Document


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
(Mark One)
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-38267
RIBBON COMMUNICATIONS INC.
(Exact name of Registrant as specified in its charter)
DELAWARE
 
82-1669692
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)

4 Technology Park Drive, Westford, Massachusetts 01886
(Address of principal executive offices) (Zip code)

(978) 614-8100
(Registrant's telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
 
Non-accelerated filer o
Smaller reporting company o
 
Emerging growth company o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act) o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No x

As of October 23, 2018, there were 106,519,406 shares of the registrant's common stock, $0.0001 par value per share, outstanding.
 




RIBBON COMMUNICATIONS INC.
FORM 10-Q
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018
TABLE OF CONTENTS

Item
 
Page
 
 
PART I FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
PART II OTHER INFORMATION
 
 




Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, which are subject to a number of risks and uncertainties. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future expenses, results of operations and financial position, integration activities, beliefs about our market capitalization, anticipated effects of the new revenue recognition standard on our financial results, business strategy, statements about the potential timing and impact of the merger and acquisition transactions described herein, plans and objectives of management for future operations, plans for future cost reductions, restructuring activities and plans for future product development and manufacturing are forward-looking statements. Without limiting the foregoing, the words "anticipates", "believes", "could", "estimates", "expects", "intends", "may", "plans", "seeks" and other similar language, whether in the negative or affirmative, are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements including, but not limited to, our successful integration activities with respect to recently completed acquisitions; our ability to realize the benefits from mergers and acquisitions; the effects of disruption from mergers and acquisitions, making it more difficult to maintain relationships with employees, customers, business partners or government entities; the timing of customer purchasing decisions and our recognition of revenues; economic conditions; our ability to recruit and retain key personnel; difficulties supporting our strategic focus on channel sales; difficulties retaining and expanding our customer base; difficulties leveraging market opportunities; the impact of restructuring and cost-containment activities; litigation; acceptance of our products and services; rapid technological and market change; our ability to protect our intellectual property rights; our ability to maintain partner, reseller, distribution and vendor support and supply relationships; higher risks in international operations and markets; the impact of increased competition; currency fluctuations; changes in the market price of our common stock; and/or failure or circumvention of our controls and procedures. We therefore caution you against relying on any of these forward-looking statements.

Important factors that could cause actual results to differ materially from those in these forward-looking statements are also discussed in Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Quarterly Report on Form 10-Q and Part I, Item 1A and Part II, Item 7A, "Risk Factors" and "Quantitative and Qualitative Disclosures About Market Risk," respectively, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Also, any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which this Quarterly Report on Form 10-Q was first filed. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

Presentation of Information

Effective October 27, 2017, we completed the merger (the "Merger") of Sonus Networks, Inc. ("Sonus"), GENBAND Holdings Company, GENBAND, Inc. and GENBAND II, Inc. (collectively, "GENBAND").

Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to "Ribbon," "Ribbon Communications," "Company," "we," "us" and "our" and "the Company" refer to (i) Sonus Networks, Inc. and its subsidiaries prior to the Merger and (ii) Ribbon Communications Inc. and its subsidiaries upon completion of the Merger, as applicable.




3



PART I FINANCIAL INFORMATION


Item 1. Financial Statements
RIBBON COMMUNICATIONS INC.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
(unaudited)

 
September 30,
2018
 
December 31,
2017
Assets
Current assets:
 
 
 
Cash and cash equivalents
$
35,984

 
$
57,073

Marketable securities
7,284

 
17,224

Accounts receivable, net
150,677

 
165,156

Inventory
21,724

 
21,303

Other current assets
19,830

 
21,463

Total current assets
235,499

 
282,219

Property and equipment, net
25,960

 
24,780

Intangible assets, net
263,393

 
244,414

Goodwill
382,493

 
335,716

Investments

 
9,031

Deferred income taxes
8,212

 
8,434

Other assets
8,496

 
6,289

 
$
924,053

 
$
910,883

Liabilities and Stockholders' Equity
Current liabilities:
 
 
 
Revolving credit facility
$
58,000

 
$
20,000

Accounts payable
43,215

 
45,851

Accrued expenses and other
74,610

 
76,380

Deferred revenue
82,489

 
100,571

Total current liabilities
258,314

 
242,802

Long-term debt, related party
23,500

 
22,500

Deferred revenue, net of current
15,985

 
14,184

Deferred income taxes
3,869

 
2,787

Other long-term liabilities
32,023

 
13,189

Total liabilities
333,691

 
295,462

Commitments and contingencies (Note 15)

 

Stockholders' equity:
 
 
 
Preferred stock, $0.01 par value per share; 10,000,000 shares authorized, none issued and outstanding

 

Common stock, $0.0001 par value per share; 240,000,000 shares authorized; 106,512,530 shares issued and outstanding at September 30, 2018; 101,752,856 shares issued and outstanding at December 31, 2017
11

 
10

Additional paid-in capital
1,722,116

 
1,684,768

Accumulated deficit
(1,134,957
)
 
(1,072,426
)
Accumulated other comprehensive income
3,192

 
3,069

Total stockholders' equity
590,362

 
615,421

 
$
924,053

 
$
910,883

See notes to the unaudited condensed consolidated financial statements.

4



RIBBON COMMUNICATIONS INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)


 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Revenue:
 
 
 
 
 
 
 
Product
$
77,283

 
$
44,120

 
$
191,937

 
$
98,305

Service
75,185

 
30,509

 
219,072

 
85,425

Total revenue
152,468

 
74,629

 
411,009

 
183,730

Cost of revenue:
 
 
 
 
 
 
 
Product
38,891

 
9,708

 
102,183

 
28,748

Service
31,343

 
10,374

 
96,208

 
30,285

Total cost of revenue
70,234

 
20,082

 
198,391

 
59,033

Gross profit
82,234

 
54,547

 
212,618

 
124,697

Operating expenses:
 
 
 
 
 
 
 
Research and development
34,403

 
20,798

 
109,056

 
61,071

Sales and marketing
31,488

 
17,454

 
94,152

 
47,850

General and administrative
15,942

 
10,833

 
46,571

 
27,993

Acquisition- and integration-related
5,570

 
1,543

 
14,262

 
6,278

Restructuring
2,397

 

 
15,162

 
1,071

Total operating expenses
89,800

 
50,628

 
279,203

 
144,263

(Loss) income from operations
(7,566
)
 
3,919

 
(66,585
)
 
(19,566
)
Interest (expense) income, net
(1,420
)
 
260

 
(2,754
)
 
772

Other (expense) income, net
(1,254
)
 
1

 
(3,058
)
 
577

(Loss) income before income taxes
(10,240
)
 
4,180

 
(72,397
)
 
(18,217
)
Income tax benefit (provision)
82

 
(727
)
 
(2,587
)
 
(1,321
)
Net (loss) income
$
(10,158
)
 
$
3,453

 
$
(74,984
)
 
$
(19,538
)
(Loss) earnings per share
 
 
 
 
 
 
 
Basic
$
(0.10
)
 
$
0.07

 
$
(0.73
)
 
$
(0.39
)
Diluted
$
(0.10
)
 
$
0.07

 
$
(0.73
)
 
$
(0.39
)
Shares used to compute (loss) earnings per share:
 
 
 
 
 
 
 
Basic
104,918

 
49,753

 
103,009

 
49,472

Diluted
104,918

 
50,131

 
103,009

 
49,472


See notes to the unaudited condensed consolidated financial statements.


5



RIBBON COMMUNICATIONS INC.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(unaudited)


 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Net (loss) income
$
(10,158
)
 
$
3,453

 
$
(74,984
)
 
$
(19,538
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(80
)
 
(13
)
 
(43
)
 
102

Unrealized gain (loss) on available-for sale marketable securities, net of reclassification adjustments for realized amounts
23

 
43

 
(10
)
 
12

Employee retirement benefits
156

 

 
156

 

Other comprehensive income, net of tax
99

 
30

 
103

 
114

Comprehensive (loss) income
$
(10,059
)
 
$
3,483

 
$
(74,881
)
 
$
(19,424
)

See notes to the unaudited condensed consolidated financial statements.


6



RIBBON COMMUNICATIONS INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)


 
Nine months ended
 
September 30,
2018
 
September 30,
2017
Cash flows from operating activities:
 
 
 
Net loss
$
(74,984
)
 
$
(19,538
)
Adjustments to reconcile net loss to cash flows (used in) provided by operating activities:
 
 
 
Depreciation and amortization of property and equipment
8,270

 
5,255

Amortization of intangible assets
37,721

 
6,845

Stock-based compensation
7,421

 
11,387

Deferred income taxes
(39
)
 
687

Foreign exchange losses
3,066

 
15

Other

 
(566
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
24,550

 
2,360

Inventory
2,783

 
1,806

Other operating assets
2,796

 
(560
)
Accounts payable
(7,679
)
 
384

Accrued expenses and other long-term liabilities
(20,033
)
 
(3,028
)
Deferred revenue
(7,413
)
 
4,000

Net cash (used in) provided by operating activities
(23,541
)
 
9,047

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(5,950
)
 
(3,265
)
Business acquisitions, net of cash acquired
(46,389
)
 

Purchases of marketable securities

 
(28,731
)
Sale/maturities of marketable securities
18,919

 
41,964

Proceeds from the sale of intangible assets

 
576

Net cash (used in) provided by investing activities
(33,420
)
 
10,544

Cash flows from financing activities:
 
 
 
Borrowings under revolving line of credit
142,500

 

Principal payments on revolving line of credit
(104,500
)
 

Principal payments of capital lease obligations
(436
)
 
(30
)
Payment of debt issuance costs
(624
)
 

Proceeds from the sale of common stock in connection with employee stock purchase plan and exercise of stock options
43

 
1,401

Payment of tax withholding obligations related to net share settlements of restricted stock awards
(830
)
 
(1,904
)
Net cash provided by (used in) financing activities
36,153

 
(533
)
Effect of exchange rate changes on cash and cash equivalents
(281
)
 
299

Net (decrease) increase in cash and cash equivalents
(21,089
)
 
19,357

Cash and cash equivalents, beginning of year
57,073

 
31,923

Cash and cash equivalents, end of period
$
35,984

 
$
51,280

 
 
 
 

7



RIBBON COMMUNICATIONS INC.
Condensed Consolidated Statements of Cash Flows (continued)
(in thousands)
(unaudited)


 
Nine months ended
 
September 30,
2018
 
September 30,
2017
Supplemental disclosure of cash flow information:
 
 
 
Interest paid
$
1,568

 
$
84

Income taxes paid
$
4,047

 
$
1,198

Income tax refunds received
$
426

 
$
91

Supplemental disclosure of non-cash investing activities:
 
 
 
Capital expenditures incurred, but not yet paid
$
344

 
$
301

Property and equipment acquired under capital lease
$
1,218

 
$

Acquisition purchase consideration - deferred payments
$
30,000

 
$

Shares of common stock issued as purchase consideration
$
30,000

 
$

Acquisition purchase consideration - assumed equity awards
$
747

 
$

Supplemental disclosure of non-cash financing activities:
 
 
 
Total fair value of restricted stock awards, restricted stock units and performance-based stock units on date vested
$
5,462

 
$
6,225


See notes to the unaudited condensed consolidated financial statements.

8



RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

(1) BASIS OF PRESENTATION

Business

Ribbon is a leading provider of network communications solutions to telecommunications, wireless and cable service providers and enterprises of all sizes across industry verticals. With over 1,000 customers around the globe, including some of the largest telecommunications service providers and enterprises in the world, Ribbon enables service providers and enterprises to modernize their communications networks and provide secure real-time communications ("RTC") solutions to their customers and employees. By securing and enabling reliable and scalable Internet Protocol ("IP") networks, Ribbon helps service providers and enterprises adopt the next generation of software-based virtualized and cloud communications technologies to drive new, incremental revenue while protecting their existing revenue streams. Ribbon's solutions provide a secure way for its customers to connect and leverage multivendor, multiprotocol communications systems and applications across their networks and the cloud, around the world and in a rapidly changing ecosystem of IP-enabled devices such as smartphones and tablets. In addition, Ribbon's solutions secure the evolution to cloud-based delivery of unified communications ("UC") solutions - both for service providers transforming to a cloud-based network and for enterprises using cloud-based UC. Ribbon goes to market through both direct sales and indirect channels globally, leveraging the assistance of resellers, and provides ongoing support to its customers through a global services team with experience in design, deployment and maintenance of some of the world's largest IP networks.

The Merger with GENBAND (see Note 2) was completed in October 2017. As a result of the Merger, Ribbon believes it is better positioned to enable network transformations to IP and to cloud-based networks for service providers and enterprise customers worldwide, with a broader and deeper sales footprint, increased ability to invest in growth, more efficient and effective research and development, and a comprehensive RTC product offering.

Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring items, necessary for their fair presentation with accounting principles generally accepted in the United States of America ("GAAP") and with the rules and regulations of the U.S. Securities and Exchange Commission ("SEC").

On October 27, 2017 (the "Merger Date"), Sonus Networks, Inc. ("Sonus") consummated an acquisition as specified in an Agreement and Plan of Merger (the "Merger Agreement") with Solstice Sapphire Investments, Inc. ("NewCo") and certain of its wholly-owned subsidiaries, GENBAND Holdings Company, GENBAND Inc. and GENBAND II, Inc. (collectively, "GENBAND") pursuant to which, following a series of merger transactions (collectively, the "Merger"), Sonus and GENBAND each became a wholly-owned subsidiary of NewCo, with Sonus deemed the acquirer in the transaction for accounting purposes. Subsequently, on November 28, 2017, the Company changed its name to "Ribbon Communications Inc."

The condensed consolidated financial statements of the Company represent the consolidated financial statements of Sonus, prior to the Merger Date, and the condensed consolidated financial statements of Ribbon, on and after the Merger Date. The financial results of GENBAND are included in Ribbon's condensed consolidated financial statements beginning on the Merger Date.

On August 3, 2018 (the "Edgewater Acquisition Date"), the Company completed the acquisition of Edgewater Networks, Inc. (“Edgewater”). The financial results of Edgewater are included in the Company's condensed consolidated financial statements for the period subsequent to the Edgewater Acquisition Date.

Interim results are not necessarily indicative of results for a full year or any future interim period. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2017 (the "Annual Report"), which was filed with the SEC on March 8, 2018.


9


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

Significant Accounting Policies

The Company's significant accounting policies are disclosed in Note 2 to the Consolidated Financial Statements included in the Annual Report. There were no material changes to the significant accounting policies during the nine months ended September 30, 2018, apart from the Company's accounting policy related to revenue recognition, as discussed below.

Effective January 1, 2018, the Company adopted Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606" or the "New Revenue Standard"), the new standard on revenue from contracts with customers, which codified Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"). As a result, the Company changed its accounting policy for revenue recognition to ensure compliance with ASC 606, which is described below and in Note 10.

Revenue Recognition Policy

The Company derives revenues from two primary sources: products and services. Product revenue includes the Company's hardware and software that function together to deliver the products' essential functionality. Software and hardware are also sold on a standalone basis. Services include customer support (software updates, upgrades and technical support), consulting, design services, installation services and training. Generally, contracts with customers contain multiple performance obligations, consisting of products and services. For these contracts, the Company accounts for individual performance obligations separately if they are considered distinct.

When an arrangement contains more than one performance obligation, the Company will generally allocate the transaction price to each performance obligation on a relative standalone selling price basis. The best evidence of a standalone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. If the good or service is not sold separately, an entity must estimate the standalone selling price by using an approach that maximizes the use of observable inputs. Acceptable estimation methods include but are not limited to: (1) adjusted market assessment; (2) expected cost plus a margin; and (3) a residual approach (when the standalone selling price is not directly observable and is either highly variable or uncertain).

The Company's software licenses typically provide a perpetual right to use the Company's software. The Company also sells term-based software licenses that expire and Software-as-a-Service ("SaaS")-based software which are referred to as subscription arrangements. The Company does not customize its software nor are installation services required, as the customer has a right to utilize internal resources or a third-party service company. The software and hardware are delivered before related services are provided and are functional without professional services or customer support. The Company has concluded that its software licenses are functional intellectual property that are distinct, as the user can benefit from the software on its own. The product revenue is typically recognized upon transfer of control or when the software is made available for download, as this is the point that the user of the software can direct the use of, and obtain substantially all of the remaining benefits from, the functional intellectual property. The Company does not recognize software revenue related to the renewal of subscription software licenses earlier than the beginning of the subscription period. Hardware product is generally sold with software to provide the customer solution.

Services revenue includes revenue from customer support and other professional services. The Company offers warranties on its products. Certain of the Company's warranties are considered to be assurance-type in nature and do not cover anything beyond ensuring that the product is functioning as intended. Based on the guidance in Accounting Standards Codification ("ASC") 606, assurance-type warranties do not represent separate performance obligations. The Company also sells separately-priced maintenance service contracts which qualify as service-type warranties and represent separate performance obligations. The Company does not allow and has no history of accepting product returns.

Customer support includes software updates on a when-and-if-available basis, telephone support, integrated web-based support and bug fixes or patches. The Company sells its customer support contracts at a percentage of list or net product price related to the support. Customer support revenue is recognized ratably over the term of the customer support agreement, which is typically one year.

The Company's professional services include consulting, technical support, resident engineer services, design services and installation services. Because control transfers over time, revenue is recognized based on progress toward completion of the

10


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

performance obligation. The method to measure progress toward completion requires judgment and is based on the nature of the products or services to be provided. The Company generally uses the input method to measure progress for its contracts because it believes such method best depicts the transfer of assets to the customer, which occurs as the Company incurs costs for the contracts. Under the cost-to-cost measure of progress, the progress toward completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. When the measure of progress is based upon expended labor, progress toward completion is measured as the ratio of labor time expended to date vs the total estimated labor time required to complete the performance obligation. Revenue is recorded proportionally as costs are incurred or labor is expended. Costs to fulfill these obligations include internal labor as well as subcontractor costs.

Customer training includes courses offered by the Company. The related revenue is typically recognized as the training services are performed.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Ribbon and its wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates and Judgments

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and judgments relied upon in preparing these consolidated financial statements include accounting for business combinations; revenue recognition for multiple element arrangements, including determining the standalone selling prices of performance obligations; inventory valuations; assumptions used to determine the fair value of stock-based compensation; intangible assets and goodwill valuations, including impairments; legal contingencies; and recoverability of Ribbon's net deferred tax assets and the related valuation allowances. Ribbon regularly assesses these estimates and records changes in estimates in the period in which they become known. Ribbon bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to the previously issued financial statements to conform to the current period presentation, none of which affected net loss as previously reported.

Fair Value of Financial Instruments

The carrying amounts of the Company's financial instruments, which include cash equivalents; marketable securities; investments; accounts receivable; revolving credit facility; accounts payable; long-term debt, related party; and other long-term liabilities; approximate their fair values.

Operating Segments

The Company operates in a single segment, as the chief operating decision maker makes decisions and assesses performance at the company level. Operating segments are identified as components of an enterprise about which separate discrete financial information is utilized for evaluation by the chief operating decision maker in making decisions regarding resource allocation and assessing performance. To date, the chief operating decision maker has made such decisions and assessed performance at the company level, as one segment. The Company's chief operating decision maker is its President and Chief Executive Officer.

Foreign Currency Translation

As part of ongoing merger integration activities, the Company conducted an assessment of the functional currencies of its foreign subsidiaries. The Company concluded that the U.S. dollar is the appropriate functional currency for the majority of the

11


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

former GENBAND foreign subsidiaries, based on its assessment of underlying factors. As such, the functional currency was changed to the U.S. dollar effective January 1, 2018.

Recent Accounting Pronouncements

In February 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income ("ASU 2018-02"), which amends ASC 220, Income Statement - Reporting Comprehensive Income, to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act and requires entities to provide certain disclosures regarding stranded tax effects. ASU 2018-02 is effective for the Company beginning January 1, 2019, with early adoption permitted. The Company is currently assessing the potential impact of the adoption of ASU 2018-02 on its consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”), which provides guidance on implementation costs incurred in a cloud computing arrangement (“CCA”) that is a service contract. ASU 2018-15 amends ASC 350, Intangibles - Goodwill and Other (“ASC 350”) to include in its scope implementation costs of a CCA that is a service contract and clarifies that a customer should apply the guidance in ASC 350-40 to determine which implementation costs should be capitalized in such a CCA. ASU 2018-15 is effective for the Company beginning January 1, 2020. The Company is currently assessing the potential impact of the adoption of ASU 2018-15 on our consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting ("ASU 2017-09"), which amends the scope of modification accounting for share-based payment arrangements such that an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. ASU 2017-09 became effective for the Company beginning January 1, 2018 for both interim and annual reporting periods. The adoption of ASU 2017-09 did not have a material impact on the Company's condensed consolidated financial statements.

In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post Retirement Benefit Cost ("ASU 2017-07"). ASU 2017-07 amends the requirements in ASC 715 to require entities to disaggregate the current-service-cost component from the other components of net benefit cost (the "other components") and include it with other current compensation costs for related employees, present the other components elsewhere in the income statement and outside of income from operations if such a subtotal is presented and disclose the income statement lines that contain the other components if they are not presented on appropriately described separate lines. ASU 2017-07 became effective for the Company beginning January 1, 2018 for both interim and annual reporting periods. The adoption of ASU 2017-07 did not have a material impact on the Company's condensed consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"), which adds or clarifies guidance on eight cash flow issues, including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or certain other debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 became effective for the Company beginning January 1, 2018 for both interim and annual reporting periods. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively from the earliest date practicable if retrospective application would be impracticable. The adoption of ASU 2016-15 did not have a material impact on the Company's condensed consolidated financial statements.


12


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) Section A - Leases: Amendments to the FASB Accounting Standards Codification ("ASU 2016-02"), its new standard on accounting for leases. ASU 2016-02 introduces a lessee model that brings most leases onto the balance sheet. ASU 2016-02 eliminates the current GAAP requirement for an entity to use bright-line tests in determining lease classification. ASU 2016-02 is effective for the Company for both interim and annual periods beginning January 1, 2019. Upon adoption of ASU 2016-02, the Company will recognize lease obligations for the right to use these assets in connection with its existing lease agreements. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements ("ASU 2018-11") and ASU 2018-10, Codification Improvements to Topic 842, Leases, both of which provided improvements to certain aspects of the guidance in ASC 842, Leases. In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842, which provided additional clarification and implementation guidance. The Company has elected to use the alternative transition method as described in ASU 2018-11, which allows entities to initially apply ASU 2016-02 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings, with no subsequent adjustments to prior period lease costs for comparability. The Company has essentially completed the lease assessment phase of implementation and is currently reviewing the contracts within its lease portfolio in order to quantify the impact of adoption on its consolidated balance sheet as of January 1, 2019. The Company expects to quantify such amounts to be recognized on the balance sheet by the end of the fourth quarter of 2018.

In addition, the FASB has issued the following accounting pronouncements, none of which the Company believes will have a material impact on its consolidated financial statements:

In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans (“ASU 2018-14”), which amends ASC 715, Compensation - Retirement Benefits (“ASC 715”) to add, remove and clarify disclosure requirements related to defined benefit pension and other postretirement plans. ASU 2018-14 is effective for the Company beginning January 1, 2020.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which changes the fair value measurement requirements of ASC 820, Fair Value Measurement (“ASC 820”). ASU 2018-13 is effective for the Company beginning January 1, 2020 for both interim and annual reporting.

In July 2018, the FASB issued ASU 2018-09, Codification Improvements (“ASU 2018-09”), which contains amendments to clarify, correct errors in or make minor improvements to the Codification. ASU 2018-09 makes improvements to multiple topics, including but not limited to comprehensive income, debt, income taxes related to both stock-based compensation and business combinations, fair value measurement and defined contribution benefit plans. ASU 2018-09 is effective for the Company beginning January 1, 2019.

In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting ("ASU 2018-07"), which expands the scope of ASC 718, Compensation - Stock Compensation ("ASC 718"), to include all share-based payment arrangements related to the acquisition of goods and services from both nonemployees and employees. As a result, most of the guidance in ASC 718 associated with employee share-based payments, including most of its requirements related to classification and measurement, applies to nonemployee share-based payment arrangements. ASU 2018-07 is effective for the Company beginning January 1, 2019, although early adoption is permitted.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory ("ASU 2016-16"), which removes the prohibition in ASC 740, Income Taxes, against the immediate recognition of the current and deferred income tax effects of intra-entity transfers of assets other than inventory. ASU 2016-16 is effective for the Company beginning January 1, 2019 for both interim and annual reporting periods.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which adds an impairment model that is based on expected losses rather than incurred losses. Under ASU 2016-13, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. ASU 2016-13 is effective for the Company beginning January 1, 2020 for both interim and annual reporting periods, with early adoption permitted.

13


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)




(2) BUSINESS ACQUISITIONS

Edgewater Networks, Inc.

On the Edgewater Acquisition Date, the Company completed its acquisition of Edgewater, a private company headquartered in San Jose, California (the "Edgewater Acquisition"). The Edgewater Acquisition was completed in accordance with the terms and conditions of the Agreement and Plan of Merger, dated as of June 24, 2018, by and among Ribbon, Merger Sub, Edgewater and Shareholder Representative Services LLC, a Colorado limited liability company, solely in its capacity as the initial holder representative (the "Edgewater Merger Agreement”).

Edgewater is a market leader in Network Edge Orchestration for the small and medium enterprise ("SME") and UC market. The Company believes that the acquisition of Edgewater will allow it to offer its global customer base a complete core-to-edge product portfolio, end-to-end service assurance and analytics solutions, and a fully integrated software-defined wide-area network ("SD-WAN") service.

As consideration for the Edgewater Acquisition, Ribbon paid, in the aggregate, $46.4 million of cash, net of cash acquired, and issued 4.2 million shares of Ribbon common stock to Edgewater's selling shareholders and holders of vested in-the-money options and warrants to acquire common stock of Edgewater (the "Edgewater Selling Stakeholders") on the Edgewater Acquisition Date. Pursuant to the Edgewater Merger Agreement and subject to the terms and conditions contained therein, Ribbon has agreed to pay the Edgewater Selling Stakeholders an additional $30 million of cash, $15 million of which is to be paid 6 months from the closing date and the other $15 million of which is to be paid as early as 9 months from the closing date and no later than 18 months from the closing date (the exact timing of which will depend on the amount of revenue generated from the sales of Edgewater products in 2018). The current portion of this deferred purchase consideration is included as a component of Accrued expenses and other, and the noncurrent portion is included as a component of Other long-term liabilities in the Company's condensed consolidated balance sheet as of September 30, 2018.

The Edgewater Acquisition has been accounted for as a business combination and the financial results of Edgewater have been included in the Company's consolidated financial statements for the period subsequent to its acquisition.

As of September 30, 2018, the valuation of acquired assets, identifiable intangible assets and certain assumed liabilities was preliminary. The Company is still in the process of investigating the facts and circumstances existing as of the Edgewater Acquisition Date in order to finalize its valuation. The Company expects to finalize the valuation of the assets acquired and liabilities assumed by the second quarter of 2019.

14


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)


A summary of the preliminary allocation of the purchase consideration for Edgewater is as follows (in thousands):

Fair value of consideration transferred:
 
  Cash consideration:
 
    Cash paid to Edgewater Selling Stakeholders
$
51,162

    Less cash acquired
(4,773
)
      Net cash consideration
46,389

    Unpaid cash consideration
30,000

    Fair value of Ribbon stock issued
30,000

    Fair value of equity awards assumed (see Note 11)
747

        Fair value of total consideration
$
107,136

 
 
Fair value of assets acquired and liabilities assumed:
 
  Current assets, net of cash acquired
$
16,837

  Property and equipment
380

  Intangible assets:
 
    Developed technology
29,500

    Customer relationships
26,100

    Trade names
1,100

  Goodwill
46,777

  Other noncurrent assets
103

  Deferred revenue
(2,749
)
  Other current liabilities
(9,402
)
  Deferred revenue, net of current
(669
)
  Other long-term liabilities
(841
)
 
$
107,136



The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to value the acquired developed technology, customer relationships and trade name intangible assets. The valuation for each of these intangible assets was based on estimated projections of expected cash flows to be generated by the assets, discounted to the present value at discount rates commensurate with perceived risk. The valuation assumptions take into consideration the Company's estimates of customer attrition, technology obsolescence and revenue growth projections. The Company is amortizing the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives, which have a weighted average life of 8.3 years (see Note 6). Goodwill resulting from the transaction is primarily due to expected synergies between the combined companies and is not deductible for tax purposes.

The Company's revenue for both the three and nine months ended September 30, 2018 included approximately $10 million of revenue attributable to Edgewater since the Edgewater Acquisition Date. The Company has not provided pro forma financial information, as the historical amounts are not significant to the Company's consolidated financial statements.

GENBAND Merger

On October 27, 2017, Sonus consummated an acquisition as specified in the Merger Agreement with NewCo and GENBAND such that, following the Merger, Sonus and GENBAND each became a wholly-owned subsidiary of NewCo, with Sonus deemed the acquirer in the transaction for accounting purposes. On November 28, 2017, the Company changed its name to "Ribbon Communications Inc."

Prior to the Merger, GENBAND was a Cayman Islands exempted company limited by shares that was formed on April 7, 2010.  Through its wholly owned operating subsidiaries, GENBAND created rapid communications and applications for service providers, enterprises, independent software vendors, system integrators and developers globally. A majority of GENBAND's

15


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

shares were held by JPMorgan Chase & Co. and managed by One Equity Partners ("OEP"). GENBAND shares were not listed on an exchange or quoted on any automated services, and there was no established trading market for GENBAND shares.

The Company believes that Sonus' and GENBAND's complementary products, solutions and strategies position the combined company to deliver comprehensive solutions to service providers and enterprises migrating to a virtualized all-IP environment in an expanded customer and global footprint.

Pursuant to the Merger Agreement, NewCo issued 50.9 million shares of Sonus common stock to the GENBAND equity holders, with the number of shares issued in the aggregate to the GENBAND equity holders equal to the number of shares of Sonus common stock outstanding immediately prior to the closing date of the Merger, such that former stockholders of Sonus would own approximately 50%, and former shareholders of GENBAND would own approximately 50%, of the shares of NewCo common stock issued and outstanding immediately following the consummation of the Merger.

In addition, NewCo repaid GENBAND’s long-term debt, including both principal and unpaid interest, to a related party of GENBAND totaling $48 million and repaid GENBAND’s management fees due to an affiliate of OEP totaling $10.3 million. NewCo also issued a promissory note for $22.5 million to certain GENBAND equity holders (the "Promissory Note").

NewCo assumed the liability under GENBAND's revolving credit facility with Silicon Valley Bank, which had outstanding borrowings and letters of credit totaling $17.9 million and $2.9 million, respectively, at October 27, 2017. At October 27, 2017, the outstanding borrowings had an average interest rate of 4.67%.

The Merger has been accounted for as a business combination and the financial results of GENBAND have been included in the Company's consolidated financial statements for the period subsequent to its acquisition.

As of September 30, 2018, the valuation of acquired assets, identifiable intangible assets and certain assumed liabilities was final. A summary of the final allocation of the purchase consideration for GENBAND is as follows (in thousands):

Fair value of consideration transferred:
 
  Cash consideration:
 
    Repayment of GENBAND long-term debt and accrued interest, related party
$
47,973

    Payment of GENBAND management fees due to majority shareholder
10,302

    Less cash acquired
(15,324
)
      Net cash consideration
42,951

  Fair value of Sonus stock issued
413,982

  Promissory note issued to GENBAND equity holders
22,500

        Fair value of total consideration
$
479,433

 
 
Fair value of assets acquired and liabilities assumed:
 
  Current assets, net of cash acquired
$
99,126

  Property and equipment
16,770

  Intangible assets:
 
    In-process research and development
5,600

    Developed technology
129,000

    Customer relationships
101,300

    Trade names
900

  Goodwill
285,825

  Other noncurrent assets
6,732

  Revolving credit facility
(17,930
)
  Deferred revenue
(32,390
)
  Other current liabilities
(80,023
)
  Deferred revenue, net of current
(6,804
)
  Other long-term liabilities
(28,673
)
 
$
479,433


16


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)



The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to value the acquired developed technology, customer relationships and trade name intangible assets. The valuation for each of these intangible assets was based on estimated projections of expected cash flows to be generated by the assets, discounted to the present value at discount rates commensurate with perceived risk. The valuation assumptions take into consideration the Company's estimates of customer attrition, technology obsolescence and revenue growth projections. The Company will reclassify its in-process research and development intangible asset to developed technology intangible asset in the period that the related product becomes generally available and begin to record amortization expense for the developed technology intangible asset at that time. The Company is amortizing the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives, which have a weighted average life of 8.3 years (see Note 6). Goodwill resulting from the transaction is primarily due to expected synergies between the combined companies and is not deductible for tax purposes.

Pro Forma Results

The following unaudited pro forma information presents the condensed combined results of operations of Sonus and GENBAND for the three and nine months ended September 30, 2017 as if the Merger had been completed on January 1, 2017, with adjustments to give effect to pro forma events that are directly attributable to the Merger. These pro forma adjustments include a reduction of historical GENBAND revenue for the fair value adjustment related to acquired deferred revenue, an increase in amortization expense for the acquired identifiable intangible assets, a decrease in historical GENBAND interest expense reflecting the extinguishment of certain of GENBAND's debt as a result of the Merger, net of the interest expense recorded in connection with the Promissory Note issued to certain GENBAND equity holders as part of the purchase consideration and the elimination of revenue and costs related to sales transactions between Sonus and GENBAND.

The unaudited pro forma results do not reflect any operating efficiencies or potential cost savings that may result from the consolidation of the operations of Sonus and GENBAND. Accordingly, these unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the combined company that would have been achieved had the Merger occurred at the beginning of the period presented, nor are they intended to represent or be indicative of future results of operations (in thousands, except per share amounts):
 
Three months ended
September 30, 2017
 
Nine months ended
September 30, 2017
 
 
 
 
Revenue
$
147,608

 
$
419,749

Net loss
$
(22,148
)
 
$
(105,666
)
Loss per share
$
(0.22
)
 
$
(1.04
)


Acquisition- and Integration-Related Expenses

Acquisition- and integration-related expenses include those expenses related to acquisitions that would otherwise not have been incurred by the Company. The acquisition-related expenses include professional and services fees such as legal, audit, consulting, paying agent and other fees, and expenses related to cash payments to certain former executives of the acquired businesses in connection with their employment agreements. These amounts include costs related to the Merger and the Edgewater Acquisition, as well as nominal amounts related to acquisitive activities. The integration-related expenses recorded in both the three and nine months ended September 30, 2018 represent incremental costs related to combining Sonus and GENBAND, such as third-party consulting and other services related to merging the two separate companies' systems and processes.

The acquisition-related amounts recorded in both the three and nine months ended September 30, 2017 relate to professional fees incurred in connection with the Company's September 2016 acquisition of Taqua, LLC. The Company's acquisition- and integration-related expenses for the three and nine months ended September 30, 2018 and 2017 were as follows

17


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

(in thousands):
 
 
 
 
 
 
 
 
 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Professional and services fees (acquisition-related)
$
2,905

 
$
1,543

 
$
5,314

 
$
6,278

Management bonuses (acquisition-related)

 

 
1,972

 

Integration-related expenses
2,665

 

 
6,976

 

 
$
5,570

 
$
1,543

 
$
14,262

 
$
6,278




(3) EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares outstanding during the period. For periods in which the Company reports net income, diluted net earnings per share is determined by using the weighted average number of common and dilutive common equivalent shares outstanding during the period unless the effect is antidilutive.

The calculations of shares used to compute loss per share were as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Weighted average shares outstanding—basic
104,918

 
49,753

 
103,009

 
49,472

Potential dilutive common shares

 
378

 

 

Weighted average shares outstanding—diluted
104,918

 
50,131

 
103,009

 
49,472



Options to purchase the Company's common stock and unvested shares of restricted and performance-based stock and stock units aggregating 3.5 million have not been included in the computation of diluted loss per share for the three and nine months ended September 30, 2018 because their effect would have been antidilutive. The Company has excluded 5.2 million weighted shares underlying options to purchase shares of the Company's common stock from the computation of diluted earnings per share for the three months ended September 30, 2017, because the options' exercise prices were greater than the average market price for the common stock and their effect would have been antidilutive. Options to purchase the Company's common stock and unvested shares of restricted and performance-based stock and stock units totaling 7.4 million shares for the nine months ended September 30, 2017 have not been included in the computation of diluted loss per share because their effect would have been antidilutive.



(4) CASH EQUIVALENTS, MARKETABLE SECURITIES AND INVESTMENTS

The Company invests in debt instruments, primarily U.S. government-backed, municipal and corporate obligations, which management believes to be high quality (investment grade) credit instruments.

The Company sold $12.5 million of its available-for sale securities in both the three and nine months ended September 30, 2018, primarily to provide cash for acquisition-related payments in connection with the Edgewater Acquisition and to support integration-related and restructuring activities in connection with the Merger. The Company recognized nominal gross gains and approximately $20,000 of gross losses from the sales of these securities. The Company did not sell any of its available-for-sale securities during the three or nine months ended September 30, 2017. At September 30, 2018, the Company did not hold any investments that matured beyond one year.


18


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

On a quarterly basis, the Company reviews its marketable securities and investments to determine if there have been any events that could create a credit impairment. Based on its reviews, the Company does not believe that any impairment existed with its current holdings at September 30, 2018.

The amortized cost, gross unrealized gains and losses and fair value of the Company's marketable debt securities and investments at September 30, 2018 and December 31, 2017 were comprised of the following (in thousands):

 
September 30, 2018
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair
value
Cash equivalents
$
427

 
$

 
$

 
$
427

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
U.S. government agency notes
$
3,997

 
$

 
$
(17
)
 
$
3,980

Corporate debt securities
3,317

 

 
(13
)
 
3,304

 
$
7,314

 
$

 
$
(30
)
 
$
7,284



 
December 31, 2017
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair
value
Cash equivalents
$
1,254

 
$

 
$

 
$
1,254

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
U.S. government agency notes
$
4,091

 
$

 
$
(19
)
 
$
4,072

Corporate debt securities
8,048

 

 
(31
)
 
8,017

Certificates of deposit
5,135

 

 

 
5,135

 
$
17,274

 
$

 
$
(50
)
 
$
17,224

Investments
 
 
 
 
 
 
 
U.S. government agency notes
$
3,992

 
$

 
$
(28
)
 
$
3,964

Corporate debt securities
3,908

 

 
(24
)
 
3,884

Certificates of deposit
1,183

 

 

 
1,183

 
$
9,083

 
$

 
$
(52
)
 
$
9,031



The Company's available-for-sale debt securities classified as Investments in the condensed consolidated balance sheet at December 31, 2017 mature after one year but within two years or less from the balance sheet date. The Company did not have any available-for-sale debt securities classified as Investments at September 30, 2018.

Fair Value Hierarchy

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. The three-tier fair value hierarchy is based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is as follows:

Level 1. Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.


19


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

Level 2. Level 2 applies to assets or liabilities for which there are inputs that are directly or indirectly observable in the marketplace, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets).

Level 3. Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

The following table shows the fair value of the Company's financial assets at September 30, 2018 and December 31, 2017. These financial assets are comprised of the Company's available-for-sale debt securities and reported under the captions Cash and cash equivalents, Marketable securities and Investments in the condensed consolidated balance sheets (in thousands):
 
 
 
Fair value measurements at
September 30, 2018 using:
 
Total carrying
value at
September 30,
2018
 
Quoted prices
in active
markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents
$
427

 
$
427

 
$

 
$

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
U.S. government agency notes
$
3,980

 
$

 
$
3,980

 
$

Corporate debt securities
3,304

 

 
3,304

 

 
$
7,284

 
$

 
$
7,284

 
$



 
 
 
Fair value measurements at
December 31, 2017 using:
 
Total carrying
value at
December 31,
2017
 
Quoted prices
in active
markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents
$
1,254

 
$
1,254

 
$

 
$

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
U.S. government agency notes
$
4,072

 
$

 
$
4,072

 
$

Corporate debt securities
8,017

 

 
8,017

 

Certificates of deposit
5,135

 

 
5,135

 

 
$
17,224

 
$

 
$
17,224

 
$

Investments
 
 
 
 
 
 
 
U.S. government agency notes
$
3,964

 
$

 
$
3,964

 
$

Corporate debt securities
3,884

 

 
3,884

 

Certificates of deposit
1,183

 

 
1,183

 

 
$
9,031

 
$

 
$
9,031

 
$


The Company's marketable securities and investments have been valued with the assistance of valuations provided by third-party pricing services, as derived from such services' pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker/dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security. The Company is ultimately responsible for the condensed consolidated financial statements and underlying estimates. Accordingly, the Company assesses the reasonableness of the valuations provided by the third-party pricing services by reviewing actual trade data, broker/dealer quotes and other similar data, which are obtained from quoted market prices or other sources.


20


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)


(5) INVENTORY

Inventory at September 30, 2018 and December 31, 2017 consisted of the following (in thousands):
 
September 30,
2018
 
December 31,
2017
On-hand final assemblies and finished goods inventories
$
19,371

 
$
18,374

Deferred cost of goods sold
3,707

 
4,569

 
23,078

 
22,943

Less noncurrent portion (included in other assets)
(1,354
)
 
(1,640
)
Current portion
$
21,724

 
$
21,303




(6) INTANGIBLE ASSETS AND GOODWILL

The Company's intangible assets at September 30, 2018 and December 31, 2017 consisted of the following (in thousands):
September 30, 2018
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
In-process research and development
*
 
$
5,600

 
$

 
$
5,600

Developed technology
6.91
 
182,880

 
53,666

 
129,214

Customer relationships
9.44
 
146,940

 
19,896

 
127,044

Trade names
3.00
 
2,000

 
465

 
1,535

Internal use software
3.00
 
730

 
730

 

 
7.86
 
$
338,150

 
$
74,757

 
$
263,393


December 31, 2017
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
In-process research and development
*
 
$
5,600

 
$

 
$
5,600

Developed technology
6.90
 
153,380

 
24,211

 
129,169

Customer relationships
9.32
 
120,840

 
12,015

 
108,825

Trade names
3.00
 
900

 
80

 
820

Internal use software
3.00
 
730

 
730

 

 
7.77
 
$
281,450

 
$
37,036

 
$
244,414


* An in-process research and development intangible asset has an indefinite life until the product is generally available, at which time such asset is typically reclassified to developed technology.


Amortization expense for intangible assets for the three and nine months ended September 30, 2018 and 2017 was as follows (in thousands):

21


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

 
Three months ended
 
Nine months ended
 
Statement of operations classification
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
 
Developed technology
$
10,593

 
$
1,602

 
$
29,455

 
$
4,769

 
Cost of revenue - product
Customer relationships
2,695

 
691

 
7,881

 
2,076

 
Sales and marketing
Trade names
160

 

 
385

 

 
Sales and marketing
 
$
13,448

 
$
2,293

 
$
37,721

 
$
6,845

 
 


Estimated future amortization expense for the Company's intangible assets at September 30, 2018 was as follows (in thousands):
Years ending December 31,
 
Remainder of 2018
$
12,003

2019
47,411

2020
46,552

2021
40,571

2022
34,156

Thereafter
82,700

 
$
263,393



The changes in the carrying value of the Company's goodwill in the nine months ended September 30, 2018 and 2017 were as follows (in thousands):
 
 
 
 
Balance at January 1
2018
 
2017
  Goodwill
$
338,822

 
$
52,499

  Accumulated impairment losses
(3,106
)
 
(3,106
)
 
335,716

 
49,393

Acquisition of Edgewater
46,777

 

Purchase accounting adjustments - acquisition of Taqua, LLC

 
498

Balance at September 30
$
382,493

 
$
49,891

 
 
 
 
Balance at September 30
 
 
 
  Goodwill
$
385,599

 
$
52,997

  Accumulated impairment losses
(3,106
)
 
(3,106
)
 
$
382,493

 
$
49,891




(7) ACCRUED EXPENSES
Accrued expenses at September 30, 2018 and December 31, 2017 consisted of the following (in thousands):
 
September 30,
2018
 
December 31,
2017
Employee compensation and related costs
$
33,174

 
$
37,782

Professional fees
8,997

 
13,743

Deferred purchase consideration - Edgewater
15,000

 

Other
17,439

 
24,855

 
$
74,610

 
$
76,380




22


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

(8) RESTRUCTURING ACCRUALS

The Company recorded restructuring expense aggregating $2.4 million in the three months ended September 30, 2018 and did not record restructuring expense in the three months ended September 30, 2017. The Company recorded restructuring expense aggregating $15.2 million in the nine months ended September 30, 2018 and $1.1 million in the nine months ended September 30, 2017.

Merger Restructuring Initiative

In connection with the Merger, the Company's management approved a restructuring plan in the fourth quarter of 2017 to eliminate certain redundant positions and facilities within the combined companies (the "Merger Restructuring Initiative"). In connection with this initiative, the Company recorded $8.5 million of restructuring expense in the fourth quarter of 2017 for severance and related costs for approximately 120 employees. The Company recorded $14.3 million in the nine months ended September 30, 2018, comprised of $2.5 million in the three months ended September 30, 2018, $5.3 million in the three months ended June 30, 2018 and $6.5 million in the three months ended March 31, 2018. The amount recorded in the three months ended September 30, 2018 related to severance and related costs for approximately 30 employees. The amounts recorded in the three months ended June 30, 2018 included $5.1 million for severance and related costs for approximately 140 employees and $0.2 million related to a U.S. facility. The amount recorded in the three months ended March 31, 2018 represented severance and related costs for approximately 115 employees. The Company anticipates it will record additional future expense in connection with this initiative for headcount and redundant facilities aggregating approximately $1 million as it continues to combine the two businesses and benefit from operational synergies. The Company expects that the amount accrued at September 30, 2018 for severance will be paid by the end of the end of the first half of 2019 and that the payments related to the expected additional future expense will be completed in 2019.

A summary of the Merger Restructuring Initiative accrual activity for the nine months ended September 30, 2018 is as follows (in thousands):
 
Balance at
January 1,
2018
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at
September 30,
2018
Severance
$
7,595

 
$
14,121

 
$
(5
)
 
$
(18,928
)
 
$
2,783

Facilities

 
193

 

 
(70
)
 
123

 
$
7,595

 
$
14,314

 
$
(5
)
 
$
(18,998
)
 
$
2,906



Assumed Restructuring Initiative

The Company assumed GENBAND's previously recorded restructuring liability, totaling $4.1 million, on the Merger Date (the "GENBAND Restructuring Initiative"). Of this amount, $3.7 million related to severance and related costs and $0.4 million related to facilities. The Company reversed $0.1 million of facilities accrual in the three months ended September 30, 2018 and net adjustments aggregating $0.9 million of expense in the nine months ended September 30, 2018 for changes in estimated costs previously accrued. The additional expense for severance relates to higher-than-previously-anticipated amounts due to certain international employees. The net additional expense for facilities relates to changes in sub-lease income assumptions for a facility previously restructured under this plan. The Company does not expect to record additional expense in connection with this initiative except for any additional adjustments for changes in estimated costs. The Company expects that the payments related to this assumed liability will be completed in 2018. A summary of the GENBAND Restructuring Initiative accrual activity for the nine months ended September 30, 2018 is as follows (in thousands):
 
Balance at
January 1,
2018
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at
September 30,
2018
Severance
$
1,916

 
$

 
$
487

 
$
(2,358
)
 
$
45

Facilities
205

 

 
366

 
(401
)
 
170

 
$
2,121

 
$

 
$
853

 
$
(2,759
)
 
$
215



23


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)


2016 Restructuring Initiative

In July 2016, the Company announced a program (the "2016 Restructuring Initiative") to further accelerate its investment in new technologies, as the communications industry migrates to a cloud-based architecture and as the Company pursues new strategic initiatives, such as new products and an expanded go-to-market footprint in selected geographies and discrete vertical markets. The Company recorded $2.0 million of restructuring expense in the aggregate in connection with this initiative, comprised of $1.9 million for severance and related costs and $0.1 million to abandon its facility in Rochester, New York (the "Rochester Facility").

In connection with the 2016 Restructuring Initiative, the Company recorded $0.5 million of restructuring expense in the nine months ended September 30, 2017, comprised of $0.4 million for severance and related costs and $0.1 million related to the Rochester Facility. The actions under the 2016 Restructuring Initiative have been implemented and accordingly, the Company does not expect to record additional expense in connection with this initiative. The amounts accrued for severance and related costs had been fully paid by the end of the third quarter of 2017. The Company expects that the amounts accrued for facilities will be paid by the end of October 2019, when the lease on the Rochester Facility expires.

A summary of the 2016 Restructuring Initiative accrual activity for the nine months ended September 30, 2018 is as follows (in thousands):
 
Balance at
January 1,
2018
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at
September 30,
2018
Facilities
$
95

 
$

 
$

 
$
(25
)
 
$
70



Taqua Restructuring Initiative

In connection with the acquisition of Taqua, the Company's management approved a restructuring plan in the third quarter of 2016 to eliminate certain redundant positions within the combined companies. On October 24, 2016, the Audit Committee of the Company's Board of Directors approved a broader Taqua restructuring plan related to headcount and redundant facilities (both restructuring plans, the "Taqua Restructuring Initiative"). The Company recorded $1.8 million of restructuring expense in the aggregate in connection with this initiative, comprised of $1.2 million for severance and related costs and $0.6 million related to the elimination of redundant facilities. The actions under the Taqua Restructuring Initiative have been implemented and accordingly, the Company does not expect to record additional expense in connection with this initiative. The amounts accrued for severance and related costs had been fully paid by the end of the third quarter of 2017. The Company expects that the amounts accrued for facilities will be paid by the end of 2018.

In connection with the Taqua Restructuring Initiative, the Company recorded $0.6 million of restructuring expense in the nine months ended September 30, 2017, comprised of $0.2 million for severance and related costs and $0.4 million for redundant facilities. A summary of the Taqua Restructuring Initiative accrual activity for the nine months ended September 30, 2018 is as follows (in thousands):
 
Balance at
January 1,
2018
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at
September 30,
2018
Facilities
$
365

 
$

 
$

 
$
(255
)
 
$
110



Balance Sheet Classification

The current portions of accrued restructuring are included as a component of Accrued expenses and the long-term portions of accrued restructuring are included as a component of Other long-term liabilities in the condensed consolidated balance sheets. The current portions of accrued restructuring totaled $3.2 million at September 30, 2018 and $10.0 million at December

24


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

31, 2017. The long-term portions of accrued restructuring totaled $0.1 million at September 30, 2018 and $0.2 million at December 31, 2017. The long-term amounts represent future lease payments on restructured facilities.



(9) DEBT

Assumed Senior Secured Credit Agreement

On the Merger Date and in connection with the Merger, the Company assumed GENBAND's Senior Secured Credit Agreement with Silicon Valley Bank ("SVB") (the "Prior Credit Agreement"), which had outstanding borrowings and letters of credit totaling $17.9 million and $2.9 million, respectively, and an average interest rate of 4.67%. GENBAND had entered into the Prior Credit Agreement with SVB effective July 1, 2016, with two of its operating subsidiaries as borrowers and GENBAND as the guarantor. The Prior Credit Agreement had a maturity date of July 1, 2019 and provided for revolving loans, including letters of credit and swingline loans, not to exceed $50 million in total, with potential further increases of $75 million available for a total revolving line of credit of up to $125 million. The Prior Credit Agreement was superseded by a Senior Secured Credit Facilities Credit Agreement, as amended, which was entered into on December 21, 2017 and is discussed below.

Senior Secured Credit Facility

On December 21, 2017, the Company entered into a Senior Secured Credit Facilities Credit Agreement (as amended, the “Credit Facility”), by and among the Company, as a guarantor, Sonus Networks, Inc., as the borrower (“Borrower”), SVB, as administrative agent (in such capacity, the “Administrative Agent”), issuing lender, swingline lender and lead arranger and the lenders party thereto (each referred to individually as a “Lender”, and collectively, the “Lenders”), which refinanced the Prior Credit Agreement. The Credit Facility includes $100 million of commitments, the full amount of which is available for revolving loans, a $15 million sublimit that is available for letters of credit and a $15 million sublimit that is available for swingline loans. The Credit Facility is scheduled to mature in December 2021, subject to a springing maturity if, on or before July 14, 2020, the existing Promissory Note issued to certain shareholders is not converted or extended to March 2022 or later. The Credit Facility includes procedures for additional financial institutions to become lenders or for any existing lender to increase its commitment under the facility, subject to an available increase of $50 million for all incremental commitments under the Credit Facility. On June 24, 2018, the Company amended the Credit Facility to, among other things, permit the Edgewater Acquisition and related transactions.

The indebtedness and other obligations under the Credit Facility are unconditionally guaranteed on a senior secured basis by the Company and GENBAND US LLC, a wholly-owned domestic subsidiary of the Company (collectively, the “Guarantors”) and each other material US domestic subsidiary of the Company. The Credit Facility is secured by first-priority liens on substantially all of the assets of the Borrower and the Guarantors, including the Company.

The Credit Facility requires periodic interest payments on any outstanding borrowings under the facility. The Borrower may prepay all revolving loans under the Credit Facility at any time without premium or penalty (other than customary LIBOR breakage costs), subject to certain notice requirements.

Revolving loans under the Credit Facility bear interest at the Borrower’s option at either the Eurodollar (LIBOR) rate plus a margin ranging from 2.50% to 3.00% per year or the base rate (the highest of the Federal Funds rate plus 0.50%, or the prime rate announced from time to time in The Wall Street Journal) plus a margin ranging from 1.50% to 2.00% per year (such margins being referred to as the “Applicable Margin”). The Applicable Margin varies depending on the Company’s consolidated leverage ratio (as defined in the Credit Facility). The base rate and the LIBOR rate are each subject to a zero percent floor.

The Borrower is charged a commitment fee ranging from 0.25% to 0.40% per year on the daily amount of the unused portions of the commitments under the Credit Facility. Additionally, with respect to all letters of credit outstanding under the Credit Facility, the Borrower is charged a fronting fee of 0.125% per year and an outstanding letter of credit fee equal to the Applicable Margin for base rate loans ranging from 1.50% to 2.00% times the amount of the outstanding letters of credit.


25


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

The Credit Facility requires compliance with financial covenants of a minimum consolidated quick ratio, minimum consolidated interest coverage ratio and maximum consolidated leverage ratio, all of which are defined in the Credit Facility and tested on a quarterly basis. In addition, the Credit Facility contains various covenants that, among other restrictions, limit the Company’s and its subsidiaries’ ability to enter into certain types of transactions, including, but not limited to: incurring or assuming indebtedness, making acquisitions or engaging in mergers, making investments, repurchasing equity and paying dividends, selling or otherwise transferring assets, changing the nature of its business and amending or making prepayments on certain junior debt. The Company was in compliance with all covenants of the Credit Facility as of September 30, 2018 and December 31, 2017.

The Credit Facility contains events of default that are customary for a secured credit facility. If an event of default relating to bankruptcy or other insolvency events with respect to a borrower occurs, all obligations under the Credit Facility will immediately become due and payable. If any other event of default exists under the Credit Facility, the lenders may accelerate the maturity of the obligations outstanding under the Credit Facility and exercise other rights and remedies, including charging a default rate of interest equal to 2.00% per year above the rate that would otherwise be applicable. In addition, if any event of default exists under the Credit Facility, the lenders may commence foreclosure or other actions against the collateral.

If any default exists under the Credit Facility, or if the Borrower is unable to make any of the representations and warranties as stated in the Credit Facility at the applicable time, the Borrower will be unable to borrow funds or have letters of credit issued under the Credit Facility, which, depending on the circumstances prevailing at that time, could have a material adverse effect on the Borrower’s liquidity and working capital.

At September 30, 2018, the Company had an outstanding debt balance of $58.0 million at an average interest rate of 5.26% and $2.6 million of outstanding letters of credit at an average interest rate of 1.75% under the Credit Facility. At December 31, 2017, the Company had an outstanding debt balance of $20.0 million at an interest rate of 4.51% and $2.9 million of outstanding letters of credit at an average interest rate of 2.00% under the Credit Facility.

Promissory Note

In connection with the Merger, on October 27, 2017, the Company issued the Promissory Note for $22.5 million to certain of GENBAND's equity holders. The Promissory Note does not amortize, and the principal thereon is payable in full on the third anniversary of its execution. Interest on the Promissory Note is payable quarterly in arrears and accrued at a rate of 7.5% per year for the first six months after issuance, and thereafter at a rate of 10% per year. The failure to make any payment under the Promissory Note when due and, with respect to payment of any interest, the continuation of such failure for a period of thirty days thereafter, constitutes an event of default under the Promissory Note. If an event of default occurs under the Promissory Note, the payees may declare the entire balance of the Promissory Note due and payable (including principal and accrued and unpaid interest) within five business days of the payees' notification to the Company of such acceleration. Interest that is not paid on the interest payment date will increase the principal amount of the Promissory Note. At September 30, 2018, the Promissory Note balance was $23.5 million, comprised of $22.5 million of principal plus $1.0 million of interest converted to principal.



(10) REVENUE RECOGNITION

In May 2014, the FASB issued ASU 2014-09, which, among other things, clarified the implementation of the new revenue guidance and delayed the adoption by one year, to January 1, 2018. The New Revenue Standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the revenue model to contracts within its scope, an entity identifies the contract(s) with a customer, identifies the performance obligations in the contract, determines the transaction price, allocates the transaction price to the performance obligations in the contract and recognizes revenue when (or as) the entity satisfies a performance obligation. Effective January 1, 2018, the Company adopted the New Revenue Standard using the modified retrospective option and identified the necessary changes to its policies,

26


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

processes, systems and controls. Under the modified retrospective method, the Company is applying the New Revenue Standard to all contracts not yet completed as of January 1, 2018, recognizing in beginning Accumulated deficit an adjustment for the cumulative effect of the change and providing additional disclosures comparing results to those as if the Company was still following the previous accounting standards. Under ASC 605, the Company concluded it did not have vendor-specific objective evidence ("VSOE") for certain elements in software bundled arrangements, which resulted in revenue being recognized ratably over the longest performance period. The majority of the transition adjustment related to these arrangements. In connection with the adoption of ASC 606, as of January 1, 2018, the Company recorded an adjustment to decrease Accumulated deficit by approximately $12 million and capitalized certain commission costs resulting directly from securing contracts which were previously expensed.

Significant Judgments

The Company's contracts with customers often include promises to transfer multiple products and services to the customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.

Judgment is required to determine the standalone selling price for each distinct performance obligation. In instances where SSP is not directly observable, such as when the Company does not sell the product or service separately, the Company determines the SSP using information that may include market conditions and other observable inputs. The Company typically has more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, the Company may use information such as the size of the customer and geographic region in determining the SSP.

Deferred Revenue

Deferred revenue represents amounts collected from or invoiced to customers in excess of revenue recognized. This results primarily from the billing of annual customer support agreements where the revenue is recognized over the term of the agreement. The value of deferred revenue will increase or decrease based on the timing of invoices and recognition of revenue.

Disaggregation of Revenue

The Company disaggregates its revenue from contracts with customers based on the nature of the products and services and the geographic regions in which each customer is domiciled. The Company's revenue for the three and nine months ended September 30, 2018 and 2017 was disaggregated as follows:
Three months ended September 30, 2018
Product revenue
 
Service revenue (maintenance)
 
Service revenue (professional services)
 
Total revenue
United States
$
49,699

 
$
34,065

 
$
9,040

 
$
92,804

Europe, Middle East and Africa
10,380

 
11,504

 
2,169

 
24,053

Japan
3,588

 
2,882

 
503

 
6,973

Other Asia Pacific
6,959

 
3,551

 
906

 
11,416

Other
6,657

 
8,154

 
2,411

 
17,222

 
$
77,283

 
$
60,156

 
$
15,029

 
$
152,468



27


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

Three months ended September 30, 2017
Product revenue
 
Service revenue (maintenance)
 
Service revenue (professional services)
 
Total revenue
United States
$
35,126

 
$
16,745

 
$
4,263

 
$
56,134

Europe, Middle East and Africa
3,072

 
2,960

 
272

 
6,304

Japan
3,376

 
2,489

 
1,552

 
7,417

Other Asia Pacific
1,771

 
992

 
47

 
2,810

Other
775

 
1,070

 
119

 
1,964

 
$
44,120

 
$
24,256

 
$
6,253

 
$
74,629



Nine months ended September 30, 2018
Product revenue
 
Service revenue (maintenance)
 
Service revenue (professional services)
 
Total revenue
United States
$
109,977

 
$
98,354

 
$
25,535

 
$
233,866

Europe, Middle East and Africa
29,807

 
35,550

 
8,157

 
73,514

Japan
16,128

 
8,431

 
2,296

 
26,855

Other Asia Pacific
21,970

 
8,905

 
3,185

 
34,060

Other
14,055

 
23,049

 
5,610

 
42,714

 
$
191,937

 
$
174,289

 
$
44,783

 
$
411,009


Nine months ended September 30, 2017
Product revenue
 
Service revenue (maintenance)
 
Service revenue (professional services)
 
Total revenue
United States
$
72,123

 
$
48,502

 
$
10,116

 
$
130,741

Europe, Middle East and Africa
10,295

 
8,006

 
1,456

 
19,757

Japan
8,569

 
7,536

 
3,768

 
19,873

Other Asia Pacific
4,180

 
2,920

 
383

 
7,483

Other
3,138

 
2,234

 
504

 
5,876

 
$
98,305

 
$
69,198

 
$
16,227

 
$
183,730



International revenue, both as a percentage of total revenue and absolute dollars, may vary from one period to the next, and accordingly, historical data may not be indicative of future periods.

The Company's product revenue from its direct sales program and from indirect sales through its channel partner program for the three and nine months ended September 30, 2018 and 2017 was as follows (in thousands):
 
 
 
 
 
 
 
 
 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Indirect sales through channel program
$
26,309

 
$
10,704

 
$
42,151

 
$
28,063

Direct sales
50,974

 
33,416

 
149,786

 
70,242

 
$
77,283

 
$
44,120

 
$
191,937

 
$
98,305



The Company's product revenue from sales to enterprise customers and from sales to service provider customers for the three and nine months ended September 30, 2018 and 2017 was as follows (in thousands):

28


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

 
 
 
 
 
 
 
 
 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Sales to enterprise customers
$
23,581

 
$
9,602

 
$
37,534

 
$
23,903

Sales to service provider customers
53,702

 
34,518

 
154,403

 
74,402

 
$
77,283

 
$
44,120

 
$
191,937

 
$
98,305



Revenue Contract Balances

The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets) and customer advances and deposits (contract liabilities) in the Company's condensed consolidated balance sheets. Amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals or upon achievement of contractual milestones. Billing may occur subsequent to revenue recognition, resulting in contract assets. The Company may receive advances or deposits from its customers before revenue is recognized, resulting in contract liabilities which are classified as deferred revenue. These assets and liabilities are reported in the Company's condensed consolidated balance sheets on a contract-by-contract basis as of the end of each reporting period. Deposits are liquidated when revenue is recognized. Changes in the contract asset and liability balances during the nine-month period ended September 30, 2018 were not materially impacted by any other factors. Nearly all of the Company's deferred revenue balance is related to services revenue, primarily customer support contracts. Unbilled receivables stem primarily from engagements where services have been performed; however, billing cannot occur until services are completed.

In some arrangements, the Company allows customers to pay for term-based software licenses and products over the term of the software license. The Company also sells SaaS-based software under subscription arrangements, with payment terms over the term of the SaaS agreement. Amounts recognized as revenue in excess of amounts billed are recorded as unbilled receivables. Unbilled receivables that are anticipated to be invoiced in the next twelve months are included in Accounts receivable on the Company's condensed consolidated balance sheets. The changes in the Company's accounts receivable, unbilled receivables and deferred revenue balances for the nine months ended September 30, 2018 were as follows (in thousands):
 
Accounts receivable
 
Unbilled accounts receivable
 
Deferred revenue (current)
 
Deferred revenue (long-term)
Balance at January 1, 2018
$
149,122

 
$
16,034

 
$
100,571

 
$
14,184

Increase (decrease), net
(13,317
)
 
(1,162
)
 
(18,082
)
 
1,801

Balance at September 30, 2018
$
135,805

 
$
14,872

 
$
82,489

 
$
15,985



The decrease in accounts receivable was primarily the result of lower billings in the current year period compared with the Company's typically higher billings at year-end. The decrease in deferred revenue was primarily due to the ratable amortization of annual customer support renewals. The Company recognized $18.4 million and $79.1 million, respectively, of revenue in the three and nine months ended September 30, 2018 that was recorded as deferred revenue at December 31, 2017. Of the Company's deferred revenue reported as long-term in its condensed consolidated balance sheet at September 30, 2018, the Company expects that approximately $3 million will be recognized as revenue in 2019, approximately $9 million will be recognized as revenue in 2020 and approximately $4 million will be recognized as revenue in 2021 and beyond.

Deferred Commissions Cost

Sales commissions earned by the Company's employees are considered incremental and recoverable costs of obtaining a contract with a customer. Under ASC 605, the costs associated with obtaining a customer contract were expensed in the period the revenue was earned. Under ASC 606, these payments have been deferred on our condensed consolidated balance sheet and amortized over the expected life of the customer contract.


29


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

Adoption of ASC 606

Under the modified retrospective method, the Company applied ASC 606 to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning January 1, 2018 are presented under ASC 606, which prior period amounts have not been adjusted and will continue to be reported in accordance with the Company's historical accounting treatment under ASC 605, Revenue Recognition ("ASC 605").

The Company recorded a net reduction to Accumulated deficit of approximately $12 million at January 1, 2018 due to the cumulative impact of adopting ASC 606, primarily related to software orders with non-VSOE services revenue. Had the Company continued to recognize revenue under ASC 605, the Company would have recognized approximately $8 million and approximately $9 million less revenue in the three and nine months ended September 30, 2018, respectively. Incremental costs that would have been recognized had the Company continued to recognize revenue under ASC 605 would not have been material to the Company's consolidated results of operations.

The Company's typical performance obligations include the following:
Performance Obligation
 
When Performance Obligation is Typically Satisfied
 
When Payment is Typically Due
Software and Product Revenue
 
 
 
 
Software licenses (perpetual or term)
 
Upon transfer of control; typically, when made available for download (point in time)
 
Within 30 days of invoicing except for term licenses which may be paid for over time
 
 
 
 
 
Software licenses (subscription)
 
Upon activation of hosted site (over time)
 
Within 30 days of invoicing
 
 
 
 
 
Hardware
 
When control of the appliances passes to the customer; typically, upon delivery (point in time)
 
Generally, within 30 days of invoicing
 
 
 
 
 
Software upgrades
 
Upon transfer of control; typically, when made available for download (point in time)
 
Generally, within 30 days of invoicing
 
 
 
 
 
Customer Support Revenue
 
 
 
 
Customer support
 
Ratably over the course of the support contract (over time)
 
At the beginning of the contract period
 
 
 
 
 
Professional Services
 
 
 
 
Other professional services (excluding education services)
 
As work is performed (over time)
 
Within 30 days of invoicing (upon completion of services)
 
 
 
 
 
Training
 
When the class is taught (point in time)
 
Within 30 days of services being performed




(11) STOCK-BASED COMPENSATION PLANS

Amended and Restated Stock Incentive Plan

The Company's Amended and Restated Stock Incentive Plan, as amended (the "Plan"), provides for the award of options to purchase the Company's common stock ("stock options"), stock appreciation rights ("SARs"), restricted common stock awards ("RSAs"), restricted common stock units ("RSUs"), performance-based stock awards ("PSAs"), performance-based stock units ("PSUs") and other stock-based awards to employees, officers, directors (including those directors who are not employees or

30


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

officers of the Company), consultants and advisors of the Company and its subsidiaries.

2002 Stock Option Plan

In connection with the Edgewater Acquisition, the Company assumed Edgewater's Amended and Restated 2002 Stock Option Plan (the "Edgewater Plan") to the extent of the shares underlying the options outstanding under the Edgewater Plan as of the Edgewater Acquisition Date (the "Edgewater Options"). The Edgewater Options were converted to like Ribbon stock options (the "Ribbon Replacement Options") using a conversion factor of 0.17, which was calculated based on the acquisition consideration of $1.20 per share of Edgewater common stock divided by the weighted average of the closing price of Ribbon common stock for the ten consecutive days, ending with the trading day that preceded the Edgewater Acquisition Date. This conversion factor was also used to convert the exercise prices of Edgewater Options to Ribbon Replacement Option exercise prices. The Ribbon Replacement Options will vest under the same schedules as the respective Edgewater Options.

The fair values of the Edgewater Options assumed were estimated using a Black-Scholes option pricing model. The Company recorded $0.7 million as additional purchase consideration for the fair value of the assumed Edgewater Options. The fair value of the Ribbon Replacement Options attributable to future service totaled $1.0 million, which will be recognized over a weighted average period of approximately two years.

Executive Equity Arrangements - PSUs

In addition to granting RSAs and RSUs to its executives and certain of its employees, the Company also grants PSUs to certain of its executives.

In May 2018, the Company granted its President and Chief Executive Officer Franklin (Fritz) Hobbs ("Mr. Hobbs"), 195,000 PSUs with both performance and service conditions (the "Hobbs PSUs"). Of the 195,000 Hobbs PSUs, one-half will vest based on the achievement of two separate metrics related to the Company's 2018 financial performance (the "Hobbs Performance Conditions"). The Company's achievement of the Hobbs Performance Conditions (and the shares of Company common stock to vest as a result thereof) will be measured on a linear sliding scale in relation to specific threshold, target and stretch performance conditions. The number of shares of common stock to be received upon vesting of the Hobbs PSUs will in no event exceed 150% of the Hobbs PSUs. The Company is recording stock-based compensation expense for the Hobbs PSUs based on its assessment of the probability that each performance condition will be achieved and the level, if any, of such achievement. Upon the determination by the Compensation Committee of the Board of Directors (the "Compensation Committee") of the number of shares that will be received upon vesting of the Hobbs PSUs, such number of shares will become fixed and the unamortized expense recorded through the remainder of the service period that ends December 31, 2020. The Company recorded stock-based compensation expense approximating $154,000 in the three months ended September 30, 2018 and $194,000 in the nine months ended September 30, 2018 in connection with the Hobbs PSUs.

From 2015 through 2017, the Company granted PSUs with both market and service conditions to certain of its executives. The terms of each PSU grant are such that up to one-third of the shares subject to the respective PSU grant will vest, if at all, on each of the respective first, second and third anniversaries of the date of grant, depending on the Company's total shareholder return ("TSR") compared with the TSR of the companies included in the Nasdaq Telecommunications Index for the same fiscal year, measured by the Compensation Committee after each of the fiscal years as defined by each grant (each, a "Performance Period"). The shares determined to be earned will vest on the anniversary of the grant date following each Performance Period. Shares subject to the PSUs that fail to be earned will be forfeited.

The PSUs that included a market condition required the use of a Monte Carlo simulation approach to model future stock price movements based upon the risk-free rate of return, the date of return, the volatility of each entity and the pair-wise covariance between each entity. These results were then used to calculate the grant date fair values of the respective PSUs. The Company is required to record expense for the PSUs with market conditions through their respective final vesting dates, regardless of the number of shares that are ultimately earned.

On March 31, 2017, the Company granted an aggregate of 165,000 PSUs with both market and service conditions to five of its executives (the "2017 PSUs"). In March 2018, the Compensation Committee determined that the performance metrics for the 2017 PSUs for the 2017 Performance Period had been achieved at the 130% level and accordingly, 33,584 shares in the

31


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

aggregate were released to the three executives holding such outstanding grants, comprised of 25,834 shares, representing the 100% achievement target, granted on March 31, 2017 and 7,750 shares, representing the 30% achievement over target, granted on March 31, 2018. The grant of the additional shares and the release of the earned shares, both of which occurred on March 31, 2018, are included in the PSU table below.

On April 1, 2016, the Company granted an aggregate of 131,250 PSUs with both market and service conditions to six of its executives (the "2016 PSUs"). In March 2018, the Compensation Committee determined that the performance metrics for the 2016 PSUs for the 2017 Performance Period had been achieved at the 130% level, and accordingly, 16,250 shares in the aggregate were released to the two executives holding such outstanding grants, comprised of 12,500 shares, representing the 100% achievement target, granted on April 1, 2016 and 3,750 shares, representing the 30% achievement over target, granted on April 1, 2018. The grant of the additional shares and the release of the earned shares, both of which occurred on April 1, 2018, are included in PSU table below.

On March 16, 2015, the Company granted an aggregate of 131,250 PSUs with both market and service conditions to eight of its executives (the "2015 PSUs"). In March 2018, the Compensation Committee determined that the performance metrics for the 2015 PSUs for the 2017 Performance Period had been achieved at the 112% level, and accordingly, 7,934 shares in the aggregate were released to the two executives holding such outstanding grants, comprised of 7,084 shares, representing the 100% achievement target, granted on March 16, 2015 and 850 shares, representing the 12% achievement over target, granted on March 16, 2018. The grant of the additional shares and the release of the earned shares, both of which occurred on March 16, 2018, are included in the PSU table below.

Stock Options

The activity related to the Company's outstanding stock options for the nine months ended September 30, 2018 was as follows:
 
Number of
Shares
 
Weighted
Average
Exercise Price
 
Weighted
Average
Remaining
Contractual Term
(years)
 
Aggregate
Intrinsic Value
(in thousands)
Outstanding at January 1, 2018
435,187

 
$
14.71

 
 
 
 
Granted

 
$

 
 
 
 
Edgewater outstanding options converted to Ribbon options
312,452

 
$
1.97

 
 
 
 
Exercised
(8,653
)
 
$
4.97

 
 
 
 
Forfeited

 
$

 
 
 
 
Expired
(109,486
)
 
$
14.40

 
 
 
 
Outstanding at September 30, 2018
629,500

 
$
8.57

 
6.12
 
$
1,538

Vested or expected to vest at September 30, 2018
589,719

 
$
9.01

 
5.96
 
$
1,352

Exercisable at September 30, 2018
344,653

 
$
14.01

 
4.41
 
$
161


 
 
The Company did not grant any stock options in the nine months ended September 30, 2018. Additional information regarding the Company's stock options for the three and nine months ended September 30, 2018 was as follows:
 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2018
Total intrinsic value of stock options exercised (in thousands)
$
13

 
$
21

Cash received from the exercise of stock options (in thousands)
$
33

 
$
43



Restricted Stock Awards and Units

The activity related to the Company's RSAs for the nine months ended September 30, 2018 was as follows:

32


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2018
1,696,582

 
$
7.68

Granted
1,123,956

 
$
6.90

Vested
(752,085
)
 
$
8.46

Forfeited
(270,075
)
 
$
7.36

Unvested balance at September 30, 2018
1,798,378

 
$
6.91



The activity related to the Company's RSUs for the nine months ended September 30, 2018 was as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2018
17,932

 
$
6.99

Granted
899,500

 
$
6.27

Vested
(17,110
)
 
$
7.00

Forfeited
(41,822
)
 
$
6.72

Unvested balance at September 30, 2018
858,500

 
$
6.25



The total fair value of shares of restricted stock granted under RSAs and RSUs that vested during the nine months ended September 30, 2018 was $6.5 million.

Performance-Based Stock Units
 
 
 
 
The activity related to the Company's PSUs for the nine months ended September 30, 2018 was as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2018
60,834

 
$
9.65

Granted
207,350

 
$
5.78

Vested
(57,768
)
 
$
9.90

Forfeited

 
$

Unvested at September 30, 2018
210,416

 
$
5.77



The total fair value of shares of restricted stock granted under PSUs that vested during the nine months ended September 30, 2018 was $0.6 million.

Employee Stock Purchase Plan

The Company's Amended and Restated 2000 Employee Stock Purchase Plan ("ESPP") is designed to provide eligible employees of the Company and its participating subsidiaries an opportunity to purchase common stock of the Company through accumulated payroll deductions. The ESPP provides for six-month offering periods with the purchase price of the stock equal to 85% of the lesser of the market price on the first or last day of the offering period. The maximum number of shares of common stock an employee may purchase during each offering period is 500, subject to certain adjustments pursuant to the ESPP.

In May 2017, the Compensation Committee determined to suspend all offering periods under the ESPP effective September 1, 2017 and until such time after the closing of the then-pending merger with GENBAND as the Compensation Committee

33


RIBBON COMMUNICATIONS INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

determines is best in its sole discretion. In September 2018, at the recommendation of the Compensation Committee, the Board determined to re-instate all offering periods under the ESPP, effective December 1, 2018.

Stock-Based Compensation

The condensed consolidated statements of operations include stock-based compensation for the three and nine months ended September 30, 2018 and 2017 as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2018
 
September 30,
2017
 
September 30,
2018
 
September 30,
2017
Product cost of revenue
$
21

 
$
75

 
$
91

 
$
261

Service cost of revenue
65

 
199

 
264

 
777

Research and development
313

 
1,095<