Source: http://ir.acacia-inc.com/node/8886/html
Timestamp: 2019-04-24 08:39:35+00:00

Document:
As of October 26, 2018, the registrant had 40,443,237 shares of common stock issued and outstanding.
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact contained in this Form 10-Q, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.
our ability to anticipate the timing and scale of ZTE’s demand for our products.
Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events or otherwise.
Acacia Communications, Inc. was incorporated on June 2, 2009, as a Delaware corporation. Acacia Communications, Inc. and its wholly-owned subsidiaries (the “Subsidiaries”) are collectively referred to as the Company. The Company is a leading provider of high-speed coherent optical interconnect products that transform communications networks, relied upon by cloud infrastructure operators and content and communication service providers, through improvements in performance and capacity and reductions in associated costs. The Company’s products include a family of low-power coherent digital signal processors and silicon photonic integrated circuits that it has integrated into families of optical interconnect modules with transmission speeds ranging from 100 to 400 gigabits per second for use in long-haul, metro and inter-data center markets. The Company is also sampling its AC1200 module that will enable, across dual wavelengths, transmission capacity of 1.2 terabits (1,200 gigabits) per second and above.
The Company is headquartered in Maynard, Massachusetts, and has established wholly-owned subsidiaries in North America, Europe and Asia as part of the Company’s global expansion.
The unaudited condensed consolidated financial statements include the accounts of Acacia Communications, Inc. and its Subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for annual financial statements. For further information, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, which was filed with the SEC on February 22, 2018. There have been no significant changes in the Company’s accounting policies from those disclosed in the Annual Report on Form 10-K that have had a material impact on the Company’s condensed consolidated financial statements.
The unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2017, and in management’s opinion, include all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s condensed consolidated balance sheet as of September 30, 2018, its condensed consolidated statements of operations for the three and nine months ended September 30, 2018 and 2017, its condensed consolidated statements of comprehensive income (loss) for the three and nine months ended September 30, 2018 and 2017, its condensed consolidated statements of stockholders’ equity for the nine months ended September 30, 2018 and 2017, and its condensed consolidated statements of cash flows for the nine months ended September 30, 2018 and 2017. All intercompany balances and transactions have been eliminated in consolidation. The financial data and the other financial information disclosed in the notes to these condensed consolidated financial statements related to the three and nine months ended September 30, 2018 and 2017 are also unaudited. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the full fiscal year or any other period.
The preparation of unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”) which supersedes the revenue recognition requirements in Accounting Standard Codification 605, Revenue Recognition (“ASC 605”) and affects any entity that enters into contracts with customers to transfer goods and services. On January 1, 2018, the Company adopted ASC 606 and all related amendments for all contracts not completed as of the adoption date using the modified retrospective method. The Company recognized the $0.2 million cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.
In accordance with ASC 606, the Company recognizes revenue under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the consideration the Company expects to be entitled. In order to achieve that core principle, the Company applies the following five step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract and (5) recognize revenue when a performance obligation is satisfied.
Revenue for product sales is recognized at the point in time when control transfers to the Company’s customers, which is generally when products are shipped from the Company’s manufacturing facilities or when delivered to the customer’s named location. When the Company performs shipping and handling activities after the transfer of control to the customer (e.g., when control transfers prior to delivery), they are considered to be fulfillment activities, and accordingly, the costs are accrued for when the related revenue is recognized. Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from revenue. See Note 3 for further disclosures and detail regarding revenue. As the impact of ASC 606 is not material to the Company, there is no pro-forma disclosure presented as of and for the three and nine months ended September 30, 2018. The Company expects the impact of the adoption of the new standard to be immaterial to its results of operations on an ongoing basis.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”). ASU 2016-16 requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in ASU 2016-16 are effective for fiscal years beginning after December 15, 2017, and were adopted by the Company in the first quarter of 2018. The amendments in ASU 2016-16 were applied using a modified retrospective approach. As the Company has not had any intra-entity transfers of assets in such period other than inventory, there has been no impact from the adoption of this standard.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash (“ASU 2016-18”). The amendments in ASU 2016-18 require that the statement of cash flows explain the change in total cash, cash equivalents and restricted cash. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company adopted the amendments in ASU 2016-18 in the first quarter of 2018 using a retrospective transition method. Other than the revised statement of cash flows presentation of restricted cash in the prior period presented, which was immaterial, the adoption of ASU 2016-18 did not have a material impact on the Company’s condensed consolidated financial statements for the three and nine months ended September 30, 2017. There is no impact to the cash flow statement for the nine months ended September 30, 2018 as there was no restricted cash balance as of the beginning or end of the period.
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”). ASU 2018-02 allows an entity to reclassify stranded income tax effects resulting from the U.S. Tax Cuts and Jobs Act (the “Act”) from accumulated other comprehensive loss to retained earnings. The amendments in ASU 2018-02 are effective for fiscal years beginning after December 15, 2018, with early adoption permitted, including adoption in any interim period for which financial statements have not yet been issued. The Company adopted and applied the ASU 2018-02 amendments in the second quarter of 2018. The adoption of the ASU 2018-02 amendments resulted in a $0.1 million cumulative-effect adjustment as of April 1, 2018, the first day of the Company’s second quarter of fiscal year 2018, between accumulated other comprehensive loss and retained earnings for the amount of the stranded tax effects.
and applied the ASU 2018-15 amendments on a prospective basis as of July 1, 2018, the first day of the Company’s third quarter of fiscal year 2018. The adoption of the ASU 2018-15 amendments resulted in approximately $0.2 million of implementation costs incurred in a hosting arrangement that is a service contract being capitalized as of September 30, 2018.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 is intended to provide more decision-useful information about expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The main provisions include presenting financial assets measured at amortized cost at the amount expected to be collected, which is net of an allowance for credit losses, and recording credit losses related to available-for-sale securities through an allowance for credit losses. The amendments in ASU 2016-13 are effective for fiscal years beginning after December 15, 2019, and must be applied using a modified retrospective approach with earlier adoption permitted for fiscal years beginning after December 15, 2018. The Company does not expect the adoption of this amendment to have a material impact on its condensed consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 will require lessees to recognize a right-of-use asset and lease liability on the balance sheet for virtually all leases. For the statement of operations, ASU 2016-02 retains a dual model requiring leases to be classified as either operating or financing leases. Operating leases will result in straight-line expense, and financing leases will have a front-loaded expense pattern with an interest expense component. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, and must be applied using a modified retrospective approach with earlier adoption permitted. The Company plans to adopt this guidance on January 1, 2019, and expects the adoption will have a material impact on its condensed consolidated balance sheets based on the valuation of right-of-use assets and lease liabilities, previously described as operating leases, calculated as the present value of the Company’s forecasted future lease commitments. The Company is continuing to assess the overall impacts of the new standard, including the discount rate to be applied in these valuations and increased leasing disclosures, as well as policy and process changes to support the new standard.
The Company adopted ASC 606 effective January 1, 2018 using the modified retrospective method. The Company recognized the cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of retained earnings. The comparative information is accounted for in accordance with the previous revenue guidance, ASC 605, and has not been restated. Revenue recognized prior to the effective date is accounted for in accordance with the accounting policies disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017. The following are the policies the Company has applied beginning January 1, 2018.
The Company generates all of its revenue from contracts with customers. The Company considers customer purchase orders, which in many cases are governed by master purchasing agreements, to be contracts with customers. The Company’s contracts with customers are generally for product only, and do not include other performance obligations such as services, extended warranties or other material rights. As part of its assessment of each contract, the Company evaluates certain factors including the customer’s ability to pay (or credit risk). For each contract, the Company considers the promise to transfer products, each of which is distinct, to be the identified performance obligations. In determining the transaction price, the price stated on the purchase order is typically fixed and represents the net consideration to which the Company expects to be entitled, and therefore there is no variable consideration. As the Company’s standard payment terms are less than one year, the Company has elected, as a practical expedient, to not assess whether a contract has a significant financing component. The Company allocates the transaction price to each distinct product based on its relative standalone selling price. The product price as specified on the purchase order is considered the standalone selling price as it is an observable source that depicts the price as if sold to a similar customer in similar circumstances. Revenue is recognized when control of the product is transferred to the customer (i.e., when the Company’s performance obligation is satisfied), which typically occurs upon shipment from the Company’s manufacturing site or delivery to the customer’s named location. In determining whether control has transferred, the Company considers if there is a present right to payment from the customer and when physical possession, legal title and risks and rewards of ownership have transferred to the customer. The Company also considered certain customer contracts that include acceptance clauses, but has concluded that delivery to the customer’s named location is the point at which the customer is able to direct the use of and obtain substantially all of the remaining benefits from the asset, and therefore the acceptance is considered a formality that does not impact the timing of revenue recognition.
delivered, assuming transfer of control has occurred. As scheduled delivery dates are within one year, the Company has elected to use the optional exemption whereby revenues allocated to future shipments of partially completed contracts are not disclosed.
The Company generally provides an assurance warranty that its products will substantially conform to the agreed-upon specifications for 12 to 24 months from the date of shipment. The Company’s liability is limited to the cost of repair or replacement of the defective part. The Company does not consider activities related to such warranties to be a separate performance obligation. The terms and conditions of sale generally do not allow for refunds or product returns other than for warranty repairs.
The Company has a limited number of customer contracts that provide for the performance of services or include multiple performance obligations. Once the Company determines the performance obligations, the Company determines the transaction price, which includes estimating the amount of variable consideration to be included in the transaction price, if any. The Company then allocates the transaction price to each performance obligation in the contract based on a relative stand-alone selling price method or using the variable consideration allocation exception if the required criteria are met. The corresponding revenues are recognized as the related performance obligations are satisfied.
The amounts of revenue recognized in the period that were included in the opening deferred revenue balance was immaterial for the three and nine months ended September 30, 2018. The increase in current and non-current deferred revenue is related to billings to, or advance payments from, customers for which the Company has not yet fulfilled its performance obligations. Deferred revenue not expected to be recognized within the Company’s operating cycle of one year is presented as a component of “Other long-term liabilities” on the condensed consolidated balance sheet.
The Company has concluded that none of the costs it has incurred to obtain and fulfill its ASC 606 contracts meet the capitalization criteria, and as such, there are no costs deferred and recognized as assets on the condensed consolidated balance sheet.
The following table provides information about disaggregated revenue based on the geographic region of the Company’s customers’ ship-to destinations, which in certain instances may be the location of a contract manufacturer rather than the Company’s end customer. Further disaggregation of revenue by geographic country can be found in Note 13.
Losses represent marketable securities that were in loss positions for less than one year.
limited to: the length of time each security was in an unrealized loss position; the extent to which fair value was less than cost; the financial condition and near-term prospects of the issuers; and the Company’s intent not to sell these securities and the assessment that it is more likely than not that the Company would not be required to sell these securities before the recovery of their amortized cost basis.
On April 15, 2018, the U.S. Department of Commerce imposed a seven-year denial of export privileges that prohibited sales to ZTE Kangxun Telecom Co. Ltd. and certain of its affiliates, together ZTE, the Company’s largest customer (the “ZTE Ban”). As a result, the Company recorded inventory write-offs of $3.9 million in the first quarter of 2018 related to finished goods inventory that had either been designed specifically for ZTE, or had been intended for consumption by ZTE and had become excess inventory due to the suspension of sales to ZTE. On June 8, 2018, ZTE and the U.S. Department of Commerce reached a new settlement, pursuant to which the ZTE Ban was terminated and ZTE was removed from the Denied Persons List effective July 13, 2018. As a result of the ZTE Ban being terminated, the Company was able to consume a portion of the ZTE inventory, resulting in a remaining reserve of $2.7 million as of September 30, 2018.
Depreciation expense was $3.5 million and $3.3 million for the three months ended September 30, 2018 and 2017, respectively, and $10.1 million and $9.1 million for the nine months ended September 30, 2018 and 2017, respectively.
Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3—Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company’s investments in money market funds, repurchase agreements, U.S. government agency debt securities, commercial paper, certificates of deposit, asset-backed securities and corporate debt securities, which are classified as Level 2 within the fair value hierarchy, were initially valued at the transaction price and subsequently valued at each reporting date utilizing market-observable data. The market-observable data included reportable trades, benchmark yields, credit spreads, broker/dealer quotes, bids, offers, current spot rates and other industry and economic events.
There were no transfers between fair value measurement levels during the three and nine months ended September 30, 2018 or 2017. For certain other financial instruments, including accounts receivable, accounts payable and other current liabilities, the carrying amounts approximate their fair value due to the relatively short maturity of these balances.
As of September 30, 2018 and December 31, 2017, there was $3.0 million and $4.8 million, respectively, of unrecognized compensation cost related to unvested common stock options which is expected to be recognized over weighted-average periods of 1.6 years and 2.2 years, respectively.
The weighted-average grant date fair value of stock options granted during the nine months ended September 30, 2018 was $15.58. No stock option awards were issued by the Company during the three months ended September 30, 2018 or the three or nine months ended September 30, 2017.
During the nine months ended September 30, 2018, the Company granted approximately 712,000 restricted stock units (“RSUs”) to employees and executives under the 2016 Equity Incentive Plan that vest upon the satisfaction of a service condition, generally over four years. The cost of any RSUs with only a service condition is determined using the fair value of the Company’s common stock on the date of grant, and compensation is recognized on a straight-line basis over the requisite vesting period.
During the nine months ended September 30, 2018, the Company granted awards covering up to a maximum of 94,854 performance-based RSUs to executive officers that include a market condition in addition to a service condition (“performance-based RSUs” or “PRSUs”). Each PRSU represents the right to receive one share of the Company’s common stock when and if the applicable vesting conditions are satisfied. The PRSUs are subject to performance-based vesting. The number of PRSUs that vest is measured based on the level of achievement of a performance objective over a three-year period (the “Performance Period”) running from January 1, 2018 through December 31, 2020, as determined and certified by the Compensation Committee of the Board of Directors following the end of the Performance Period. The level of achievement will be determined based on the Company’s percentile achievement of relative total shareholder returns against an external comparator group during the Performance Period (the “Relative TSR Objective”). Vesting of the PRSUs is also subject to the applicable officer’s continued provision of services to the Company through the vesting date, except in the case of death or disability where vesting will be pro-rated for time worked during the Performance Period. No PRSUs will vest unless a threshold level of achievement of the Relative TSR Objective is achieved.
As soon as practicable following each vesting date of RSUs, including PRSUs, the Company will issue to the holder of the RSUs the number of shares of common stock equal to the aggregate number of RSUs that have vested. Notwithstanding the foregoing, the Company may, in its sole discretion, in lieu of issuing shares of common stock to the holder of the RSUs, pay the holder an amount in cash equal to the fair market value of such shares of common stock. To date, the Company has not settled any vested RSUs with cash.
The granted amount includes the 94,854 PRSUs which is the maximum number that were granted to executives during the nine months ended September 30, 2018.
As of September 30, 2018 and December 31, 2017, there was $58.3 million and $47.8 million, respectively, of total unrecognized compensation cost related to unvested RSUs which is expected to be recognized over weighted-average periods of 2.7 years and 2.9 years, respectively.
As discussed further in Note 9, in 2018 the Company granted a maximum of 94,854 PRSUs to executives that include a market condition and a service condition. An estimate of the number of shares contingently issuable based on average market prices through September 30, 2018 has been included in the antidilutive table above.
The Company’s principal facilities are located in Maynard, Massachusetts and Holmdel, New Jersey and are leased by the Company under non-cancelable operating leases that expire in February 2025, with respect to the Massachusetts facility, and January 2022, with respect to the New Jersey facility. The Company also leases office space in various locations with expiration dates between 2019 and 2021. Several of the lease agreements include leasehold improvement incentives, escalating lease payments, renewal provisions and other provisions which require the Company to pay taxes, insurance and maintenance costs. All of the Company’s facility leases are accounted for as operating leases. Rent expense is recorded over each respective lease term on a straight-line basis. Rent expense was $1.2 million for the three months ended September 30, 2018 and 2017, and $3.6 million and $3.9 million for the nine months ended September 30, 2018 and 2017, respectively.
In addition to the lease payments, the Company has committed to approximately $1.3 million for tenant improvements at its Maynard and San Jose facilities that are expected to be incurred during the next two quarters.
The Company’s standard warranty obligation to its customers provides for repair or replacement of a defective product at the Company’s discretion for a period of time following purchase, generally between 12 and 24 months. Factors that affect the warranty obligation include product failure rates, material usage and service delivery costs incurred in correcting product failures. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. The estimated cost associated with fulfilling the Company’s warranty obligation to customers is recorded in cost of revenue.
In May 2017, the Company announced a quality issue at one of its three contract manufacturers (the “Quality Issue”) that affected a portion of the units manufactured by the contract manufacturer over an approximate four month period, which is estimated at approximately 1,300 AC400 units and 5,100 CFP units under warranty. Based on the ongoing evaluation of such units, the Company established reserves to cover anticipated costs, including cost estimates for product repairs, rework of component inventory with the contract manufacturer and rescreening costs associated with this Quality Issue. These costs are estimated based on the results of completed testing in addition to yield, fall-out rates and component part recovery cost estimates based on the Company’s historical experience.
On January 21, 2016, ViaSat, Inc. filed a lawsuit in California state court, later removed to the U.S. District Court for the Southern District of California, against the Company alleging, among other things, breach of contract, breach of the implied covenant of good faith and fair dealing and misappropriation of trade secrets. On February 19, 2016, the Company responded to ViaSat’s lawsuit and alleged counterclaims against ViaSat including, among other things, patent misappropriation, breach of contract, breach of the implied covenant of good faith and fair dealing, misappropriation of trade secrets and unfair competition, which ViaSat denied in its response filed March 16, 2016. On September 28, 2018 the matter was remanded back to California state court and is currently pending a scheduling conference with the judge. While it is not possible to predict the outcome of this matter with certainty, based on the information available to the Company today, the Company currently believes that this lawsuit will not have a material adverse effect on the Company’s business or its consolidated financial position, results of operations or cash flows.
On July 28, 2017, the Company filed a lawsuit in the Commonwealth of Massachusetts Superior Court - Business Litigation Session against ViaSat asserting commercial disparagement, libel, slander of title, unfair competition, intentional interference with advantageous relations and intentional interference with contractual relations. On April 5, 2018, ViaSat responded to the Company’s action and alleged counterclaims including, among other things, breach of contract, breach of the implied covenant of good faith and fair dealing, misappropriation of trade secrets, and unfair competition. On October 23, 2018, the court entered a scheduling order requiring fact and expert discovery to be completed in the first half of 2019. While it is not possible to predict the outcome of this matter with certainty, based on the information available to us today, we currently believe that this lawsuit will not have a material adverse effect on our business or our consolidated financial position, results of operations or cash flows.
Both the California and Massachusetts lawsuits with ViaSat are still pending, and discovery is closed in the California action filed by ViaSat and ongoing in the Massachusetts action filed by the Company.
August 14, 2017; Zhang v. Acacia Communications, Inc., et al., Case No. 1:17-cv-11518 (D. Mass.), filed August 16, 2017; and Kebler v. Acacia Communications, Inc., et al., Case No. 1:17-cv-11695 (D. Mass.), filed September 7, 2017. Each complaint purports to be brought on behalf of an alleged class of those who purchased the Company’s securities between August 11, 2016 and July 13, 2017, and alleges that the defendants violated Sections 10(b) and/or 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by making allegedly false and/or misleading statements regarding, among other matters, demand for the Company’s products, the Company’s financial guidance, and/or the Company’s quality control process as it relates to the Quality Issue. Each complaint seeks, among other relief, unspecified compensatory damages, attorneys’ fees, and costs.
On October 13, 2017, a fourth purported securities class action complaint was filed in the U.S. District Court for the District of Massachusetts against the Company, certain of its directors and executive officers (Murugesan Shanmugaraj, John Gavin, Francis Murphy, Eric Swanson, Peter Chung, Benny Mikkelsen, Stan Reiss, John Ritchie, Vincent Roche, Mehrdad Givehchi, John LoMedico, Bhupendra Shah and Christian Rasmussen), certain persons or entities that sold the Company’s common stock in the Company’s October 2016 follow-on public offering, and the underwriters of such offering, captioned Rollhaus v. Acacia Communications, Inc., et al., Case No. 17-cv-11988 (D. Mass). The complaint purports to be brought on behalf of an alleged class of those who purchased the Company’s common stock pursuant to or traceable to the follow-on offering, and alleges that the defendants violated Sections 11, 12(a)(2) and/or 15 of the Securities Act of 1933 by making allegedly false and/or misleading statements regarding, among other matters, demand for the Company’s products, the Company’s financial guidance, and/or the Company’s quality control process as it relates to the Quality Issue. The complaint seeks, among other relief, unspecified compensatory damages, rescission, attorneys’ fees, and costs.
On November 7, 2017, the court consolidated these four securities class actions (under docket number 1:17-cv-11504). On November 9, 2017, the court appointed lead plaintiffs for the consolidated action. Lead plaintiffs filed a consolidated amended class action complaint on January 8, 2018. The amended complaint makes allegations similar to those in the original four complaints, against the same defendants, seeks similar relief as the original actions, and alleges that some or all of the defendants violated Sections 11, 12(a)(2) and/or 15 of the Securities Act of 1933 and Sections 10(b) and/or 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. All defendants filed motions to dismiss the consolidated amended complaint on February 9, 2018. The court held a hearing on the motions to dismiss on March 29, 2018, afforded the plaintiffs an additional 30 days to file a motion for leave to file a further amended complaint, and took the motions to dismiss under advisement. On April 30, 2018, plaintiffs filed a motion for leave to amend the complaint. On June 15, 2018, the court granted defendants’ motions to dismiss and denied plaintiffs leave to file an amended complaint. On June 25, 2018, the court entered judgment and dismissed the case against all the defendants. No notice of appeal has been filed.
In November and December 2017, three purported shareholder derivative lawsuits were filed in the United States District Court for the District of Massachusetts against certain of the Company’s directors and executive officers (Murugesan Shanmugaraj, John Gavin, Francis Murphy, Eric Swanson, Peter Chung, Benny Mikkelsen, Stan Reiss, John Ritchie, Vincent Roche, Mehrdad Givehchi, Bhupendra Shah and Christian Rasmussen) and the Company as a nominal defendant. A fourth purported shareholder derivative lawsuit was filed against the same defendants in the same court on March 13, 2018. The complaints are captioned Colgan v. Shanmugaraj et al., Case No. 1:17-cv-12350 (D. Mass.), filed November 29, 2017; Wong v. Shanmugaraj et al., Case No. 1:17-cv-12550 (D. Mass.), filed December 22, 2017; Dennis v. Shanmugaraj et al., Case No. 1:17-cv-12571 (D. Mass.), filed December 28, 2017; and Farah-Franco et al. v. Shanmugaraj et al., Case No. 1:18-cv-10465 (D. Mass), filed March 13, 2018. The court has consolidated these complaints with the class actions (under docket number 1:17-cv-11504).
The court appointed lead plaintiffs for the consolidated derivative actions on April 20, 2018. On May 1, 2018, plaintiff Dennis voluntarily dismissed his case without prejudice. Lead plaintiffs filed a consolidated amended derivative complaint on May 30, 2018. The amended derivative complaint generally alleges that the individual defendants breached fiduciary duties owed to the Company by making or causing the Company to make allegedly false and/or misleading statements regarding, among other matters, demand for the Company’s products, the Company’s financial guidance, and/or the Company’s quality control process as it relates to the Quality Issue, and by selling stock in Acacia with knowledge of these allegedly false and/or misleading statements. The complaint also alleges that certain individual defendants caused the Company to issue an allegedly false and/or misleading proxy statement on or about April 6, 2017 regarding, among other matters, the reelection of certain directors. The complaint purports to assert derivative claims for violation of Section 11 of the Securities Act of 1933; Sections 10(b), 14(a), and 29(b) of the Securities Exchange Act of 1934, as well as Rule 10b-5 promulgated thereunder; breach of fiduciary duty; insider trading; waste of corporate assets; and unjust enrichment. The complaint seeks to recover on behalf of the Company for any liability it incurs as a result of the individual defendants’ alleged misconduct. The complaint also seeks declaratory, equitable and monetary relief, restitution, and attorneys’ fees and costs.
On April 9, 2018, a purported shareholder filed a complaint against the Company in the Court of Chancery of the State of Delaware seeking to inspect certain of the Company’s books and records pursuant to 8 Del. C. §220 (“Section 220”). The complaint is captioned Silberberg v. Acacia Communications, Inc., Case No. 2018-0262-TMR (Del. Ch.). The Company filed its answer on April 27, 2018. The plaintiff filed a motion for judgment on the pleadings on May 1, 2018. The Company filed its cross-motion for judgment on the pleadings and opposition on May 11, 2018. The plaintiff replied on May 16, 2018. The Court held a telephonic hearing on these motions on May 29, 2018. On June 1, 2018, the Chancery Court granted the plaintiff’s motion and entered judgment for the plaintiff, and the Company thereafter produced documents to the shareholder pursuant to his Section 220 demand.
On July 19, 2018, the parties reached an agreement in principle to settle the above-referenced derivative litigation and Section 220 litigation. The settlement involves certain corporate governance changes. The settlement is contingent on approval by the court in the District of Massachusetts hearing the consolidated derivative actions.
On September 14, 2018, the parties executed their Stipulation and Agreement of Settlement, Compromise and Release, and the plaintiffs filed a motion for preliminary approval of the settlement. On September 17, 2018, the court issued an order preliminarily approving the settlement, requiring notice of the settlement be issued to the Company’s shareholders, and scheduling a hearing to consider final approval of the settlement. The plaintiffs will seek an award of attorneys’ fees and costs, which the Company intends to oppose. The settlement is not contingent on the plaintiffs’ request for attorneys’ fees and costs. The hearing to consider final settlement approval and the plaintiffs’ request for an award of attorneys’ fees and costs is scheduled for December 19, 2018. There can be no assurance that the settlement will be approved by the court.
The Company intends to continue to engage in a vigorous defense of the litigation described above. However, the Company is unable to predict the ultimate outcome of these proceedings, and, therefore cannot estimate possible losses or ranges of losses, if any, or the materiality of any such losses. An unfavorable resolution of these matters in any reporting period may have a material adverse effect on the Company’s results of operations and cash flows for that period. In addition, the timing of the final resolution of these proceedings is uncertain. The Company will incur litigation and other expenses as a result of these proceedings, which could have a material impact on the Company’s business, consolidated financial position, results of operations and cash flows.
In addition, from time to time the Company may become involved in legal proceedings or be subject to claims arising in the ordinary course of its business. Although the results of litigation and claims cannot be predicted with certainty, the Company currently believes that the final outcome of these ordinary course matters will not have a material adverse effect on the Company’s business or on its consolidated financial position, results of operations or cash flows. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources and other factors.
In the ordinary course of business, the Company enters into various agreements containing standard indemnification provisions. The Company’s indemnification obligations under such provisions are typically in effect from the date of execution of the applicable agreement through the end of the applicable statute of limitations. During the three and nine months ended September 30, 2018 and 2017, the Company did not experience any losses related to these indemnification obligations. The Company does not expect significant claims related to these indemnification obligations, and consequently, has concluded that the fair value of these obligations is not material. Accordingly, as of September 30, 2018 and December 31, 2017, no amounts have been accrued related to such indemnification provisions.
The Act was enacted on December 22, 2017 and, among other changes, this legislation: (1) reduced the U.S. federal corporate tax rate from 35% to 21%; (2) required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax-deferred; (3) created new taxes on certain foreign sourced earnings; (4) provided a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries; (5) included a new provision designed to currently tax certain global intangible low-taxed income (“GILTI”) of controlled foreign corporations, which allows for a deduction of up to 50% of GILTI (subject to some limitations) and the possibility of using foreign tax credits (“FTCs”) to reduce the resulting income tax liability (also subject to some limitations); and (6) limited the deduction for net operating loss carryovers generated in the taxable years beginning after December 31, 2017 to 80% of taxable income computed without regard to the deduction. Accounting Standard Codification (“ASC”) 740 requires filers to record the effect of tax law changes in the period enacted. However, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”) that permits filers to record provisional amounts during a measurement period ending no later than one year from the date of the Act’s enactment.
As of September 30, 2018, the Company has not completed the accounting for the tax effects of enactment of this legislation; however, the Company has made a reasonable estimate of the effects on its existing deferred tax balances, the one-time transition tax and provisional state taxes on future repatriations. For the items for which the Company was able to determine a reasonable estimate, the Company recognized a provisional amount of $31.4 million under SAB 118 as a component of income tax expense in the year ended December 31, 2017.
The Company is subject to income tax in the United States as well as other tax jurisdictions in which it conducts business. Earnings from non-U.S. activities are subject to local country income tax. As a result of the one-time transaction tax under the Act, the impact of GILTI on the Company’s future foreign earnings, and the lack of certain foreign governments’ withholding tax imposed on dividends, the Company no longer needs to take a position as to the permanent reinvestment of certain of its foreign earnings. Moreover, the Company’s determination that foreign earnings are permanently reinvested will be limited in most cases to situations where foreign earnings are required to meet working capital needs.
The Company’s tax provision for interim periods has historically been determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter. In each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual tax rate changes, the Company makes a cumulative adjustment in that quarter. In the nine months ended September 30, 2018, the Company’s tax benefit was limited and was calculated based on its year-to-date results. The Company’s quarterly tax provision (benefit), and its quarterly estimate of its annual effective tax rate, are subject to significant volatility due to several factors, including the Company’s ability to accurately predict its pre-tax income and loss in multiple jurisdictions, as well as the portions of stock-based compensation that will either not generate tax benefits or the tax benefit is unpredictable and reflected when realized by employees.
For the three months ended September 30, 2018, the Company recorded income tax expense of $1.9 million as compared to a benefit from income taxes of $8.6 million for the three months ended September 30, 2017, resulting in an effective tax rate of 18.6% and (87.4)% for the three months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018, the Company recorded a benefit from income taxes of $10.0 million as compared to a benefit from income taxes of $24.6 million for the nine months ended September 30, 2017, resulting in an effective tax rate of 70.6% and (71.6)% for the nine months ended September 30, 2018 and 2017, respectively. The expense from income taxes recorded in the three months ended September 30, 2018 is primarily a result of the Company’s pre-tax income position, offset by the recognition of excess tax benefits from the taxable compensation on share-based awards recognized in the three months ended September 30, 2018, as well as federal and state research and development credits. The benefit from income taxes recorded in the nine months ended September 30, 2018 is primarily a result of the Company’s pre-tax loss position, the recognition of excess tax benefits from the taxable compensation on share-based awards recognized in the nine months ended September 30, 2018, and federal and state research and development credits. The benefit from income taxes recorded in the three and nine months ended September 30, 2017 was primarily a result of the recognition of excess tax benefits from the taxable compensation on share-based awards recognized in the three and nine months ended September 30, 2017 and the favorable effect of foreign statutory tax rates applicable to income earned outside the United States under the Company’s corporate structure. The Company’s historical provision (benefit) for income taxes is not necessarily reflective of its future results of operations.
The Company has been selected for examination by the Internal Revenue Service for its 2014 through 2016 tax years. It is difficult to estimate the final outcome or when the examination will be settled.
As of September 30, 2018 and December 31, 2017, the Company identified $4.8 million and $4.5 million, respectively, of gross uncertain tax positions. Included in those balances as of September 30, 2018 and December 31, 2017 are $1.9 million and $2.3 million, respectively, of tax benefits that, if recognized, would impact the effective tax rate. These have been accrued for as long-term liabilities on the Company’s condensed consolidated balance sheets. The Company’s existing tax positions will continue to generate an increase in unrecognized tax benefits in subsequent periods. The Company’s policy is to record interest and penalties related to unrecognized tax benefits as income tax expense. During the three and nine months ended September 30, 2018 and 2017, the amounts recorded related to the accrual of interest and penalties were immaterial in each period.
On July 24, 2018, the Ninth Circuit Court of Appeals issued an opinion in Altera Corp. v. Commissioner requiring related parties in an intercompany cost-sharing arrangement to share expenses related to share-based compensation. This opinion reversed the prior decision of the United States Tax Court. On August 7, 2018, the Ninth Circuit Court of Appeals withdrew this opinion to allow time for a reconstituted panel to confer on the appeal. As the final resolution with respect to cost-sharing of stock-based compensation remains unclear, the Company is currently not planning to revise its cost-sharing arrangements and will continue to monitor developments in the Altera case. A reinstatement of the Ninth Circuit Court of Appeals’ opinion could adversely affect the Company’s tax obligations and effective tax rate.
The Company operates as one operating segment. Operating segments are defined as components of an enterprise for which separate financial information is regularly evaluated by the chief operating decision maker (“CODM”), which is the Company’s president and chief executive officer, in deciding how to allocate resources and assess performance. The Company’s CODM evaluates the Company’s financial information and resources and assesses the performance of these resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information can be found in the condensed consolidated financial statements.
Customer A was subject to U.S. Department of Commerce restrictions that prevented sales to this customer from April 15, 2018 through July 13, 2018.
The Company also outsources certain engineering projects to vendors located throughout the world. Total research and development costs incurred with one vendor were less than 10% during the three and nine months ended September 30, 2018, and were 25% and 17% during the three and nine months ended September 30, 2017, respectively.
One of the members of the Company’s Board of Directors, Vincent Roche, is also the President and Chief Executive Officer and a member of the board of directors of Analog Devices, Inc. (“ADI”). The Company, through its contract manufacturers, periodically purchases supplies from ADI pursuant to purchase orders negotiated on an arm’s length basis between ADI and the Company’s contract manufacturers at prevailing prices. These purchased supplies are used as content in certain of the Company’s manufactured products. Based on shipments, the Company’s contract manufacturers made purchases from ADI of approximately $1.0 million and $1.4 million during the three months ended September 30, 2018 and 2017, respectively, and $2.5 million and $3.5 million during the nine months ended September 30, 2018 and 2017, respectively.
In 2018, the Company entered into a product development agreement with ADI related to the development of integrated circuits for $1.5 million, of which no costs were incurred during the three months ended September 30, 2018 and $0.5 million of costs were incurred during the nine months ended September 30, 2018.
One of the members of the Company’s Board of Directors, Peter Y. Chung, is also a member of the board of directors of M/A-COM Technology Solutions, Inc. (“MACOM”). The Company, through its contract manufacturers, periodically purchases supplies from MACOM. These purchased supplies are used as content in certain of the Company’s manufactured products. Based on shipments, the Company’s contract manufacturers made no purchases and $0.2 million of purchases from MACOM during the three months ended September 30, 2018 and 2017, respectively, and $0.3 million and $0.7 million of purchases during the nine months ended September 30, 2018 and 2017, respectively.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K filed with the SEC on February 22, 2018. As discussed in the section titled “Special Note Regarding Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or if they prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” under Part II, Item 1A below.
Our mission is to deliver high-speed coherent optical interconnect products that transform communications networks, relied upon by cloud infrastructure operators and content and communication service providers, through improvements in performance and capacity and reductions in associated costs. By converting optical interconnect technology to a silicon-based technology, a process we refer to as the siliconization of optical interconnect, we believe we are leading a disruption that is analogous to the computing industry’s integration of multiple functions into a microprocessor. Our products include a family of low-power coherent digital signal processor application-specific integrated circuits, or DSP ASICs, and silicon photonic integrated circuits, or silicon PICs, which we have integrated into families of optical interconnect modules with transmission speeds ranging from 100 to 400 gigabits per second, or Gbps, for use in long-haul, metro and inter-data center markets. We are also sampling our AC1200 module that will enable, across dual wavelengths, transmission capacity of 1.2 terabits per second (1,200 Gbps). Our modules perform a majority of the digital signal processing and optical functions in optical interconnects and offer low power consumption, high density and high speeds at attractive price points.
Revenue from our five largest customers, the mix of which customers varied across each period, was 76% and 79% during the three months ended September 30, 2018 and 2017, respectively, and 67% and 72% during the nine months ended September 30, 2018 and 2017, respectively.
The following tables set forth the components of our condensed consolidated statements of operations for each of the periods presented and as a percentage of our revenue for those periods. The period-to-period comparison of operating results is not necessarily indicative of results for future periods.

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