss
$
(8,717
)
 
$
(18,489
)
Numerator for basic net loss per share
(8,717
)
 
(18,489
)
Numerator for diluted net loss per share
$
(8,717
)
 
$
(18,489
)
Denominator:
 
 
 
Denominator for basic net loss per share - weighted average shares
119,216

 
115,867

Denominator for diluted net income loss per share
119,216

 
115,867

Net loss per share:
 
 
 
Basic
$
(0.07
)
 
$
(0.16
)
Diluted
$
(0.07
)
 
$
(0.16
)

The following table presents potential shares of common stock excluded from the calculation of diluted net loss per share as their effect would have been anti-dilutive:
 
Three Months Ended
(in thousands)
July 28, 2019
 
July 29, 2018
Stock options and restricted stock units
3,367

 
5,710


0.50% Convertible Senior Notes due 2033 and 0.50% Convertible Senior Notes due 2036 were excluded from the calculation of diluted earnings per share under the treasury stock method for the periods when the conversion price exceeded the average market price for the Company's common stock.

4. Inventories
Inventories consist of the following:
As of
(in thousands)
July 28, 2019
 
April 28, 2019
Raw materials
$
65,846

 
$
63,749

Work-in-process
212,302

 
191,479

Finished goods
42,407

 
43,800

Total inventories
$
320,555

 
$
299,028



5. Investments
The Company's portfolio of fixed income securities consists of term bank certificates of deposit. All of the Company's investments in fixed income securities have original maturity (maturity at the purchase date) of less than 12 months and are reported as short-term investments in the consolidated balance sheets as of July 28, 2019 and April 28, 2019. All of the Company's investments in fixed income securities are classified as held-to-maturity since the Company has the positive intent and ability to hold these investments until maturity. These investments are carried at amortized cost.
The Company's investments in fixed income securities as of July 28, 2019 and April 28, 2019 were as follows:
 
 
July 28, 2019
 
April 28, 2019
 
 
 
 
Gross Unrealized
 
 
 
 
 
Gross Unrealized
 
 
(in thousands)
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value
Certificates of deposit
 

 

 

 

 
100,000

 

 

 
100,000




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During the three month periods ended July 28, 2019 and July 29, 2018, there were no gross unrealized gains or losses, no realized gains or losses, and no other-than-temporary impairments.

6. Debt

0.50% Convertible Senior Notes Due 2036
In December 2016, the Company issued and sold $575.0 million in aggregate principal amount of 0.50% Convertible Senior Notes due 2036 (the "2036 Notes") at par. The terms of the notes are governed by an indenture by and between the Company and Wells Fargo Bank, National Association, as Trustee. The notes will mature on December 15, 2036, unless earlier repurchased, redeemed or converted. The notes are senior unsecured and unsubordinated obligations of the Company, and are effectively subordinated to the Company's secured indebtedness and the indebtedness and other liabilities of the Company's subsidiaries. The notes bear interest at a rate of 0.5% per year, payable semi-annually in arrears on June 15 and December 15 each year.

Holders of the notes may convert their notes at their option prior to the close of business on the business day immediately preceding June 15, 2036 only under the following circumstances: (1) during any fiscal quarter commencing after the fiscal quarter ending on January 29, 2017 (and only during such fiscal quarter), if the last reported sale price of the Company's common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period ("measurement period"), in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the applicable conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events, e.g., a merger or an acquisition. On or after June 15, 2036 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their notes at any time, regardless of whether any of the foregoing circumstances have occurred. The conversion rate will initially equal 22.6388 shares of common stock per $1,000 principal amount of notes (which is equivalent to an initial conversion price of approximately $44.17 per share of common stock), subject to adjustment. Upon conversion of a note, the Company will pay or deliver, as the case may be, either cash, shares of its common stock or a combination of cash and shares of its common stock, at the Company's election, as provided in the indenture. If holders elect to convert their notes in connection with a "fundamental change" (as defined in the indenture) that occurs on or before December 22, 2021, the Company will, to the extent provided in the indenture, increase the conversion rate applicable to such notes ("make-whole feature").

Holders will have the option to require the Company to redeem for cash any notes held by them in the event of a fundamental change, e.g., a merger or an acquisition, at a purchase price equal to 100% of the principal amount of the notes plus accrued and unpaid interest to, but excluding, the redemption date. Holders also have the option to require the Company to redeem for cash any notes held by them on December 15, 2021, December 15, 2026 and December 15, 2031 at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest to, but excluding, the redemption date. The Company may redeem the notes in whole or in part at any time on or after December 22, 2021 at 100% of the principal amount, plus accrued and unpaid interest to, but excluding, the redemption date.

The Company considered the features embedded in the notes, that is, the conversion feature, the holders' put feature, the Company's call feature, and the make-whole feature, and concluded that they are not required to be bifurcated and accounted for separately from the host debt instrument.

Because of its option to settle conversion of the notes in cash, the Company separated the liability and equity components of the notes. The carrying amount of the liability component at issuance date of $465.1 million was calculated by estimating the fair value of similar liabilities without a conversion feature. The residual principal amount of the notes of $109.9 million was allocated to the equity component. The resulting debt discount is amortized as interest expense. As of July 28, 2019, the remaining debt discount amortization period was 29 months.


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As of July 28, 2019, the 2036 Notes consisted of the following (in thousands):
Liability component:
 
Principal
$
575,000

Unamortized debt discount
(56,047
)
Unamortized debt issuance costs
(2,207
)
Net carrying amount of the liability component
$
516,746

Carrying amount of the equity component
$
109,881



The Company incurred approximately $5.7 million in transaction costs in connection with the issuance of the notes. These costs were allocated to the liability and equity components in proportion to the allocation of proceeds. Transaction costs of $4.6 million, allocated to the liability component, were recognized as a debt discount and are amortized. Transaction costs of $1.1 million, allocated to the equity component, were recognized as a reduction of additional paid-in capital.

The following table sets forth interest expense information related to the 2036 Notes:
 
Three Months Ended
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
Contractual interest expense
$
719

 
$
719

Amortization of the debt discount
5,464

 
5,208

Amortization of issuance costs
231

 
231

Total interest cost
$
6,414

 
$
6,158

Effective interest rate on the liability component
4.85
%
 
4.85
%

The Company applies the treasury stock method to determine the potential dilutive effect of the 2036 Notes on net income per share as a result of the Company's intent and stated policy to settle the principal amount of the 2036 Notes in cash.

0.50% Convertible Senior Notes Due 2033
In December 2013, the Company issued and sold $258.8 million in aggregate principal amount of 0.50% Convertible Senior Notes due 2033 (the "2033 Notes") at par. The terms of the notes are governed by an indenture by and between the Company and Wells Fargo Bank, National Association, as Trustee. The notes were to mature on December 15, 2033, unless earlier repurchased, redeemed or converted. The notes were senior unsecured and unsubordinated obligations of the Company, and were effectively subordinated to the Company's secured indebtedness and the indebtedness and other liabilities of the Company's subsidiaries. The notes bore interest at a rate of 0.5% per year, payable semi-annually in arrears on June 15 and December 15 each year.

Holders of the notes were entitled to convert their notes at their option prior to the close of business on the business day immediately preceding June 15, 2033 only under the following circumstances: (1) during any fiscal quarter commencing after the fiscal quarter ending on January 26, 2014 (and only during such fiscal quarter), if the last reported sale price of the Company's common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter was greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period ("measurement period"), in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the applicable conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events, e.g., a merger or an acquisition. On or after June 15, 2033 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders were entitled to convert their notes at any time, regardless of whether any of the foregoing circumstances have occurred. The conversion rate was initially equal 33.1301 shares of common stock per $1,000 principal amount of notes (which is equivalent to an initial conversion price of approximately $30.18 per share of common stock), subject to adjustment. Upon conversion of a note, the Company would have paid or delivered, as the case may be, either cash, shares of its common stock or a combination of cash and shares of its common stock, at the Company's election, as provided in the indenture. If holders had elected to convert their notes in connection with a "fundamental change" (as defined in the indenture) that occured on or before December 22, 2018, the Company would have, to the extent provided in the indenture, increased the conversion rate applicable to such notes ("make-whole feature").


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Holders had the option to require the Company to redeem for cash any notes held by them in the event of a fundamental change, e.g., a merger or an acquisition, at a purchase price equal to 100% of the principal amount of the notes plus accrued and unpaid interest to, but excluding, the redemption date. Holders also had the option to require the Company to redeem for cash any notes held by them on December 15, 2018, December 15, 2023 and December 15, 2028 at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest to, but excluding, the redemption date. The Company had the right to redeem the notes in whole or in part at any time on or after December 22, 2018 at 100% of the principal amount, plus accrued and unpaid interest to, but excluding, the redemption date.

The Company considered the features embedded in the notes, that is, the conversion feature, the holders' put feature, the Company's call feature, and the make-whole feature, and concluded that they are not required to be bifurcated and accounted for separately from the host debt instrument.

Because of its option to settle conversion of the notes in cash, the Company separated the liability and equity components of the notes. The carrying amount of the liability component at issuance date of $209.1 million was calculated by estimating the fair value of similar liabilities without a conversion feature. The residual principal amount of the notes of $49.6 million was allocated to the equity component. The resulting debt discount was amortized as interest expense and was fully amortized as of July 28, 2019.

In December 2018, the holders of the 2033 Notes representing approximately $257.7 million of the principal amount of the 2033 Notes exercised their rights to redeem their 2033 Notes at a redemption price equal to 100% of the principal amount of the notes. All redemptions were in accordance with the original terms of the 2033 Notes and no gain or loss was recognized as a result of redemption.

On May 1, 2019, the Company redeemed all remaining $1.1 million of the principal amount of the 2033 Notes at a redemption price equal to 100% of the principal amount of the notes. This redemption was in accordance with the original terms of the 2033 Notes and no gain or loss was recognized as a result of redemption.

The Company incurred approximately $3.8 million in transaction costs in connection with the issuance of the notes. These costs were allocated to the liability and equity components in proportion to the allocation of proceeds. Transaction costs of $3.1 million, allocated to the liability component, were recognized as a non-current asset and amortized as interest expense and were fully amortized as of July 28, 2019. Transaction costs of $725,000, allocated to the equity component, were recognized as a reduction of additional paid-in capital.

The following table sets forth interest expense information related to the 2033 Notes:
 
Three Months Ended
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
Contractual interest expense
$

 
$
324

Amortization of the debt discount

 
2,719

Amortization of issuance costs

 
154

Total interest cost
$

 
$
3,197

Effective interest rate on the liability component
n/a

 
4.87
%

The Company applied the treasury stock method to determine the potential dilutive effect of the 2033 Notes on net income per share as a result of the Company's intent and stated policy to settle the principal amount of the 2033 Notes in cash.

7. Fair Value of Financial Instruments
The Company's financial instruments not measured at fair value on a recurring basis as of July 28, 2019 and April 28, 2019 were as follows:
 
July 28, 2019
 
April 28, 2019
 
Carrying
 
Fair Value
 
Carrying
 
Fair Value
(in thousands)
Amount
 
Level 1
Level 2
Level 3
Total
 
Amount
 
Level 1
Level 2
Level 3
Total
Certificates of deposit
$

 
$

$

$

$

 
$
100,000

 
$

$
100,000

$

$
100,000

2033 Notes
$

 
$

$

$

$

 
$
1,054

 
$
1,063

$

$

$
1,063

2036 Notes
$
516,746

 
$
565,452

$

$

$
565,452

 
$
511,051

 
$
564,302

$

$

$
564,302



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The fair values of the Company's investments in certificates of deposit are based on quoted market prices for similar instruments or non-binding market prices that are corroborated by observable market data. The fair values of the 2033 Notes and the 2036 Notes are based on the price in the open market as of or close to the respective balance sheet dates. The difference between the carrying value and the fair value for the convertible notes is primarily due to the spread between the conversion price and the market value of the shares underlying the conversion as of each respective balance sheet date.

8. Legal Matters
The Company accrues a liability for legal contingencies when it believes that it is both probable that a liability has been incurred and that it can reasonably estimate the amount of the loss. The Company reviews these accruals and adjusts them to reflect ongoing negotiations, settlements, rulings, advice of legal counsel and other relevant information. To the extent new information is obtained and the Company's views on the probable outcomes of claims, suits, assessments, investigations or legal proceedings change, changes in the Company's accrued liabilities would be recorded in the period in which such determination is made. For the matters referenced below, the amount of liability is not probable or the amount cannot be reasonably estimated and, therefore, accruals have not been made. In addition, in accordance with the relevant authoritative guidance, for matters which the likelihood of material loss is at least reasonably possible, the Company provides disclosure of the possible loss or range of loss; however, if a reasonable estimate cannot be made, the Company will provide disclosure to that effect.
Due to the nature of the Company's business, it is subject to claims alleging infringement by various Company products and services. The Company believes that it has meritorious defenses to the allegations made in its pending cases and intends to vigorously defend these lawsuits; however, it is currently unable to determine the ultimate outcome of these or similar matters. In addition, the Company is a defendant in various litigation matters generally arising out of the normal course of business. Although it is difficult to predict the ultimate outcomes of these cases, the Company believes that it is not reasonably possible that the ultimate outcomes will materially and adversely affect its business, financial position, results of operations or cash flows.

Class Action and Shareholder Derivative Litigation
Several securities class action lawsuits related to the Company's March 8, 2011 earnings announcement alleging claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 have been filed in the United States District Court for the Northern District of California on behalf of a purported class of persons who purchased stock between December 2, 2010 through March 8, 2011. The named defendants are the Company and Jerry Rawls, its former Chief Executive Officer and former Chairman of the Board, and Eitan Gertel, its former Chief Executive Officer. To date, no specific amount of damages has been alleged. The cases were consolidated, a lead plaintiff was appointed and a consolidated complaint was filed. The Company filed a motion to dismiss the case. On January 16, 2013, the District Court granted the Company's motion to dismiss and granted the lead plaintiffs leave to amend the consolidated complaint. An amended consolidated complaint was filed on February 6, 2013. Thereafter, the Company filed a renewed motion to dismiss the case. On September 30, 2013, the District Court granted the Company's motion and dismissed the case with prejudice, and plaintiff appealed. On January 8, 2016, the Ninth Circuit Court of Appeals reversed the judgment in part for further proceedings in the District Court. On July 15, 2016, lead plaintiff filed a Second Amended Complaint in the District Court. On August 19, 2016, the Company moved to dismiss. On May 1, 2017, the District Court denied the motion and a case scheduling order has been issued. On December 5, 2017, the District Court issued an order denying class certification. On February 1, 2018, the plaintiff filed a petition with the Ninth Circuit Court of Appeals for permission to appeal the denial of class certification and, on July 13, 2018, the Ninth Circuit Court of Appeals denied the petition for permission to appeal. On October 10, 2018, the plaintiff filed a new motion for class certification, which the Company opposed. On May 24, 2019, the District Court denied plaintiffs motion for class certification and granted judgement on the pleadings in favor of the Company and the other defendants. The plaintiff filed a notice of appeal on June 20, 2019.
In addition, two purported shareholder derivative lawsuits related to the Company's March 8, 2011 earnings announcement have been filed in the California Superior Court for the County of Santa Clara, and a third derivative lawsuit has been filed in the United States District Court for the Northern District of California. The complaints assert claims for alleged breach of fiduciary duty, unjust enrichment, and waste on behalf of the Company. Named as defendants are the members of the Company's board of directors at the time of the claim and certain officers, including Jerry Rawls, the Company's former Chief Executive Officer and former Chairman of the Board, Eitan Gertel, the Company’s former Chief Executive Officer, and Kurt Adzema, the Company’s Chief Financial Officer. No specific amount of damages has been alleged and, by the derivative nature of the lawsuits, no damages will be alleged against the Company. The state court cases were consolidated, a lead plaintiff was appointed to file a consolidated complaint, and the cases were stayed by the agreement of the parties. On August 7, 2017, the plaintiff in the federal case filed an amended complaint. On September 5, 2018, the court granted the motion to dismiss with leave to amend. The parties agreed to settle the federal case and, on February 20, 2019, plaintiff filed an unopposed motion for

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preliminary approval of the settlement, under which the Company has agreed to implement a series of enhancements to its corporate governance policies and procedures. The court granted the motion for preliminary approval on April 18, 2019 and final approval on June 27, 2019.

Litigation relating to the Merger
In January, 2019, eight lawsuits have been filed by alleged Finisar stockholders challenging the Merger: (i) Hein, et al. v. Finisar Corporation, et al., 19CV340510, in the Superior Court of California, County of Santa Clara; (ii) Tenvold, et al. v. Finisar Corporation, et al., 1:19-cv-00050, in the United States District Court for the District of Delaware; (iii) Klein, et al. v. Finisar Corporation, et al., 5:19-cv-00155, in the United States District Court for the Northern District of California; (iv) Wheby Jr., et al. v. Finisar Corporation, et al., 1:19-cv-00064, in the United States District Court for the District of Delaware; (v) Sharma v. Finisar Corporation, et al., 5:19-cv-00220, in the United States District Court for the Northern District of California; (vi) Davis, et al. v. Finisar Corporation, et al., 3:19-cv-00271, in the United States District Court for the Northern District of California; (vii) Bushansky, et al. v. Finisar Corporation, et al., 5:19-cv-00446, in the United States District Court for the Northern District of California; and (viii) Pappey, et al. v. Finisar Corporation, et al., 1:19-cv-00167, in the United States District Court for the District of Delaware (collectively, the “Actions”).
Plaintiffs in the Actions named as defendants Finisar and each member of the Finisar Board. In addition, plaintiffs in the Hein, Tenvold, and Klein actions named II-VI and Merger Subsidiary as defendants. Further, plaintiffs in the Hein, Tenvold, Klein, Wheby, Jr., Davis, Bushansky, and Pappey actions sought to recover on behalf of a putative class consisting of all similarly situated Finisar stockholders.
Plaintiff in the Hein action alleged that the Finisar Board breached its fiduciary duties to Finisar stockholders by, among other things, purportedly engaging in an insufficient sales process, obtaining inadequate merger consideration, and filing a materially misleading preliminary proxy statement. The Hein plaintiff further asserted that II-VI and the Merger Subsidiary knowingly aided and abetted the Finisar Board in breaching their fiduciary duties to Finisar stockholders by entering into the Merger. The Hein plaintiff sought a preliminary and permanent injunction of the proposed transaction unless the proxy statement was amended, rescission and unspecified damages if the Merger was consummated, and attorneys’ fees and expert fees and costs.
Plaintiffs in the Tenvold, Klein, Wheby Jr., Sharma, Davis, Bushansky, and Pappey actions purported to state claims for violations of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 and, in the case of the Davis complaint, Regulation G promulgated thereunder. Plaintiffs in these actions generally alleged that the preliminary proxy statement omits material information with respect to the Merger, and sought, among other things, an order enjoining the defendants from proceeding with closing the Merger; unspecified damages, attorneys’ fees and expert fees, and expenses and costs; and in the event the Merger was consummated before entry of final judgment, rescission of the Merger or rescissory damages. Defendants believe that the complaints are without merit.
Following the filing of the Actions, counsel for Finisar and for the Plaintiffs engaged in arms-length negotiations concerning claims raised in the Actions and took certain actions that resulted in Finisar filing a Schedule DEFA14A on March 11, 2019, with the U.S. Securities and Exchange Commission that contained supplemental disclosures relating to the Merger. On March 12, 2019, Plaintiffs voluntarily dismissed the Actions with prejudice as to the Plaintiffs’ individual claims and without prejudice to claims asserted on behalf of a purported putative class of Finisar stockholders.

9. Guarantees and Indemnifications
Upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligations it assumes under that guarantee. As permitted under Delaware law and in accordance with the Company's bylaws, the Company indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving in such capacity at the Company's request. The term of the indemnification period is for the officer's or director's lifetime. The Company may terminate the indemnification agreements with its officers and directors upon 90 days written notice, but termination will not affect claims for indemnification relating to events occurring prior to the effective date of termination. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer liability insurance policy that may enable it to recover a portion of any future amounts paid.
The Company enters into indemnification obligations under its agreements with other companies in its ordinary course of business, including agreements with customers, business partners and insurers. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities or the use of the Company's products. These indemnification provisions generally survive termination of the underlying agreement. In some cases, the maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited.

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The Company believes the fair value of these indemnification obligations is immaterial. Accordingly, the Company has not recorded any liabilities for these agreements as of July 28, 2019. To date, the Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements.


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

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We use words like “anticipates,” “believes,” “plans,” “expects,” “future,” “intends” and similar expressions to identify these forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events; however, our business and operations are subject to a variety of risks and uncertainties, and, consequently, actual results may materially differ from those projected by any forward-looking statements. As a result, you should not place undue reliance on these forward-looking statements since they may not occur.

Certain factors that could cause actual results to differ from those projected are discussed in “Part II. Other Information, Item 1A. Risk Factors.” We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events.

The following discussion should be read together with our condensed consolidated financial statements and related notes thereto included elsewhere in this report.

Business Overview

We are a global technology leader in optical communications, providing components and subsystems to networking equipment manufacturers, data center operators, telecom service providers, consumer electronics and automotive companies. We design products that meet the increasing demands for network bandwidth, data storage and 3D sensing subsystems. Our optical subsystems consist primarily of transmitters, receivers, transceivers, transponders and active optical cables, which provide the fundamental optical-electrical, or optoelectronic interface for interconnecting the electronic equipment used in these networks, including the switches, routers, and servers used in wireline networks as well as the antennas and base stations used in wireless networks. These products rely on the use of semiconductor lasers and photodetectors in conjunction with integrated circuits and novel optoelectronic packaging to provide a cost-effective means for transmitting and receiving digital signals over fiber optic cable at speeds ranging from less than 1 gigabit per second, or Gbps, to more than 400 Gbps, over distances of less than 10 meters to more than 2,000 kilometers, using a wide range of network protocols and physical configurations.

We also provide products known as wavelength selective switches, or WSS. In long-haul and metro networks, each fiber may carry 50 to more than 100 different high-speed optical wavelengths. WSS are switches that are used to dynamically switch network traffic from one optical fiber to multiple other fibers without first converting to an electronic signal. The wavelength selective feature means that WSS enable any wavelength or combination of wavelengths to be switched from the input fiber to the output fibers. WSS products are sometimes combined with other components and sold as linecards that plug into a system chassis referred to as a reconfigurable optical add/drop multiplexers, or ROADM.

We have also entered the 3D Sensing market. 3D Sensing enables features such as facial recognition, gaming and virtual reality, as well as automotive market applications such as LiDAR and in-cabin recognition. VCSELs (Vertical Cavity Surface Emitting Lasers) are core to 3D Sensing. We leverage our experience in laser technology in our 3D Sensing products.

Our line of optical components also includes packaged lasers and photodetectors for data communication and telecommunication applications.

Demand for our products is largely driven by the continually growing need for additional network bandwidth created by the ongoing proliferation of data and video traffic from video downloads, Internet protocol TV, social networking, on-line gaming, file sharing, enterprise IP/Internet traffic, cloud computing, and data center virtualization that must be handled by both wireline and wireless networks. Mobile traffic is increasing as the result of proliferation of smartphones, tablet computers, and other mobile devices.

Our manufacturing operations are vertically integrated and we produce many of the key components used in making our products, including lasers, photodetectors and integrated circuits, or ICs, designed by our internal IC engineering teams. We also have internal assembly and test capabilities that make use of internally designed equipment for the automated testing of our optical subsystems and components.

We sell our products primarily to manufacturers of storage systems, networking equipment and telecommunication equipment such as Broadcom, Ciena, Cisco Systems, Dell EMC, Ericsson, FiberHome, Fujitsu, Hewlett Packard Enterprise,

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Huawei, IBM, Juniper, Nokia, QLogic (now a subsidiary of Marvell Technology), and ZTE, and to their contract manufacturers. These customers, in turn, sell their systems to businesses and to wireline and wireless telecommunication service providers and cable TV operators, collectively referred to as carriers. We also sell products to end-users.

Our cost of revenues consists of materials, salaries and related expenses for manufacturing personnel, manufacturing overhead, warranty expense, inventory adjustments for obsolete and excess inventory and the amortization of acquired developed technology associated with acquisitions that we have made. As a result of building a vertically integrated business model, our manufacturing cost structure has become more fixed. While this can be beneficial during periods when demand is strong, it can be more difficult to reduce costs during periods when demand for our products is weak, product mix is unfavorable or selling prices are generally lower. While we have undertaken measures to reduce our operating costs, there can be no assurance that we will be able to reduce our cost of revenues sufficiently to achieve or sustain profitability.

Since October 2000, we have completed the acquisition of two publicly-held companies. We have also completed the acquisition of 13 privately-held companies and certain businesses and assets from seven other companies in order to broaden our product offerings and provide new sources of revenue, production capabilities and access to advanced technologies that we believe will enable us to reduce our product costs and develop innovative and more highly integrated product platforms while accelerating the timeframe required to develop such products.
Merger Agreement
On November 8, 2018, the Company, II-VI Incorporated, a Pennsylvania corporation ("Parent" or "II-VI") and Mutation Merger Sub Inc., a Delaware corporation and a wholly owned subsidiary of Parent ("Merger Subsidiary"), entered into an Agreement and Plan of Merger (the "Merger Agreement"), pursuant to which, among other things, Merger Subsidiary will be merged with and into the Company (the "Merger"), with the Company surviving the Merger as a wholly owned subsidiary of Parent.

At the time the Merger becomes effective (the "Effective Time"), each issued and outstanding share of common stock, par value $0.001 per share, of the Company ("Company Stock") (other than shares of Company Stock owned by Parent or Merger Subsidiary or any direct or indirect wholly owned subsidiary of Parent, which will be cancelled without consideration, and holders of Company Stock, if any, who properly exercise their appraisal rights under the General Corporation Law of the State of Delaware) outstanding immediately prior to the Merger will be automatically cancelled and converted into the right to receive, for each share of Company Stock, at the stockholder’s election and subject to proration in the event the cash consideration or Parent Common Stock (as defined below) consideration is oversubscribed, either (i) $26.00 in cash (the "Cash Election Consideration"), (ii) 0.5546 of a share of common stock, no par value, of Parent ("Parent Common Stock") (the "Stock Election Consideration"), or (iii) a combination of (A) 0.2218 of a share of Parent Common Stock (the "Exchange Ratio") and (B) $15.60 in cash, without interest (the "Mixed Election Consideration"). On an average basis across all shares of Company Stock (including the Options (as defined below) and Performance RSUs (as defined below)), at the closing of the Merger, 60% of the aggregate amount of the outstanding shares of Company Stock (including the Options and Performance RSUs) will be converted into the right to receive the Cash Election Consideration, with the remaining 40% converted into the right to receive the Stock Election Consideration.

Pursuant to the Merger Agreement, at the Effective Time, each outstanding and unexercised option to purchase Company Stock (whether vested or unvested) (an "Option") shall automatically be cancelled and terminated and converted into the right to receive an amount of Mixed Election Consideration equal to the product of (i) the excess, if any, of the Cash Election Consideration over the exercise price per share of such Option multiplied by (ii) the number of shares of Company Stock subject to such Option, payable no later than the Company’s next payroll date after the closing of the Merger. Further, as of the Effective Time, each award of restricted stock units of the Company that is outstanding immediately prior to the Effective Time and is subject to a performance-based vesting condition (a "Performance RSU") that relates solely to the value of Company Stock will vest as to a number of shares determined under the terms of the award and will be cancelled and extinguished and converted into the right to receive the Cash Election Consideration, the Stock Election Consideration or the Mixed Election Consideration in accordance with the election made by the holder of such Performance RSU. At the Effective Time, each other award of restricted stock units of the Company that is outstanding and unvested will be assumed by Parent and continue to be subject to substantially the same terms and conditions (including vesting requirements) as in effect immediately prior to the Effective Time, except that the number of shares of Parent Common Stock subject to such assumed restricted stock unit awards will be equal to the product of (i) the number of shares of Company Stock underlying such unvested restricted stock unit award as of immediately prior to the Effective Time multiplied by (ii) the sum of the (A) Exchange Ratio plus (B) the quotient obtained by dividing $15.60 by the Equity Award Measurement Price. The "Equity Award Measurement Price" means the volume weighted average price per share of Parent Common Stock on NASDAQ for the ten (10) consecutive trading days ending on (and including) the third trading day immediately prior to the Effective Time.

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The Merger Agreement also provides, among other things, that the board of directors of Parent (the "Parent Board") will appoint, at the Effective Time, three members, each of whom are (i) members of the board of directors of the Company (the "Board") as of the date of the Merger Agreement, (ii) mutually agreed to by the Company and Parent, acting in good faith, and (iii) reasonably approved by the Corporate Governance and Nominating Committee of the Parent Board.

The closing of the Merger is subject to, among other things, the adoption of the Merger Agreement by the affirmative vote of the holders of at least a majority of the outstanding shares of Company Stock (the "Company Stockholder Approval"), which was obtained on March 26, 2019, and the affirmative vote of at least a majority of the votes cast for the proposal on the issuance of the Parent Common Stock and any restricted units of Parent issuable in connection with the Merger (the "Parent Stockholder Approval"), which was obtained on March 26, 2019. The closing of the Merger is also subject to various customary conditions, including the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; receipt of other specified regulatory approvals; the absence of any temporary restraining order, preliminary or permanent injunction or other order issued by any court of competent jurisdiction enjoining or otherwise prohibiting the consummation of the Merger; the SEC having declared effective a Form S-4 with respect to, and the approval of the listing on NASDAQ of, the shares of Parent Common Stock issuable in connection with the Merger; the accuracy of the representations and warranties contained in the Merger Agreement (generally subject to a material adverse effect qualification); compliance with the covenants and agreements in the Merger Agreement in all material respects; and no material adverse effect on either the Company or Parent. The closing of the Merger is also subject to Parent, the Company and Wells Fargo Bank, National Association (the "Trustee"), entering into a supplemental indenture in connection with that certain (i) indenture, dated as of December 16, 2013 (the "2033 Notes Indenture"), by and among the Company and the Trustee governing the Company’s 0.50% Convertible Senior Notes due 2033 (the "2033 Notes"), which was cancelled and discharged on May 1, 2019 in connection with the redemption of all of the remaining outstanding 2033 Notes, and (ii) indenture, dated as of December 21, 2016 (the "2036 Notes Indenture" and, together with the 2033 Notes Indentures, the "Indentures"), by and among the Company and the Trustee governing the Company’s 0.50% Convertible Senior Notes due 2036 (the "2036 Notes" and, together with the 2033 Notes, the "Notes") providing, among other items, (a) at and after the Effective Time, pursuant, and subject to, the terms and conditions of the applicable Indenture, for the change in right to convert each $1,000 principal amount of the 2033 Notes and the 2036 Notes, as applicable, into the amount of shares of Parent Common Stock and cash, or the combination thereof, that a holder of a number of shares of Company Stock equal to the conversion rate of the 2033 Notes and the 2036 Notes immediately prior to the Effective Time would have owned or been entitled to receive upon the Effective Time, and (b) Parent’s full and unconditional guarantee, on a senior unsecured basis, of the 2033 Notes and the 2036 Notes. Though not a condition to Closing, Parent and Merger Subsidiary are also obligated to use its reasonable best efforts to obtain debt financing that, together with the other financial resources of Parent, will be sufficient to satisfy all of Parent’s and Merger Subsidiary’s payment obligations under the Merger Agreement.

Pursuant, and subject, to the terms and conditions of the Indentures, each holder of Notes will have the right, at such holder’s option, to require the Company to repurchase any or all of such holder’s Notes, on the date specified by the Company that is not less than 20 business days and not more than 35 business days after the date of the Company’s notice to holders of the occurrence of the Merger, such notice to be delivered within 20 business days of the Effective Time, at a repurchase price equal to 100% of the principal amount thereof, together with accrued and unpaid interest to, but excluding, the repurchase date ("Merger Repurchase Date"). Further pursuant, and subject, to the terms and conditions of the Indentures, all or any portion of a holder’s Notes may be surrendered for conversion at any time from or after the date that is 25 scheduled trading days prior to the anticipated Effective Time (or, if later, the business day after the Company gives holders notice of the Merger) until the Merger Repurchase Date.

The Company has made customary representations and warranties in the Merger Agreement. The Company is also subject to customary covenants, including, among others, covenants (i) to conduct its business in the ordinary course during the period between the execution of the Merger Agreement and the closing of the Merger, (ii) not to engage in specified types of transactions during this period unless agreed to in writing by Parent, (iii) to convene and hold a meeting of its stockholders for the purpose of obtaining the Company Stockholder Approval, which was held and such approval was obtained on March 26, 2019, and (iv) subject to certain exceptions, not to withdraw, amend or modify in a manner adverse to Parent the recommendation of the Board that the Company’s stockholders adopt the Merger Agreement.

Parent has made customary representations and warranties in the Merger Agreement. Parent is also subject to customary covenants, including, among others, (i) to conduct its business in the ordinary course during the period between the execution of the Merger Agreement and the closing of the Merger, (ii) not to engage in specified types of transactions during this period unless agreed to in writing by the Company, (iii) to convene and hold a meeting of its shareholders for the purpose of obtaining the Parent Stockholder Approval, which was held and such approval was obtained on March 26, 2019, and (iv) subject to certain exceptions, not to withdraw, amend or modify in a manner adverse to the Company the recommendation of the Parent

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Board that Parent’s shareholders vote in favor of the issuance of the Parent Common Stock issuable in connection with the Merger.

The Merger Agreement contains certain termination rights, including the right of the Company to terminate the Merger Agreement under specified circumstances to accept an unsolicited superior proposal from a third party. The Merger Agreement provides that, upon termination of the Merger Agreement by the Company or Parent under specified circumstances (including termination by the Company to accept a superior proposal), a termination fee of $105,200,000 will be payable by the Company to Parent. The Company termination fee is also payable under certain other specified circumstances set forth in the Merger Agreement. Further, the Company has the right to terminate the Merger Agreement if the Parent Board fails to recommend that the shareholders of Parent vote in favor of the issuance of the Parent Common Stock issuable in connection with the Merger or if the Parent withdraws, amends or modifies such recommendation. If the Company timely exercises its right to terminate the Merger Agreement after it obtains actual knowledge of such failure to recommend, or withdrawal, amendment or modification of such recommendation, a termination fee of $105,200,000 will be payable by Parent to the Company. The Merger Agreement also provides that each party to the Merger Agreement may compel the other party or parties thereto to specifically perform its or their obligations under the Merger Agreement.

The foregoing description of the Merger Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the Merger Agreement, which was filed as Exhibit 2.1 to our Current Report on Form 8-K on November 9, 2018 and is incorporated herein by reference.

Critical Accounting Estimates
The preparation of our financial statements and related disclosures requires that we make estimates, assumptions and judgments that can have a significant impact on our revenue and operating results, as well as on the value of certain assets and contingent liabilities on our balance sheet. The methods, assumptions, and estimates that we use in applying our accounting policies may require us to apply judgments regarding matters that are inherently uncertain. We consider an accounting policy to be a critical estimate if: (1) we must make assumptions that were uncertain when the judgment was made, and (2) changes in the estimate assumptions, or the selection of a different estimate methodology, could have a significant impact on our financial position and the results that we report in our consolidated financial statements. While we believe that our estimates, assumptions, and judgments are reasonable, they are based on the information available when the estimate was made. We believe there have been no significant changes in our critical accounting estimates from those described in our Annual Report on Form 10-K for the fiscal year ended April 28, 2019.

Results of Operations

Revenues (by market application)
Three Months Ended
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Datacom revenue
$
199,456

 
$
238,120

 
$
(38,664
)
 
(16
)%
Telecom revenue
85,572

 
79,216

 
6,356

 
8
 %
Total revenues
$
285,028

 
$
317,336

 
$
(32,308
)
 
(10
)%
 
 
 
 
 
 
 
 
Datacom revenue for the three month period ended July 28, 2019 decreased approximately $38.7 million compared to the three month period ended July 29, 2018 primarily due to an approximately $23.2 million decrease in 40 and below Gbps datacom transceiver revenue and approximately $13.4 million decrease in 100 Gbps datacom transceiver revenue.

Telecom revenue for the three month period ended July 28, 2019 increased approximately $6.4 million compared to the three month period ended July 29, 2018 primarily due to an approximately $5.2 million increase in WSS products revenue.

Amortization of Acquired Developed Technology
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
471

 
$
496

 
$
(25
)
 
(5
)%

Amortization of acquired developed technology for the three month period ended July 28, 2019 decreased compared to the three month period ended July 29, 2018 due to the roll-off of amortization of certain intangible assets related to our prior acquisitions.


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Impairment of Long-Lived Assets
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
1,665

 
$

 
$
1,665

 
100
%

During the three month period ended July 28, 2019, we recorded a $1.7 million charge for the impairment of certain long-lived assets due to the planned retirement of such assets resulting from product and facility transitions.

Gross Profit
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
85,265

 
$
80,684

 
$
4,581

 
6
%
As a percentage of revenues
30
%
 
25
%
 
 
 
 

Gross profit is calculated as revenues less cost of revenues, amortization of acquired developed technology, and, if applicable, impairment of long-lived assets. The gross profit increase for the three month period ended July 28, 2019, compared to the three month period ended July 29, 2018 was attributable primarily to the increase in gross margin.

Gross margin is gross profit reflected as a percentage of revenues. Our cost of revenues consists of materials, salaries and related expenses for manufacturing personnel, manufacturing overhead, warranty expense, and inventory adjustments for excess and obsolete inventory. Gross margin for the three month period ended July 28, 2019 increased compared to the three month period ended July 29, 2018 mostly due to favorable product mix.

Our industry is characterized by products with average selling prices that decrease over time and we expect this trend to continue. Future decreases in average selling prices may have an unfavorable impact on our future gross profit, which may be partially or fully offset in any period in the event that we are successful in decreasing the cost of manufacturing our products being sold, increasing the number of units sold and/or increasing the sales of products with higher gross margins. Future decreases in average selling prices also may have an unfavorable impact on our future gross margin, which may be partially or fully offset in any period in the event that we are successful in decreasing the cost of manufacturing our products being sold and/or increasing the sales of products with higher gross margins.

Research and Development Expenses
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
52,151

 
$
63,059

 
$
(10,908
)
 
(17
)%

Research and development expenses consist primarily of salaries and related costs of employees engaged in research and design activities, including stock-based compensation charges related to those employees, costs of design tools and computer hardware, costs related to prototyping, and allocated facilities and IT support costs. Research and development expenses for the three month period ended July 28, 2019 decreased compared to the three month period ended July 29, 2018 primarily due to a decrease in employee compensation related expenses as a result of restructuring activities undertaken during the first quarter of fiscal 2019 as well as employee severance compensation and other expenses incurred during the first quarter of fiscal 2019 related to restructuring activities undertaken during the first quarter of fiscal 2019.

Sales and Marketing Expenses
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
12,107

 
$
12,480

 
$
(373
)
 
(3
)%

Sales and marketing expenses consist primarily of salaries and related costs of employees engaged in sales and marketing functions, including stock-based compensation charges related to those employees, commissions for our external sales representatives, costs related to marketing and promotional activities, and allocated facilities and IT support costs. Sales and marketing expenses for the three month period ended July 28, 2019 decreased compared to the three month period ended July 29, 2018 primarily due to a decrease in employee compensation related expenses as a result of restructuring activities undertaken during the first quarter of fiscal 2019 as well as employee severance compensation and other expenses incurred during the first quarter of fiscal 2019 related to restructuring activities undertaken during the first quarter of fiscal 2019.


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General and Administrative Expenses
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
13,234

 
$
12,643

 
$
591

 
5
%

General and administrative expenses consist primarily of salaries and related costs of employees engaged in general and administrative functions, including stock-based compensation charges related to those employees, legal, audit and other professional fees, insurance costs, human resources and other corporate costs, and allocated facilities and IT support costs. General and administrative expenses for the three month period ended July 28, 2019 increased compared to the three month period ended July 29, 2018 primarily due to transaction expenses incurred during the first quarter of fiscal 2020 related to the Merger.

Start-Up Costs
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
17,076

 
$
7,553

 
$
9,523

 
100
%

Start-up costs consist of operating expenses, including employee compensation, facility maintenance and other expenses, related to our recently purchased 700,000 square foot manufacturing facility in Sherman, Texas during the period while it is being brought to its intended use.

Interest Income
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
4,424

 
$
5,155

 
$
(731
)
 
(14
)%

Interest income for the three month period ended July 28, 2019 decreased compared to the three month period ended July 29, 2018 primarily due to the redemption of our 0.50% Convertible Senior Notes due 2033 during the third quarter of fiscal 2019.

Interest Expense
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
6,423

 
$
9,386

 
$
(2,963
)
 
(32
)%

Interest expense for the three month period ended July 28, 2019 decreased compared to the three month period ended July 29, 2018 primarily due to the redemption of our 0.50% Convertible Senior Notes due 2033 during the third quarter of fiscal 2019.

Other Income (Expense), Net
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
(2,132
)
 
$
(1,789
)
 
$
(343
)
 
19
%

Other expense, net for the three month period ended July 28, 2019 increased compared to the three month period ended July 29, 2018 primarily due to fluctuations of foreign currency exchange rates.

Provision for (Benefit from) Income Taxes
 
 
 
 
 
 
 
(in thousands, except percentages)
July 28, 2019
 
July 29, 2018
 
Change
 
% Change
Three months ended
$
(4,947
)
 
$
(3,222
)
 
$
(1,725
)
 
54
%

The benefit from income taxes for the three month period ended July 28, 2019 increased compared to the three month period ended July 29, 2018 primarily due to a discrete tax benefit associated with stock-based compensation.


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Liquidity and Capital Resources
 
Three Months Ended
(in millions)
July 28, 2019
 
July 29, 2018
Net cash provided by operating activities
$
17.1

 
$
59.8

Net cash provided by (used in) investing activities
$
54.8

 
$
(50.3
)
Net cash provided by (used in) financing activities
$
(3.8
)
 
$
4.4


Operating Cash Flows
Net cash provided by operating activities in the three month period ended July 28, 2019 primarily consisted of our net loss, as adjusted to exclude depreciation, amortization and other non-cash items totaling $39.1 million. Net cash provided by operating activities in the three month period ended July 29, 2018 primarily consisted of our net loss, as adjusted to exclude depreciation, amortization and other non-cash items totaling $39.7 million.

Investing Cash Flows
Net cash provided by investing activities in the three month period ended July 28, 2019 consisted of maturities of short-term investments, offset by expenditures for capital assets. Net cash used in investing activities in the three month period ended July 29, 2018 consisted of expenditures for capital assets, offset by net maturities of short-term investments.

Financing Cash Flows
Net cash used in financing activities in the three month period ended July 28, 2019 primarily consisted of share repurchases for tax withholdings on vesting of restricted stock units. Net cash provided by financing activities in the three month period ended July 29, 2018 consisted of proceeds from the issuance of shares under our employee stock option and stock purchase plans, offset by share repurchases for tax withholdings on vesting of restricted stock units.
Contractual Obligations and Commercial Commitments
Our contractual obligations at July 28, 2019 were as follows (in thousands):
 
 
 
Payments Due by Period
 
 
 
Less than
 
 
 
 
 
After
Contractual Obligations
Total
 
1 year
 
1-3 Years
 
4-5 Years
 
5 Years
0.5% Convertible Senior Notes due 2036
575,000

 

 
575,000

 

 

Interest on 2036 Notes (a)
6,828

 
2,875

 
3,953

 

 

Operating leases
54,574

 
11,344

 
22,101

 
13,292

 
7,837

Capital purchase obligations
30,560

 
30,560

 

 

 

Other purchase obligations
122,589

 
122,589

 

 

 

Total contractual obligations
$
789,551

 
$
167,368

 
$
601,054

 
$
13,292

 
$
7,837

_________________
(a)
Includes interest on our 0.50% Convertible Senior Notes due 2036 through December 2021 as we have the right to redeem the notes in whole or in part at any time on or after December 22, 2021.

The 2036 Notes are convertible into shares of our common stock at specified conversion prices by the holders at their option prior to the close of business on the business day immediately preceding June 15, 2036 only under the following circumstances: (1) during any fiscal quarter commencing after the fiscal quarter ending on January 29, 2017 (and only during such fiscal quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period ("measurement period"), in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after June 15, 2036 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their notes at any time, regardless of whether any of the foregoing circumstances have occurred. The 2036 Notes are also subject to redemption by the holders in December 2021, 2026 and 2031. These notes are redeemable by us, in whole or in part, at any time on or after December 22, 2021.

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Capital purchase obligations represent commitments for the construction or purchase of property, equipment and improvements. They were not recorded as liabilities on our consolidated balance sheets as of July 28, 2019, as we had not yet received the related goods or taken title to the property.
Other purchase obligations represent all open purchase orders and contractual obligations in the ordinary course of business for which we have not received the goods or services. Although open purchase orders are considered enforceable and legally binding, their terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services.

Sources of Liquidity and Capital Resource Requirements

At July 28, 2019, our principal sources of liquidity consisted of approximately $882 million of cash and cash equivalents, of which approximately $150 million was held by our foreign subsidiaries.

We believe that our existing balances of cash and cash equivalents, together with the cash expected to be generated from future operations, will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional financing to fund our operations in the future, to finance future acquisitions that we may propose to undertake or to repay or otherwise retire all of our outstanding 2036 Notes, in the aggregate principal amount of $575.0 million, which are subject to redemption by the holders in December 2021, 2026 and 2031. A significant contraction in the capital markets, particularly in the technology sector, may make it difficult for us to raise additional capital if and when it is required, especially if we experience disappointing operating results. If adequate capital is not available to us as required, or is not available on favorable terms, our business, financial condition and results of operations will be adversely affected.

Off-Balance-Sheet Arrangements

At July 28, 2019 and April 28, 2019, we did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.


Item 3. Quantitative and Qualitative Disclosures About Market Risk

For quantitative and qualitative disclosures about market risk affecting Finisar, see Item 7A: “Quantitative and Qualitative Disclosures about Market Risk” in our Annual Report on Form 10-K for the fiscal year ended April 28, 2019. Our exposure related to market risk has not changed materially since April 28, 2019.


Item 4. Controls and Procedures

Evaluation of Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Interim Office of the Chief Executive and our Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Interim Office of the Chief Executive and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended July 28, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Reference is made to “Part I, Item 1, Financial Statements - Note 8. Legal Matters” for a description of pending legal proceedings, including material developments in certain of those proceedings during the quarter ended July 28, 2019.

Item 1A. Risk Factors

OUR FUTURE PERFORMANCE IS SUBJECT TO A VARIETY OF RISKS, INCLUDING THOSE DESCRIBED BELOW. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS COULD BE HARMED AND THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE. YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED IN THIS REPORT, INCLUDING OUR CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES. THE RISK FACTORS DESCRIBED BELOW DO NOT CONTAIN ANY MATERIAL CHANGES FROM THOSE PREVIOUSLY DISCLOSED IN ITEM 1A OF OUR ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED APRIL 28, 2019.

There are risks and uncertainties associated with the Merger.

The Merger, whether or not consummated, may result in a loss of our key personnel and may disrupt our sales and marketing or other key business activities, including our relationships with customers, suppliers and other third parties, which may have an adverse impact on our financial performance. Our business relationships may be subject to disruption due to uncertainty associated with the Merger, which could have an adverse effect on our results of operations, cash flows and financial condition and, following the completion of the Merger, those of the combined company. Additionally, we have incurred and will continue to incur substantial financial advisory, legal, and other professional fees and expenses in connection with the Merger, which we must pay regardless of whether the Merger is completed. These payments will negatively impact our results of operations, cash flows and financial condition.

Parties with which we do business may be uncertain as to the effects on them from the Merger and the related transactions, including their current or future business relationships with us or the combined company. These relationships may be subject to disruption, as customers, suppliers and other persons with whom we have business relationships may delay or defer certain business decisions or might decide to terminate, change or renegotiate their relationships with us, or consider entering into business relationships with parties other than us or the combined company. Additionally, our current and prospective employees may experience uncertainty about their roles with us or the combined company following the Merger, which may materially adversely affect our ability to attract and retain key personnel during the pendency of the Merger. These disruptions could have an adverse effect on our results of operations, cash flows and financial position or those of the combined company following the completion of the Merger. The risk, and adverse effect, of any disruption could be exacerbated by a delay in completion of the Merger or termination of the Merger Agreement.

The Merger is subject to a number of conditions, some of which are outside of the parties’ control, and, if these conditions are not satisfied, the Merger Agreement may be terminated and the Merger may not be completed. The Merger Agreement contains a number of conditions that must be fulfilled to complete the Merger. These conditions include, among other customary conditions, regulatory approvals, including in China, and that certain supplemental indenture being entered into by Parent, the Company and Trustee with respect to the Notes. These conditions are described in more detail in the Merger Agreement, which is included as Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on November 9, 2018. The required satisfaction of these conditions could delay the completion of the Merger for a significant period of time or prevent it from occurring. Any delay in completing the Merger could cause us or the combined company not to realize some or all of the benefits that the parties expect us or the combined company to achieve in connection with the Merger. Further, there is no assurance that all of the conditions set forth in the Merger Agreement will be satisfied or waived to the extent permitted by applicable law or that the Merger will occur when or as expected. If the Merger is not completed, the share price of our common stock could decline, for reasons including the loss of the premium over the pre-announcement market price of our common stock that was to be paid upon consummation of the Merger.

Further, until the earlier of the Effective Time and the termination of the Merger Agreement, the Merger Agreement restricts us from taking specified actions without the consent of II-VI, and requires us to generally operate in the ordinary course of business consistent with past practices. These restrictions may prevent us from making appropriate changes to our businesses, retaining its workforce, paying dividends or pursuing attractive business opportunities that may arise prior to the completion of the Merger.

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Lawsuits have been filed against us, our Board, II-VI, and Merger Subsidiary, and other lawsuits may be filed against us, II-VI, Merger Subsidiary, and/or their respective boards of directors challenging the Merger. An adverse ruling in any such lawsuit may prevent the Merger from being completed.

In January, 2019, eight lawsuits have been filed by alleged Finisar stockholders challenging the Merger: (i) Hein, et al. v. Finisar Corporation, et al., 19CV340510, in the Superior Court of California, County of Santa Clara; (ii) Tenvold, et al. v. Finisar Corporation, et al., 1:19-cv-00050, in the United States District Court for the District of Delaware; (iii) Klein, et al. v. Finisar Corporation, et al., 5:19-cv-00155, in the United States District Court for the Northern District of California; (iv) Wheby Jr., et al. v. Finisar Corporation, et al., 1:19-cv-00064, in the United States District Court for the District of Delaware; (v) Sharma v. Finisar Corporation, et al., 5:19-cv-00220, in the United States District Court for the Northern District of California; (vi) Davis, et al. v. Finisar Corporation, et al., 3:19-cv-00271, in the United States District Court for the Northern District of California; (vii) Bushansky, et al. v. Finisar Corporation, et al., 5:19-cv-00446, in the United States District Court for the Northern District of California; and (viii) Pappey, et al. v. Finisar Corporation, et al., 1:19-cv-00167, in the United States District Court for the District of Delaware (collectively, the "Actions").

Plaintiffs in the Actions named as defendants Finisar and each member of the Finisar Board. In addition, plaintiffs in the Hein, Tenvold, and Klein actions named II-VI and Merger Subsidiary as defendants. Further, plaintiffs in the Hein, Tenvold, Klein, Wheby, Jr., Davis, Bushansky, and Pappey actions sought to recover on behalf of a putative class consisting of all similarly situated Finisar stockholders.

Plaintiff in the Hein action alleged that the Finisar Board breached its fiduciary duties to Finisar stockholders by, among other things, purportedly engaging in an insufficient sales process, obtaining inadequate merger consideration, and filing a materially misleading preliminary proxy statement. The Hein plaintiff further asserted that II-VI and the Merger Subsidiary knowingly aided and abetted the Finisar Board in breaching their fiduciary duties to Finisar stockholders by entering into the Merger. The Hein plaintiff sought a preliminary and permanent injunction of the proposed transaction unless the proxy statement was amended, rescission and unspecified damages if the Merger was consummated, and attorneys’ fees and expert fees and costs.

Plaintiffs in the Tenvold, Klein, Wheby Jr., Sharma, Davis, Bushansky, and Pappey actions purported to state claims for violations of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 and, in the case of the Davis complaint, Regulation G promulgated thereunder. Plaintiffs in these actions generally alleged that the preliminary proxy statement omits material information with respect to the Merger, and sought, among other things, an order enjoining the defendants from proceeding with closing the Merger; unspecified damages, attorneys’ fees and expert fees, and expenses and costs; and in the event the Merger was consummated before entry of final judgment, rescission of the Merger or rescissory damages. Defendants believe that the complaints are without merit.

Following the filing of the Actions, counsel for Finisar and for the Plaintiffs engaged in arms-length negotiations concerning claims raised in the Actions and took certain actions that resulted in Finisar filing a Schedule DEFA14A on March 11, 2019, with the U.S. Securities and Exchange Commission that contained supplemental disclosures relating to the Merger. On March 12, 2019, Plaintiffs voluntarily dismissed the Actions with prejudice as to the Plaintiffs’ individual claims and without prejudice to claims asserted on behalf of a purported putative class of Finisar stockholders.

The litigation relating to the Merger are discussed in detail in "Part I, Item 1, Financial Statements - Note 8. Legal Matters" in this Form 10-Q. There can be no assurance that additional complaints will not be filed with respect to the Merger. One of the conditions to completion of the Merger is the absence of any applicable law (including any order) being in effect that prohibits completion of the Merger. Accordingly, if a plaintiff is successful in obtaining an order prohibiting completion of the Merger, then such order may prevent the Merger from being completed, or from being completed within the expected timeframe.

Our quarterly revenues and operating results fluctuate due to a variety of factors, which may result in volatility or a decline in the price of our stock.

Our quarterly operating results have varied significantly due to a number of factors, including:

fluctuation in demand for our products;
the timing of new product introductions or enhancements by us and our competitors;
the level of market acceptance of new and enhanced versions of our products;
the timing of acquisitions that we have undertaken;
the timing or cancellation of large customer orders;

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the timing of capital expenditures associated with our new manufacturing facility in Sherman, Texas;
changes in levels of our customers' forecasted demand;
the length and variability of the sales cycle for our products;
pricing policy changes by us and our competitors and suppliers;
the availability of development funding;
changes in the mix of products sold;
inventory changes;
increased competition in product lines, and competitive pricing pressures; and
the evolving and unpredictable nature of the markets for products incorporating our optical components and subsystems.

We expect that our operating results will continue to fluctuate in the future as a result of these factors and a variety of other factors, including:

fluctuations in manufacturing yields;
the emergence of new industry standards;
failure to anticipate changing customer product requirements;
the loss or gain of important customers;
product obsolescence; and
the amount of research and development expenses associated with new product introductions.

Our operating results could also be harmed by:

adverse changes in economic conditions in various geographic areas where we or our customers do business;
acts of terrorism and international conflicts or domestic crises;
other conditions affecting the timing of customer orders or our ability to fill orders of customers subject to export control or U.S. economic sanctions; or
a downturn in the markets for our customers' products, particularly the data storage and networking and telecommunication components markets.

We may experience a delay in generating or recognizing revenues for a number of reasons. Open orders at the beginning of each quarter are typically lower than expected revenues for that quarter and are generally cancelable with minimal notice. Accordingly, we depend on obtaining orders during each quarter for shipment in that quarter to achieve our revenue objectives. Failure to ship these products by the end of a quarter may adversely affect our operating results. Furthermore, our customer agreements typically provide that the customer may delay scheduled delivery dates and cancel orders within specified timeframes without significant penalty. Because we base our operating expenses on anticipated revenue trends and a high percentage of our expenses are fixed in the short term, any delay in generating or recognizing forecasted revenues or changes in levels of our customers' forecasted demand could significantly harm our business. It is likely that in some future quarters our operating results will again decrease from the previous quarter or fall below the expectations of securities analysts and investors.

As a result of these factors, our operating results may vary significantly from quarter to quarter. Accordingly, we believe that period-to-period comparisons of our results of operations should not be relied upon as indications of future performance. Any shortfall in revenues or net income from the previous quarter or from levels expected by the investment community could cause a decline in the trading price of our stock.

We may lose sales if our suppliers or independent contract manufacturers fail to meet our needs or go out of business.

We currently purchase a number of key components used in the manufacture of our products from single or limited sources, and we rely on several independent contract manufacturers to supply us with certain key components and subassemblies, including lasers, modulators, and printed circuit boards. We depend on these sources to meet our production needs. Moreover, we depend on the quality of the components and subassemblies that they supply to us, over which we have limited control. Several of our suppliers are or may become financially unstable as the result of current global market conditions. In addition, from time to time we have encountered shortages and delays in obtaining components, and we may encounter additional shortages and delays in the future. If we cannot supply products due to a lack of components, or are unable to redesign products with other components in a timely manner, our business will be significantly harmed. We generally have no long-term contracts with any of our component suppliers or contract manufacturers. As a result, a supplier or contract manufacturer can discontinue supplying components or subassemblies to us without penalty. If a supplier were to discontinue supplying a key component or cease operations, the resulting product manufacturing and delivery delays could be lengthy, and

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our business could be substantially harmed. We are also subject to potential delays in the development by our suppliers of key components which may affect our ability to introduce new products. Similarly, disruptions in the operations of our key suppliers or in the services provided by our contract manufacturers, including disruptions due to natural disasters, or the transition to other suppliers of these key components or services could lead to supply chain problems or delays in the delivery of our products. These problems or delays could damage our relationships with our customers and adversely affect our business.

We use rolling forecasts based on anticipated product orders to determine our component and subassembly requirements. Lead times for materials and components that we order vary significantly and depend on factors such as specific supplier requirements, contract terms and current market demand for particular components. If we overestimate our component requirements, we may have excess inventory, which would increase our costs. If we underestimate our component requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences could significantly harm our business.

If we are unable to realize anticipated cost savings from the transfer of certain manufacturing operations to our overseas locations and increased use of internally-manufactured components our results of operations could be harmed.

As part of our ongoing initiatives to reduce the cost of revenues, we expect to realize significant cost savings through (i) the transfer of certain product manufacturing operations to lower cost off-shore locations and (ii) product engineering changes to enable the broader use of internally-manufactured components. The transfer of production to overseas locations may be more difficult and costly than we currently anticipate which could result in increased transfer costs and time delays. Further, following transfer, we may experience lower manufacturing yields than those historically achieved in our U.S. manufacturing locations. In addition, the engineering changes required for the use of internally-manufactured components may be more technically-challenging than we anticipate and customer acceptance of such changes could be delayed. Adverse changes in currency exchange rates between the U.S. dollar and the applicable local currency and/or unanticipated increases in labor costs at our lower cost manufacturing locations could limit the anticipated benefits of the transfer of certain product manufacturing operations to such lower cost locations. If we fail to achieve the planned product manufacturing transfer and increase in internally-manufactured component use within our currently anticipated timeframe, or if our manufacturing yields decrease as a result, we may be unsuccessful in achieving cost savings or such savings will be less than anticipated, and our results of operations could be harmed.

Continued competition in our markets may lead to an accelerated reduction in our prices, revenues and market share.

The end markets for optical products have experienced significant industry consolidation during the past few years while the industry that supplies these customers has experienced less consolidation. As a result, the markets for optical subsystems and components are highly competitive. Our current competitors include a number of domestic and international companies, many of which have substantially greater financial, technical, marketing and distribution resources and brand name recognition than we have. Increased consolidation in our industry, should it occur, will reduce the number of our competitors, but would be likely to further strengthen surviving industry participants. We may not be able to compete successfully against either current or future competitors. Companies competing with us may introduce products that are competitively priced, have increased performance or functionality, or incorporate technological advances and may be able to react quicker to changing customer requirements and expectations. There is also the risk that network systems vendors may re-enter the subsystem market and begin to manufacture the optical subsystems incorporated in their network systems. Increased competition could result in significant price erosion, reduced revenue, lower margins or loss of market share, any of which would significantly harm our business. Our principal competitors for data communication applications include Applied Optoelectronics, Foxconn, Innolight, Lumentum, and Sumitomo. Our principal competitors for telecommunication applications include Acacia Communications, Fujitsu Optical Components, Lumentum, and Sumitomo. Our competitors continue to introduce improved products and we will have to do the same to remain competitive.

Decreases in average selling prices of our products may reduce our gross margins.

The market for optical subsystems is characterized by declining average selling prices resulting from factors such as increased competition, overcapacity, the introduction of new products and increased unit volumes as manufacturers continue to deploy network and storage systems. We have in the past experienced, and in the future may experience, substantial period-to-period fluctuations in operating results due to declining average selling prices. We anticipate that average selling prices will decrease in the future in response to product introductions by competitors or us, or by other factors, including pricing pressures from significant customers. In particular, we typically conduct pricing negotiations for our existing products with some of our largest telecommunication OEM customers in the last several months of the calendar year. Decreases in our average selling prices resulting from these negotiations typically become effective at the beginning of the next calendar year and generally

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have an adverse impact on our gross margins in future quarters. This impact is typically most pronounced in our fourth fiscal quarter ending in April, when the impact of the new pricing is first felt over a full quarter. In order to sustain profitable operations, we must continually reduce costs for our existing products and also develop and introduce on a timely basis new products that incorporate features that can be sold at higher average selling prices. Failure to do so could cause our revenues and gross margins to decline, which would result in additional operating losses and significantly harm our business.

We may be unable to reduce the cost of our products sufficiently to enable us to compete with others. Our cost reduction efforts may not allow us to keep pace with competitive pricing pressures and could adversely affect our margins. In order to remain competitive, we must continually reduce the cost of manufacturing our products through design and engineering changes. We may not be successful in redesigning our products or delivering our products to market in a timely manner. We cannot assure you that any redesign will result in sufficient cost reductions to allow us to reduce the price of our products to remain competitive or improve our gross margins.

Shifts in our product mix may result in declines in gross margins.

Gross margins on individual products fluctuate over the product's life cycle. Our overall gross margins have fluctuated from period to period as a result of shifts in product mix, the introduction of new products, decreases in average selling prices for older products and our ability to reduce product costs. These fluctuations are expected to continue in the future.

Failure to accurately forecast our revenues could result in additional charges for obsolete or excess inventories or non-cancelable purchase commitments.

We base many of our operating decisions, and enter into purchase commitments, on the basis of anticipated revenue trends which are highly unpredictable. Some of our purchase commitments are not cancelable, and in some cases we are required to recognize a charge representing the amount of material or capital equipment purchased or ordered which exceeds our actual requirements. In the past, we have periodically experienced significant growth followed by a significant decrease in customer demand such as occurred in fiscal 2001, when revenues increased by 181% followed by a decrease of 22% in fiscal 2002. Based on projected revenue trends during these periods, we acquired inventories and entered into purchase commitments in order to meet anticipated increases in demand for our products, which did not materialize. As a result, we recorded significant charges for obsolete and excess inventories and non-cancelable purchase commitments which contributed to substantial operating losses in fiscal 2002. Should revenues in future periods again fall substantially below our expectations, or should we fail again to accurately forecast changes in demand mix, we could again be required to record substantial charges for obsolete or excess inventories or non-cancelable purchase commitments.

If we encounter sustained yield problems or other delays in the production or delivery of our internally-manufactured components or in the final assembly and test of our products, we may lose sales and damage our customer relationships.

Our manufacturing operations are highly vertically integrated. In order to reduce our manufacturing costs, we have acquired a number of companies, and business units of other companies that manufacture optical components incorporated in our optical subsystem products and have developed our own facilities for the final assembly and testing of our products. For example, we design and manufacture many critical components incorporated in transceivers used for data communication and telecommunication applications, including all of the short wavelength VCSEL lasers, at our wafer fabrication facility in Allen, Texas and manufacture a portion of our internal requirements for longer wavelength lasers at our wafer fabrication facility in Fremont, California. We assemble and test most of our transceiver products at our facilities in Ipoh, Malaysia and Wuxi, China. As a result of this vertical integration, we have become increasingly dependent on our internal production capabilities. The manufacture of critical components, including the fabrication of wafers, and the assembly and testing of our products, involve highly complex processes. For example, minute levels of contaminants in the manufacturing environment, difficulties in the fabrication process or other factors can cause a substantial portion of the components on a wafer to be nonfunctional. These problems may be difficult to detect at an early stage of the manufacturing process and often are time-consuming and expensive to correct. From time to time, we have experienced problems achieving acceptable yields at our wafer fabrication facilities, resulting in delays in the availability of components. Moreover, an increase in the rejection rate of products during the quality control process before, during or after manufacture and/or shipping of such products, results in lower yields and margins. In addition, changes in manufacturing processes required as a result of changes in product specifications, changing customer needs and the introduction of new product lines have historically significantly reduced our manufacturing yields, resulting in low or negative margins on those products. Poor manufacturing yields over a prolonged period of time could adversely affect our ability to deliver our subsystem products to our customers and could also affect our sale of components to customers in the merchant market. Our inability to supply components to meet our internal needs could harm our relationships with customers and have an adverse effect on our business.


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The markets for our products are subject to rapid technological change, and to compete effectively we must continually introduce new products that achieve market acceptance.

The markets for our products are characterized by rapid technological change, frequent new product introductions, substantial capital investment, changes in customer requirements and evolving industry standards with respect to the protocols used in data communication and telecommunication networks. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address these changes as well as current and potential customer requirements. For example, the market for optical subsystems is currently characterized by a trend toward the adoption of "pluggable" modules and subsystems that do not require customized interconnections and by the development of more complex and integrated optical subsystems. We expect that new technologies will emerge as competition and the need for higher and more cost-effective bandwidth increases. The introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. In addition, a slowdown in demand for existing products ahead of a new product introduction could result in a write-down in the value of inventory on hand related to existing products and/or a charge for the impairment of long-lived assets related to such products. We have in the past experienced a slowdown in demand for existing products and delays in new product development and such slowdown in demand and delays may occur in the future. To the extent customers defer or cancel orders for existing products due to a slowdown in demand or in the expectation of a new product release or if there is any delay in development or introduction of our new products or enhancements of our products, our operating results would be adversely affected. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements, or to license these technologies from third parties. Product development delays may result from numerous factors, including:

changing product specifications and customer requirements;
unanticipated engineering complexities;
expense reduction measures we have implemented, and others we may implement, to conserve our cash and attempt to achieve and sustain profitability;
difficulties in hiring and retaining necessary technical personnel;
difficulties in reallocating engineering resources and overcoming resource limitations; and
changing market or competitive product requirements.

The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate prediction of technological and market trends. The introduction of new products also requires significant investment to ramp up production capacity, for which benefit will not be realized if customer demand does not develop as expected. Ramping of production capacity also entails risks of delays which can limit our ability to realize the full benefit of the new product introduction. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Many of these factors are beyond our control. Any failure to respond to technological change would significantly harm our business.

In addition, in order to achieve widespread market acceptance, we must differentiate ourselves from our competition through product offerings and brand name recognition. We cannot assure you that we will be successful in making this differentiation or achieving widespread acceptance of our products. Failure of our existing or future products to maintain and achieve widespread levels of market acceptance will significantly impair our revenue growth.

Our entry into the market for components for consumer electronic products, specifically our VCSEL array products for 3D sensing, involves special risks.

We have recently entered into the market for components for consumer electronic products with our VCSEL array products for 3D sensing. We have purchased a facility in Sherman, Texas to expand our production capacity for these products and expect to continue to incur material costs in this expansion during fiscal year 2020. We have not previously participated in this market. The market for components for consumer electronics products and our expansion involve additional risks, including:

We expect our customer base for these products to be highly concentrated. If we are not able to meet the needs of our customers in this area, including with respect to timing and volume of production, performance and quality, we could lose business with our customers. Loss of business with any one customer could have a materially negative impact on our revenue and gross margin.
We have made and continue to make significant investment in the expansion of our production capacity for our VCSEL arrays for 3D sensing, including the development of a high-volume production facility in Sherman, Texas. If we are unable to complete our production expansion plan and have our new production lines qualified by our

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customers on a timely basis, we could harm our customer relationships and lose business, which could have a materially negative impact on our revenue and gross margin.
We expect revenue from our components for consumer electronic products to have significant seasonal variance due to the timing of new customer product introductions and demand.

Our future success ultimately depends on the continued growth of the communications industry and, in particular, the continued expansion of global information networks, particularly those directly or indirectly dependent upon a fiber optics infrastructure.

We are relying on increasing demand for voice, video and other data delivered over high-bandwidth network systems as well as commitments by network systems vendors to invest in the expansion of the global information network. As network usage and bandwidth demand increase, so does the need for advanced optical networks to provide the required bandwidth. Without network and bandwidth growth, the need for optical subsystems and components, and hence our future growth as a manufacturer of these products, will be jeopardized, and our business would be significantly harmed.

We depend on large purchases from a few significant customers, and any loss, cancellation, reduction or delay in purchases by these customers could harm our business.

A small number of customers have consistently accounted for a significant portion of our revenues. Our success will depend on our continued ability to develop and manage relationships with our major customers. Although we are attempting to expand our customer base, we expect that significant customer concentration will continue for the foreseeable future. We may not be able to offset any decline in revenues from our existing major customers with revenues from new customers, and our quarterly results may be volatile because we are dependent on large orders from these customers that may be reduced, delayed, or cancelled.

The markets in which we have historically sold our optical subsystems and components products are dominated by a relatively small number of systems manufacturers, thereby limiting the number of our potential customers. Recent consolidation of portions of our customer base, including telecommunication systems manufacturers, and potential future consolidation, may have a material adverse impact on our business. Our dependence on large orders from a relatively small number of customers makes our relationship with each customer critically important to our business. We cannot assure you that we will be able to retain our major customers, attract additional customers, or that our customers will be successful in selling their products that incorporate our products. We have in the past experienced delays and reductions in orders from some of our major customers. In addition, our customers have in the past sought price concessions from us, and we expect that they will continue to do so in the future. Expense reduction measures that we have implemented over the past several years, and additional action we are taking to reduce costs, may adversely affect our ability to introduce new and improved products which may, in turn, adversely affect our relationships with some of our key customers. Further, some of our customers may in the future shift their purchases of products from us to our competitors or to joint ventures between these customers and our competitors, or may in certain circumstances produce competitive products themselves. The loss of one or more of our major customers, any reduction or delay in sales to these customers, our inability to successfully develop relationships with additional customers, or future price concessions that we may make could significantly harm our business.

Because we do not have long-term contracts with our customers, our customers may cease purchasing our products at any time if we fail to meet our customers' needs.

Typically, we do not have long-term contracts with our customers. As a result, our agreements with our customers do not provide any assurance of future sales. Accordingly:

our customers can stop purchasing our products at any time without penalty;
our customers are free to purchase products from our competitors; and
our customers are not required to make minimum purchases.

Sales are typically made pursuant to inventory hub arrangements under which customers may draw down inventory to satisfy their demand as needed or pursuant to individual purchase orders, often with extremely short lead times. If we are unable to fulfill these orders in a timely manner, it is likely that we will lose sales and customers. If our major customers stop purchasing our products for any reason, our business, financial condition, and results of operations would be harmed.

Our customers often evaluate our products for long and variable periods, which causes the timing of our revenues and results of operations to be unpredictable.


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The period of time between our initial contact with a customer and the receipt of an actual purchase order typically spans over a year. During this time, customers may perform, or require us to perform, extensive and lengthy evaluation and testing of our products before purchasing and using the products in their equipment. These products often take substantial time to develop because of their complexity and because customer specifications sometimes change during the development cycle. Our customers do not typically share information on the duration or magnitude of these qualification procedures. The length of these qualification processes also may vary substantially by product and customer, and, thus, cause our results of operations to be unpredictable. While our potential customers are qualifying our products and before they place an order with us, we may incur substantial research and development and sales and marketing expenses and expend significant management effort. Even after incurring such costs, we ultimately may not be able to sell any products to such potential customers. In addition, these qualification processes often make it difficult to obtain new customers, as customers are reluctant to expend the resources necessary to qualify a new supplier if they have one or more existing qualified sources. Once our products have been qualified, the agreements that we enter into with our customers typically contain no minimum purchase commitments. Failure of our customers to incorporate our products into their systems would significantly harm our business.

Our products may contain defects that may cause us to incur significant costs, divert our attention from product development efforts and result in a loss of customers.

Our products are complex and defects may be found from time to time. Networking products frequently contain undetected software or hardware defects when first introduced or as new versions are released. In addition, our products are often embedded in or deployed in conjunction with our customers' products, which incorporate a variety of components produced by third parties. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may cause us to incur significant damages or warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relation problems or loss of customers, all of which would harm our business.

We may not be able to obtain additional capital in the future, and failure to do so may harm our business.

We believe that our existing balances of cash and cash equivalents, together with the cash expected to be generated from future operations, will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional financing to fund our operations in the future, to finance future acquisitions that we may propose to undertake or to repay or otherwise retire our outstanding 2036 Notes, in the aggregate principal amount of $575.0 million, which are subject to redemption by the holders in December 2021, 2026 and 2031. Due to the unpredictable nature of the capital markets, particularly in the technology sector, we cannot assure you that we will be able to raise additional capital if and when it is required, especially if we experience disappointing operating results. If adequate capital is not available to us as required, or is not available on favorable terms, we could be required to significantly reduce or restructure our business operations. If we do raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our existing stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders.

Our international business and operations expose us to additional risks.

Products shipped to customers located outside the United States account for a majority of our revenues. In addition, we have significant tangible assets located outside the United States. Our principal manufacturing facilities are located in Malaysia and China. We currently operate smaller facilities in Australia, Korea, Sweden and Germany, and we are further expanding one of our manufacturing facilities in China. We also rely on several contract manufacturers located in Asia for our supply of key subassemblies. Conducting business outside the United States subjects us to a number of additional risks and challenges, including:

periodic changes in a specific country's or region's economic conditions, such as recession;
compliance with a wide variety of domestic and foreign laws and regulations (including those of municipalities or provinces where we have operations) and unexpected changes in those laws and regulatory requirements, including uncertainties regarding taxes, social insurance contributions and other payroll taxes and fees to governmental entities, tariffs, quotas, export controls, export licenses and other trade barriers;
unanticipated restrictions on our ability to sell to foreign customers where sales of products and the provision of services may require export licenses or are prohibited by government action (for example, in early 2018, the U.S. Department of Commerce prohibited the export and sale of a broad category of U.S. products, as well as the provision of services, to ZTE Corporation, and in 2019, to Huawei, both of which are our customers in China);
certification requirements;
environmental regulations;

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fluctuations in foreign currency exchange rates;
inadequate protection of intellectual property rights in some countries;
potential political, legal and economic instability, foreign conflicts, and the impact of regional and global infectious illnesses in the countries in which we and our customers, suppliers and contract manufacturers are located;
preferences of certain customers for locally produced products;
difficulties and costs of staffing and managing international operations across different geographic areas and cultures, including assuring compliance with the U.S. Foreign Corrupt Practices Act and other U. S. and foreign anticorruption laws;
seasonal reductions in business activities in certain countries or regions; and
fluctuations in freight rates and transportation disruptions.

These factors, individually or in combination, could impair our ability to effectively operate one or more of our foreign facilities or deliver our products, result in unexpected and material expenses, or cause an unexpected decline in the demand for our products in certain countries or regions. Our failure to manage the risks and challenges associated with our international business and operations could have a material adverse effect on our business.

Changes in government trade policies, including the imposition of tariffs and export restrictions, could limit our ability to sell our products to certain customers, which may materially adversely affect our sales and results of operations.

The current U.S. President, members of his administration, and other public officials, including members of the current U.S. Congress, have made public statements indicating possible significant changes in U.S. trade policy and have taken certain actions that may impact U.S. trade policy, including imposing new or increased tariffs on certain goods imported into the United States. Since we manufacture a significant majority of our products outside the United States, such changes, if adopted, could have a disproportionate impact on our business and make our products more expensive and less competitive in domestic markets. Furthermore, changes in U.S. trade policy could trigger retaliatory actions by affected countries, which could impose restrictions on our ability to do business in or with affected countries or prohibit, reduce or discourage purchases of our products by foreign customers, leading to increased costs of components contained in our products, increased costs of manufacturing our products, and higher prices for our products in foreign markets. For example, there are risks that the Chinese government may, among other things, require the use of local suppliers, compel companies that do business in China to partner with local companies to conduct business and provide incentives to government-backed local customers to buy from local suppliers. Changes in, and responses to, U.S. trade policy could reduce the competitiveness of our products and cause our sales and revenues to drop, which could materially and adversely impact our business and results of operations.

The U.S. or foreign governments may take administrative, legislative or regulatory action that could materially interfere with our ability to sell products in certain countries, particularly in China. For example, between July 2018 and May 2019, the Office of the United States Trade Representative imposed 25% tariffs on specified product lists, including certain electronic components and equipment, totaling approximately $250 billion in Chinese imports. In response, China imposed or proposed new or higher tariffs on U.S. products. The U.S. government has also threatened to impose tariffs on an additional $325 billion of Chinese imports, and China has threatened additional retaliatory actions. While the imposition of these tariffs did not have a direct, material adverse impact on our business during fiscal year 2019, the direct and indirect effects of tariffs and other restrictive trade policies are difficult to measure and are only one part of a larger U.S./China economic and trade policy disagreement. For example, the list of proposed U.S. tariffs on Chinese products released in July 2018 includes transceiver and other products manufactured in our facility in Wuxi, China. If these new tariffs are implemented, sales of our products manufactured in China and shipped to the United States