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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________________________
Form 10-Q
_____________________________________________________
(Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 29, 2017

¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File No. 000-25826
_____________________________________________________
HARMONIC INC.
(Exact name of registrant as specified in its charter)
_____________________________________________________
Delaware
77-0201147
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
4300 North First Street
San Jose, CA 95134
(408) 542-2500
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
____________________________________________
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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer
¨
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
 
Emerging growth company 
¨
 
 
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares of the registrant’s Common Stock, $.001 par value, outstanding on October 30, 2017 was 81,618,569.


Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
 
 

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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARMONIC INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share data)
 
September 29, 2017
 
December 31, 2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
50,039

 
$
55,635

Short-term investments

 
6,923

Accounts receivable, net
71,582

 
86,765

Inventories
31,754

 
41,193

Prepaid expenses and other current assets
22,682

 
26,319

Total current assets
176,057

 
216,835

Property and equipment, net
30,731

 
32,164

Goodwill
241,932

 
237,279

Intangibles, net
23,316

 
29,231

Other long-term assets
39,926

 
38,560

Total assets
$
511,962

 
$
554,069

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Other debts and capital lease obligations, current
$
7,434

 
$
7,275

Accounts payable
31,839

 
28,892

Income taxes payable
1,411

 
1,166

Deferred revenue
52,811

 
52,414

Accrued and other current liabilities
52,828

 
55,150

Total current liabilities
146,323

 
144,897

Convertible notes, long-term
107,318

 
103,259

Other debts and capital lease obligations, long-term
15,439

 
13,915

Income taxes payable, long-term
591

 
2,926

Deferred tax liabilities, long-term
327

 

Other non-current liabilities
21,366

 
18,431

Total liabilities
291,364

 
283,428

Commitments and contingencies (Note 18)

 

Stockholders’ equity:

 
 
Preferred stock, $0.001 par value, 5,000 shares authorized; no shares issued or outstanding

 

Common stock, $0.001 par value, 150,000 shares authorized; 81,606 and 78,456 shares issued and outstanding at September 29, 2017 and December 31, 2016, respectively
82

 
78

Additional paid-in capital
2,267,213

 
2,254,055

Accumulated deficit
(2,045,967
)
 
(1,976,222
)
Accumulated other comprehensive loss
(730
)
 
(7,270
)
Total stockholders’ equity
220,598

 
270,641

Total liabilities and stockholders’ equity
$
511,962

 
$
554,069

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

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HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
 
Three months ended
 
Nine months ended
 
September 29, 2017
 
September 30, 2016
 
September 29, 2017
 
September 30, 2016
Revenue:
 
 
 
 
 
 
 
Product
$
58,161

 
$
70,285

 
$
158,657

 
$
205,342

Services
33,853

 
31,121

 
98,615

 
87,467

Total net revenue
92,014

 
101,406

 
257,272

 
292,809

Cost of revenue:
 
 
 
 
 
 
 
Product
27,736

 
34,460

 
85,843

 
105,698

Services
17,253

 
15,583

 
50,181

 
44,054

Total cost of revenue
44,989

 
50,043

 
136,024

 
149,752

Total gross profit
47,025

 
51,363

 
121,248

 
143,057

Operating expenses:
 
 
 
 
 
 
 
Research and development
21,289

 
24,202

 
73,226

 
74,272

Selling, general and administrative
37,121

 
36,112

 
104,377

 
105,498

Amortization of intangibles
793

 
3,009

 
2,347

 
9,606

Restructuring and related charges
2,028

 
(27
)
 
4,084

 
4,488

Total operating expenses
61,231

 
63,296

 
184,034

 
193,864

Loss from operations
(14,206
)
 
(11,933
)
 
(62,786
)
 
(50,807
)
Interest expense, net
(2,794
)
 
(2,734
)
 
(8,064
)
 
(7,806
)
Other expense, net
(498
)
 
(328
)
 
(1,828
)
 
(5
)
Loss on impairment of long-term investment

 
(1,259
)
 

 
(2,735
)
Loss before income taxes
(17,498
)
 
(16,254
)
 
(72,678
)
 
(61,353
)
(Benefit from) provision for income taxes
(1,915
)
 
(242
)
 
(1,568
)
 
518

Net loss
$
(15,583
)
 
$
(16,012
)
 
$
(71,110
)
 
$
(61,871
)
 
 
 
 
 
 
 
 
Net loss per share:
 
 
 
 
 
 
 
Basic and diluted
$
(0.19
)
 
$
(0.21
)
 
$
(0.88
)
 
$
(0.80
)
Shares used in per share calculation:
 
 
 
 
 
 
 
Basic and diluted
81,445

 
78,092

 
80,618

 
77,475

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

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HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited, in thousands)
 
Three months ended
 
Nine months ended
 
September 29, 2017
 
September 30, 2016
 
September 29, 2017
 
September 30, 2016
Net loss
$
(15,583
)
 
$
(16,012
)
 
$
(71,110
)
 
$
(61,871
)
Other comprehensive income (loss) before tax:
 
 
 
 
 
 
 
Change in unrealized gain on cash flow hedges:
 
 
 
 
 
 
 
Unrealized gain arising during the period

 
121

 

 
279

(Gain) loss reclassified into earnings

 
(47
)
 

 
53

 

 
74

 

 
332

Change in unrealized gain (loss) on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized (loss) gain arising during the period
8

 
(1,208
)
 
(605
)
 
(1,178
)
Loss reclassified into earnings

 
1,259

 

 
2,735

 
8

 
51

 
(605
)
 
1,557

Change in foreign currency translation adjustments
2,265

 
523

 
7,147

 
(154
)
Other comprehensive income before tax
2,273

 
648

 
6,542

 
1,735

Less: Provision for (benefit from) income taxes

 
(3
)
 
2

 
20

Other comprehensive income, net of tax
2,273

 
651

 
6,540

 
1,715

Total comprehensive loss
$
(13,310
)
 
$
(15,361
)
 
$
(64,570
)
 
$
(60,156
)
The accompanying notes are an integral part of these condensed consolidated financial statements.

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HARMONIC INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Nine months ended
 
September 29, 2017
 
September 30, 2016
Cash flows from operating activities:
 
 
 
Net loss
$
(71,110
)
 
$
(61,871
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Amortization of intangibles
6,232

 
12,711

Depreciation
11,045

 
13,198

Stock-based compensation
11,107

 
8,542

Amortization of discount on convertible debt and issuance cost
4,060

 
3,669

Restructuring, asset impairment and loss on retirement of fixed assets
565

 
1,476

Amortization of non-cash warrant
38

 

Loss on impairment of long-term investment

 
2,735

Foreign currency adjustments
1,795

 
(911
)
Provision for excess and obsolete inventories
5,578

 
6,246

Allowance for doubtful accounts and returns
4,309

 
1,222

Other non-cash adjustments, net
298

 
251

Changes in operating assets and liabilities, net of effects of acquisition:
 
 
 
Accounts receivable
11,367

 
(12,869
)
Inventories
6,188

 
2,225

Prepaid expenses and other assets
6,702

 
(5,938
)
Accounts payable
2,129

 
2,505

Deferred revenue
(1,098
)
 
20,038

Income taxes payable
(2,122
)
 
(827
)
Accrued and other liabilities
(3,053
)
 
(5,040
)
Net cash used in operating activities
(5,970
)
 
(12,638
)
Cash flows from investing activities:
 
 
 
Acquisition of business, net of cash acquired

 
(75,669
)
Proceeds from maturities of investments
3,106

 
18,692

Proceeds from sales of investments
3,792

 

Purchases of property and equipment
(9,075
)
 
(11,423
)
Net cash used in investing activities
(2,177
)
 
(68,400
)
Cash flows from financing activities:
 
 
 
Payment of convertible debt issuance costs

 
(582
)
Proceeds from other debts and capital leases
6,344

 
5,968

Repayment of other debts and capital leases
(7,008
)
 
(8,038
)
Proceeds from common stock issued to employees
4,697

 
3,736

Payment of tax withholding obligations related to net share settlements of restricted stock units
(2,757
)
 
(1,313
)
Net cash provided by (used in) financing activities
1,276

 
(229
)
Effect of exchange rate changes on cash and cash equivalents
1,275

 
(182
)
Net decrease in cash and cash equivalents
(5,596
)
 
(81,449
)
Cash and cash equivalents at beginning of period
55,635

 
126,190

Cash and cash equivalents at end of period
$
50,039

 
$
44,741


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

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HARMONIC INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1: BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) which Harmonic Inc. (“Harmonic,” or the “Company”) considers necessary for a fair statement of the results of operations for the interim periods covered and the consolidated financial condition of the Company at the date of the balance sheets. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 3, 2017 (the “2016 Form 10-K”). The interim results presented herein are not necessarily indicative of the results of operations that may be expected for the full fiscal year ending December 31, 2017, or any other future period. The Company’s fiscal quarters are based on 13-week periods, except for the fourth quarter, which ends on December 31.
The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The year-end condensed balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”).
On February 29, 2016, the Company completed the acquisition of Thomson Video Networks (“TVN”). TVN is now a part of the Company’s Video segment and its results of operations are included in the Company’s Condensed Consolidated Statements of Operations beginning March 1, 2016. During the fourth quarter of 2016, the Company completed the accounting for this business combination.

Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Significant Accounting Policies

The Company’s significant accounting policies are described in Note 2 to its audited Consolidated Financial Statements included in the 2016 Form 10-K. There have been no significant changes to these policies during the nine months ended September 29, 2017 other than those disclosed in Note 2, “Standards Implemented”.


NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
New standards to be implemented

In May 2014, the Financial Accounting Standards Board (“FASB”) issued a new standard, Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, as amended, which will supersede nearly all existing revenue recognition guidance. Under ASU 2014-09, an entity is required to recognize revenue upon transfer of promised goods or services to customers in an amount that reflects the expected consideration received in exchange for those goods or services. ASU No. 2014-09 defines a five-step process in order to achieve this core principle, which may require the use of judgment and estimates, and also requires expanded qualitative and quantitative disclosures relating to the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, including significant judgments and estimates used.

The FASB has issued several amendments to the new standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations. The amendments include ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606)-Principal versus Agent Considerations, which was issued in March 2016, and clarifies the implementation guidance for principal versus agent considerations in ASU 2014-09, and ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606)-Identifying Performance Obligations and Licensing, which was issued in April 2016, and amends the guidance in ASU No. 2014-09 related to identifying performance obligations and accounting for licenses of

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intellectual property. The new standard permits adoption either by using (i) a full retrospective approach for all periods presented in the period of adoption or (ii) a modified retrospective approach with the cumulative effect of initially applying the new standard recognized at the date of initial application and providing certain additional disclosures. The new standard is effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted for annual reporting periods beginning after December 15, 2016. The Company will adopt the new standard effective January 1, 2018.

The Company currently plans to adopt using the modified retrospective approach. However, a decision regarding the adoption method has not been finalized at this time. The Company’s final determination will depend on a number of factors, such as the significance of the impact of the new standard on its financial results, system readiness, including that of software procured from third-party providers, and its ability to accumulate and analyze the information necessary to assess the impact on prior period financial statements, as necessary.

The Company is currently evaluating the impact of the new standard on its accounting policies, processes, and system requirements. The Company has made and will continue to make investments in systems to enable timely and accurate reporting under the new standard. While the Company continues to assess all potential impacts under the new standard, there is the potential for significant impacts to the timing of recognition of software licenses with undelivered features and professional services revenue related to service contracts with acceptance terms as well as contract acquisition costs, both with respect to the amounts that will be capitalized as well as the period of amortization.

Under current industry-specific software revenue recognition guidance, the Company has historically concluded that it did not have vendor-specific objective evidence (“VSOE”) of fair value of the undelivered features relating to delivered software licenses, and accordingly, it has deferred entire revenue for such software licenses until the delivery of features. Professional services included in arrangements with acceptances have also been recognized on receipt of acceptance. The new standard, which does not retain the concept of VSOE, requires an evaluation of whether the undelivered features are distinct performance obligations and, therefore, should be separately recognized when delivered compared to the timing of delivery of software license. Professional services will generally be recorded as services are provided. Depending on the outcome of the Company’s evaluation, the timing of when revenue is recognized could change for future features and professional services under the new standard.

As part of the Company’s preliminary evaluation, it has also considered the impact of the guidance in ASC 340-40, Other Assets and Deferred Costs; Contracts with Customers, and the interpretations of the FASB Transition Resource Group for Revenue Recognition (“TRG”) from their November 7, 2016 meeting with respect to capitalization and amortization of incremental costs of obtaining a contract. As a result of this new guidance, the Company is currently assessing if it will need to capitalize any costs of obtaining the contract, including additional sales commissions. Under the Company’s current accounting policy, it expenses the commission costs immediately as incurred.

While the Company continues to assess the potential impacts of the new standard, including the areas described above, the Company does not know or cannot yet reasonably estimate quantitative information related to the impact of the new standard on its financial statements at this time.

In January 2016, the FASB issued an accounting standard update which requires equity investments to be measured at fair value with changes in fair value recognized in net income and simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. The accounting standard update also updates certain presentation and disclosure requirements. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2018 and early adoption is permitted. The adoption of this new standard is not expected to have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB amended the existing accounting standard for lease accounting. Under this guidance, lessees and lessors should apply a “right-of-use” model in accounting for all leases (including subleases) and eliminate the concept of operating leases and off-balance sheet leases. This new leases standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. The new standard will be effective for the Company beginning in the first quarter of fiscal 2019 and early adoption is permitted. The Company is currently evaluating the methods and impact of adopting this new leases standard on its consolidated financial statements.

In June 2016, the FASB issued new guidance that changes the impairment model for most financial assets and certain other instruments. For trade receivables and other instruments, the Company will be required to use a new forward-looking “expected loss” model.  Additionally, credit losses on available-for-sale debt securities should be recorded through an allowance for credit losses limited to the amount by which fair value is below amortized cost. The new guidance will be effective for the Company

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beginning in the first quarter of fiscal 2019 and early adoption is permitted. The Company is currently evaluating the impact of adopting this new accounting guidance on its consolidated financial statements.

In August 2016, the FASB issued an accounting standard update that addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2018 on a retrospective basis, and early adoption is permitted. The adoption of this new standard is not expected to have a material impact on the Company’s consolidated financial statements.

In November 2016, the FASB issued an accounting standard update which requires companies to include restricted cash and restricted cash equivalents in its cash and cash equivalent balances in the statement of cash flows. Transfers between cash, cash equivalents, restricted cash, and restricted cash equivalents are no longer presented in the statement of cash flows. The new guidance requires a reconciliation of the totals in the statement of cash flows to the related captions. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2018 on a retrospective basis, and early adoption is permitted. The adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued an accounting standard update to simplify the test for goodwill impairment. It removes Step 2 of the goodwill impairment test and requires the assessment of fair value of individual assets and liabilities of a reporting unit to measure goodwill impairments. Goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value. The accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2020 on a prospective basis, and early adoption is permitted. The Company is currently evaluating the impact of adopting this new accounting guidance on its consolidated financial statements.

In January 2017, the FASB issued an accounting standard update to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance will be effective for the Company beginning in the first quarter of fiscal 2018 on a prospective basis, and early adoption is permitted. The adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued a new accounting standard to improve the presentation of net periodic pension cost and net periodic post-retirement benefit cost. This new standard will be effective for the Company beginning in the first quarter of fiscal 2018 on a retrospective basis and early adoption is permitted. The adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In May 2017, the FASB issued a new accounting standard to clarify when to account for a change to the terms or conditions for a share-based payment award as a modification. It requires modification accounting only if the fair value, the vesting condition or the classification of the award changes as a result of the change in terms or conditions. This new standard will be effective for the Company beginning in the first quarter of fiscal 2018 on a prospective basis and early adoption is permitted. The adoption of this new standard is not expected to have a material impact on the Company’s consolidated financial statements.

Standards Implemented

In February 2015, the FASB issued an accounting standard update that changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The accounting standard update became effective for the Company beginning in the first quarter of fiscal 2017. The application of this accounting standard update did not have any impact on the Company's Consolidated Balance Sheet or Statement of Operations upon adoption.

In July 2015, the FASB issued an accounting standard update that requires inventory to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company adopted this accounting standard update beginning in the first quarter of fiscal 2017 and the adoption did not have a material impact on its consolidated financial statements.

In March 2016, the FASB issued an accounting standard update to clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. The Company adopted this accounting standard update beginning in the first quarter of fiscal 2017 and the adoption did not have any impact on its consolidated financial statements.


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In March 2016, the FASB issued an accounting standard update for the accounting of share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The new standard eliminated the requirement to report excess tax benefits and certain tax deficiencies related to share-based payment transactions as additional paid-in capital. It also removes the requirement to delay recognition of a windfall tax benefit until it reduces current taxes payable. Under the new guidance, the benefit will be recorded when it arises, subject to normal valuation allowance considerations. The Company adopted this new accounting standard beginning in the first quarter of fiscal 2017 using a modified-retrospective transition method and recorded a cumulative effect of $4.6 million of additional gross deferred tax asset associated with shared-based payment and an offsetting valuation allowance of the same amount, therefore resulting in no net impact to the Company’s beginning retained earnings. Prior to January 1, 2017, stock-based compensation expense was recorded net of estimated forfeitures in the Company’s condensed consolidated statements of operations and, accordingly, was recorded for only those stock-based awards that the Company expected to vest. Upon the adoption of this accounting standard update, effective January 1, 2017, the Company changed its accounting policy to account for forfeitures as they occur. The change was applied on a modified retrospective approach with a cumulative effect adjustment of $69,000 to retained earnings as of January 1, 2017 (which increased the accumulated deficit). The implementation of this accounting standard update has no impact to the Company’s condensed statement of cash flows because the Company does not have any excess tax benefits from share-based compensation because its tax provision is primarily under full valuation allowance. No prior periods were recast as a result of this change in accounting policy.

In October 2016, the FASB issued an accounting standard update which requires companies to recognize the income tax consequences of all intra-entity sales of assets other than inventory when they occur. As a result, a reporting entity would recognize the tax expense from the sale of the asset in the seller’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. Any deferred tax asset that arises in the buyer’s jurisdiction would also be recognized at the time of the transfer. The Company early adopted this accounting standard update during the first quarter of fiscal 2017 on a modified retrospective approach and recorded a cumulative-effect adjustment of $1.4 million to the retained earnings as of January 1, 2017 (which reduced the accumulated deficit). Correspondingly, in the first quarter of fiscal 2017, the Company recognized an additional $1.1 million of net deferred tax assets, after netting with $2.1 million of valuation allowance, and write off the remaining $0.3 million of unamortized tax expenses deferred under the previous guidance to provision for income taxes in the first quarter of fiscal 2017.


NOTE 3: BUSINESS ACQUISITION
On February 29, 2016, the Company, through its wholly-owned subsidiary Harmonic International AG, completed its acquisition of 100% of the share capital and voting rights of TVN, a global leader in advanced video compression solutions headquartered in Rennes, France, for a final purchase price of $82.5 million in cash. The Company believes that its acquisition of TVN has strengthened, and will continue to strengthen, the Company’s competitive position in the video infrastructure market as well as to enhance the depth and scale of the Company’s research and development and service and support capabilities in the video arena.

During the fourth quarter of 2016, the Company completed the accounting for this business combination. The final TVN purchase price has been allocated to tangible and intangible assets acquired and liabilities assumed on the basis of their respective estimated fair values on the acquisition date. The Company’s allocation of TVN purchase consideration is as follows (in thousands):

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Assets:
 
  Cash and cash equivalents
$
6,843

  Accounts receivable, net
14,933

  Inventories
3,462

  Prepaid expenses and other current assets
2,412

  Property and equipment, net
9,942

  French R&D tax credit receivables (1)
26,421

  Other long-term assets
2,134

Total assets
$
66,147

Liabilities:
 
  Other debts and capital lease obligations, current
8,362

  Accounts payable
12,494

  Deferred revenue
2,504

  Accrued and other current liabilities
18,365

  Other debts and capital lease obligations, long-term
16,087

  Other non-current liabilities
6,467

  Deferred tax liabilities
2,126

Total liabilities
$
66,405

 
 
Goodwill
41,670

Intangibles
41,100

Total purchase consideration
$
82,512

(1) See Note 8, “Balance Sheet Components-Prepaid expenses and other current assets” for more information on French R&D tax credit receivables.

The following table presents details of the intangible assets acquired through this business combination (in thousands, except years):
 
Estimated Useful Life (in years)
 
Fair Value
Backlog
6 months
 
$
3,600

Developed technology
4 years
 
21,700

Customer relationships
5 years
 
15,200

Trade name
4 years
 
600

 
 
 
$
41,100


The goodwill is not expected to be deductible for income tax purposes but the intangibles assets acquired are expected to be deductible for income tax purposes in certain jurisdictions. Both goodwill and intangibles assets acquired are assigned to the Company’s video reporting unit.

Acquisition- and integration- related expenses

As a result of the TVN acquisition, the Company incurred the acquisition- and integration- related expenses summarized in the table below (in thousands):


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Acquisition-related
 
Integration-related
 
 
Three months ended
 
Nine months ended
 
Three months ended
 
Nine months ended
 
 
September 30, 2016
 
September 29, 2017
 
September 30, 2016
 
September 29, 2017
 
September 30, 2016
Product cost of revenue
 
$

 
$

 
$

 
$
119

 
$
342

 
$
610

Research and development
 

 

 

 
152

 
7

 
702

Selling, general and administrative
 
534

 
3,855

 
117

 
4,365

 
2,385

 
6,502

  Total acquisition- and integration-related expenses in operating expenses
 
534

 
3,855

 
117

 
4,636

 
2,734

 
7,814

Interest expense, net
 

 

 

 
98

 

 
98

     Total acquisition- and integration-related expenses
 
$
534

 
$
3,855

 
$
117

 
$
4,734

 
$
2,734

 
$
7,912



These costs consisted of acquisition-related costs which include outside legal, accounting and other professional services as well as integration-related costs which include incremental costs resulting from the TVN acquisition that are not expected to generate future benefits once the integration is fully consummated. These costs are expensed as incurred. The Company expects to continue to have some TVN integration-related costs throughout the remainder of 2017, primarily outside legal and advisory fees relating to re-organization of TVN’s legal entities.


NOTE 4: SHORT-TERM INVESTMENTS
As of September 29, 2017, the Company has no short-term investments. The following table summarizes the Company’s short-term investments as of December 31, 2016 (in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
As of December 31, 2016
 
 
 
 
 
 
 
Corporate bonds
$
6,928

 
$

 
$
(5
)
 
$
6,923

Total short-term investments
$
6,928

 
$

 
$
(5
)
 
$
6,923

The Company’s short-term investments as of December 31, 2016 had maturities of less than one year. These available-for-sale investments are presented as “Current Assets” in the Condensed Consolidated Balance Sheets as they were available for current operations. Realized gains and losses from the sale of investments were not material for the three and nine months ended September 29, 2017 and September 30, 2016.

NOTE 5: INVESTMENTS IN OTHER EQUITY SECURITIES
From time to time, the Company may acquire certain equity investments for the promotion of business objectives and these investments are classified as long-term investments and included in “Other long-term assets” in the Condensed Consolidated Balance Sheet.

In 2014, the Company acquired a 3.3% interest in Vislink plc (“Vislink”), a U.K. public company listed on the AIM exchange in London, for $3.3 million. The investment in Vislink is being accounted for as a cost method investment as the Company does not have significant influence over the operational and financial policies of Vislink. Since the Vislink investment is also an available-for-sale security, its value is marked to market for the difference in fair value at period end. The carrying value of Vislink was $0.2 million and $0.8 million at September 29, 2017 and December 31, 2016, respectively. Vislink’s accumulated unrealized (loss) gain, net of taxes was $(0.3) million and $0.3 million at September 29, 2017 and December 31, 2016, respectively.

Beginning in late 2015 and continuing through 2016, Vislink’s stock price was below the Company’s cost basis for a prolonged period of time and based on the Company’s assessment, impairment charges of $1.5 million and $1.2 million for Vislink were recorded in the first and third quarter of 2016, respectively, reflecting the new reduced cost basis of the Vislink investment at

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September 30, 2016. As of December 31, 2016, Vislink’s stock price increased approximately 67% from the stock price as of September 30, 2016.

On February 3, 2017, Vislink (from thereon, referred to as Pebble Beach Systems) completed their disposal of its hardware division and changed its name to Pebble Beach Systems. On February 6, 2017, Pebble Beach Systems announced its financial results for fiscal 2016 which showed a significant increase in operating losses. As of September 29, 2017, Pebble Beach Systems’ stock price had declined approximately 82% from the stock price as of December 31, 2016 and Pebble Beach Systems is currently seeking alternatives to maximize value for its shareholders, which could include a sale of the company. In view of Pebble Beach Systems’ potential sale opportunity, the Company determined that the decline in the fair value of Pebble Beach Systems’ investment is not considered permanent yet, and as a result, the cumulative $0.6 million loss in Pebble Beach Systems’ investment in the nine months ended September 29, 2017 was recorded to other comprehensive loss. The Company’s remaining maximum exposure to loss from the Pebble Beach Systems’ investment at September 29, 2017 was approximately $0.5 million, consisting of the carrying value of $0.2 million and the accumulated unrealized loss of $(0.3) million.

The assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than the Company’s cost basis; the financial condition and near-term prospects of the investment; and the Company’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value.

Unconsolidated Variable Interest Entities (“VIE”)

In 2014, the Company acquired an 18.4% interest in Encoding.com, Inc. (“EDC”), a video transcoding service company headquartered in San Francisco, California, for $3.5 million by purchasing EDC’s Series B preferred stock. EDC is considered a variable interest entity but the Company determined that it is not the primary beneficiary of EDC. As a result, EDC is accounted for as a cost method investment.

The Company determined that there were no indicators existing at September 29, 2017 that would indicate that the EDC investment was impaired. The Company’s maximum exposure to loss from the EDC’s investment at September 29, 2017 was limited to its investment cost of $3.6 million, including $0.1 million of transaction costs.

The Company’s total investments in equity securities of other privately and publicly held companies, as discussed above, were $3.8 million and $4.4 million as of September 29, 2017 and December 31, 2016, respectively, and such investments were considered as long-term investments and were included in “Other long-term assets” in the Condensed Consolidated Balance Sheet.


NOTE 6: DERIVATIVES AND HEDGING ACTIVITIES
The Company uses forward contracts to manage exposures to foreign currency exchange rates. The Company’s primary objective in holding derivative instruments is to reduce the volatility of earnings and cash flows associated with fluctuations in foreign currency exchange rates and the Company does not use derivative instruments for trading purposes. The use of derivative instruments expose the Company to credit risk to the extent that the counterparties may be unable to meet their contractual obligations, as such, the potential risk of loss with any one counterparty is closely monitored by the Company.
Derivatives Not Designated as Hedging Instruments (Balance Sheet Hedges)
The Company’s balance sheet hedges consist of foreign currency forward contracts, mature generally within three months, are carried at fair value and are used to minimize the short-term impact of foreign currency exchange rate fluctuation on cash and certain trade and inter-company receivables and payables. Changes in the fair value of these foreign currency forward contracts are recognized in “Other expense, net” in the Condensed Consolidated Statement of Operations and are largely offset by the changes in the fair value of the assets or liabilities being hedged.
The locations and amounts of designated and non-designated derivative instruments’ gains and losses reported in the Company’s Accumulated Other Comprehensive Loss (“AOCI”) and Condensed Consolidated Statements of Operations were as follows (in thousands):

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Three months ended
 
Nine months ended
 
Financial Statement Location
 
September 29, 2017
 
September 30, 2016
 
September 29, 2017
 
September 30, 2016
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
Gains in AOCI on derivatives (effective portion)
AOCI
 
$

 
$
121

 
$

 
$
279

Gains (losses) reclassified from AOCI into income (effective portion)
Cost of Revenue
 
$

 
$
6

 
$

 
$
(7
)
 
Operating Expense
 

 
41

 

 
(46
)
 
  Total
 
$

 
$
47

 
$

 
$
(53
)
Losses recognized in income on derivatives (ineffectiveness portion and amount excluded from effectiveness testing)
Other expense, net
 
$

 
$
(8
)
 
$

 
$
(57
)
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
Gains (losses) recognized in income
Other expense, net
 
$
119

 
$
(162
)
 
$
(66
)
 
$
(496
)
The U.S. dollar equivalents of all outstanding notional amounts of foreign currency forward contracts, including the Euro, British pound, Israeli shekels, Japanese yen and Mexican peso, are summarized as follows (in thousands):

 
September 29, 2017
 
December 31, 2016
Derivatives not designated as hedging instruments:
 

 

Purchase
 
$
12,925

 
$
4,056

Sell
 
$
1,501

 
$
11,157

The locations and fair value amounts of the Company’s derivative instruments reported in its Condensed Consolidated Balance Sheets are as follows (in thousands):
 
 
 
 
Asset Derivatives
 
 
 
Derivative Liabilities
 
 
Balance Sheet Location
 
September 29, 2017
 
December 31, 2016
 
Balance Sheet Location
 
September 29, 2017
 
December 31, 2016
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency contracts
 
Prepaid expenses and other current assets
 
$
13

 
$
54

 
Accrued Liabilities
 
$
45

 
$
40

Total derivatives
 
 
 
$
13

 
$
54

 
 
 
$
45

 
$
40

Offsetting of Derivative Assets and Liabilities
The Company recognizes all derivative instruments on a gross basis in the Condensed Consolidated Balance Sheets. However, the arrangements with its counterparties allows for net settlement, which are designed to reduce credit risk by permitting net settlement with the same counterparty. As of September 29, 2017, information related to the offsetting arrangements was as follows (in thousands):
 
 
 
 
 
 
 
 
Gross Amounts of Derivatives Not Offset in the Condensed Consolidated Balance Sheets
 
 
 
 
Gross Amounts of Derivatives
 
Gross Amounts of Derivatives Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Derivatives Presented in the Condensed Consolidated Balance Sheets
 
Financial Instrument
 
Cash Collateral Pledged
 
Net Amount
Derivative Assets
 
$
13

 

 
$
13

 
$
(6
)
 

 
$
7

Derivative Liabilities
 
$
45

 

 
$
45

 
$
(6
)
 

 
$
39


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Table of Contents

In connection with foreign currency derivatives entered in Israel, the Company’s subsidiaries in Israel are required to maintain a compensating balance with their bank at the end of each month. The compensating balance arrangements do not legally restrict the use of cash and as of September 29, 2017, the total compensating balance maintained was $2.5 million.


NOTE 7: FAIR VALUE MEASUREMENTS
The applicable accounting guidance establishes a framework for measuring fair value and requires disclosure about the fair value measurements of assets and liabilities. This guidance requires the Company to classify and disclose assets and liabilities measured at fair value on a recurring basis, as well as fair value measurements of assets and liabilities measured on a nonrecurring basis in periods subsequent to initial measurement, in a three-tier fair value hierarchy as described below.
The guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date.
Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The guidance describes three levels of inputs that may be used to measure fair value:
Level 1 — Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.
Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company primarily uses broker quotes for valuation of its short-term investments. The forward exchange contracts are classified as Level 2 because they are valued using quoted market prices and other observable data for similar instruments in an active market.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The carrying value of the Company’s financial instruments, including cash equivalents, restricted cash, accounts receivable, accounts payable and accrued and other current liabilities, approximate fair value due to their short maturities.
The Company uses the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The fair value of the Company’s convertible notes is influenced by interest rates, the Company’s stock price and stock market volatility. The estimated fair value of the Company’s convertible notes based on a market approach was approximately $114.2 million and $143.5 million as of September 29, 2017 and December 31, 2016, respectively, and represents a Level 2 valuation. The Company’s other debts and capital leases assumed from the TVN acquisition are classified within Level 2 because these borrowings are not actively traded and the majority of them have a variable interest rate structure based upon market rates currently available to the Company for debt with similar terms and maturities. Additionally, the Company considers the carrying amount of its capital lease obligations to approximate their fair value because the weighted average interest rate used to formulate the carrying amounts approximates current market rates. The other debts and capital leases outstanding as of September 29, 2017 were $22.9 million in the aggregate. (See Note 11, “Convertible Notes, Other debts and Capital Leases” for additional information).
The fair value of the Company’s liability for the TVN voluntary departure plan (“TVN VDP”) as of September 29, 2017 of $6.0 million is classified within Level 3 because discount rates which are unobservable in the market were being used to measure the fair value of this liability. (See Note 10, “Restructuring and related Charges-TVN VDP” for additional information). The fair value of the TVN defined pension benefit plan liability of $5.1 million as of September 29, 2017 is disclosed in Note 12, “Employee Benefit Plans and Stock-based Compensation-TVN Retirement Benefit Plan.”
During the nine months ended September 29, 2017, there were no nonrecurring fair value measurements of assets and liabilities subsequent to initial recognition.

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Table of Contents

The following table sets forth the fair value of the Company’s financial assets and liabilities measured at fair value on a recurring basis based on the three-tier fair value hierarchy (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
As of September 29, 2017
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
246

 
$

 
$

 
$
246

Prepaids and other current assets
 
 
 
 
 
 
 
Derivative assets

 
13

 

 
13

Other assets
 
 
 
 
 
 
 
Long-term investment
200

 

 

 
200

Total assets measured and recorded at fair value
$
446

 
$
13

 
$

 
$
459

Accrued and other current liabilities
 
 
 
 
 
 
 
Derivative liabilities
$

 
$
45

 
$

 
$
45

 Accrued TVN VDP, current portion

 

 
3,519

 
3,519

Other non-current liabilities
 
 
 
 
 
 
 
        Accrued TVN VDP, long-term portion

 

 
2,485

 
2,485

Total liabilities measured and recorded at fair value
$

 
$
45

 
$
6,004

 
$
6,049

 
Level 1
 
Level 2
 
Level 3
 
Total
As of December 31, 2016
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
8,301

 
$

 
$

 
$
8,301

Corporate bonds

 
6,923

 

 
6,923

Prepaids and other current assets
 
 
 
 
 
 
 
Derivative assets

 
54

 

 
54

Other assets
 
 
 
 
 
 
 
Long-term investment
809

 

 

 
809

Total assets measured and recorded at fair value
$
9,110

 
$
6,977

 
$

 
$
16,087

Accrued and other current liabilities
 
 
 
 
 
 
 
Derivative liabilities
$

 
$
40

 
$

 
$
40

        Accrued TVN VDP, current portion

 

 
6,597

 
6,597

Other non-current liabilities
 
 
 
 
 
 
 
        Accrued TVN VDP, long-term portion

 

 
3,053

 
3,053

Total liabilities measured and recorded at fair value
$

 
$
40

 
$
9,650

 
$
9,690

NOTE 8: BALANCE SHEET COMPONENTS
The following tables provide details of selected balance sheet components (in thousands):
 
September 29, 2017

December 31, 2016
Accounts receivable, net:
 
 
 
Accounts receivable
$
77,320

 
$
91,596

Less: allowances for doubtful accounts, returns and discounts
(5,738
)
 
(4,831
)
     Total
$
71,582

 
$
86,765



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Table of Contents

 
September 29, 2017

December 31, 2016
Prepaid expenses and other current assets:
 
 
 
Deferred cost of revenue
$
6,217

 
$
6,856

French R&D tax credits receivable(1)
6,475

 
5,895

Prepaid maintenance, royalty, rent, property taxes and value added tax
4,942

 
5,526

Prepaid customer incentive(2)
1,124

 
1,162

Restricted cash(3)
803

 
731

Other
3,121

 
6,149

Total
$
22,682

 
$
26,319


(1) The Company’s acquired TVN subsidiary in France (the “TVN French Subsidiary”) participates in the French Crédit d’Impôt Recherche (“CIR”) program (the “R&D tax credits”) which allows companies to monetize eligible research expenses. The R&D tax credits can be used to offset against income tax payable to the French government in each of the four years after being incurred, or if not utilized, are recoverable in cash. The amount of R&D tax credits recoverable are subject to audit by the French government. The R&D tax credit receivables at September 29, 2017 were approximately $26.5 million and are expected to be recoverable from 2018 through 2021 with $6.5 million reported under “Prepaid and other Current Assets” and $20.0 million reported under “Other Long-term Assets” on the Company’s Condensed Consolidated Balance Sheets.
(2) On September 26, 2016, the Company issued a warrant to purchase shares of its common stock (the “Warrant”) to Comcast pursuant to which Comcast may, subject to certain vesting provisions, purchase up to 7,816,162 shares of the Company’s common stock subject to adjustment in accordance with the terms of the Warrant, for a per share exercise price of $4.76. The portion of the Warrant which vested on September 26, 2016 had a value of approximately $1.6 million and is deemed a customer incentive paid upfront and cumulatively, $0.5 million of this prepaid incentive has been recorded as a reduction to the Company’s net revenues from Comcast. The remaining $1.1 million of this prepaid incentive is reported as an asset under “Prepaid expenses and other current assets” on the Company’s Condensed Consolidated Balance Sheet as of September 29, 2017. The Company considers this asset to be recoverable based on the expectation of Comcast’s future purchases of the pertinent products.
(3) The restricted cash balances are held as cash collateral security for certain bank guarantees. These restricted funds are invested in bank deposits and cannot be withdrawn from the Company’s accounts without the prior written consent of the applicable secured party. Additionally, as of September 29, 2017, the Company had approximately $1.2 million of restricted cash for the bank guarantee associated with the TVN French Subsidiary’s office building lease. This amount is reported under “Other Long-term Assets” on the Company’s Condensed Consolidated Balance Sheets.
 
September 29, 2017

December 31, 2016
Inventories:
 
 
 
Raw materials
$
3,825

 
$
9,889

Work-in-process
1,290

 
2,318

Finished goods
14,146

 
17,776

Service-related spares
12,493

 
11,210

Total
$
31,754

 
$
41,193


 
September 29, 2017
 
December 31, 2016
Property and equipment, net:
 
 
 
   Machinery and equipment
$
86,971

 
$
97,989

   Capitalized software
34,496

 
34,519

   Leasehold improvements
14,745

 
14,455

   Furniture and fixtures
6,797

 
8,993

      Property and equipment, gross
143,009

 
155,956

      Less: accumulated depreciation and amortization
(112,278
)
 
(123,792
)
         Total
$
30,731

 
$
32,164



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Table of Contents

 
September 29, 2017
 
December 31, 2016
Accrued and other current liabilities:
 
 
 
   Accrued employee compensation and related expenses
$
14,866

 
$
19,377

   Accrued TVN VDP, current (1)
3,519

 
6,597

   Accrued warranty
4,341

 
4,862

   Customer deposits
4,526

 
4,537

   Contingent inventory reserves
3,840

 
2,210

   Accrued Avid litigation settlement, current (2)
2,500

 

   Accrued royalty payments
2,325

 
1,912

   Others
16,911

 
15,655

      Total
$
52,828

 
$
55,150


(1) See Note 10, “Restructuring and related charges-TVN VDP,” for additional information on the Company’s TVN VDP liabilities.

(2) See Note 18, “Commitments and Contingencies-Legal Proceedings,” for additional information on the Company’s accrual for the Avid litigation settlement.


NOTE 9: GOODWILL AND IDENTIFIED INTANGIBLE ASSETS
Goodwill
Goodwill represents the difference between the purchase price and the estimated fair value of the identifiable assets acquired and liabilities assumed. Goodwill is allocated among and evaluated for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment. The Company has two reporting units, Video and Cable Edge. The Company tests for goodwill impairment at the reporting unit level on an annual basis, or more frequently, if events or changes in circumstances indicate that the asset is more likely than not impaired. The Company’s annual goodwill impairment test is performed in the fiscal fourth quarter, with a testing date at the end of October.

During 2016, the Company recorded goodwill of $41.7 million for the TVN acquisition. Goodwill from the TVN acquisition is assigned to the Video reporting unit.

The changes in the carrying amount of goodwill by reportable segments for the nine months ended September 29, 2017 were as follows (in thousands):
 
Video
 
Cable Edge
 
Total
Balance as of December 31, 2016
$
176,519

 
$
60,760

 
$
237,279

   Foreign currency translation adjustment
4,603

 
50

 
4,653

Balance as of September 29, 2017
$
181,122

 
$
60,810

 
$
241,932

Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows and determining appropriate discount rates, growth rates, an appropriate control premium and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit which could trigger impairment. If the Company’s assumptions and related estimates change in the future, or if the Company’s reporting structure changes or other events and circumstances change (e.g. such as a sustained decrease in the Company’s stock price), the Company may be required to record impairment charges in future periods. Any impairment charges that the Company may take in the future could be material to its results of operations and financial condition.
The Company performed its annual goodwill impairment review at October 31, 2016. Based on the impairment test performed, management concluded that goodwill was not impaired as the Video and Cable Edge reporting units had estimated fair values in excess of their carrying value by approximately 67% and 123%, respectively.
The Company has not recorded any impairment charges related to goodwill for any prior periods.

18



Intangible Assets
The following is a summary of intangible assets (in thousands):
 
 
 
September 29, 2017
 
December 31, 2016
 
Weighted Average Remaining Life (Years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Amount
Developed core technology
2.4
 
$
31,707

 
$
(19,101
)
 
$
12,606

 
$
31,707

 
$
(15,216
)
 
$
16,491

Customer relationships/contracts
3.4
 
44,748

 
(34,425
)
 
10,323

 
44,384

 
(32,098
)
 
12,286

Trademarks and trade names
2.4
 
641

 
(254
)
 
387

 
573

 
(119
)
 
454

Maintenance agreements and related relationships
N/A
 
5,500

 
(5,500
)
 

 
5,500

 
(5,500
)
 

Order Backlog
N/A
 
3,011

 
(3,011
)
 

 
3,011

 
(3,011
)
 

Total identifiable intangibles
 
 
$
85,607

 
$
(62,291
)
 
$
23,316

 
$
85,175

 
$
(55,944
)
 
$
29,231


Amortization expense for the identifiable purchased intangible assets for the three and nine months ended September 29, 2017 and September 30, 2016 was allocated as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 29,
2017
 
September 30,
2016
 
September 29,
2017
 
September 30,
2016
Included in cost of revenue
$
1,295

 
$
1,380

 
$
3,885

 
$
3,105

Included in operating expenses
793

 
3,009

 
2,347

 
9,606

Total amortization expense
$
2,088

 
$
4,389

 
$
6,232

 
$
12,711

The estimated future amortization expense of purchased intangible assets with definite lives is as follows (in thousands):
 
Cost of Revenue
 
Operating
Expenses
 
Total
Year ended December 31,
 
 
 
 
 
2017 (remaining three months)
$
1,296

 
$
794

 
$
2,090

2018
5,180

 
3,182

 
8,362

2019
5,180

 
3,182

 
8,362

2020
950

 
3,048

 
3,998

2021

 
504

 
504

Total future amortization expense
$
12,606

 
$
10,710

 
$
23,316


NOTE 10: RESTRUCTURING AND RELATED CHARGES
The Company implemented several restructuring plans in the past few years. The goal of these plans was to bring operational expenses to appropriate levels relative to its net revenues, while simultaneously implementing extensive company-wide expense control programs.
The Company accounts for its restructuring plans under the authoritative guidance for exit or disposal activities. The restructuring and related charges are included in “Product cost of revenue” and “Operating expenses-restructuring and related charges” in the Condensed Consolidated Statements of Operations. The following table summarizes the restructuring and related charges (in thousands):

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Table of Contents

 
Three months ended
 
Nine months ended
 
September 29,
2017

September 30,
2016
 
September 29,
2017
 
September 30,
2016
Restructuring and related charges in:
 
 
 
 
 
 
 
Product cost of revenue
$
549

 
$
(1
)
 
$
1,335

 
$
(24
)
Operating expenses-Restructuring and related charges
2,028

 
(27
)
 
4,084

 
4,488

Total restructuring and related charges
$
2,577

 
$
(28
)
 
$
5,419

 
$
4,464

Harmonic 2016 Restructuring
In the first quarter of 2016, the Company implemented a new restructuring plan (the “Harmonic 2016 Restructuring Plan”) to streamline the corporate organization, thereby reducing operating costs by consolidating duplicative resources in connection with the acquisition of TVN. The planned activities have primarily resulted, and will primarily result, in cash expenditures related to severance and related benefits and exiting certain operating facilities and disposing of excess assets. In the second quarter of 2016, the Company also initiated the TVN VDP in France to streamline the organization of the TVN French Subsidiary.

In 2016, the Company recorded an aggregate of $20.0 million of restructuring and related charges under the Harmonic 2016 Restructuring Plan, of which $2.2 million was primarily related to the Company exiting from an excess facility at its U.S. headquarters and the remaining $17.8 million was related to severance and benefits for the termination of 118 employees worldwide, including 83 employees in France who participated in the TVN VDP. (See details of TVN VDP described below). Additionally, the restructuring and related charges under the Harmonic 2016 Restructuring Plan in 2016 were partially offset by approximately $2.0 million of gain from TVN pension curtailment. For the employees who participated in the TVN VDP, their pension benefit is funded by the TVN VDP and, as a result, the TVN defined benefit pension plan was remeasured at December 31, 2016, which resulted in a non-cash curtailment gain. This gain was recorded as an offset to restructuring and related costs in 2016.
The Company also incurred $16.9 million of TVN acquisition- and integration-related expenses in 2016 and another $2.7 million in the nine months ended September 29, 2017. The Company expects to continue to have some TVN integration-related costs throughout the remainder of 2017, primarily consisting of outside legal and advisory fees relating to the re-organization of TVN’s legal entities. (See Note 3, “Business Acquisition,” for additional information on TVN acquisition-and integration-related expenses).
In the three and nine months ended September 29, 2017, the Company recorded $0.1 million and $2.9 million of restructuring and related charges under the Harmonic 2016 Restructuring Plan, respectively. The restructuring and related charges under the Harmonic 2016 Restructuring Plan in the nine months ended September 29, 2017 consisted of $1.8 million of TVN VDP charges and $1.1 million of severance for 21 non-VDP employees worldwide who were terminated under this plan during the first six months of 2017.

TVN VDP

During 2016, the Company consulted and worked with the works council for the TVN French Subsidiary and applicable union representatives to establish a voluntary departure plan to enable French employees of TVN to voluntarily terminate with certain benefits. A total of 83 employees applied for the TVN VDP and were duly approved by the Company in the fourth quarter of 2016. The total TVN VDP costs, including severance, certain benefits and taxes, as well as administration costs, is estimated at approximately $15.3 million, in aggregate, at the inception of the plan and will be paid over a period of four years, based on the TVN VDP terms agreed with each employee. The total final payout to the employees may be different from the initial estimates depending on the final social charges imputed on each employee’s total income and benefits received. The Company does not expect the final payout to be materially different from the initial estimates. The fair value of the total TVN VDP liability at inception was estimated to be approximately $14.8 million.
The Company accounts for these special termination benefits in accordance with ASC 712, “Compensation - Nonretirement Postemployment Benefits,” which requires that the special termination benefits be recognized as a liability and a loss beginning when an employee accepts the offer of voluntary termination and the amount can be reasonably estimated. Where an employee is required to work beyond a minimum statutory notice period, the cost of the special termination benefit is recognized as an expense over the employee’s remaining service period. Where the employee is not required to work beyond a minimum statutory notice period, the cost of the special termination benefit is recognized upon the date the employee accepts the offer of voluntary termination, provided that the amount of the benefit can be estimated. Out of the 83 employees who applied for TVN VDP, 11 of them are

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required to work beyond the minimum statutory notice period into 2017. Based on the application of the accounting guidance, the Company recorded $1.8 million and $13.1 million of TVN VDP costs in the first nine months of 2017 and in the year ended 2016, respectively. Cumulatively, the Company had paid an aggregate of $9.7 million of TVN VDP costs, of which $3.5 million was paid in 2016 and $6.2 million was paid in 2017. The fair value of the TVN VDP liability balance at September 29, 2017 was $6.0 million.
The table below shows the estimated future payments for TVN VDP as of September 29, 2017 (in thousands):
Years ending December 31,
 
2017 (remaining three months)
$
1,145

2018
2,937

2019
1,379

2020
543

Total
$
6,004

Excess Facility in San Jose, California

In January 2016, the Company exited an excess facility at its U.S. headquarters in San Jose, California and recorded $1.4 million in facility exit costs. The fair value of these liabilities is based on a net present value model using a credit-adjusted risk-free rate. The liability will be paid out over the remainder of the leased properties’ terms, which continue through August 2020. As of the cease-use date, the fair value of this restructuring liability totaled $2.5 million. Offsetting these charges was an adjustment for deferred rent liability relating to this space of $1.1 million. In December 2016, as a result of a change in estimated sublease income, the restructuring liability was increased by $0.6 million.

The following table summarizes the activity in the Company’s restructuring accrual related to the Harmonic 2016 Restructuring Plan during the nine months ended September 29, 2017 (in thousands):
 
Excess facilities
 
VDP (1)
 
Severance and benefits (2)
 
Total
Balance at December 31, 2016
$
2,375

 
$
9,650

 
$
1,519

 
$
13,544

Charges for 2016 Harmonic Restructuring Plan
73

 
1,781

 
1,137

 
2,991

Adjustments to restructuring provisions

 

 
(7
)
 
(7
)
Cash payments
(921
)
 
(6,232
)
 
(2,512
)
 
(9,665
)
Foreign exchange gain

 
805

 
36

 
841

Balance at September 29, 2017
1,527

 
6,004

 
173

 
7,704

Less: current portion (3)
(730
)
 
(3,519
)
 
(173
)
 
(4,422
)
Long-term portion (3)
$
797

 
$
2,485

 
$

 
$
3,282


(1) See discussion of the TVN VDP above for future estimated payments through 2020.
(2) The Company anticipates that the remaining severance and benefits accrual at September 29, 2017 will be fully paid in 2017.
(3) The current portion and long-term portion of the restructuring liability are reported under “Accrued and other current liabilities” and “Other non-current liabilities”, respectively, on the Company’s Condensed Consolidated Balance Sheets.

Harmonic 2017 Restructuring
In the third quarter of 2017, the Company committed to a new restructuring plan (the “Harmonic 2017 Restructuring Plan”) to better align its operating costs with the continued decline in its net revenues. The restructuring activities under the Harmonic 2017 Restructuring Plan primarily consisted of global workforce reductions and an excess facility closure.

In the three and nine months ended September 29, 2017, the Company recorded $2.4 million of restructuring and related charges under the Harmonic 2017 Restructuring Plan consisting of $2.1 million of employee severance and $0.3 million related to the closure of the Company’s research and development office in New York.

The following table summarizes the activity in the Company’s restructuring accrual related to the Harmonic 2017

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Restructuring Plan during the three months ended September 29, 2017 (in thousands):

 
Excess facilities
 
Non-VDP Severance and benefits
 
Total
Charges for 2017 Restructuring Plan
318

 
2,117

 
2,435

Cash payments
(45
)
 
(1,593
)
 
(1,638
)
Non-cash write-offs
58

 

 
58

Balance at September 29, 2017
331

 
524

 
855

Less: current portion (1)
(160
)
 
(524
)
 
(684
)
Long-term portion (2)
$
171

 
$

 
$
171

(1) The Company anticipates that the remaining severance and benefits accrual at September 29, 2017 will be fully paid within the next twelve months.
(2) The current portion and long-term portion of the restructuring liability are reported under “Accrued and other current liabilities” and “Other non-current liabilities”, respectively, on the Company’s Condensed Consolidated Balance Sheets.

NOTE 11: CONVERTIBLE NOTES, OTHER DEBTS AND CAPITAL LEASES
4.00% Convertible Senior Notes
In December 2015, the Company issued $128.25 million in aggregate principal amount of 4.0% unsecured convertible senior notes due December 1, 2020 (the “offering” or “Notes”, as applicable) through a private placement with a financial institution. The Notes do not contain any financial covenants and the Company can settle the Notes in cash, shares of common stock, or any combination thereof. The Notes can be converted under certain circumstances described below, based on an initial conversion rate of 173.9978 shares of common stock per $1,000 principal amount of Notes (which represents an initial conversion price of approximately $5.75  per share). Interest on the Notes is payable semiannually in arrears on June 1 and December 1 of each year.
Concurrent with the closing of the offering, the Company used $49.9 million of the net proceeds to repurchase 11.1 million shares of the Company’s common stock from purchasers of the offering in privately negotiated transactions. In addition, the Company incurred approximately $4.1 million in debt issuance costs resulting in net proceeds to the Company of approximately $74.2 million, which was used to fund the TVN acquisition.
Prior to September 1, 2020, holders of the Notes may convert the Notes at their option only under the following circumstances: (1) during any fiscal quarter commencing after the fiscal quarter ending on April 1, 2016, if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price of the Notes on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. Commencing on September 1, 2020 until the close of business on the second scheduled trading day immediately preceding the maturity date, the Notes will be convertible in multiples of $1,000 principal amount regardless of the foregoing circumstances.
If a fundamental change occurs, holders of the Notes may require the Company to purchase all or any portion of their Notes for cash at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, if specific corporate events occur prior to the maturity date, the conversion rate may be increased for a holder who elects to convert the Notes in connection with such a corporate event.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the initial proceeds of the Notes as a whole. The difference between the initial proceeds of the Notes and the liability component (the “debt discount”) of $26.9 million is amortized to interest expense using the effective interest method over the term of the Notes. The equity component of the Notes is included in additional paid-in capital in the Condensed Consolidated Balance Sheets and is not remeasured as long as it continues to meet the conditions for equity classification.

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In accounting for the transaction costs related to the issuance of the Notes, the Company allocated the total amount of $4.1 million to the liability and equity components using the same proportions as the proceeds from the Notes. Transaction costs attributable to the liability component were $3.2 million and were recorded as a direct deduction from the carrying amount of the debt liability in long-term liability in the Condensed Consolidated Balance Sheets and are being amortized to interest expense in the Condensed Consolidated Statements of Operations using the effective interest method over the term of the Notes. Transaction costs attributable to the equity component were $0.9 million and were netted with the equity component of the Notes in additional paid-in capital in the Condensed Consolidated Balance Sheets.
The following table presents the components of the Notes as of September 29, 2017 and December 31, 2016 (in thousands, except for years and percentages):
 
September 29, 2017
 
December 31, 2016
Liability:
 
 
 
  Principal amount
$
128,250

 
$
128,250

  Less: Debt discount, net of amortization
(18,680
)
 
(22,302
)
  Less: Debt issuance costs, net of amortization
(2,252
)
 
(2,689
)
  Carrying amount
$
107,318

 
$
103,259

  Remaining amortization period (years)
3.2

 
3.9

  Effective interest rate on liability component
9.94
%
 
9.94
%
 
 
 
 
Equity:
 
 
 
  Value of conversion option
$
26,925

 
$
26,925

  Less: Equity issuance costs
(863
)
 
(863
)
  Carrying amount
$
26,062

 
$
26,062

The following table presents interest expense recognized for the Notes (in thousands):

 
Three months ended
 
Nine months ended
 
September 29, 2017
 
September 30, 2016
 
September 29, 2017
 
September 30, 2016
Contractual interest expense
$
1,283

 
$
1,283

 
$
3,848

 
$
3,848

Amortization of debt discount
1,235

 
1,117

 
3,623

 
3,274

Amortization of debt issuance costs
149

 
135

 
437

 
395

  Total interest expense recognized
$
2,667

 
$
2,535

 
$
7,908

 
$
7,517


Other Debts and Capital Leases

In connection with the TVN acquisition, the Company assumed a variety of debt and credit facilities in France to satisfy the financing requirements of TVN operations. These arrangements are summarized in the table below (in thousands):
 
September 29, 2017
 
December 31, 2016
Financing from French government agencies related to various government incentive programs (1)
$
20,205

 
$
17,930

Term loans (2)
1,334

 
1,400

Obligations under capital leases
1,334

 
1,860

  Total debt obligations
22,873

 
21,190

  Less: current portion
(7,434
)
 
(7,275
)
  Long-term portion
$
15,439

 
$
13,915

(1) As of September 29, 2017, the Company’s TVN French Subsidiary had an aggregate of $20.2 million of loans due to various financing programs of French government agencies, $17.3 million of which are related to loans backed by R&D tax credit receivables. As of September 29, 2017, the TVN French Subsidiary had an aggregate of $26.5 million of R&D tax credit receivables from the French government from 2018 through 2021. (See Note 8, “Balance Sheet Components-Prepaid expenses

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and other current assets,” for more information). These tax loans have a fixed rate of 0.6%, plus EURIBOR 1 month + 1.3% and mature between 2018 through 2020. The remaining loans of $2.9 million at September 29, 2017 primarily relate to financial support from French government agencies for R&D innovation projects at minimal interest rates and these loans mature between 2020 through 2023.

(2) One of the term loans with a certain financial institution contains annual covenants that require the TVN French Subsidiary to maintain a minimum working capital balance and various other financial covenants and restrictions that limit the French Subsidiary’s ability to incur additional indebtedness. The annual covenant is based on French statutory year-end results and the TVN French Subsidiary failed the 2016 covenant test primarily due to the Company’s plan to integrate TVN’s operations into other subsidiaries for tax planning and logistics purposes. In early 2017, the Company informed the financial institution of the 2016 covenant test results and was told by the financial institution to continue with the original payment schedule. The Company reported the entire loan balance with this financial institution under “Other debts and capital lease obligations, current” in the Condensed Consolidated Balance Sheets. The loan balance was approximately $0.4 million at both September 29, 2017 and December 31, 2016.

Future minimum repayments

The table below shows the future minimum repayments of debts and capital lease obligations for TVN as of September 29, 2017 (in thousands):

Years ending December 31,
Capital lease obligations
 
Other Debt obligations
2017 (remaining three months)
$
305

 
$
616

2018
864

 
6,058

2019
93

 
6,995

2020
50

 
6,800

2021
22

 
505

Thereafter

 
565

Total
$
1,334

 
$
21,539


Line of Credit
On September 27, 2017, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (the “Bank”). The Loan Agreement provides for a secured revolving credit facility in an aggregate principal amount of up to $15.0 million. Under the terms of the Loan Agreement, the principal amount of loans, plus the face amount of any outstanding letters of credit, at any time cannot exceed up to 85% of the Company’s eligible receivables. Prior to November 1, 2017, the Company may borrow up to $7.5 million in excess of the borrowing base limit, calculated based on eligible accounts receivable balances. Under the terms of the Loan Agreement, the Company may also request letters of credit from the Bank. The proceeds of any loans under the Loan Agreement will be used for working capital and general corporate purposes.
There were no borrowings under the Loan Agreement from the closing of the Loan Agreement through September 29, 2017.
Loans under the Loan Agreement will bear interest, at the Company’s option, and subject to certain conditions, at an annual rate of either a prime rate or a LIBOR rate (each as customarily defined), plus an applicable margin. The applicable margin for LIBOR rate advances is 2.25%. There will be no applicable margin for prime rate advances when the Company is in compliance with the liquidity requirement of at least $20.0 million in the aggregate of consolidated cash plus availability under the Loan Agreement (the “Liquidity Requirement”) and a 0.25% margin for prime rate advances when the Company is not in compliance with the Liquidity Requirement. The Company may not request LIBOR advances when it is not in compliance with the Liquidity Requirement. Interest on each advance is due and payable monthly and the principal balance is due at maturity.
The Company’s obligations under the revolving credit facility are secured by a security interest on substantially all of its assets, excluding intellectual property.
The Loan Agreement contains customary affirmative and negative covenants limiting the Company’s ability and the ability of the Company’s subsidiaries, to, among other things, dispose of assets, undergo a change in control, merge or consolidate, make acquisitions, incur debt, incur liens, pay dividends, enter into affiliate transactions, repurchase stock and make investments, in each case subject to certain exceptions. The Company must comply with financial covenants requiring it to maintain (i) a short-term asset to short-term liabilities ratio of at least 1.10 to 1.00 and (ii) minimum adjusted EBITDA, in the amounts and for the

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periods as set forth in the Loan Agreement. The Company must also maintain a minimum liquidity amount, comprised of unrestricted cash held at accounts with the Bank plus proceeds available to be drawn under the Loan Agreement, equal to (i) at least $15.0 million at all times on or prior to October 31, 2017 and (ii) at least $10.0 million at all times on and after November 1, 2017. As of September 29, 2017, the Company was in compliance with the covenants under the Loan Agreement.

NOTE 12: EMPLOYEE BENEFIT PLANS AND STOCK-BASED COMPENSATION
Equity Award Plans
The Company’s stock benefit plans include the employee stock purchase plan and current active stock plans adopted in 1995 and 2002 as well as one stock plan in connection with an acquisition in 2010. See Note 13, “Employee Benefit Plans and Stock-based Compensation” of Notes to Consolidated Financial Statements in the 2016 Form 10-K for details pertaining to each plan.
The Company’s stockholders approved an amendment to the 1995 Stock Plan at the Company’s 2017 annual meeting of stockholders (the “2017 Annual Meeting”) which increased the number of shares of common stock reserved for issuance under the 1995 Stock Plan by 7,000,000 shares. The Company’s stockholders also approved an amendment to the 2002 Director Stock Plan at the 2017 Annual Meeting which increased the number of shares of common stock reserved for issuance under the 2002 Director Stock Plan by 400,000 shares.
The following table summarizes the Company’s stock option, restricted stock units (“RSUs”), performance-based stock awards (“PRSUs”) and market-based awards activities during the nine months ended September 29, 2017 (in thousands, except per share amounts):
 
 
 
Stock Options Outstanding
 
RSUs Outstanding**
 
Shares
Available for
Grant
 
Number
of
Shares
 
Weighted
Average
Exercise Price
 
Number
of
Units
 
Weighted
Average
Grant
Date Fair
Value
Balance at December 31, 2016
3,912

 
5,019

 
$
6.01

 
3,864

 
$
4.26

Authorized
7,400

 

 

 

 

Granted*
(4,446
)
 
30

 
5.10

 
2,943

 
5.40

Options exercised

 
(97
)
 
3.03

 

 

Shares released

 

 

 
(2,244
)
 
4.12

Forfeited*
2,490

 
(717
)
 
5.95

 
(1,182
)
 
5.05

Balance at September 29, 2017
9,356

 
4,235

 
$
6.09

 
3,381

 
$
5.04

* Grants of RSUs and any non-statutory stock options issued at prices less than the fair market value on the date of grant decrease the plan reserve 1.5 shares for every unit or share granted and any forfeitures of these awards due to their not vesting would increase the plan reserve by 1.5 shares for every unit or share forfeited.
** The preceding table includes PRSUs and market-based award activities during the nine months ended September 29, 2017.
Performance-based awards (PRSUs)
In August 2016, the Company granted 898,533 shares of PRSUs to fund a portion of its 2016 incentive bonus payment obligations to its key executives and other eligible employees. From March 2017 through April 2017, the Company granted another 582,806 PRSUs to fund its first half 2017 incentive bonus payment obligations. The vesting of the PRSUs is based on the achievement of certain financial and non-financial operating goals of the Company and vesting occurs within three to six months from the grant date. Each quarterly period, the Company estimates the probability of the achievement of these performance goals and recognizes any related stock-based compensation expense. If the achievement of such performance goals is not probable, no compensation expense is recognized.
Market-based awards

In the nine months ended September 29, 2017, the Company granted 344,500 RSUs to its key executives and certain eligible employees that may vest during a three-year period as part of its long-term incentive program. The vesting conditions of these

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awards are tied to the market value of the Company's common stock. The fair value of these shares was estimated using a Monte-Carlo simulation.

The following table summarizes information about stock options outstanding as of September 29, 2017 (in thousands, except per share amounts and terms):
 
Number
of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
Vested and expected to vest
4,176

 
$
6.10

 
3.1
 
$
84

Exercisable
3,505

 
6.31

 
2.7
 
84

The intrinsic value of options vested and expected to vest and exercisable as of September 29, 2017 is calculated based on the difference between the exercise price and the fair value of the Company’s common stock as of September 29, 2017. The intrinsic value of options exercised is calculated based on the difference between the exercise price and the fair value of the Company’s common stock as of the exercise date. The intrinsic value of options exercised during the three and nine months ended September 29, 2017 was $6,000 and $0.3 million, respectively. The intrinsic value of options exercised during both the three months and nine months ended September 30, 2016 was $0.1 million.

The following table summarizes information about RSUs and PRSUs outstanding as of September 29, 2017 (in thousands, except term):
 
Number of
Shares
Underlying
Restricted
Stock
Units
 
Weighted
Average
Remaining
Vesting
Period
(Years)
 
Aggregate
Fair
Value
Vested and expected to vest
2,759

 
0.8
 
$
8,415

The fair value of RSUs and PRSUs vested and expected to vest as of September 29, 2017 is calculated based on the fair value of the Company’s common stock as of September 29, 2017.
Employee Stock Purchase Plan (“ESPP”)
The Company’s stockholders approved an amendment to the 2002 Employee Stock Purchase Plan (the “ESPP”) at the 2017 Annual Meeting which increased the number of shares of common stock reserved for issuance under the ESPP by 1,500,000 shares. As of September 29, 2017, the number of shares of common stock available for issuance under the ESPP was 1,114,796. In the event that there are insufficient shares in the plan to fully fund the issuance, the available shares will be allocated across all participants based on their contributions relative to the total contributions received for the offering period.
Retirement Benefit Plan
As part of the TVN acquisition the Company assumed obligations under a defined benefit pension plan. The plan is unfunded and there are no contributions to the plan required by any laws or funding regulations, discretionary contributions or non-cash contributions expected to be made. The table below shows the components of net periodic benefit costs (in thousands):
 
Three months ended
 
Nine months ended
 
September 29, 2017
 
September 30, 2016
 
September 29,
2017
 
September 30,
2016
Service cost
$
55

 
$
70

 
$
165

 
$
164

Interest cost
16

 
29

 
48

 
68

Recognized net actuarial loss
1

 

 
4

 

  Net periodic benefit cost included in operating loss
$
72

 
$
99

 
$
217

 
$
232

The present value of the Company’s pension obligation as of September 29, 2017 was $5.1 million, of which $55,000 was reported under “Accrued and other liabilities” and $5.0 million was reported under “Other non-current liabilities” on the Company’s

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Condensed Consolidated Balance Sheets. The present value of the Company’s pension obligation as of December 31, 2016 was $4.3 million.

401(k) Plan
The Company has a retirement/savings plan for its U.S. employees, which qualifies as a thrift plan under Section 401(k) of the Internal Revenue Code. This plan allows participants to contribute up to the applicable Internal Revenue Code limitations under the plan. The Company has made discretionary contributions to the plan of 25% of the first 4% contributed by eligible participants, up to a maximum contribution per participant of $1,000 per year. The contributions for the nine months ended September 29, 2017 and September 30, 2016 were $326,000 and $316,000, respectively.

Stock-based Compensation
The following table summarizes stock-based compensation expense for all plans (in thousands):
 
Three months ended
 
Nine months ended
 
September 29,
2017
 
September 30,
2016
 
September 29,
2017
 
September 30,
2016
Stock-based compensation in:
 
 
 
 
 
 
 
Cost of revenue
$
478

 
$
360

 
$
1,623

 
$
1,011

Research and development expense
1,183

 
771

 
3,496

 
2,581

Selling, general and administrative expense
2,059

 
1,549

 
5,988

 
4,950

Total stock-based compensation in operating expense
3,242

 
2,320

 
9,484

 
7,531

Total stock-based compensation
$
3,720

 
$
2,680

 
$
11,107

 
$
8,542

As of September 29, 2017, the Company had approximately $13.5 million of unrecognized stock-based compensation expense related to unvested stock options and awards that are expected to be recognized over a weighted-average period of approximately 1.6 years.
Valuation Assumptions
The Company estimates the fair value of employee stock options and stock purchase rights under the ESPP using a Black-Scholes option valuation model. The value of the stock purchase rights under the ESPP consists of: (1) the 15% discount on the purchase of the stock; (2) 85% of the fair value of the call option; and (3) 15% of the fair value of the put option. The call option and put option were valued using the Black-Scholes option pricing model. At the date of grant, the Company estimated the fair value of each stock option grant and stock purchase right granted under the ESPP using the following weighted average assumptions:
 
Employee Stock Options
 
Three months ended
 
Nine months ended
 
September 30,
2016
 
September 29,
2017
 
September 30,
2016
Expected term (years)
4.30

 
4.60

 
4.30

Volatility
39
%
 
43
%
 
36
%
Risk-free interest rate
1.0
%
 
1.7
%
 
1.4
%
Expected dividends
0.0
%
 
0.0
%
 
0.0
%
There were no employee stock options granted in the three months ended September 29, 2017.

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ESPP Purchase Period Ending
 
December 31,
2017
 
June 30,
2017
 
December 31,
2016
 
July 1,
2016
Expected term (years)
0.50

 
0.49

 
0.50

 
0.5

Volatility
43
%
 
41
%
 
70
%
 
54
%
Risk-free interest rate
1.2
%
 
1.0
%
 
0.6
%
 
0.4
%
Expected dividends
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Estimated weighted average fair value per share at purchase date
$1.42
 
$1.40
 
$1.04
 
$1.19
The expected term of the employee stock options represents the weighted-average period that the stock options are expected to remain outstanding. The computation of the expected term was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The expected term of the stock purchase rights under the ESPP represents the period of time from the beginning of the offering period to the purchase date. The Company uses its historical volatility for a period equivalent to the expected term of the options to estimate the expected volatility. The risk-free interest rate that the Company uses in the Black-Scholes option valuation model is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term. The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
Prior to January 1, 2017, stock-based compensation expense was recorded net of estimated forfeitures in the Company’s condensed consolidated statements of operations and, accordingly, was recorded for only those stock-based awards that the Company expected to vest. Upon the adoption of the accounting standard update (ASU 2016-09, “Improvements to Employee Share-Based payments”) issued by FASB, effective January 1, 2017, the Company changed its accounting policy to account for forfeitures as they occur. The change was applied on a modified retrospective approach with a cumulative effect adjustment of $69,000 to retained earnings as of January 1, 2017 (which increased the accumulated deficit).
The Company estimated the fair value of the market-based awards granted in March 2017 on the date of grant using a Monte Carlo simulation with the following assumptions: volatility 46.7%, risk-free interest rate 1.57% and dividend yield of 0%.
Total compensation cost recognized related to these market-based awards was approximately $0.4 million and $0.8 million for the three and nine months ended September 29, 2017, respectively. As of September 29, 2017, $0.5 million of total unrecognized compensation cost related to these awards is expected to be recognized over a weighted-average period of approximately 0.56 years.

The weighted-average fair value per share of options granted was $1.00 for the three months ended September 30, 2016. There were no options granted during the three months ended September 29, 2017. The weighted-average fair value per share of options granted was $1.85 and $0.97 for the nine months ended September 29, 2017 and September 30, 2016, respectively.

The fair value of all stock options vested during the three months ended September 29, 2017 and September 30, 2016 was $0.3 million and $0.4 million, respectively. The fair value of all stock options vested during the nine months ended September 29, 2017 and September 30, 2016 was $1.4 million and $1.8 million, respectively.

There were no realized tax benefits attributable to stock options exercised in jurisdictions where this expense is deductible for tax purposes for the three and nine months ended September 29, 2017 and September 30, 2016, respectively.

The aggregate fair value of RSUs and PRSUs released during the three months ended September 29, 2017 and September 30, 2016 was $1.9 million and $1.6 million, respectively. The aggregate fair value of RSUs and PRSUs released during the nine months ended September 29, 2017 and September 30, 2016 was $9.2 million and $8.6 million, respectively.



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NOTE 13: INCOME TAXES
The Company reported the following operating results for the periods presented (in thousands):
 
Three months ended
 
Nine months ended
 
September 29,
2017
 
September 30,
2016
 
September 29,
2017
 
September 30,
2016
Loss before income taxes
$
(17,498
)
 
$
(16,254
)
 
$
(72,678
)
 
$
(61,353
)
(Benefit from) provision for income taxes
(1,915
)
 
(242
)
 
(1,568
)
 
518

Effective income tax rate
10.9
%
 
1.5
%

2.2
%

(0.8
)%
The Company operates in multiple jurisdictions and its profits are taxed pursuant to the tax laws of these jurisdictions. The Company’s effective income tax rate may be affected by changes in, or interpretations of tax laws and tax agreements in any given jurisdiction, utilization of net operating loss and tax credit carry forwards, changes in geographical mix of income and expense, and changes in management’s assessment of matters such as the ability to realize deferred tax assets. The Company’s effective tax rate varies from year to year primarily due to the absence of several onetime, discrete items that benefited or decremented the tax rates in the previous years.
The Company’s effective income tax rate of 2.2% for the nine months ended September 29, 2017 was different from the U.S. federal statutory rate of 35%, primarily due to the Company’s geographical income mix and favorable tax rates associated with certain earnings from operations in lower-tax jurisdictions, partially offset by the increase in the valuation allowance against U.S. federal, California and other state deferred tax assets and detriment from non-deductible stock-based compensation. In addition, in the first quarter of 2017, the Company was able to recognize a one-time tax benefit of approximately $1.2 million as a result of the merger of the Company’s two subsidiaries in Israel, which was approved by the Israeli government in the first quarter of 2017. In the third quarter of 2017, the Company recorded $2.4 million of tax benefit associated with the release of tax reserves for uncertain tax positions resulting from the expiration of the statutes of limitations on the Company’s US corporate tax returns for the 2013 tax year. For the nine months ended September 29, 2017, the remaining discrete adjustments to the Company's tax expense were primarily withholding taxes and the accrual of interest on uncertain tax positions.
The Company's effective income tax rate of (0.8)% for the nine months ended September 30, 2016 was different from the U.S. federal statutory rate of 35%, primarily due to favorable tax rates associated with certain earnings from operations in lower-tax jurisdictions, and the tax benefit from the realization of certain deferred tax assets as a result of the TVN acquisition, partially offset by the increase in the valuation allowance against U.S. federal, California and other state deferred tax assets, detriment from non-deductible stock-based compensation, non-deductible amortization of foreign intangibles, and the net of various discrete tax adjustments.
The Company files U.S. federal and state, and foreign income tax returns in jurisdictions with varying statutes of limitations during which such tax returns may be audited and adjusted by the relevant tax authorities. The 2014 through 2016 tax years generally remain subject to examination by U.S. federal and most state tax authorities. In significant foreign jurisdictions, the 2007 through 2016 tax years generally remain subject to examination by their respective tax authorities. In 2016, the U.S. Internal Revenue Service concluded its examination of the Company’s income tax return for the tax year 2012, which commenced in August 2015. In addition, a subsidiary of the Company was under audit for the 2012 and 2013 tax years, which commenced in 2015, by the Israel tax authority and concluded with no adjustment. If, upon the conclusion of an audit, the ultimate determination of taxes owed in the jurisdictions under audit is for an amount in excess of the tax provision the Company has recorded in the applicable period, the Company’s overall tax expense, effective tax rate, operating results and cash flow could be materially and adversely impacted in the period of adjustment.
The Company’s operations in Switzerland are subject to a reduced tax rate under the Switzerland tax holiday which requires various thresholds of investment and employment in Switzerland. The Company has met these various thresholds and the Switzerland tax holiday is effective through the end of 2018.
As of September 29, 2017, the total amount of gross unrecognized tax benefits, including interest and penalties, was approximately $17.6 million, of which $0.7 million would affect the Company’s effective tax rate if the benefits are eventually recognized. The remaining gross unrecognized tax benefit does not affect the Company’s effective tax rate as it relates to positions that would be settled with tax attributes such as net operating loss carryforward or tax credits previously subject to a valuation allowance. The Company recognizes interest and penalties related to unrecognized tax positions in income tax expense. The Company had $0.4 million of gross interest and penalties accrued as of September 29, 2017. The Company will continue to review its tax positions and provide for, or reverse, unrecognized tax benefits as issues arise. As of September 29, 2017, the Company anticipates that the balance of gross unrecognized tax benefits will decrease up to approximately $0.5 million due to expiration of the applicable statutes of limitations over the next 12 months.

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In March 2016, the FASB issued an accounting standard update for the accounting of share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The new standard eliminated the requirement to report excess tax benefits and certain tax deficiencies related to share-based payment transactions as additional paid-in capital. It also removes the requirement to delay recognition of a windfall tax benefit until it reduces current taxes payable. Under the new guidance, the benefit will be recorded when it arises, subject to normal valuation allowance considerations. The Company adopted this new accounting standard beginning in the first quarter of fiscal 2017 using a modified-retrospective transition method and recorded a cumulative effect of $4.6 million of additional gross deferred tax asset associated with shared-based payment and an offsetting valuation allowance of the same amount, therefore resulting