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 March 31, 2020
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)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.0001
RBBN
The Nasdaq Global Select Market
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 May 4, 2020, there were 144,771,217 shares of the registrant's common stock, $0.0001 par value per share, outstanding.
 




RIBBON COMMUNICATIONS INC.
FORM 10-Q
QUARTERLY PERIOD ENDED MARCH 31, 2020
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, potential stock repurchases, remaining settlement payments, beliefs about our market capitalization, business strategy, statements about the potential impact of the merger and acquisition transactions described herein, plans and objectives of management for future operations, plans for future cost reductions, changes to our operating segments, if any, restructuring activities and plans for future product offerings, 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, risks related to the COVID-19 pandemic on the global economy and financial markets as well as on the Company, our customers and suppliers, which may impact our sales, gross margin, customer demand and our ability to supply our products to our customers; risks that the businesses of ECI Telecom Group Ltd. ("ECI") will not be integrated successfully or that the combined companies will not realize estimated cost savings; failure to realize anticipated benefits of the merger with ECI; potential litigation relating to the merger with ECI and disruptions from the integration efforts that could harm our business; integration activities with respect to ECI and our other 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; unpredictable fluctuations in quarterly revenue and operating results; failure to compete successfully against telecommunications equipment and networking companies; failure to grow our customer base or generate recurring business from our existing customers; consolidation in the telecommunications industry; credit risks; 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; actions taken by significant stockholders; difficulties providing solutions that meet the needs of customers; market acceptance of our products and services; rapid technological and market change; our ability to protect our intellectual property rights and obtain necessary licenses; our ability to maintain partner, reseller, distribution and vendor support and supply relationships; our negotiating position relative to our large customers; the limited supply of certain components of our products; the potential for defects in our products; risks related to the terms of our credit agreement; higher risks in international operations and markets; the impact of increased competition; increases in tariffs, trade restrictions or taxes on our products; 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 year ended December 31, 2019 as updated by Part II, Item 1A. "Risk Factors" of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2020. 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.



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)
 
March 31,
2020
 
December 31,
2019
Assets
Current assets:
 
 
 
Cash and cash equivalents
$
96,830

 
$
44,643

Restricted cash
13,238

 

Accounts receivable, net
205,793

 
192,706

Inventory
67,067

 
14,800

Other current assets
45,904

 
27,146

Total current assets
428,832

 
279,295

Property and equipment, net
46,903

 
28,976

Intangible assets, net
452,930

 
213,366

Goodwill
414,389

 
224,896

Deferred income taxes
6,225

 
4,959

Operating lease right-of-use assets
66,295

 
36,654

Other assets
56,915

 
26,762

 
$
1,472,489

 
$
814,908

Liabilities and Stockholders' Equity
Current liabilities:
 
 
 
Current portion of term debt
$
13,500

 
$
2,500

Revolving credit facility

 
8,000

Accounts payable
89,323

 
31,412

Accrued expenses and other
136,019

 
56,700

Operating lease liabilities
18,201

 
7,719

Deferred revenue
113,699

 
100,406

Total current liabilities
370,742

 
206,737

Long-term debt, net of current
381,743

 
45,995

Operating lease liabilities, net of current
55,857

 
37,202

Deferred revenue, net of current
25,911

 
20,482

Deferred income taxes
17,443

 
4,648

Other long-term liabilities
67,089

 
16,589

Total liabilities
918,785

 
331,653

Commitments and contingencies (Note 18)

 

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; 144,351,304 shares issued and outstanding at March 31, 2020; 110,471,995 shares issued and outstanding at December 31, 2019
14

 
11

Additional paid-in capital
1,860,150

 
1,747,784

Accumulated deficit
(1,300,237
)
 
(1,267,067
)
Accumulated other comprehensive (loss) income
(6,223
)
 
2,527

Total stockholders' equity
553,704

 
483,255

 
$
1,472,489

 
$
814,908


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
 
March 31,
2020
 
March 31,
2019
Revenue:
 
 
 
Product
$
75,899

 
$
47,480

Service
82,083

 
71,448

Total revenue
157,982

 
118,928

Cost of revenue:
 
 
 
Product
44,933

 
33,147

Service
31,479

 
29,192

Total cost of revenue
76,412

 
62,339

Gross profit
81,570

 
56,589

Operating expenses:
 
 
 
Research and development
42,295

 
35,933

Sales and marketing
36,351

 
30,059

General and administrative
17,205

 
18,694

Acquisition- and integration-related
12,384

 
3,199

Restructuring and related
2,075

 
4,932

Total operating expenses
110,310

 
92,817

Loss from operations
(28,740
)
 
(36,228
)
Interest expense, net
(3,395
)
 
(1,364
)
Other (expense) income, net
(844
)
 
7,774

Loss before income taxes
(32,979
)
 
(29,818
)
Income tax provision
(191
)
 
(1,014
)
Net loss
$
(33,170
)
 
$
(30,832
)
Loss per share:
 
 
 
Basic
$
(0.27
)
 
$
(0.29
)
Diluted
$
(0.27
)
 
$
(0.29
)
Weighted average shares used to compute loss per share:
 
 
 
Basic
120,992

 
108,167

Diluted
120,992

 
108,167


See notes to the unaudited condensed consolidated financial statements.


5



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


 
Three months ended
 
March 31,
2020
 
March 31,
2019
Net loss
$
(33,170
)
 
$
(30,832
)
Other comprehensive income (loss), net of tax:
 
 
 
Unrealized loss on interest rate swap
(9,527
)
 

Foreign currency translation adjustments
777

 
(8
)
Unrealized gain on available-for sale marketable securities, net of reclassification adjustments for realized amounts

 
13

Employee retirement benefits

 
32

Other comprehensive (loss) income, net of tax
(8,750
)
 
37

Comprehensive loss
$
(41,920
)
 
$
(30,795
)

See notes to the unaudited condensed consolidated financial statements.


6



RIBBON COMMUNICATIONS INC.
Condensed Consolidated Statements of Stockholders' Equity
(in thousands, except shares)
(unaudited)

 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2020
 
Common stock
 
 
 
 
 
 
 
 
 
Shares
 
Amount
 
Additional paid-in capital
 
Accumulated deficit
 
Accumulated other comprehensive income (loss)
 
Total stockholders' equity
Balance at January 1, 2020
110,471,995

 
$
11

 
$
1,747,784

 
$
(1,267,067
)
 
$
2,527

 
$
483,255

Exercise of stock options
3,014

 


 
5

 


 


 
5

Vesting of restricted stock awards and units
1,016,982

 


 


 


 


 

Vesting of performance-based stock units
315,866

 


 


 


 


 

Shares of restricted stock returned to the Company under net share settlements to satisfy tax withholding obligations
(273,104
)
 


 
(792
)
 


 


 
(792
)
Shares issued as consideration in connection with the acquisition of ECI Telecom Group Ltd.
32,500,000

 
3

 
108,547

 


 


 
108,550

Shares issued as consideration in connection with the acquisition of Anova Data, Inc.
316,551

 


 
1,630

 


 


 
1,630

Stock-based compensation expense


 


 
2,976

 


 


 
2,976

Other comprehensive loss


 


 


 


 
(8,750
)
 
(8,750
)
Net loss


 


 


 
(33,170
)
 


 
(33,170
)
Balance at March 31, 2020
144,351,304

 
$
14

 
$
1,860,150

 
$
(1,300,237
)
 
$
(6,223
)
 
$
553,704


7



RIBBON COMMUNICATIONS INC.
Condensed Consolidated Statements of Stockholders' Equity (continued)
(in thousands, except shares)
(unaudited)

 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2019
 
Common stock
 
 
 
 
 
 
 
 
 
Shares
 
Amount
 
Additional paid-in capital
 
Accumulated deficit
 
Accumulated other comprehensive income
 
Total stockholders' equity
Balance at January 1, 2019
106,815,636

 
$
11

 
$
1,723,576

 
$
(1,136,992
)
 
$
3,703

 
$
590,298

Exercise of stock options
88,354

 


 
151

 


 


 
151

Vesting of restricted stock awards and units
806,813

 


 


 


 


 

Vesting of performance-based stock units
9,466

 


 


 


 


 

Shares of restricted stock returned to the Company under net share settlements to satisfy tax withholding obligations
(181,428
)
 


 
(968
)
 


 


 
(968
)
Shares issued as consideration in connection with the acquisition of Anova Data, Inc.
2,948,793

 


 
15,186

 


 


 
15,186

Reclassification of liability to equity for bonuses converted to stock


 


 
1,052

 


 


 
1,052

Stock-based compensation expense


 


 
4,139

 


 


 
4,139

Other comprehensive income


 


 


 


 
37

 
37

Net loss


 


 


 
(30,832
)
 


 
(30,832
)
Balance at March 31, 2019
110,487,634

 
$
11

 
$
1,743,136

 
$
(1,167,824
)
 
$
3,740

 
$
579,063


See notes to the unaudited condensed consolidated financial statements.


8



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


 
Three months ended
 
March 31,
2020
 
March 31,
2019
Cash flows from operating activities:
 
 
 
Net loss
$
(33,170
)
 
$
(30,832
)
Adjustments to reconcile net loss to cash flows provided by operating activities:
 
 
 
Depreciation and amortization of property and equipment
3,474

 
2,921

Amortization of intangible assets
14,334

 
11,922

Amortization of debt issuance costs
1,854

 
88

Stock-based compensation
2,976

 
4,139

Deferred income taxes
(99
)
 
347

Reduction in deferred purchase consideration
(69
)
 
(8,124
)
Foreign currency exchange losses
854

 
352

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
46,156

 
53,854

Inventory
4,468

 
3,692

Other operating assets
(478
)
 
(762
)
Accounts payable
(27,029
)
 
(6,999
)
Accrued expenses and other long-term liabilities
22,310

 
(13,095
)
Deferred revenue
4,351

 
2,076

Net cash provided by operating activities
39,932

 
19,579

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(6,017
)
 
(3,766
)
Business acquisitions, net of cash acquired
(346,852
)
 

Maturities of marketable securities

 
5,295

Proceeds from the sale of fixed assets
43,500

 

Net cash (used in) provided by investing activities
(309,369
)
 
1,529

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

 
37,000

Principal payments on revolving line of credit
(8,000
)
 
(35,000
)
Proceeds from issuance of term debt
403,500

 

Principal payments of long-term debt
(48,750
)
 

Payment of deferred purchase consideration

 
(21,876
)
Principal payments of finance leases
(338
)
 
(230
)
Payment of debt issuance costs
(10,573
)
 

Proceeds from the exercise of stock options
5

 
151

Payment of tax withholding obligations related to net share settlements of restricted stock awards
(792
)
 
(968
)
Net cash provided by (used in) financing activities
335,052

 
(20,923
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(190
)
 
59

Net increase in cash, cash equivalents and restricted cash
65,425

 
244

Cash and cash equivalents, beginning of year
44,643

 
43,694

Cash, cash equivalents and restricted cash, end of period
$
110,068

 
$
43,938

 
 
 
 

9



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


 
Three months ended
 
March 31,
2020
 
March 31,
2019
Supplemental disclosure of cash flow information:
 
 
 
Interest paid
$
688

 
$
831

Income taxes paid
$
1,259

 
$
777

Income tax refunds received
$

 
$
100

Supplemental disclosure of non-cash investing activities:
 
 
 
Capital expenditures incurred, but not yet paid
$
6,300

 
$
399

  Acquisition purchase consideration - deferred payments
$

 
$
1,700

  Shares of common stock issued as purchase consideration
$
110,180

 
$
15,186

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
$
3,182

 
$
4,334


See notes to the unaudited condensed consolidated financial statements.

10



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

(1) BASIS OF PRESENTATION

Business

Ribbon is a leading provider of next generation software solutions to telecommunications, wireless and cable service providers and enterprises of all sizes across industry verticals. With the March 3, 2020 completion of the merger with ECI Telecom Group Ltd ("ECI"), Ribbon now also provides optical and packet networking products and software-defined solutions to service providers and critical infrastructure sectors like utilities, government and defense. With over 1,000 customers around the globe, including some of the largest telecommunications service providers, enterprises and utilities in the world, Ribbon enables its customers to evolve and modernize their communications networks and packet optical networking infrastructures through software and hardware. By securing and enabling reliable and scalable Internet Protocol ("IP") and packet optical networks and applications, Ribbon helps its customers adopt the next generation of software-, cloud- and edge-based technologies to drive new, incremental revenue, while protecting their existing revenue streams. Ribbon's software solutions provide a secure way for its customers to connect and leverage multivendor, multiprotocol communications systems and applications across their networks and the cloud in a rapidly changing ecosystem of IP-enabled devices, such as smartphones and tablets. In addition, Ribbon's software solutions secure 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 - and support the increasing demand on network infrastructure created by ongoing IP traffic growth and the forecast demand and build-outs to be created by increased traffic from 5G applications and devices. Ribbon sells its products and solutions through both direct sales and indirect channels, 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 software IP networks.

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 March 3, 2020 (the "ECI Merger Date"), the Company merged with ECI Telecom Group Ltd. ("ECI") (the "ECI Merger"). The financial results of ECI are included in the Company's condensed consolidated financial statements for the period subsequent to the ECI Merger Date.

On February 28, 2019 (the "Anova Acquisition Date"), the Company acquired the business and technology assets of Anova Data, Inc. ("Anova"). The financial results of Anova are included in the Company's condensed consolidated financial statements for the period subsequent to the Anova 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, 2019 (the "Annual Report"), which was filed with the SEC on February 28, 2020.

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 three months ended March 31, 2020, with the exception of policies on transfers of financial assets and warranty costs:

Transfers of Financial Assets. The Company's recently acquired subsidiary, ECI Telecom Group Ltd. ("ECI"), maintains customer receivables factoring agreements with a number of financial institutions. Under the terms of these agreements, the Company may transfer receivables to the financial institutions, on a non-recourse basis, provided that the financial institutions approve the receivables in advance. The Company maintains credit insurance policies from major insurance providers or obtains letters of credit from the customers for a majority of its factored trade receivables. In some cases, the Company maintains some recourse obligations, limited to events of commercial disputes, such as product defects, which are not covered under the credit insurance policy, and are unrelated to the credit worthiness of the customer. The Company does not expect any

11


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

recourse to take place in the foreseeable future due to commercial disputes. The Company accounts for the factoring of its financial assets as a sale of the assets and records the factoring fees, when incurred, as a component of interest expense in the condensed consolidated statements of operations and the proceeds from the sales of receivables are included in cash from operating activities in the condensed consolidated statements of cash flows. During the three months ended March 31, 2020, the Company received $15.1 million of cash from the sale of certain accounts receivable and recorded $0.1 million of interest expense in connection with these transactions.

Warranty. The Company records warranty liabilities for estimated costs of fulfilling its obligations under standard limited hardware and software warranties at the time of sale. The liability for standard warranties is included in Accrued expenses and other and Other non-current liabilities in the condensed consolidated balance sheet at March 31, 2020. The specific warranty terms and conditions vary depending upon the country in which the Company does business, but generally includes material costs, technical support, labor and associated overhead over a period ranging from one to three years. The Company's liability for product warranties was $15.7 million, of which $6.7 million was current and included in Accrued expenses and other and $9.0 million was long-term and included in Other long-term liabilities in the Company's condensed consolidated balance sheet at March 31, 2020. The Company did not have a warranty accrual at December 31, 2019.

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 Ribbon 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 revenue and expenses during the reporting periods. Significant estimates and judgments relied upon in preparing these condensed consolidated financial statements include accounting for business combinations, revenue recognition for multiple element arrangements, inventory valuations, assumptions used to determine the fair value of stock-based compensation, intangible asset 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, not affecting previously reported net loss, have been made to the previously issued financial statements to conform to the current period presentation.

Restricted Cash

The Company classifies as restricted cash all cash pledged as collateral to secure long-term obligations and all cash whose use is otherwise limited by contractual provisions. At March 31, 2020, the Company had $13.2 million of restricted cash, comprised of $8.4 million restricted in connection with a tax payment on certain fixed assets formerly held by ECI that were sold in connection with the ECI Merger, and $4.8 million restricted short-term bank deposits pledged to secure certain performance and financial bonds as security for the Company's obligations under tenders, contracts and to one of its main subcontractors.

Fair Value of Financial Instruments

The carrying amounts of the Company's financial instruments approximate their fair values and include cash equivalents, accounts receivable, borrowings under a revolving credit facility, accounts payable and long-term debt.


12


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

Operating Segments

The Company currently operates in a single segment, as the chief operating decision maker made decisions and assessed performance at the company level. The Company's chief operating decision maker is its President and Chief Executive Officer, who began his employment with the Company effective March 1, 2020. From January 1, 2020 to March 1, 2020, the Company's chief operating decision makers were its former Interim Co-Presidents and Chief Executive Officers. 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. However, with the acquisition of ECI, the Company's chief operating decision maker is currently assessing the appropriate separate discrete financial information he will utilize for making such decisions. Accordingly, the Company is reporting one operating segment for the three months ended March 31, 2020.

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.

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.

Recent Accounting Pronouncements

The Financial Accounting Standards Board ("FASB") has issued the following accounting pronouncements, all of which became effective for the Company in 2020 and none of which had a material impact on the Company's condensed consolidated financial statements:

In March 2020, the FASB issued Accounting Standards Update ("ASU") 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting ("ASU 2020-04"), which provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria that reference LIBOR or another reference rate expected to be discontinued.

In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments ("ASU 2020-03"), which makes narrow-scope amendments related to topics regarding fair value option disclosures, applicability of the portfolio exception in Accounting Standards Codification ("ASC") 820 to nonfinancial items, disclosures for depository and lending institutions, cross reference to guidance in ASC 470-50 on line of credit or revolving debt arrangements, cross reference to net asset value practical expedient in ASC 820-10, interaction between ASC 842 and ASC 326 and between ASC 326 and ASC 860-20.

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

13


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

ASC 350-40 to determine which implementation costs should be capitalized in such a CCA.

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, to add, remove and clarify disclosure requirements related to defined benefit pension and other postretirement plans.

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.

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. In April and May 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments ("ASU 2019-04") and ASU 2019-05 Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief ("ASU 2019-05"), respectively. ASU 2019-04 provides transition relief for entities adopting ASU 2016-13 and ASU 2019-05 clarifies certain aspects of the accounting for credit losses, hedging activities and financial instruments in connection with the adoption of ASU 2016-13.

The FASB has issued the following accounting pronouncement which becomes effective for the Company in 2021, which the Company does not believe will have a material impact on its condensed consolidated financial statements upon adoption:

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ("ASU 2019-12"), which modifies ASC 740 to simplify the accounting for income taxes. ASU 2019-12 addresses the accounting for hybrid tax regimes, tax basis step-up in goodwill obtained in a transaction that is not a business combination, separate financial statements of legal entities not subject to tax, intraperiod tax allocation exception to incremental approach, ownership changes in investments - changes from a subsidiary to an equity method investment, ownership changes in investments - changes from an equity method investment to a subsidiary, interim period accounting for enacted changes in tax law and year-to-date loss limitation in interim period tax accounting.


(2) BUSINESS ACQUISITIONS

ECI

On the ECI Merger Date, Ribbon completed its previously announced merger transaction with ECI in accordance with the terms of the Agreement and Plan of Merger, dated as of November 14, 2019, by and among Ribbon, ECI, an indirect wholly-owned subsidiary of Ribbon ("Merger Sub"), Ribbon Communications Israel Ltd. and ECI Holding (Hungary) kft, pursuant to which Merger Sub merged with and into ECI, with ECI surviving such merger as a wholly-owned subsidiary of Ribbon. Prior to the ECI Merger Date, ECI was a privately-held global provider of end-to-end packet-optical transport and software-defined networking ("SDN") and network function virtualization ("NFV") solutions for service providers, enterprises and data center operators. Ribbon believes the ECI Merger positions the Company for growth and enhances its competitive strengths by expanding its product portfolio beyond solutions primarily supporting voice applications to include data applications and optical networking.

As consideration for the ECI Merger, Ribbon issued the ECI shareholders and certain others 32.5 million shares of Ribbon common stock with a fair value of $108.6 million (the "Stock Consideration") and paid $322.5 million of cash, comprised of $183.3 million to repay ECI's outstanding debt, including both principal and interest, and $139.2 million paid to ECI's selling shareholders (the "Cash Consideration"). In addition, ECI shareholders received $33.4 million from the sale of certain of ECI's real estate assets. Cash Consideration was financed through cash on hand and committed debt financing consisting of a new $400 million term loan facility (the "2020 Term Loan") and new $100 million revolving credit facility (together, the "2020 Credit Facility"), which was undrawn at the ECI Merger Date.

14


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


The ECI Merger has been accounted for as a business combination and the financial results of ECI have been included in the Company's condensed consolidated financial statements for the period subsequent to the ECI Merger. The Company's financial results for the three months ended March 31, 2020 include $30.0 million of revenue and $3.3 million of net loss attributable to ECI for the period subsequent to the ECI Merger Date.

As of March 31, 2020, the valuation of acquired assets, identifiable intangible assets and certain assumed liabilities was preliminary. The Company is continuing the process of investigating the facts and circumstances existing as of the ECI Merger Date in order to finalize its valuation. Included in the additional work required to finalize the valuation of assets acquired and liabilities assumed, the Company is assessing the impact of the COVID-19 pandemic on the estimated future revenue and cash flows. This assessment could result in significant changes between the preliminary valuations of the individual identifiable intangible assets and goodwill. The Company expects to finalize the valuation of the assets acquired and liabilities assumed by the first quarter of 2021.

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

Fair value of consideration transferred:
 
  Cash consideration:
 
    Repayment of ECI outstanding debt obligations
$
183,266

    Cash paid to selling shareholders
139,244

    Payment to selling shareholders from sale of ECI real estate assets
33,400

    Less cash and restricted cash acquired
(9,058
)
      Net cash consideration
346,852

  Fair value of Ribbon stock issued
108,550

        Fair value of total consideration
$
455,402

 
 
Fair value of assets acquired and liabilities assumed:
 
  Current assets, net of cash and restricted cash acquired
$
131,447

  Property and equipment
55,207

  Intangible assets:
 
    In-process research and development
31,000

    Developed technology
106,900

    Customer relationships
114,000

    Trade names
2,000

  Goodwill
189,493

  Other noncurrent assets
56,204

  Deferred revenue
(7,731
)
  Other current liabilities
(143,873
)
  Deferred revenue, net of current
(6,641
)
  Deferred tax liability
(13,308
)
  Other long-term liabilities
(59,296
)
 
$
455,402



The preliminary allocation of purchase consideration to the fair value of assets acquired and liabilities assumed includes a noncurrent asset of $5.7 million, which represents an indemnification receivable from ECI's selling shareholders for certain liabilities for uncertain tax positions in accordance with the Agreement and Plan of Merger.

The Company is still evaluating the fair value of acquired assets and assumed liabilities, the values of which may be subject to change based on the finalization of their respective fair values. The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to value the acquired in-process research and development, developed technology, customer relationships and trade name intangible assets. The Company is still evaluating the forecast and the value of these assets could change materially as the Company finalizes the

15


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

forecast and other inputs used to value these 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 arising from the ECI Merger in relation to the expected cash flows from the individual intangible assets over their respective useful lives, which have a weighted average life of 12.44 years (see Note 5). Goodwill results from assets that are not separately identifiable as part of the transaction and is not deductible for tax purposes.

Pro Forma Results

The following unaudited pro forma information presents the condensed combined results of operations of Ribbon and ECI for the three months ended March 31, 2020 and 2019 as if the ECI Merger had been completed on January 1, 2019, with adjustments to give effect to pro forma events that are directly attributable to the ECI Merger. These pro forma adjustments include an increase in research and development expense related to the conformance of ECI's cost capitalization policy to Ribbon's, additional amortization expense for the acquired identifiable intangible assets, a decrease in historical ECI interest expense reflecting the extinguishment of certain of ECI's debt as a result of the ECI Merger, and an increase in interest expense reflecting the new debt entered into by the Company in connection with the ECI Merger. Pro forma adjustments also include the elimination of acquisition- and integration-related costs directly attributable to the acquisition from the three months ended March 31, 2020 and inclusion of such costs in the three months ended March 31, 2019.

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 Ribbon and ECI. 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 ECI Merger occurred at January 1, 2019, nor are they intended to represent or be indicative of future results of operations (in thousands, except per share amounts):
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Revenue
$
183,189

 
$
208,947

Net loss
$
(39,129
)
 
$
(63,699
)
Loss per share
$
(0.25
)
 
$
(0.45
)


Anova Data, Inc.

On the Anova Acquisition Date, the Company acquired the business and technology assets of Anova, a private company headquartered in Westford, Massachusetts that provides advanced analytics solutions (the "Anova Acquisition"). The Anova Acquisition was completed in accordance with the terms and conditions of an asset purchase agreement, dated as of January 31, 2019 (the "Anova Asset Purchase Agreement"). As consideration for the Anova Acquisition, Ribbon issued 2.9 million shares of Ribbon common stock with a fair value of $15.2 million to Anova's sellers and equity holders on the Anova Acquisition Date and held back an additional 330,000 shares with a fair value of $1.7 million (the "Anova Deferred Consideration"), of which 316,551 shares were issued after post-closing adjustments on March 4, 2020. The Anova Deferred Consideration was included as a component of Accrued expenses and other current liabilities in the Company's condensed consolidated balance sheet at December 31, 2019.

The Anova Acquisition was accounted for as a business combination and the financial results of Anova have been included in the Company's condensed consolidated financial statements for the period subsequent to the Anova Acquisition Date. The results for the three months ended March 31, 2019 were not significant to the Company's condensed consolidated financial statements and accordingly, the Company has not provided pro forma financial information. As of March 31, 2020, the valuation of acquired assets, identifiable intangible assets and assumed liabilities was final, as the Company finalized the valuation of the assets acquired and liabilities assumed in the fourth quarter of 2019. The purchase consideration aggregating $16.9 million was allocated to $11.2 million of identifiable intangible assets with a weighted average life of 6.25 years (see Note 5) and working capital items aggregating $0.1 million of net assets acquired. The remaining unallocated amount of $5.5

16


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

million was recorded as goodwill. The goodwill is deductible for tax purposes.

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, including professional and services fees such as legal, audit, consulting, paying agent and other fees. These amounts include costs related to prior acquisitions, as well as nominal amounts related to acquisitive activities. Integration-related expenses represent incremental costs related to combining the Company and its business acquisitions, such as third-party consulting and other third-party services related to merging previously separate companies' systems and processes. The acquisition-related costs in the three months ended March 31, 2020 primarily relate to the ECI Merger; the acquisition-related costs in the three months ended March 31, 2019 primarily relate to the Anova Acquisition.

The Company's acquisition- and integration-related expenses for the three months ended March 31, 2020 and 2019 were as follows (in thousands):
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Professional and services fees (acquisition-related)
$
12,374

 
$
1,505

Integration-related expenses
10

 
1,694

 
$
12,384

 
$
3,199



(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 earnings (loss) per share were as follows (in thousands):
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Weighted average shares outstanding—basic
120,992

 
108,167

Potential dilutive common shares

 

Weighted average shares outstanding—diluted
120,992

 
108,167



Options to purchase the Company's common stock and unvested shares of restricted and performance-based stock and stock units aggregating 11.7 million shares have not been included in the computation of diluted loss per share for the three months ended March 31, 2020 because their effect would have been antidilutive. Options to purchase the Company's common stock, unvested shares of restricted and performance-based stock and stock units, and shares in connection with future purchases under the Company's Amended and Restated 2000 Employee Stock Purchase Plan, as amended (the "ESPP"), aggregating 4.5 million shares have not been included in the computation of diluted loss per share for the three months ended March 31, 2019 because their effect would have been antidilutive.



17


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

(4) INVENTORY

Inventory at March 31, 2020 and December 31, 2019 consisted of the following (in thousands):
 
March 31,
2020
 
December 31,
2019
On-hand final assemblies and finished goods inventories
$
71,964

 
$
13,283

Deferred cost of goods sold
4,167

 
2,441

 
76,131

 
15,724

Less noncurrent portion (included in other assets)
(9,064
)
 
(924
)
Current portion
$
67,067

 
$
14,800



(5) INTANGIBLE ASSETS AND GOODWILL

The Company's intangible assets at March 31, 2020 and December 31, 2019 consisted of the following (in thousands):
March 31, 2020
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
In-process research and development
*
 
$
36,600

 
$

 
$
36,600

Developed technology
7.92
 
295,780

 
109,714

 
186,066

Customer relationships
11.83
 
266,140

 
38,507

 
227,633

Trade names
3.60
 
4,000

 
1,369

 
2,631

Internal use software
3.00
 
730

 
730

 

 
9.13
 
$
603,250

 
$
150,320

 
$
452,930



December 31, 2019
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
In-process research and development
*
 
$
5,600

 
$

 
$
5,600

Developed technology
6.79
 
188,880

 
100,760

 
88,120

Customer relationships
9.46
 
152,140

 
33,350

 
118,790

Trade names
5.20
 
2,000

 
1,144

 
856

Internal use software
3.00
 
730

 
730

 

 
7.82
 
$
349,350

 
$
135,984

 
$
213,366


* 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 months ended March 31, 2020 and 2019 was as follows (in thousands):
 
Three months ended
 
Statement of operations classification
 
March 31,
2020
 
March 31,
2019
 
Developed technology
$
8,954

 
$
9,645

 
Cost of revenue - product
Customer relationships
5,156

 
2,130

 
Sales and marketing
Trade names
224

 
147

 
Sales and marketing
 
$
14,334

 
$
11,922

 
 

18


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



Estimated future amortization expense for the Company's intangible assets at March 31, 2020 was as follows (in thousands):
Years ending December 31,
 
Remainder of 2020
$
44,869

2021
64,323

2022
58,153

2023
51,445

2024
43,477

Thereafter
190,663

 
$
452,930



The changes in the carrying value of the Company's goodwill in the three months ended March 31, 2020 and 2019 were as follows (in thousands):
 
 
 
 
Balance at January 1
2020
 
2019
  Goodwill
$
392,302

 
$
386,761

  Accumulated impairment losses
(167,406
)
 
(3,106
)
 
224,896

 
383,655

Acquisition of ECI
189,493

 

Acquisition of Anova

 
5,541

Balance at March 31
$
414,389

 
$
389,196

 
 
 
 
Balance at March 31
 
 
 
  Goodwill
$
581,795

 
$
392,302

  Accumulated impairment losses
(167,406
)
 
(3,106
)
 
$
414,389

 
$
389,196



(6) ACCRUED EXPENSES
Accrued expenses at March 31, 2020 and December 31, 2019 consisted of the following (in thousands):
 
March 31,
2020
 
December 31,
2019
Employee compensation and related costs
$
51,718

 
$
27,166

Professional fees
12,875

 
13,331

Taxes payable
18,424

 
842

Other
53,002

 
15,361

 
$
136,019

 
$
56,700



(7) RESTRUCTURING AND FACILITIES CONSOLIDATION INITIATIVES

The Company recorded restructuring and related expense aggregating $2.1 million and $4.9 million in the three months ended March 31, 2020 and 2019, respectively. Restructuring and related expense includes both restructuring expense (primarily severance and related costs), estimated future variable lease costs for vacated properties with no intent or ability of sublease, and accelerated rent amortization expense.

For restructuring events that involve lease assets and liabilities, the Company applies lease reassessment and modification guidance and evaluates the right-of-use assets for potential impairment. If the Company plans to exit all or

19


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

distinct portions of a facility and does not have the ability or intent to sublease, the Company will accelerate the amortization of each of those lease components through the vacate date. The accelerated amortization is recorded as a component of Restructuring and related expense in the Company's condensed consolidated statements of operations. Related variable lease expenses will continue to be expensed as incurred through the vacate date, at which time the Company will reassess the liability balance to ensure it appropriately reflects the remaining liability associated with the premises and record a liability for the estimated future variable lease costs.

The components of Restructuring and related expense for the three months ended March 31, 2020 and 2019 were as follows (in thousands):
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Severance and related costs
$
1,771

 
$
4,919

Variable and other facilities-related costs
234

 
13

Accelerated amortization of lease assets due to cease-use
70

 

 
$
2,075

 
$
4,932



ECI Executive Severance

In connection with the ECI Merger, the Company is releasing three former executives of ECI and recorded $1.1 million of restructuring and related expense for severance for these individuals in accordance with their respective employment and related agreements in the three months ended March 31, 2020. At March 31, 2020, these amounts had not yet been paid. The Company expects these amounts will be paid by the end of 2020.


2019 Restructuring and Facilities Consolidation Initiative

In June 2019, the Company implemented a restructuring plan to further streamline the Company's global footprint, improve its operations and enhance its customer delivery (the "2019 Restructuring Initiative"). The 2019 Restructuring Initiative includes facility consolidations, refinement of the Company's research and development activities, and a reduction in workforce. In connection with this initiative, the Company expects to reduce its focus on hardware and appliance-based development over time and to increase its development focus on software virtualization, functional simplicity and important customer requirements. The facility consolidations under the 2019 Restructuring Initiative (the "Facilities Initiative") include a consolidation of the Company's North Texas sites into a single campus, housing engineering, customer training and support, and administrative functions, as well as a reduction or elimination of certain excess and duplicative facilities worldwide. In addition, the Company intends to substantially consolidate its global software laboratories and server farms into two lower cost North American sites. The Company continues to evaluate its properties included in the Facilities Initiative for accelerated amortization and/or right-of-use asset impairment. The Company expects that the actions under the Facilities Initiative will be completed by the end of 2020.

In connection with the 2019 Restructuring Initiative, the Company recorded restructuring expense and related expense of $1.0 million in the three months ended March 31, 2020, comprised of $0.7 million for severance and related costs for five employees and $0.3 million related to facilities. The Company expects that it will record nominal additional Restructuring and related expense related to severance and related costs under the 2019 Restructuring Initiative. A summary of the 2019 Restructuring Initiative accrual activity for severance and related costs for the three months ended March 31, 2020 is as follows (in thousands):

20


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

 
Balance at
January 1,
2020
 
Initiatives
charged to
expense
 
Reclassify accelerated amortization to operating lease liabilities
 
Cash
payments
 
Balance at
March 31,
2020
Severance
$
2,110

 
$
655

 
$

 
$
(1,253
)
 
$
1,512

Facilities
991

 
304

 
(70
)
 
(272
)
 
953

 
$
3,101

 
$
959

 
$
(70
)
 
$
(1,525
)
 
$
2,465



Accelerated rent amortization is recognized from the date that the Company commences the plan to fully or partially vacate a facility, for which there is no intent or ability to enter into a sublease, through the final vacate date. The accelerated rent amortization recorded in connection with the Facilities Initiative reduced the value of the Company's Operating lease right-of-use assets recorded in the Company's condensed consolidated balance sheets at March 31, 2020 and December 31, 2019, respectively. The liability for the total lease payments for each respective facility is included as a component of Operating lease liabilities in the Company's condensed consolidated balance sheets, both current and noncurrent (see Note 17). The Company may incur additional future expense if it is unable to sublease other locations included in the Facilities Initiative.

GENBAND Merger Restructuring Initiative

In connection with the merger in 2017 between Sonus Networks, Inc. and GENBAND (the "GENBAND Merger"), the Company implemented a restructuring plan in the fourth quarter of 2017 to eliminate certain redundant positions and facilities within the combined companies (the "GENBAND Merger Restructuring Initiative"). In connection with this initiative, the Company recorded $4.9 million in the three months ended March 31, 2019, virtually all of which was for severance and related costs for approximately 40 employees. The GENBAND Merger Restructuring Initiative is substantially complete, and the Company anticipates that it will record nominal future expense, if any, in connection with this initiative, with amounts accrued at March 31, 2020 to be paid by the end of 2020.

A summary of the GENBAND Merger Restructuring Initiative accrual activity for the three months ended March 31, 2020 is as follows (in thousands):
 
Balance at
January 1,
2020
 
Cash
payments
 
Balance at
March 31,
2020
Severance
$
409

 
$
(351
)
 
$
58


 
 
 
 
 
 
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 long-term portions of accrued restructuring totaled $0.9 million at both March 31, 2020 and December 31, 2019.



21


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

(8) WARRANTY ACCRUALS

The changes in the Company's accrual balance in the three months ended March 31, 2020 were as follows (in thousands):
Balance at January 1, 2020
$

Assumed liability in connection with ECI Merger
15,706

Current period provisions
502

Settlements
(528
)
Balance at March 31, 2020
$
15,680



Of the amount recorded at March 31, 2020, $6.7 million was current and included as a component of Accrued expenses and other and $9.0 million was long-term and included as a component of Other long-term liabilities in the Company's condensed consolidated balance sheet. The Company did not have a warranty accrual during the three months ended March 31, 2019.


(9) DEBT

Senior Secured Credit Facility

On December 21, 2017, the Company entered into a Senior Secured Credit Facilities Credit Agreement (the “Credit Facility”), by and among the Company, as a guarantor, Sonus Networks, Inc., as the borrower (“Borrower”), Silicon Valley Bank ("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 with SVB that the Company had assumed in connection with the GENBAND Merger. The Credit Facility included $100 million of commitments, the full amount of which was available for revolving loans, a $15 million sublimit that was available for letters of credit and a $15 million sublimit that was available for swingline loans. On June 24, 2018, the Company amended the Credit Facility to, among other things, permit the August 2018 acquisition of Edgewater Networks, Inc. and related transactions.

2019 Credit Facility

On April 29, 2019, the Company entered into a syndicated, amended and restated Credit Facility (the "2019 Credit Facility"). The 2019 Credit Facility provided for a $50 million term loan facility that was advanced in full on April 29, 2019 and a $100 million revolving line of credit. The 2019 Credit Facility also included procedures for additional financial institutions to become syndicate lenders, or for any existing lender to increase its commitment under either the term loan facility or the revolving loan facility, subject to an aggregate increase of $75 million for incremental commitments under the 2019 Credit Facility. The 2019 Credit Facility was scheduled to mature in April 2024. At December 31, 2019, the Company had an outstanding term loan debt balance of $48.8 million and an outstanding revolving line of credit balance of $8 million with a combined average interest rate of 3.30%, and $5.4 million of outstanding letters of credit at an interest rate of 1.50%.

The indebtedness and other obligations under the 2019 Credit Facility were unconditionally guaranteed on a senior secured basis by the Company and each other material U.S. domestic subsidiary of the Company (collectively, the “Guarantors”). The 2019 Credit Facility was secured by first-priority liens on substantially all of the assets of the Borrower and the Guarantors, including the Company.

The 2019 Credit Facility required periodic interest payments on any outstanding borrowings under the facility. The Borrower could prepay all revolving loans under the 2019 Credit Facility at any time without premium or penalty (other than customary LIBOR breakage costs), subject to certain notice requirements.

Revolving loans under the 2019 Credit Facility bore interest at the Borrower’s option at either the Eurodollar (LIBOR) rate plus a margin ranging from 1.50% to 3.00% per year or the base rate (the highest of the Federal Funds rate plus 0.50%, or

22


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

the prime rate announced from time to time in The Wall Street Journal) plus a margin ranging from 0.50% to 2.00% per year (such margins being referred to as the “Applicable Margin”). The Applicable Margin varied depending on the Company’s consolidated leverage ratio (as defined in the 2019 Credit Facility). The base rate and the LIBOR rate were each subject to a zero percent floor.

The 2019 Credit Facility required compliance with certain financial covenants, including a minimum consolidated quick ratio, minimum consolidated fixed charge coverage ratio and maximum consolidated leverage ratio, all of which were defined in the 2019 Credit Facility and tested on a quarterly basis. The Company was in compliance with all covenants of the 2019 Credit Facility at December 31, 2019.

In addition, the 2019 Credit Facility contained various covenants that, among other restrictions, limited the Company’s and its subsidiaries’ ability to enter into certain types of transactions, including, but not limited to: incurring or assuming indebtedness; granting or assuming liens; making acquisitions or engaging in mergers; making dividend and certain other restricted payments; making investments; selling or otherwise transferring assets; engaging in transactions with affiliates; entering into sale and leaseback transactions; entering into burdensome agreements; changing the nature of its business; modifying its organizational documents; and amending or making prepayments on certain junior debt.

The 2019 Credit Facility contained 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 occurred, all obligations under the 2019 Credit Facility would immediately become due and payable. If any other event of default existed under the 2019 Credit Facility, the lenders could accelerate the maturity of the obligations outstanding under the 2019 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 existed under the New Credit Facility, the lenders could commence foreclosure or other actions against the collateral.

If any default existed under the 2019 Credit Facility, or if the Borrower was unable to make any of the representations and warranties as stated in the 2019 Credit Facility at the applicable time, the Borrower would be unable to borrow funds or have letters of credit issued under the 2019 Credit Facility, which, depending on the circumstances prevailing at that time, could have had a material adverse effect on the Borrower’s liquidity and working capital.

2020 Credit Facility

On March 3, 2020, the Company entered into a Senior Secured Credit Facilities Credit Agreement (the "2020 Credit Agreement"), by and among the Company, as a guarantor, Ribbon Communications Operating Company, Inc., as the borrower ("Borrower"), Citizens Bank, N.A., as administrative agent, a lender, issuing lender, swingline lender, joint lead arranger and bookrunner, Santander Bank, N.A., as a lender, joint lead arranger and bookrunner, and the other lenders party thereto (each, together with Citizens Bank, N.A. and Santander Bank, N.A., referred to individually as a "Lender", and collectively, the "Lenders"). The proceeds of the Credit Agreement were used, in part, to pay off in full all obligations of the Company under the 2019 Credit Facility.

The 2020 Credit Agreement provides for $500 million of commitments from the lenders to the Borrower, comprised of a $400 million term loan (the "2020 Term Loan Facility") and a $100 million facility available for revolving loans (the "2020 Revolving Credit Facility" and together with the 2020 Term Loan Facility, the "2020 Credit Facility"). Under the 2020 Revolving Credit Facility, a $30 million sublimit is available for letters of credit and a $20 million sublimit is available for swingline loans. The 2020 Credit Facility is scheduled to mature in March 2025. Under the 2020 Credit Agreement, the Company is required to make quarterly principal payments aggregating $10 million over the next twelve months, $20 million per year for the following three years, and $30 million in the last year, with a $300 million final payment due on the maturity date. The 2020 Credit Agreement includes procedures for additional financial institutions to become lenders thereunder, or for any existing lender to fund one or more new tranches of term loans, or increase its commitment under the 2020 Term Loan Facility or the 2020 Revolving Credit Facility, subject, in each case, to an aggregate dollar limit equal to 100% of the Company's Consolidated Adjusted EBITDA (as defined in the 2020 Credit Agreement) as of the most recently ended quarter for which financial statements have been delivered to the lenders, plus additional amounts, so long as the Borrower's Consolidated Net Leverage Ratio (as defined in the 2020 Credit Agreement) does not exceed 2.75:1.00.


23


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

The indebtedness and other obligations under the 2020 Credit Facility are unconditionally guaranteed on a senior secured basis by the Company, Edgewater Networks, Inc., a wholly-owned subsidiary of the Company, and Genband Inc., a wholly-owned subsidiary of the Company (together, the "Guarantors"). The 2020 Credit Facility is secured by first-priority liens on substantially all of the assets of the Borrower and the Guarantors, including substantially all of the assets of the Company.

The 2020 Credit Agreement requires periodic interest payments until maturity. The Borrower may prepay all loans under the 2020 Credit Agreement at any time without premium or penalty (other than customary LIBOR breakage costs), subject to certain notice requirements.

Loans incurred under the 2020 Credit Facility bear interest at the Borrower's option at either the LIBOR rate plus a margin ranging from 1.50% to 3.50% per year, or the base rate (the highest of the Federal Funds Effective Rate (as defined in the Credit Agreement) plus 0.5%, or the prime rate announced from time to time in The Wall Street Journal) plus a margin ranging from 0.50% to 2.50% per year (the "Applicable Margin"). The Applicable Margin varies depending on the Company's Consolidated Net Leverage Ratio (as defined in the 2020 Credit Agreement). The base rate and the LIBOR rate are each subject to a zero percent floor.

The 2020 Credit Agreement requires compliance with certain financial covenants, including a minimum Consolidated Fixed Charge Coverage Ratio and a maximum Consolidated Net Leverage Ratio (each as defined in the 2020 Credit Agreement, and each tested on a quarterly basis). The Company was in compliance with all covenants of the 2020 Credit Agreement at March 31, 2020.

In addition, the 2020 Credit Agreement contains various covenants that, among other restrictions, limit the Company’s and its subsidiaries’ ability to incur or assume indebtedness; grant or assume liens; make acquisitions or engage in mergers; sell, transfer, assign or convey assets; repurchase equity and make dividend and certain other restricted payments; make investments; engage in transactions with affiliates; enter into sale and leaseback transactions; enter into burdensome agreements; change the nature of its business; modify their organizational documents; and amend or make prepayments on certain junior debt.

The 2020 Credit Agreement 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 the Company or any of its subsidiaries occurs, all obligations under the 2020 Credit Agreement will immediately become due and payable. If any other event of default exists under the 2020 Credit Agreement, the lenders may accelerate the maturity of the obligations outstanding under the Credit Agreement 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 2020 Credit Agreement, the lenders may commence foreclosure or other actions against the collateral.

At March 31, 2020, the Company had an outstanding 2020 Term Loan Facility balance of $400 million at an average interest rate of 3.9%. The 2020 Revolving Credit Facility did not have an outstanding balance but had $5.6 million of letters of credit outstanding with an interest rate of 3.0%.

Short-Term Loans

The Company has three outstanding uncommitted and unsecured short-term loans aggregating $3.5 million which it uses for financing exports in China, two of which are with China Zheshang Bank and one of which is with Bank of Communications Hangzhou Branch. These short term loans were all entered into in March 2020 and expire at various dates in June and July 2020. At March 31, 2020, these short-term loans had a weighted average interest rate of 3.97%.

Letters of Credit and Performance and Bid Bonds

The Company uses letters of credit, performance and bid bonds in the course of its business. As of March 31, 2020, the Company had $33.3 million of letters of credit, bank guarantees, performance and bid bonds outstanding (collectively, "Guarantees"), comprised of the $5.6 million of letters of credit under the 2020 Credit Agreement described above, and $27.7 million of Guarantees under various uncommitted facilities. At March 31, 2020, the Company had cash collateral of $4.7 million supporting the Guarantees under its uncommitted facilities. This cash collateral is included in Restricted cash in the condensed consolidated balance sheet at March 31, 2020.

24


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



(10) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Company is exposed to financial market risk related to foreign currency fluctuations and changes in interest rates. These exposures are actively monitored by management. To manage the volatility related to the exposure to changes in interest rates, the Company has entered into a derivative financial instrument. Management's objective is to reduce, where it is deemed appropriate to do so, fluctuations in earnings and cash flows associated with changes in interest rates. Ribbon's policies and practices are to use derivative financial instruments only to the extent necessary to manage exposures. Ribbon does not hold or issue derivative financial instruments for trading or speculative purposes.

The Company records derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a specific risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge, or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

Cash Flow Hedge of Interest Rate Risk

The 2020 Credit Facility is comprised of the 2020 Term Loan Facility and the 2020 Revolving Credit Facility. The 2020 Term Loan Facility had an outstanding balance of $400 million at March 31, 2020. The 2020 Revolving Credit Facility was undrawn at March 31, 2020. The 2020 Credit Facility has variable interest rates based on LIBOR (see Note 9). As a result of exposure to interest rate movements, during March 2020, the Company entered into an interest rate swap arrangement, which effectively converted its $400 million term loan with its variable-rate interest based upon one-month LIBOR to an aggregate fixed rate of 0.904%, plus a leverage-based margin as defined in the 2020 Credit Facility. The notional amount of this swap as of March 31, 2020 was $400 million and the swap matures on March 3, 2025, the same date the 2020 Credit Facility matures.

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company is using an interest rate swap as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income in the condensed consolidated balance sheet and is subsequently reclassified into earnings in the period that the hedged forecasted transactions affect earnings. During the three months ended March 31, 2020, such a derivative was used to hedge the variable cash flows associated with the 2020 Credit Facility. Any ineffective portion of the change in fair value of the derivative would be recognized directly in earnings. However, during the three months ended March 31, 2020, there was no hedge ineffectiveness recorded by the Company.

Amounts reported in accumulated other comprehensive income related to the Company's derivative will be reclassified to interest expense as interest is accrued on the Company’s variable-rate debt. Based upon projected forward rates, the Company estimates as of March 31, 2020 that $2.4 million may be reclassified as an increase to interest expense over the next twelve months.

The impact of the Company’s derivative financial instrument on its condensed consolidated statement of comprehensive loss for the three months ended March 31, 2020 was as follows (in thousands):

25


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

Loss recognized in other comprehensive loss on derivative (effective portion)
 
$
(9,717
)
Amount reclassified from accumulated other comprehensive loss to interest expense (effective portion)
 
$
190



The Company's derivative liability designed as a hedging instrument and the related fair values and locations in the condensed consolidated balance sheet at March 31, 2020 are as follows (in thousands):
 
Balance sheet location
 
 
Interest rate derivative - liability derivative
Accrued expenses and other
 
$
(238
)
Interest rate derivative - liability derivative
Other long-term liabilities
 
$
(9,289
)


The Company has classified the interest rate derivative aggregating $9.5 million at March 31, 2020 as a Level 2 within the fair value hierarchy (see Note 1).


(11) REVENUE RECOGNITION

The Company accounts for revenue in accordance with ASC 606, Revenue from Contracts with Customers ("ASC 606"), which it adopted on January 1, 2018 using the modified retrospective method.

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 ASC 606, assurance-type warranties do not represent separate performance obligations. The Company also sells separately-priced maintenance service

26


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

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 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 versus 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.

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)
 
Generally, 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)
 
Generally, within 30 days of invoicing
 
 
 
 
 
Appliances
 
When control of the appliance 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)
 
Generally, within 30 days of invoicing
 
 
 
 
 
Professional Services
 
 
 
 
Other professional services (excluding training services)
 
As work is performed (over time)
 
Generally, within 30 days of invoicing (upon completion of services)
 
 
 
 
 
Training
 
When the class is taught (point in time)
 
Generally, within 30 days of services being performed



27


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

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 ("SSP") for each distinct performance obligation. 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 is a contract liability representing 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 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 months ended March 31, 2020 and 2019 was disaggregated as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2020
Product revenue
 
Service revenue (maintenance)
 
Service revenue (professional services)
 
Total revenue
United States
$
36,365

 
$
31,466

 
$
10,566

 
$
78,397

Europe, Middle East and Africa
20,365

 
14,810

 
4,015

 
39,190

Japan
4,952

 
2,874

 
2,614

 
10,440

Asia Pacific
9,991

 
4,637

 
2,264

 
16,892

Other
4,226

 
7,281

 
1,556

 
13,063

 
$
75,899

 
$
61,068

 
$
21,015

 
$
157,982



Three months ended March 31, 2019
Product revenue
 
Service revenue (maintenance)
 
Service revenue (professional services)
 
Total revenue
United States
$
28,446

 
$
32,787

 
$
7,343

 
$
68,576

Europe, Middle East and Africa
6,458

 
10,723

 
2,849

 
20,030

Japan
3,961

 
2,913

 
1,562

 
8,436

Asia Pacific
4,675

 
3,663

 
869

 
9,207

Other
3,940

 
6,903

 
1,836

 
12,679

 
$
47,480

 
$
56,989

 
$
14,459

 
$
118,928



The Company's product revenue from indirect sales through its channel partner program and from its direct sales program for the three months ended March 31, 2020 and 2019 was as follows (in thousands):

28


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

 
Three months ended
 
March 31,
2020
 
March 31,
2019
Indirect sales through channel partner program
$
28,604

 
$
19,174

Direct sales
47,295

 
28,306

 
$
75,899

 
$
47,480



The Company's product revenue from sales to enterprise customers and from sales to service provider customers for the three months ended March 31, 2020 and 2019 was as follows (in thousands):
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Sales to enterprise customers
$
27,281

 
$
14,755

Sales to service provider customers
48,618

 
32,725

 
$
75,899

 
$
47,480



Revenue Contract Balances

The timing of revenue recognition, billings and cash collections results in billed accounts receivable; unbilled receivables, which are contract assets; and customer advances and deposits, which are 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. Completion of services and 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 that 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. Changes in the contract asset and liability balances during the three months ended March 31, 2020 were not materially impacted by any factors other than billing and revenue recognition. 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 three months ended March 31, 2020 were as follows (in thousands):
 
Accounts receivable
 
Unbilled accounts receivable
 
Deferred revenue (current)
 
Deferred revenue (long-term)
Balance at January 1, 2020
$
168,502

 
$
24,204

 
$
100,406

 
$
20,482

Increase (decrease), net
1,286

 
11,801

 
13,293

 
5,429

Balance at March 31, 2020
$
169,788

 
$
36,005

 
$
113,699

 
$
25,911



The Company recognized approximately $41 million of revenue in the three months ended March 31, 2020 that was recorded as deferred revenue at December 31, 2019 and approximately $33 million of revenue in the three months ended March 31, 2019 that was recorded as deferred revenue at December 31, 2018. Of the Company's deferred revenue reported as long-term in its condensed consolidated balance sheet at March 31, 2020, the Company expects that approximately $12 million will

29


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

be recognized as revenue in 2021, approximately $8 million will be recognized as revenue in 2022 and approximately $6 million will be recognized as revenue in 2023 and beyond.

All freight-related customer invoicing is recorded as revenue, while the shipping and handling costs that occur after control of the promised goods or services transfer to the customer are reported as fulfillment costs, a component of Cost of revenue - product in the Company's condensed consolidated statements of operations.

Deferred Commissions Cost

Sales commissions earned by the Company's employees are considered incremental and recoverable costs of obtaining a contract with a customer. Expense related to commission payments has been deferred on our condensed consolidated balance sheet and is being amortized over the expected life of the customer contract, which averages five years. At both March 31, 2020 and December 31, 2019, the Company had $3.6 million of deferred sales commissions capitalized.


(12) COMMON STOCK REPURCHASES

In the second quarter of 2019, the Board approved a stock repurchase program (the "Repurchase Program") pursuant to which the Company may repurchase up to $75 million of the Company's common stock prior to April 18, 2021. Repurchases under the Repurchase Program may be made in the open market, in privately negotiated transactions or otherwise, with the amount and timing of repurchases depending on market conditions and corporate discretion. The Repurchase Program does not obligate the Company to acquire any particular amount of common stock and may be extended, modified, suspended or discontinued at any time at the Board's discretion. The stock repurchases are being funded using the Company's working capital. The Company did not repurchase any stock during the three months ended March 31, 2020. At March 31, 2020, the Company had $70.5 million remaining under the Repurchase Program for future repurchases.


(13) STOCK-BASED COMPENSATION PLANS

2019 Stock Incentive Plan

The Company's 2019 Incentive Award Plan (the "2019 Plan") provides for the award of options to purchase the Company's common stock ("stock options"), stock appreciation rights ("SARs"), restricted stock awards ("RSAs"), performance-based stock awards ("PSAs"), restricted stock units ("RSUs"), performance-based stock units ("PSUs") and other stock- or cash-based awards. Awards can be granted under the 2019 Plan to the Company's employees, officers and non-employee directors, as well as consultants and advisors of the Company and its subsidiaries.

2007 Plan

The Company's 2007 Plan provided for the award of stock options, SARs, RSAs, RSU, PSAs, PSUs and other stock-based awards to employees, officers, non-employee directors, consultants and advisors of the Company and its subsidiaries. On and following June 5, 2019, with the exception of shares underlying awards outstanding as of that date, no additional shares may be granted under the 2007 Plan.

Assumed Stock Plans

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 Ribbon stock options (the "Ribbon Replacement Options") which are vesting under the same schedules as the respective Edgewater Options.

In connection with the Company's acquisitions of Performance Technologies Inc. ("PT") in 2014, and Network Equipment Technologies, Inc. ("NET") in 2012, the Company assumed their stock plans (collectively, the "Assumed Plans"). Any outstanding awards under the Assumed Plans that in the future expire, terminate, are cancelled or surrendered, or are

30


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

repurchased by the Company will be returned to the 2019 Plan. Accordingly, at March 31, 2020, no additional shares may be granted under the Assumed Plans.

Executive Equity Arrangements

Inducement Awards

In connection with his appointment as President and Chief Executive Office of Ribbon, and as an inducement for Bruce McClelland's ("Mr. McClelland") commencement of employment, the Company awarded Mr. McClelland sign-on equity grants, comprised of an RSU grant and a PSU grant with both market and service conditions (the "Inducement PSUs") on March 16, 2020. Subject to Mr. McClelland's continued employment, 462,963 RSUs are eligible to vest on the earlier of March 16, 2021 or the date of the consummation of a change in control of the Company and, upon vesting, will be settled in shares of Ribbon's common stock. The RSUs had a fair market value of $1.0 million on the date of grant. Subject to Mr. McClelland's continued employment, the PSUs are eligible to vest and be settled in up to 4,750,000 shares of Ribbon common stock upon the achievement of specified share price thresholds on or prior to September 1, 2024. These grants are reported in the applicable tables below.

Other Performance-Based Stock Grants

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, including the Inducement PSUs granted to Mr. McClelland as described above.

2019 PSU Grants. In March and April 2019, the Company granted certain of its executives an aggregate of 872,073 PSUs, of which 523,244 PSUs had both performance and service conditions (the "Performance PSUs") and 348,829 PSUs had both market and service conditions (the "Market PSUs").

Each executive's Performance PSU grant is comprised of three consecutive fiscal year performance periods from 2019 through 2021 (each, a "Fiscal Year Performance Period"), with one-third of the Performance PSUs attributable to each Fiscal Year Performance Period. The number of shares that will vest for each Fiscal Year Performance Period will be based on the achievement of certain metrics related to the Company's financial performance for the applicable year on a standalone basis (each, a "Fiscal Year Performance Condition"). In the third quarter of 2019, the Company adjusted the 2019 Performance PSU goals to reflect the changes to the Company's calculation of certain metrics. There was no incremental expense in connection with this modification. In March 2020, the Compensation Committee determined that the performance metrics for the 2019 Performance PSUs had been achieved at the 30.493% level. The Company's achievement of the 2019 Fiscal Year Performance Conditions (and the number of shares of Company common stock to vest as a result thereof) was measured on a linear sliding scale in relation to specific threshold, target and stretch performance conditions. The Company is recording stock-based compensation expense for the Performance PSUs based on its assessment of the probability that each performance condition will be achieved and the level, if any, of such achievement. As of March 31, 2020, the Company determined that the grant date criteria for the 2020 and 2021 Fiscal Year Performance Periods had not been met, as the 2020 and 2021 Fiscal Year Performance Conditions had not been established by the Company. Accordingly, the stock-based compensation expense recorded in the three months ended March 31, 2020 in connection with the Performance PSUs is related only to those number of shares representing the final achievement level for the PSUs with 2019 Fiscal Year Performance Conditions. The Compensation Committee will determine the number of shares earned, if any, after the Company's financial results for each Fiscal Year Performance Period are finalized. Upon the determination by the Compensation Committee of the number of shares that will be received upon vesting of the Performance PSUs, such number of shares will become fixed and the unamortized expense will be recorded through the remainder of the service period that ends March 15, 2022, at which time the total Performance PSUs earned, if any, will vest, pending each executive's continued employment with the Company through that date. The number of shares of common stock to be achieved upon vesting of the Performance PSUs will in no event exceed 200% of the Performance PSUs. Shares subject to the Performance PSUs that fail to be earned will be forfeited.

The Market PSUs have one three-year performance period which will end on December 31, 2021 (the "Market Performance Period"). The number of shares subject to the Market PSUs that will vest, if any, on March 15, 2022, will be dependent upon the Company's total shareholder return ("TSR") compared with the TSR of the companies included in the Nasdaq Telecommunications Index for the same Market Performance Period, measured by the Compensation Committee after

31


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

the Market Performance Period ends. The shares determined to be earned will vest on March 15, 2022, pending each executive's continued employment with the Company through that date. The number of shares of common stock to be achieved upon vesting of the Market PSUs will in no event exceed 200% of the Market PSUs. Shares subject to the Market PSUs that fail to be earned will be forfeited.

2018 PSU Grant. In May 2018, the Company granted Franklin Hobbs, the Company's former President and Chief Executive Officer ("Mr. Hobbs"), 195,000 PSUs with both performance and service conditions (the "2018 PSUs"). Of the 195,000 2018 PSUs, one-half of such PSUs were eligible to vest based on the achievement of two separate metrics related to the Company's 2018 financial performance (the "2018 Performance Conditions"). The Company's achievement of the 2018 Performance Conditions (and the number of shares of Company common stock to be received upon vesting as a result thereof) were 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 2018 PSUs would in no event exceed 150% of the 2018 PSUs. The Compensation Committee determined that the performance metrics for all of the 2018 PSUs had been achieved at the 150% level, for a total of 292,500 shares eligible to be issued. In connection with Mr. Hobbs' separation from the Company effective December 31, 2019, the vesting schedule for the 2018 Shares earned was accelerated and the shares were released on January 30, 2020.

Accounting for PSUs with Market Conditions. PSUs that include a market condition require 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 are 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. As of March 31, 2020, the calculation of the grant date fair value of the Inducement PSUs had not been completed. The Company used a grant date fair value of $2.16, the closing stock price on the date of grant, to calculate expense attributable to the three months ended March 31, 2020 for the Inducement PSUs. The Company is also using this stock price for PSU activity reported in the PSU table below. Upon completion of the Monte Carlo analysis and finalization of the grant date fair value of the Inducement PSUs, which it expects to complete in the second quarter of 2020, the Company will record a cumulative adjustment to expense and adjust their grant date fair value for subsequent reporting. The Company does not expect the cumulative adjustment to expense will have a material impact on its consolidated financial statements.

Stock Options

The activity related to the Company's outstanding stock options for the three months ended March 31, 2020 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, 2020
297,124

 
$
11.55

 
 
 
 
Granted

 
$

 
 
 
 
Exercised
(3,014
)
 
$
1.74

 
 
 
 
Forfeited
(1,470
)
 
$
1.80

 
 
 
 
Expired
(4,920
)
 
$
18.10

 
 
 
 
Outstanding at March 31, 2020
287,720

 
$
11.59

 
4.33
 
$
109

Vested or expected to vest at March 31, 2020
285,559

 
$
11.66

 
4.31
 
$
108

Exercisable at March 31, 2020
260,307

 
$
12.58

 
4.03
 
$
85

 
 
Additional information regarding the Company's stock options for the three months ended March 31, 2020 was as follows (in thousands):
Total intrinsic value of stock options exercised
$
5

Cash received from the exercise of stock options
$
5


32


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



Restricted Stock Awards and Units

The activity related to the Company's RSAs for the three months ended March 31, 2020 was as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2020
487,976

 
$
6.87

Granted

 
$

Vested
(89,920
)
 
$
7.04

Forfeited
(4,499
)
 
$
7.04

Unvested balance at March 31, 2020
393,557

 
$
6.83



The activity related to the Company's RSUs for the three months ended March 31, 2020 was as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2020
2,790,060

 
$
5.11

Granted
4,123,151

 
$
2.22

Vested
(927,062
)
 
$
4.81

Forfeited
(237,818
)
 
$
4.69

Unvested balance at March 31, 2020
5,748,331

 
$
3.10



The total grant date fair value of shares of restricted stock granted under RSAs and RSUs that vested during the three months ended March 31, 2020 was $5.1 million.

Performance-Based Stock Units
 
 
 
 
The activity related to the Company's PSUs for the three months ended March 31, 2020 was as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2020
1,067,073

 
$
5.94

Granted
4,847,500

 
$
2.23

Vested
(315,866
)
 
$
5.53

Forfeited
(359,777
)
 
$
5.51

Unvested balance at March 31, 2020
5,238,930

 
$
2.52



The total grant date fair value of shares of restricted stock granted under PSUs that vested during the three months ended March 31, 2020 was $1.7 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 closing market price on the first or last day of the offering period. The maximum number of shares

33


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

of common stock an employee may purchase during each offering period is 500, subject to certain adjustments pursuant to the ESPP. The last purchase under the ESPP purchase period ended on November 30, 2019.

Stock-Based Compensation

The condensed consolidated statements of operations include stock-based compensation for the three months ended March 31, 2020 and 2019 as follows (in thousands):
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Product cost of revenue
$
27

 
$
14

Service cost of revenue
130

 
92

Research and development
558

 
507

Sales and marketing
752

 
984

General and administrative
1,509

 
2,542

 
$
2,976

 
$
4,139


There was no income tax benefit for employee stock-based compensation expense for the three months ended March 31, 2020 or 2019 due to the valuation allowance recorded.

At March 31, 2020, there was $26.3 million, net of expected forfeitures, of unrecognized stock-based compensation expense related to unvested stock options, stock awards and stock units. This expense is expected to be recognized over a weighted average period of approximately three years.



(14) MAJOR CUSTOMERS

The following customers contributed 10% or more of the Company's revenue in the three months ended March 31, 2020 and 2019:
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Verizon Communications Inc.
13%
 
15%
AT&T Inc.
10%
 
10%


At March 31, 2020, there were no customers that accounted for 10% or more of the Company's accounts receivable balance. At December 31, 2019, one customer accounted for 10% or more of the Company's accounts receivable balance, representing approximately 22% of total accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable, although in some instances the Company may require letters of credit to support customer outstanding accounts receivable balances. The Company maintains an allowance for doubtful accounts and such losses have been within management's expectations.


(15) RELATED PARTY TRANSACTIONS

As a portion of the consideration for the GENBAND Merger, on October 27, 2017, the Company issued a Promissory Note for $22.5 million to certain of GENBAND's equity holders who, following the GENBAND Merger, owned greater than five percent of the Company's outstanding shares. As described in Note 9, the Promissory Note did not amortize and the principal thereon was payable in full on the third anniversary of its execution. Interest on the Promissory Note was 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,

34


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

the continuation of such failure for a period of thirty days thereafter, constituted an event of default under the Promissory Note. If an event of default occurred under the Promissory Note, the payees could 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. On April 29, 2019, the Company repaid in full all outstanding amounts under the Promissory Note, aggregating $24.7 million. The Company did not incur any early termination penalties in connection with this repayment.


(16) INCOME TAXES

The Company's income tax provisions for the three months ended March 31, 2020 and 2019 reflect the Company's estimates of the effective rates expected to be applicable for the respective full years, adjusted for any discrete events, which are recorded in the period that they occur. These estimates are reevaluated each quarter based on the Company's estimated tax expense for the full year. The estimated effective tax rate includes the impact of valuation allowances in various jurisdictions.

The Company continues to evaluate the impact of various COVID-19 relief packages offered by various countries, including the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, which was enacted into law on March 27, 2020. At this time, the Company does not anticipate any material tax impacts.


(17) LEASES

The Company has operating and finance leases for corporate offices, research and development facilities, and certain equipment. Operating leases are reported separately in the Company's condensed consolidated balance sheets. Assets acquired under finance leases are included in Property and equipment, net, in the condensed consolidated balance sheets.

The Company determines if an arrangement is a lease at inception. A contract is determined to contain a lease component if the arrangement provides the Company with a right to control the use of an identified asset. Lease agreements may include lease and non-lease components. In such instances for all classes of underlying assets, the Company does not separate lease and non-lease components but rather, accounts for the entire arrangement under leasing guidance. Leases with an initial term of 12 months or less are not recorded on the balance sheet and lease expense for these leases is recognized on a straight-line basis over the lease term.

Right-of-use assets and lease liabilities are initially measured based on the present value of the future minimum fixed lease payments (i.e., fixed payments in the lease contract) over the lease term at the commencement date. As the Company's existing leases do not have a readily determinable implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of future minimum fixed lease payments. The Company calculates its incremental borrowing rate to reflect the interest rate that it would have to pay to borrow on a collateralized basis an amount equal to the lease payments in a similar economic environment over a similar term and considers its historical borrowing activities and market data from entities with comparable credit ratings in this determination. The measurement of the right-of-use asset also includes any lease payments made prior to the commencement date (excluding any lease incentives) and initial direct costs incurred. The Company assessed its right-of-use assets for impairment as of March 31, 2020 and December 31, 2019 and determined no impairment has occurred.

Lease terms may include options to extend or terminate the lease and the Company incorporates such options in the lease term when it has the unilateral right to make such an election and it is reasonably certain that the Company will exercise that option. In making this determination, the Company considers its prior renewal and termination history and planned usage of the assets under lease, incorporating expected market conditions.

For operating leases, lease expense for minimum fixed lease payments is recognized on a straight-line basis over the lease term. The expense for finance leases includes both interest and amortization expense components, with the interest component calculated based on the effective interest method and the amortization component calculated based on straight-line amortization of the right-of-use asset over the lease term. Lease contracts may contain variable lease costs, such as common area maintenance, utilities and tax reimbursements that vary over the term of the contract. Variable lease costs are not included

35


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

in minimum fixed lease payments and as a result, are excluded from the measurement of the right-of-use assets and lease liabilities. The Company expenses all variable lease costs as incurred.

In connection with the 2019 Restructuring Initiative, certain lease assets related to facilities will be partially or fully vacated as the Company consolidates its facilities. The Company has no plans to enter into sublease agreements for certain facilities. The Company ceased use of these facilities in the first quarter of 2020 and the third quarter of 2019. Accordingly, the Company accelerated the amortization of the associated lease assets through the planned cease-use date of each facility, resulting in additional amortization expense of $0.1 million in the three months ended March 31, 2020. The Company previously recorded $3.7 million of additional amortization expense in the year ended December 31, 2019. The Company did not record additional amortization expense in the three months ended March 31, 2019. The Company recorded nominal expense in the three months ended March 31, 2020 for estimated future variable lease costs. The Company did not record expense for future variable lease costs in the three months ended March 31, 2019 but recorded $0.9 million in the aggregate in the year ended December 31, 2019. All of these amounts were recorded as Restructuring and related expense in the Company's consolidated statements of operations. At both March 31, 2020 and December 31, 2019, the Company had accruals of $0.9 million for all future anticipated variable lease costs related to these facilities. The Company may incur additional future expense if it is unable to sublease other locations included in the Facilities Initiative.

The Company leases its corporate offices and other facilities under operating leases, which expire at various times through 2029. The Company's corporate headquarters is located in a leased facility in Westford, Massachusetts under a lease that expires in August 2028. The Company's finance leases primarily consist of equipment.

At March 31, 2020, the Company had 107,800 square feet of building space in North Dallas, Texas under construction as part of the Facilities Initiative. The Company's leased Plano, Texas facility will be vacated upon completion of the construction of the North Dallas, Texas site. At that time, employees will relocate to the new site as part of the Facilities Initiative. The construction of the new North Dallas, Texas site is expected to be completed in 2020.

The Company's right-of-use lease assets and lease liabilities at March 31, 2020 and December 31, 2019 were as follows (in thousands):

 
Classification
 
March 31,
2020
 
December 31,
2019
Assets
 
 
 
 
 
  Operating lease assets
Operating lease right-of-use assets
 
$
66,295

 
$
36,654

  Finance lease assets*
Property and equipment, net
 
2,093

 
2,420

    Total leased assets
 
 
$
68,388

 
$
39,074

 
 
 
 
 
 
Liabilities
 
 
 
 
 
  Current
 
 
 
 
 
    Operating
Operating lease liabilities
 
$
18,201

 
$
7,719

    Finance
Accrued expenses and other
 
1,376

 
1,005

  Noncurrent
 
 
 
 
 
    Operating
Operating lease liabilities, net of current
 
55,857

 
37,202

    Finance
Other long-term liabilities
 
1,436

 
2,144

      Total lease liabilities
 
 
$
76,870

 
$
48,070


* Finance lease assets were recorded net of accumulated depreciation of $2.3 million and $2.0 million at March 31, 2020 and December 31, 2019, respectively.

The components of lease expense for the three months ended March 31, 2020 and 2019 were as follows (in thousands):

36


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

 
Three months ended
 
March 31,
2020
 
March 31,
2019
 
 
 
 
Operating lease cost*
$
3,344

 
$
2,441

Finance lease cost


 


  Amortization of leased assets
319

 
244

  Interest on lease liabilities
55

 
64

Short-term lease cost
5,523

 
4,671

Variable lease costs (costs excluded from minimum fixed lease payments)
637

 
601

    Net lease cost
$
9,878

 
$
8,021


* Operating lease cost for the three months ended March 31, 2020 includes $0.1 million of accelerated amortization for certain assets partially or fully vacated in 2020 with no intent or ability to sublease.

Other information related to the Company's leases as of and for the three months ended March 31, 2020 and 2019 was as follows (in thousands, except lease terms and percentages):
 
Three months ended
 
March 31,
2020
 
March 31,
2019
Cash paid for amounts included in the measurement of lease liabilities
 
 
 
  Operating cash flows for operating leases
$
3,113

 
$
2,355

  Operating cash flows for finance leases
$
55

 
$
64

  Financing cash flows for finance leases
$
338

 
$
230


 
March 31,
2020
 
December 31,
2019
Weighted average remaining lease term (years)
 
 
 
  Operating leases
5.36

 
6.73

  Finance leases
2.19

 
2.35

Weighted average discount rate
 
 
 
  Operating leases
5.58
%
 
6.50
%
  Finance leases
7.49
%
 
7.54
%

Future minimum fixed lease payments under noncancelable leases at March 31, 2020 and December 31, 2019 were as follows (in thousands):
 
March 31, 2020
 
Operating
 
Finance
 
leases
 
leases
Remainder of 2020
$
16,251

 
$
1,214

2021
19,067

 
1,179

2022
15,345

 
587

2023
12,889

 
36

2024
6,692

 

2025 and beyond
16,127

 

  Total lease payments
86,371

 
3,016

  Less: interest
(12,313
)
 
(204
)
    Present value of lease liabilities
$
74,058

 
$
2,812




37


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

 
December 31, 2019
 
Operating
 
Finance
 
leases
 
leases
2020
$
10,290

 
$
1,644

2021
9,468

 
1,159

2022
7,665

 
581

2023
7,067

 

2024
5,303

 

2025 and beyond
15,738

 

  Total lease payments
55,531

 
3,384

  Less: interest
(10,610
)
 
(235
)
    Present value of lease liabilities
$
44,921

 
$
3,149



(18) COMMITMENTS AND CONTINGENCIES

Litigation Settlement

As previously disclosed, the Company was involved in six lawsuits (together, the "Lawsuits") with Metaswitch Networks Ltd., Metaswitch Networks Corp. and Metaswitch Inc. (collectively, "Metaswitch"). In five of the Lawsuits, the Company was the plaintiff and, in three of those five lawsuits, the Company was also a counterclaim defendant. In the sixth case, the Company was the defendant.

On April 22, 2019, the Company and Metaswitch agreed to a binding mediator's proposal that resolved the six Lawsuits between the Company and Metaswitch (the "Lawsuits"). The Company and Metaswitch signed a Settlement and Cross-License Agreement on May 29, 2019 (the "Royalty Agreement"). Pursuant to the terms of the Royalty Agreement, Metaswitch has agreed to pay the Company an aggregate amount of $63.0 million, which includes cash payments of $37.5 million during the second quarter of 2019 and $25.5 million payable in three installments annually, beginning June 26, 2020, with such installment payments accruing interest at a rate of 4% per year. As part of the Royalty Agreement, the Company and Metaswitch (i) have released the other from all claims and liabilities; (ii) have licensed each party's existing patent portfolio to the other party; and (iii) have requested the applicable courts to dismiss the Lawsuits.

The Company received $37.5 million of aggregate payments from Metaswitch in the second quarter of 2019 and recorded notes receivable for future payments of $25.5 million, comprised of $8.5 million in Other current assets and $17.0 million in Other assets in the condensed consolidated balance sheets at both March 31, 2020 and December 31, 2019.

Contingencies

On November 8, 2018, Ron Miller, a purported stockholder of the Company, filed a Class Action Complaint (the "Miller Complaint") in the United States District Court for the District of Massachusetts (the "Massachusetts District Court") against the Company and three of its former officers (collectively, the "Defendants"), claiming to represent a class of purchasers of Sonus common stock during the period from January 8, 2015 through March 24, 2015 and alleging violations of the federal securities laws. Similar to a previous complaint entitled Sousa et al. vs. Sonus Networks, Inc. et al., which was dismissed with prejudice by an order dated June 6, 2017, the Miller Complaint claims that the Defendants made misleading forward-looking statements concerning Sonus' expected fiscal first quarter of 2015 financial performance, which statements were also the subject of an August 7, 2018 Securities and Exchange Commission Cease and Desist Order, whose findings the Company neither admitted nor denied. The Miller plaintiffs are seeking monetary damages.

After the Miller Complaint was filed, several parties filed and briefed motions seeking to be selected by the Massachusetts District Court to serve as a Lead Plaintiff in the action. On June 21, 2019, the Massachusetts District Court appointed a group as Lead Plaintiffs and the Lead Plaintiffs filed an amended complaint on July 19, 2019. On August 30, 2019, the Defendants filed a motion to dismiss the Miller Complaint and, on October 4, 2019, the Lead Plaintiffs filed an opposition to the motion to dismiss. There was an oral argument on the motion to dismiss on February 12, 2020.


38


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

In addition, the Company is often a party to disputes and legal proceedings that it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material effect on the Company's business or condensed consolidated financial statements.



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


The following discussion of the financial condition and results of operations of Ribbon Communications Inc. should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2019, which was filed with the U.S. Securities and Exchange Commission on February 28, 2020.

Overview

We are a leading provider of next generation software solutions to telecommunications, wireless and cable service providers and enterprises of all sizes across industry verticals. With the March 3, 2020 completion of the merger with ECI Telecom Group Ltd ("ECI"), we now also provide optical and packet networking products and software-defined solutions to service providers and critical infrastructure sectors like utilities, government and defense. With over 1,000 customers around the globe, including some of the largest telecommunications service providers, enterprises and utilities in the world, we enable our customers to evolve and modernize their communications networks and packet optical networking infrastructures through software and hardware. By securing and enabling reliable and scalable Internet Protocol ("IP") and packet optical networks, we help our customers adopt the next generation of software-, cloud- and edge-based technologies to drive new, incremental revenue, while protecting their existing revenue streams. Our software solutions provide a secure way for our customers to connect and leverage multivendor, multiprotocol communications systems and applications across their networks and the cloud, in a rapidly changing ecosystem of IP-enabled devices, such as smartphones and tablets. In addition, our software solutions secure 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 - and support the increasing demand on network infrastructure created by ongoing IP traffic growth and the forecast demand and build-outs to be created by increased traffic from 5G applications and devices. We sell our products and solutions through both direct sales and indirect channels, leveraging the assistance of resellers, and provide ongoing support to its customers through a global services team with experience in design, deployment and maintenance of some of the world's largest software IP networks.

Impact of COVID-19 on Our Business

In December 2019, a novel strain of the coronavirus (COVID-19) was reported to have been detected in Wuhan, China and on March 11, 2020, it was declared by the World Health Organization to be a global pandemic. The COVID-19 pandemic has had a negative effect on the global economy, disrupting the various manufacturing, commodity and financial markets and increasing volatility, and has impeded global supply chains, including that of our recently acquired subsidiary, ECI. Dampened global economic conditions as a result of the COVID-19 pandemic may cause our customers to restrict spending or delay purchases for an indeterminate period of time and consequently cause our revenues to decline. In addition, our ability to deliver our solutions as agreed upon with our customers depends on the ability of our global contract manufacturers, vendors, licensors and other business partners to deliver products or perform services we have procured from them. If the COVID-19 pandemic impairs the ability of our business partners to support us on a timely basis, or negatively impacts the demand for our customers' other products and services, our ability to perform our customer contracts as well as the demand for our solutions may suffer. In addition, disruptions from the COVID-19 pandemic could include, and with respect to ECI have included, disruption of logistics necessary to import, export and deliver our solutions. The COVID-19 pandemic may also place limitations on the ability of our associates to perform their work due to illness caused by the pandemic or local, state or federal orders requiring associates to remain at home. Concerns over the economic impact of the COVID-19 pandemic have also caused extreme volatility in financial and other capital markets which has and may continue to adversely impact our stock price. Such volatility may also adversely impact our ability to access capital markets if and when we would be required to do so. The degree to which the COVID-19 pandemic ultimately impacts our business, financial position and results of operations will depend on

39



future developments beyond our control, including the severity of the pandemic, the extent of actions to contain or treat the virus, how quickly and to what extent normal economic and operating conditions can resume, and the severity and duration of the global economic downturn that results from the pandemic.

As a response to the ongoing COVID-19 pandemic, we have implemented plans to manage our costs. We have significantly limited the addition of new employees and third party contracted services, eliminated all travel except where necessary to meet customer or regulatory needs, and acted to limit discretionary spending. To the extent the business disruption continues for an extended period, additional cost management actions will be considered. Any future asset impairment charges, increases in allowance for doubtful accounts or restructuring charges could be more likely and will be dependent on the severity and duration of this crisis.

Presentation

Unless otherwise noted, all financial amounts, excluding tabular information, in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") are rounded to the nearest thousand dollar amount, and all percentages, excluding tabular information, are rounded to the nearest percentage point.

Business Acquisitions

ECI Telecom Group Ltd

On March 3, 2020 ("ECI Merger Date"), we completed the merger transaction with ECI in accordance with the terms of the Agreement and Plan of Merger, dated as of November 14, 2019, by and among Ribbon, an indirect wholly-owned subsidiary of Ribbon ("Merger Sub"), Ribbon Communications Israel Ltd., ECI, and ECI Holding (Hungary) kft, pursuant to which Merger Sub merged with and into ECI, with ECI surviving such merger as a wholly-owned subsidiary of Ribbon (the "ECI Merger"). Prior to the ECI Merger Date, ECI was a privately-held global provider of end-to-end packet-optical transport and SDN/NFV solutions for service providers, enterprises and data center operators. Ribbon believes the ECI Merger positions the Company for growth and enhances its competitive strengths by expanding its product portfolio beyond solutions primarily supporting voice applications to include data applications and optical networking.

As consideration for the ECI Merger, we issued the ECI shareholders and certain others 32.5 million shares of Ribbon common stock with a fair value of $108.6 million (the "Stock Consideration") and paid $322.5 million of cash, comprised of $183.3 million to repay ECI's outstanding debt, including both principal and interest, and $139.2 million paid to ECI's selling shareholders (the "Cash Consideration"). In addition, ECI shareholders received $33.4 million from the sale of certain of ECI's real estate assets. Cash Consideration was financed through cash on hand and committed debt financing consisting of a new $400 million term loan facility (the "2020 Term Loan") and new $100 million revolving credit facility (together, the "2020 Credit Facility"), which was undrawn at the ECI Merger Date.

Anova Data, Inc.

On February 28, 2019 (the "Anova Acquisition Date"), we acquired the business and technology assets of Anova Data, Inc. ("Anova"), a private company headquartered in Westford, Massachusetts (the "Anova Acquisition"). Anova is a provider of advanced analytics solutions and its next generation products provide a cloud-native, streaming analytics platform for network and subscriber optimization and monetization. The Company believes that the Anova Acquisition will reinforce and extend Ribbon's strategy to expand into network optimization, security and data monetization via big data analytics and machine learning.

As consideration for the Anova Acquisition, we issued 2.9 million shares of our common stock with a fair value of $15.2 million to Anova's sellers and equity holders on the Anova Acquisition Date and held back an additional 330,000 shares of our common stock with a fair value of $1.7 million (the "Deferred Purchase Consideration"), of which 316,551 shares were issued after post-closing adjustments on March 4, 2020. The Deferred Purchase Consideration was included as a component of Accrued expenses and other current liabilities in our condensed consolidated balance sheet at December 31, 2019. The Anova Acquisition has been accounted for as a business combination and the financial results of Anova have been included in our consolidated financial statements for the period subsequent to the Anova Acquisition Date.


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Financial Overview

Financial Results

We reported losses from operations of $29 million and $36 million for the three months ended March 31, 2020 and 2019, respectively. Our revenue was $158 million and $119 million in the three months ended March 31, 2020 and 2019, respectively.

Our gross profit was $82 million and $57 million in the three months ended March 31, 2020 and 2019, respectively. Our gross profit as a percentage of revenue ("total gross margin") was 52% and 48% in the three months ended March 31, 2020 and 2019, respectively.

Our operating expenses were $110 million and $93 million in the three months ended March 31, 2020 and 2019, respectively. Operating expenses for the three months ended March 31, 2020 included $12 million of acquisition- and integration-related expense and $2 million of restructuring and related expense. Operating expenses for the three months ended March 31, 2019 included $3 million of acquisition- and integration-related expense and $5 million of restructuring and related expense.

We recorded stock-based compensation expense of $3 million and $4 million in the three months ended March 31, 2020 and 2019, respectively. These amounts are included as components of both Cost of revenue and Operating expenses in our condensed consolidated statements of operations.

See "Results of Operations" in this MD&A for a discussion of the changes in our revenue and expenses for the three months ended March 31, 2020 compared with the three months ended March 31, 2019.

Restructuring and Cost Reduction Initiatives

In connection with the ECI Merger, we are releasing three former executives of ECI and recorded $1 million of restructuring and related expense for severance for these individuals in accordance with their respective employment and related agreements in the three months ended March 31, 2020. At March 31, 2020, these amounts had not yet been paid. We expect these amounts will be paid by the end of 2020.

In June 2019, we implemented a restructuring plan to further streamline our global footprint, improve our operations and enhance our customer delivery (the "2019 Restructuring Initiative"). The 2019 Restructuring Initiative includes facility consolidations, refinement of our research and development activities, and a reduction in workforce. In connection with this initiative, we expect to reduce our focus on hardware and appliance-based development over time and to increase our development focus on software virtualization, functional simplicity and important customer requirements. The facility consolidations under the 2019 Restructuring Initiative (the "Facilities Initiative") include a consolidation of our North Texas sites into a single campus, housing engineering, customer training and support, and administrative functions, as well as a reduction or elimination of certain excess and duplicative facilities worldwide. In addition, we intend to substantially consolidate our global software laboratories and server farms into two lower cost North American sites. We continue to evaluate our properties included in the Facilities Initiative for accelerated amortization and/or right-of-use asset impairment. We expect that the actions under the Facilities Initiative will be completed by the end of 2020.

In connection with the 2019 Restructuring Initiative, we recorded restructuring and related expense of $1 million in the three months ended March 31, 2020, comprised of $0.7 million for severance and related costs for 5 employees and $0.3 million related to facilities. We expect that nearly all of the amount accrued for severance and related costs at March 31, 2020 will be paid by the end of 2020. We estimate that we will record nominal, if any, additional restructuring and related expense related to severance and related costs under the 2019 Restructuring Initiative.

Accelerated rent amortization is recognized from the date that we commence the plan to fully or partially vacate a facility, for which there is no intent or ability to enter into a sublease, through the final vacate date. We recorded $0.1 million of accelerated rent amortization in the three months ended March 31, 2020 and had previously recorded $4 million of accelerated rent amortization in the second half of 2019 as components of restructuring and related expense. The accelerated rent amortization recorded in connection with the 2019 Restructuring Initiative reduced our Operating lease right-of-use assets in our condensed consolidated balance sheets at March 31, 2020 and December 31, 2019. We continue to evaluate our properties included in the Facilities Initiative for accelerated amortization and/or right-of-use asset impairment. We may incur additional future expense if we are unable to sublease other locations included in the Facilities Initiative.


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In connection with the Sonus-GENBAND merger (the "GENBAND Merger") in 2017, we implemented a restructuring plan in the fourth quarter of 2017 to eliminate certain redundant positions and facilities within the combined companies (the "GENBAND Merger Restructuring Initiative"). We recorded restructuring and related expense of $5 million in the three months ended March 31, 2019 under this initiative, primarily for severance and related costs for approximately 40 employees. We did not record expense in connection with the GENBAND Merger Restructuring Initiative in the three months ended March 31, 2020. The GENBAND Merger Restructuring Initiative is substantially complete, and we anticipate that we will record nominal future expense, if any, in connection with this initiative, with amounts at March 31, 2020 to be paid by the end of 2020.

Critical Accounting Policies and Estimates

Management's discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment: revenue recognition, valuation of inventory, warranty accruals, loss contingencies and reserves, stock-based compensation, business combinations, goodwill and intangible assets, accounting for leases and accounting for income taxes. If actual results differ significantly from management's estimates and projections, there could be a material effect on our condensed consolidated financial statements. There were no significant changes to our critical accounting policies from December 31, 2019 through March 31, 2020 with the exception of warranty accruals. For a further discussion of our other critical accounting policies and estimates, please refer to our Annual Report on Form 10-K for the year ended December 31, 2019.

Warranty Accruals. We record warranty liabilities for estimated costs of fulfilling our obligations under standard limited hardware and software warranties at the time of sale. The liability for standard warranties is included in Accrued expenses and other and Other non-current liabilities in our condensed consolidated balance sheet at March 31, 2020. The specific warranty terms and conditions vary depending upon the country in which the Company does business, but generally includes material costs, technical support, labor and associated overhead over a period ranging from one to three years. We provide for the estimated costs to fulfill customer warranty obligations for certain of our products upon recognition of the related revenue. Estimated warranty costs include estimates for material costs, technical support, labor and associated overhead. Warranty is included as a component of Cost of revenue in our condensed consolidated statements of operations, and is determined based on actual warranty cost experience, estimates of component failure rates and our management's industry experience. Our sales contracts do not permit the right of return of the product by the customer after the product has been accepted.


Results of Operations

Three months ended March 31, 2020 and 2019

Revenue. Revenue for the three months ended March 31, 2020 and 2019 was as follows (in millions, except percentages):
 
Three months ended
 
Increase
from prior year
 
March 31,
2020
 
March 31,
2019
 
$
 
%
Product