NPTN Neophotonics Corp - 10-K

ITEM 1A.     RISK FACTORS

RISKS ASSOCIATED WITH THE MERGER

Our proposed Merger may be delayed or not occur at all for a variety of reasons, some of which are outside of the parties' control, and if these conditions are not satisfied, the Merger Agreement may be terminated and the Merger may not be completed.

On November 3, 2021, we entered into the Merger Agreement, with Lumentum Holdings Inc. and Neptune Merger Sub, Inc., a wholly owned subsidiary of Lumentum Holdings. The Merger Agreement provides for the merger of the Neptune Merger Sub with and into us, which we refer to as the “Merger”, with us surviving the Merger as a wholly owned subsidiary of Lumentum. Completion of the Merger is subject to customary closing conditions, including (i) obtaining Chinese antitrust approvals (ii) the absence of governmental injunctions or other legal restraints prohibiting the Merger or imposing certain antitrust restraints and (iii) the absence of a “Material Adverse Effect,” as defined in the Merger Agreement. In addition, the obligation of each party to consummate the Merger is conditioned upon, among other things, the accuracy of the representations and warranties of the other party (subject to certain materiality exceptions), and material compliance by the other party with its covenants under the Merger Agreement. Therefore, the Merger may not be completed or may not be completed as quickly as expected.

In addition, if the Merger is not completed by August 3, 2022, either we or Lumentum may choose to terminate the Merger Agreement (subject to two automatic extensions if the closing is delayed due to certain conditions to closing relating to antitrust laws not being satisfied but all other conditions to the closing are otherwise satisfied or could be satisfied at the closing). Either party may also elect to terminate the Merger Agreement in certain other circumstances, including by mutual written consent of both parties.

Failure to complete the Merger could adversely affect our business and the market price of our common stock in a number of ways, including:

• The market price of our common stock may decline to the extent that the current market price reflects an assumption that the Merger will be consummated;

• If the Merger Agreement is terminated under certain circumstances specified in the Merger Agreement, we would be required to pay a termination fee of $27,500,000;

• We have incurred, and will continue to incur, significant expenses for professional services in connection with the Merger for which we will have received little or no benefit if the Merger is not consummated; and

• A failed Merger may result in negative publicity and/or give a negative impression of us in the investment community, with our suppliers, and with our customers.

Efforts to complete the Merger could disrupt our relationships with third parties and employees, divert management’s attention, or result in negative publicity or legal proceedings, any of which could negatively impact our operating results and ongoing business.

We have expended, and continue to expend, significant management time and resources in an effort to complete the Merger, which may have a negative impact on our ongoing business. Uncertainty regarding the outcome of the Merger and our future could disrupt our business relationships with our existing and potential customers, suppliers, vendors, landlords and other business partners, who may attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than us. Uncertainty regarding the outcome of the Merger could also adversely affect our ability to recruit and retain key personnel and other employees. The pendency of the Merger may also result in negative publicity and a negative impression of us in the financial markets, and it has led to, and may result in additional, litigation against us and our directors and officers. Such litigation is distracting to management and, may, in the future, require us to incur significant costs. Such litigation could result in the Merger being delayed and/or enjoined by a court of competent jurisdiction, which could prevent the Merger from becoming effective. The occurrence of any of these events individually or in combination could have a material and adverse effect on our business, financial condition and results of operations.

The Merger Agreement contains provisions that limit our ability to pursue alternatives to the Merger which could discourage a potential competing acquiror from making an alternative transaction proposal.

The Merger Agreement contains provisions that preclude our ability to pursue alternatives to the Merger and require us to refrain from authorizing or knowingly permitting our representatives from soliciting alternative transactions, which likely would discourage a potential third-party acquiror or merger partner from making an alternative transaction proposal that we could not accept in light of the approval of the Merger by our stockholders.

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Additionally, if the Merger Agreement is terminated and we determine to seek another business combination, we may not be able to negotiate a transaction with another party on terms comparable to, or better than, the terms of the Merger.

While the Merger Agreement is in effect, we are subject to restrictions on our business activities.

While the Merger Agreement is in effect, we are subject to restrictions on our business activities and must generally operate our business in the ordinary course, subject to certain exceptions. These restrictions could prevent us from pursuing attractive business opportunities that may arise prior to the consummation of the Merger. Although we may be able to pursue such activities with the Lumentum’s consent, Lumentum may not be willing to provide its consent for us to do so.

If the Merger occurs, our stockholders will not be able to participate in any further upside to our business.

If the Merger is consummated, our stockholders will receive $16.00 in cash per share, without interest and subject to applicable tax withholding, of our common stock owned by them, and will not receive any shares of Lumentum’s common stock. As a result, if our business following the Merger performs well, our current stockholders will not receive any additional consideration and will therefore not receive any benefit from any such future performance of our business.

Litigation could delay and or prevent the Merger from becoming effective or from becoming effective within the expected timeframe.

We and our directors were named as defendants in several lawsuits brought by purported stockholders challenging the Merger and seeking various forms of injunctive and declaratory relief, as well as awards of damages, costs, expert fees and attorneys’ fees. While the plaintiffs in these lawsuits have dismissed their claims, we may be subject to additional future litigation challenging the Merger. One of the conditions to the completion of the Merger is that no injunction by any governmental entity of competent jurisdiction, such as a court, will be in effect that prohibits or makes illegal the consummation of the Merger. As such, if any future legal actions result in an injunction prohibiting the consummation of the Merger, then such injunction may prevent the Merger from becoming effective or from becoming effective within the expected timeframe, either of which could substantially harm our business.

RISKS ASSOCIATED WITH OUR BUSINESS

We are dependent on a small number of customers for a significant portion of our revenue and the loss of, or a significant reduction in orders in any period from any of these major customers may reduce our revenue and adversely impact our results of operations.

The telecommunications systems market is concentrated with approximately ten global network equipment manufacturing companies having collectively more than 90% market share. We have generated most of our revenue from a limited number of customers. Our top five customers accounted for 75%, 79%, and 84% of our revenue in the in the years ending December 31, 2021, 2020, and 2019 respectively. Four customers were greater than 10% of our revenue for the year ended December 31, 2021, and three customers were greater than 10% for the year ended December 31, 2020.

The lack of significant growth from, the loss of, or a significant reduction in orders from any of our major customers would materially and adversely affect our revenue and results of operations. In 2021, the reduction in revenue from Huawei, our largest customer in 2020, due to Department of Commerce export restrictions had a material adverse effect on our results of operations in 2021. Our sales to Huawei are expected to remain adversely impacted.

Supply constraints and manufacturing problems could impact manufacturing yields or result in delays in product shipments to customers and could adversely affect our revenue, competitive position, and reputation.

Our products contain purchased components including electronic components and semiconductors. Due to the global shortages in the supply of semiconductors, we have experienced delays and disruptions in our manufacturing operations as well as increased costs to ensure supply. These delays and disruptions have adversely impacted component manufacturing volumes and have resulted in delays in our product shipments. As a result, product shipments to our customers have been delayed beyond the shipment schedules requested by our customers, which has negatively affected our revenue and margins. Until the global shortages in the supply of semiconductors is resolved, our manufacturing volumes and shipment dates to customers and product costs may continue to be adversely impacted. Continued shortages in the supply of semiconductors and other electronic components may also cause us to experience quality control problems in our manufacturing operations, could negatively affect our competitive position and reputation, and we may be unable to meet our growth and revenue targets due to an inability to purchase sufficient components for our products to satisfy customer demand.

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Additionally, manufacturing of new products and manufacturing yields generally depend on a number of factors, including the stability and manufacturability of the product design, manufacturing improvements gained over cumulative production volumes, the quality and consistency of component parts and the nature and extent of customization requirements by customers. Capacity constraints, raw materials shortages, logistics issues, labor shortages, volatility in utilization of manufacturing operations, supporting utility services and other manufacturing supplies, the introduction of new product lines, rapid increases in production demands and changes in customer requirements, manufacturing facilities or processes, or those of some third party contract manufacturers and suppliers of raw materials and components have caused, and may in the future cause, reduced manufacturing yields, negatively impacting the gross margin on, and our production capacity for, those products.

Our ability to maintain sufficient manufacturing yields is particularly challenging with respect to PICs due to the complexity and required precision of a large number of unique manufacturing process steps. Manufacturing yields for PICs can also suffer if contaminated materials or materials that do not meet highly precise composition requirements are inadvertently utilized. Because a large portion of our PIC manufacturing costs are fixed, PIC manufacturing yields can have a substantial effect on our gross margin. Lower than expected manufacturing yields could also delay product shipments and decrease our revenue.

Additionally, it is possible that purchased components could contain quality defects, manufacturing defects, performance problems or even counterfeit substitutes, each of which could result in manufacturing issues. As a result, we could incur additional costs that would adversely affect our gross margin, and product shipments to our customers could be delayed beyond the shipment schedules requested by our customers, which would negatively affect our revenue, competitive position and reputation.

Our solutions for the Cloud and data center market segments may not achieve broader market acceptance, which would prevent us from increasing our revenue and market share.

Part of our overall strategy is to continue to expand our optoelectronic solutions for the highest speed Cloud and data center market segments. If we fail to achieve broader acceptance of our products in the Cloud and data center markets, there would be an adverse impact on our ability to increase our revenue, gain market share and achieve and sustain profitability. Our ability to achieve broader market acceptance for our products will be impacted by a number of factors, but not limited to:

• Our ability to produce optoelectronic solutions for 100G to 800G and beyond that compete favorably against other solutions on the basis of price, quality, reliability and performance;

• Our ability to timely introduce and complete new designs and timely qualify and certify our products;

• Whether major Cloud and hyperscale data center operators will adopt our solutions, which are based on a new network architecture and have a limited history in these market segments;

• Our ability to develop products that comply with applicable standards and regulatory requirements, as well as potential in-country manufacturing requirements; and;

• Our ability to develop and maintain successful relationships with our customers and suppliers, many of whom are large companies with substantial negotiating power.

• If the Cloud and data center market segments delay their deployments or fail to grow as expected, or if demand for our solutions in these segments fails to materialize, our business, financial condition, results of operations, and prospects will suffer.

If our key customers do not qualify our products for use or do not award us design wins, then our results of operations may suffer.

Prior to placing volume purchase orders with us, most of our customers require us to obtain their approval, a process called qualification in our industry, for our new and existing products. Our customers often audit our manufacturing facilities and perform other vendor evaluations during this process. The qualification process involves product sampling and reliability testing and collaboration with our product management and engineering teams in the design and manufacturing stages. If we are unable to qualify our products with customers, then our revenue would be lower than expected and we may not be able to recover the costs associated with the qualification process which would have an adverse effect on our results of operations.

In addition, due to evolving technological changes in our markets, a customer may cancel or modify a design project before we have qualified our product or begun volume manufacturing of a qualified product. It is unlikely that we would be able to recover the expenses for cancelled or unutilized custom design projects.

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Once we have achieved qualification, there is no guarantee that our customers will purchase our products in volume. Our customers typically select two to three vendors per design or version of their products and award a design win. If we are not awarded a design win, our customer will not place volume purchase orders for that version of the customer product.

We face intense competition which could negatively impact our results of operations and market share.

The communications networks industry is highly competitive. Our competitors range from large international companies offering a wide range of products to smaller companies specializing in niche products.

Some of our competitors have substantially greater name brand recognition, technical, financial, and marketing resources, and greater manufacturing capacity, as well as better-established relationships with customers, than we do. Some of our competitors have more resources to develop or acquire, and more experience in developing or acquiring, new products and technologies. Some of our competitors may be able to develop new products more quickly than us, may be able to develop products that are more reliable or which provide more functionality than ours, and may be able to ramp production faster than we can. In addition, some of our competitors have the financial resources to offer competitive products at below-market pricing levels that could prevent us from competing effectively and result in a loss of sales or market share or cause us to lower prices for our products.

We also face competition from some of our customers who evaluate our capabilities against the merits of manufacturing products internally. Due to the fact that such customers are not seeking to make a comparable profit directly from the manufacture of these products or for other reasons, they may have the ability to provide competitive products at a lower total cost than we would charge such customers. As a result, these customers may purchase less of our products and there would be additional pressure to lower our selling prices which, accordingly, would negatively impact our revenue and gross margin.

Customer demand is difficult to accurately forecast and, as a result, we may be unable to optimally match production with customer demand.

We make planning and spending decisions based on our estimates of customer requirements. The short-term nature of commitments by many of our customers, and the possibility of unexpected changes in demand for their products, reduce our ability to accurately estimate future customer requirements. Additionally, due to global semiconductor and electronic component shortages, the purchase lead time for many have our components has increased substantially, in some cases to over a year. To ensure that we have sufficient components to build our products to meet expected customer demands, we have placed non-cancellable orders for these components. A sudden reduction in customer demand would have a material adverse effect on our operating results, as occurred in 2017, because many of our costs and operating expenses are relatively fixed.

On the other hand, customers may require rapid increases in production, which can strain our resources, cause our manufacturing to be negatively impacted by materials shortages, necessitate higher or more restrictive procurement commitments, increase our manufacturing yield loss and scrapping of excess materials, result in delayed shipments and/or reduce our gross margins. We may not have sufficient capacity at any given time to meet the volume demands of our customers, and we may have difficulty expanding our manufacturing operations on a timely basis to meet increasing customer demand. Additionally, one or more of our suppliers may not have sufficient capacity at any given time to meet our volume demands. Any inability to meet customer demands for rapid increases in production in the future could have a material adverse effect on our business, financial condition, results of operations and prospects.

If we fail to retain our key personnel or if we fail to attract additional qualified personnel, we may not be able to achieve our anticipated growth and our business could suffer.

Our success and ability to implement our business strategy depends upon the continued contributions of our senior management team and others, including senior management in foreign subsidiaries and our technical and operations employees in all locations. Our future success depends, in part, on our ability to attract and retain key personnel, including our senior management and others. The loss of services of members of our senior management team or key personnel or the inability to continue to attract and retain qualified personnel could have a material adverse effect on our business. Competition for highly skilled technical and operations people where we operate is extremely intense, and we continue to face challenges identifying, hiring and retaining qualified personnel in many areas of our business. The anticipated merger has also created perceived uncertainty from current and prospective employees, which has placed additional strain on our ability to attract and retain key personnel.

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We have had a history of losses, we returned to losses in the fourth quarter of 2021, and losses may recur in the future.

We have had a history of losses and we may incur additional losses in future periods. As of December 31, 2021, our accumulated deficit was $459.6 million. Due to the global semiconductor shortage, shipments to our customers were delayed and as a result our revenue suffered in 2021. Our inability to purchase sufficient semiconductor components to meet customer demand for our products may result in additional losses in 2022.

We continue to review our expenditures related to the ongoing operations of our business for their effectiveness. We plan to make adjustments to our expenditures as needed. These include expenditures related to the sales, marketing and development of our products and to maintain our manufacturing facilities and research and development operations. Operations and assets that are deemed to be less effective have been and may in the future be subject to restructuring, which could lead to increased operating losses in future periods when and if restructuring charges are incurred.

We are subject to governmental export and import rules and regulations that could subject us to liability, impair our ability to compete in international markets, or restrict our sales to certain customers.

We are subject to export and import control laws, trade regulations and other rules that limit which products we sell and where and to whom we sell our products. The United States, China, and various countries regulate the export or import of certain technologies and have enacted laws that could limit our ability to distribute our products. Failure to comply with these and similar laws or any limitation on our ability to export or sell our products or to obtain any required licenses would adversely affect our business, financial condition and results of operations.

The United States Department of Commerce, Bureau of Industry and Security (“BIS”) has added Huawei and certain of its affiliates and Fiberhome and certain of its affiliates to its Entity List. To comply with the restrictions and requirements of the Entity list, we have conducted multiple systematic assessments of our products to ensure compliance. The BIS restrictions impact our products, our manufacturing processes, our manufacturing equipment, and our components. Due to the complexity of such regulations, we sometimes have halted shipment to these customers while the assessments were underway, resulting in adverse revenue impact.

Any additions to or changes in laws, rules, or regulations may result in our inability to ship products to customers, a reduction in the type or quantity of products we can ship, or our inability to use existing suppliers, resulting in negative impacts on our cost structure and results of operation. Various newly enacted and proposed laws and regulations, such as the proposed new regulations in the United States on Information and Communications Technology and Services (“ICTS”) and the Export Control Law (“ECL”) enacted in China, could result in new licensing requirements delays, restrictions, or prohibitions the import, export, or sale of our products to various countries or customers.

Additionally, even if we are legally able to sell the same types of products we have sold historically to affected customers, such customers may decide not to purchase these products for various reasons, including to reduce its own risks of being exposed to disruptions of its supply chain. Furthermore, there can be no assurance that the various regulatory entities, including the U.S. government, will not challenge our determination of which products and associated technology are not subject to the applicable laws, rules, and regulations.

Continued tension in U.S.-China trade relations may adversely impact our business and operating results.

The U.S. government has taken certain other actions in the past several years that impact U.S.-China trade relations, including recently imposed tariffs affecting certain products manufactured in China. Some products manufactured by our Chinese affiliates are subject to tariffs if imported into the United States. In addition, the China government has taken certain reciprocal actions, including tariffs, which affect certain products manufactured in the United States. Certain of our products manufactured in our U.S. operations were included in the tariffs imposed on imports into China from the United States. As of March 2020, tariffs on most of the products we imported into China have been eliminated. However, there can be no assurance that China will not re-impose these or similar tariffs, impose export restrictions, or take other retaliatory trade actions that may have a material impact on our business.

It is unknown whether and to what extent additional new tariffs or other new laws or regulations will be adopted that increase the cost of importing products to or from the United States, or from China to the United States. Further, it is unknown what effect that any such new tariffs or retaliatory actions would have on us or our industry and customers. As additional new tariffs, legislation and/or regulations are implemented, or if existing trade agreements are renegotiated or if China or other affected countries take retaliatory trade actions, such changes could have a material adverse effect on our business, financial condition, results of operations or cash flows.

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In response to trade tensions, the Chinese government and/or individual Chinese customers may take steps to reduce their supply chain dependence on products from U.S. suppliers through their own internal developments or the selection of non-U.S. suppliers, placing us at a commercial disadvantage and potentially affecting our business.

Our future results of operations may be subject to volatility as a result of exposure to fluctuations in foreign exchange rates, primarily the Chinese Renminbi (RMB) and Japanese Yen (JPY) exchange rates.

We are exposed to foreign exchange risks. Foreign currency fluctuations may adversely affect our revenue and our costs and expenses, and hence our results of operations. A substantial portion of our business is conducted through our subsidiaries based in China, whose functional currency is the RMB, and in Japan, whose functional currency is the JPY. The value of the RMB against the U.S. dollar and other currencies and the value of the JPY against the U.S. dollar and other currencies fluctuate and are affected by, among other things, changes in political and economic conditions.

We depend upon outside contract manufacturers for a portion of the manufacturing process for some of our products. Our operations and revenue related to these products could be adversely affected if we encounter problems with any such contract manufacturer.

While many of our products are manufactured internally, we also rely upon contract manufacturers in Thailand, China, Japan, other Asia locations, and Canada to provide back-end manufacturing and production of some of our products. Our reliance on contract manufacturers for some of our products makes us vulnerable to possible production capacity constraints, reduced control over their supply chains, delivery schedules, manufacturing yields, manufacturing quality controls and costs. If one of our contract manufacturers is unable to meet all of our customer demand in a timely fashion, whether due to their direct operating control, due to their supply chain or due to the Covid-19 pandemic or other factors, this could have a material adverse effect on the revenue from our products.

Increasing inflation may negatively impact our business.

Inflation in the United States and worldwide may result in increased costs and additional shortages of supplies and components that are critical to the manufacturing of our products, may increase cost of borrowing through our lines of credit, and may reduce our purchasing power, all of which would have a negative impact on our results of operation.

We are under continuous pressure to reduce the prices of our products, which has adversely affected, and may continue to adversely affect, our gross margins.

The communications networks industry has been characterized by declining product prices over time as technological advances improve performance of new products and put pressure on existing products to reduce prices. We have reduced the prices of many of our products in the past, most often during annual end-of-year price negotiation. We expect pricing pressure for our products to continue. To maintain or increase their market share, our competitors also reduce prices of their products each year. In addition, our customers may seek to internally develop and manufacture competing products at a lower cost than we would otherwise charge, which would add additional pressure on us to lower our selling prices. If we are unable to offset any future reductions in our average selling prices by increasing our sales volume, reducing our costs or introducing new products, our gross margin would be adversely affected.

The communications networks industry has long product development cycles requiring us to incur product development costs without assurances of an acceptable investment return.

Large volumes of communications equipment and support structures are installed with considerable expenditures of funds and other resources, and long investment return period expectations. At the component supplier level, these cycles create considerable, typically multi-year, gaps between the commencement of new product development and volume purchases. Due to changing industry and customer requirements, we are constantly developing new products, including seeking to further integrate functions on PICs and developing and using new technologies in our products. These development activities necessitate significant investment of capital. Our new products often require a long time to develop because of their complexity and rigorous testing and qualification requirements. Accordingly, we and our competitors often incur significant research and development and sales and marketing costs for products that, initially, will be purchased by our customers long after much of the cost is incurred and, in some cases, may never be purchased due to changes in industry or customer requirements in the interim.

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The majority of our customer contracts do not commit customers to specified buying levels, and many of our customers may decrease, cancel or delay their buying levels at any time with little or no advance notice to us.

Our products are typically sold pursuant to individual purchase orders or by use of a vendor-managed inventory ("VMI"), model, which is a process by which we ship agreed quantities of products to a customer-designated location and those products remain our inventory and we retain the title and risk of loss for those products until the customer takes possession of the products. Our customers are typically not contractually committed to buy any quantity of products beyond firm purchase orders. Many of our customers may increase, decrease, cancel or delay purchase orders already in place, which may impact our level of business.

We may be subject to disruptions or failures in information technology systems and network infrastructures that could have a material adverse effect on our business and financial condition.

We rely on the efficient and uninterrupted operation of complex information technology systems and network infrastructures to operate our business. A disruption, infiltration or failure of our information technology systems as a result of software or hardware malfunctions, system implementations or upgrades, computer viruses, cyber-attacks, third-party security breaches, employee error, theft or misuse, malfeasance, power disruptions, natural disasters or accidents could cause breaches of data security, loss of intellectual property and critical data and the release and misappropriation of sensitive competitive information and partner, customer and employee personal data. Any of these events could harm our competitive position, result in a loss of customer confidence, cause us to incur significant costs to remedy any damages and ultimately materially adversely affect our business and financial condition.

In December 2020, we discovered that we were affected by the Solar Winds Corporation cybersecurity breach; however our comprehensive review by an internal information security group and a third party cybersecurity investigator found no evidence of any suspicious activity on our networks or of any compromise to our data.

Despite using updated security measures, our systems may continue to be vulnerable to cyber security attacks or breaches. While we continually work to safeguard our internal network systems, processes, procedures, and user training to mitigate these potential risks, there is no assurance that these measures will be sufficient to prevent future cyber-attacks. Because security incidents are often not detected immediately, we also may face difficulties or delays in identifying or responding to security breaches and security-related incidents. Additionally, if we discover a threat and take remediation efforts, there may be compromises to our data that our investigation did not uncover or additional undiscovered malware on our networks which could result in further breaches of data security or interruptions of our information technology systems.

The Covid-19 pandemic has and could further harm our operations and our financial operations.

Our operations and supply chain are and could continue to be impacted by the implications of the Covid-19 pandemic, which could harm our future revenue and financial condition and increase our costs and expenses. Our manufacturing operations in Silicon Valley, California; Tokyo, Japan; and Shenzhen and Dongguan, China have been affected and could continue to be affected with actions such as being temporarily shut down, requiring longer lead times or being subject to logistics issues. The same issues have affected and could continue to impact key suppliers in Patumthanee, Thailand, and Ottawa, Canada and other locations throughout United States and Asia. The efficiency of our business operations (including sales and research and development) could also be reduced as a result of compliance with shelter-in-place orders in Silicon Valley, California; Ottawa, Canada; and Shenzhen and Wuhan, China.

Similarly, our worldwide operations could be subject to secondary effects of the pandemic. Even if our facilities are not directly affected, the pandemic and its effects could substantially disrupt the business of our suppliers or customers, which could have a material adverse effect on us.

Accordingly, we may experience significant disruptions as a result of the Covid-19 pandemic that could materially impact our business, including:

• Slower customer deployments of systems using our products due to uncertainty in the business climate;

• Reduced demand for our products;

• Disruptions of the supply chain of components needed for our products; and

• Disruptions of our ability to conduct sales, marketing, product development and other important business activities.

The extent to which the Covid-19 pandemic will continue to impact our business will depend on future developments, which are highly uncertain and cannot be predicted with confidence, such as the duration of the outbreak, travel restrictions, governmental mandates issued to mitigate the spread of the disease, business closures, economic disruptions, and the effectiveness of actions taken to contain and treat the virus. Accordingly, we expect the Covid-19 pandemic may have a

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negative impact on our sales and our results of operations, the size and duration of which are difficult to predict. We are not insured against major public health events, including the Covid-19 pandemic.

To the extent the Covid-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in this ‘‘Risk Factors’’ section, such as reduced spending for communications networks, fluctuations in customer demand, manufacturing and supply constraints, and our ability to raise capital (if necessary).

If the Merger is not completed or is delayed substantially, we may need to raise additional capital in order to pursue our business strategies or maintain our operations, and we may not be able to obtain capital when desired on favorable terms, if at all, or without dilution to our stockholders.

We believe that our existing cash and cash equivalents, and cash flows from our operating activities and funds available under our credit facilities will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, we operate in an industry that makes our prospects difficult to evaluate. It is possible that we may not generate sufficient cash flow from operations or otherwise have the capital resources to meet our future capital needs. If this occurs and the Merger is not completed or is substantially delayed, we may need additional financing to continue operations or execute on our current or future business strategies, including to:

• Invest in our research and development efforts (particularly in the Cloud and data center interconnect market segments), including by hiring additional technical and other personnel;

• Maintain and expand our operating or manufacturing infrastructure (particularly for our Cloud and data center products);

• Acquire complementary businesses, products, services or technologies; or

• Otherwise pursue our strategic plans and respond to competitive pressures.

We do not know with certainty what forms of financing, if any, will be available to us. If financing is not available on acceptable terms, if and when needed, our ability to fund our operations, enhance our research and development and sales and marketing functions, develop and enhance our products, respond to unanticipated events, including unanticipated opportunities, or otherwise respond to competitive pressures could be adversely impacted.

If we incur additional indebtedness through arrangements such as credit agreements or term loans, such arrangements may impose restrictions and covenants that limit our ability to respond appropriately to market conditions, make capital investments or take advantage of business opportunities. In addition, any additional debt arrangements we may enter into would likely require us to make regular interest payments, which could adversely affect our results of operations.

We may be exposed to costs or losses from product lines that we intend to exit or may undertake divestiture of portions of our business that require us to continue providing substantial post-divestiture transition services and support, which may cause us to incur unanticipated costs and liabilities and adversely affect our financial condition and results of operations.

We have a strategy to exit products that have been declining in revenue and have lower gross margins than our other higher speed products. We may incur additional costs in connection with the sale or end-of-life of these products, or other products and/or facilities in the future, and our revenues and net income could be negatively impacted, particularly in the short term, in connection with the end-of-life or sales of such products and/or facilities. It is also possible that we could incur continued costs or liabilities after the end-of-life process is completed, which could have a material adverse effect on our financial condition or operating results.

Spending for communications networks is cyclical in nature, and any future downturn may reduce demand for our products and revenue.

Our future success as a provider of components, modules and subsystems to leading network equipment vendors depends on continued capital spending on global communications networks. Network traffic has experienced rapid growth driven primarily by bandwidth-intensive content, including cloud services, mobile video and data services, wireless 4G/LTE and now 5G services, social networking, video conferencing and other multimedia. This growth is intensified by the proliferation of fixed and wireless devices that are enabling consumers to access content at increasing data rates anytime and anywhere. Our future success depends on continued demand for high-bandwidth, high-speed communications networks and the ability of network equipment vendors and carrier data center operators to fulfill this demand. Our business and financial results will suffer if anticipated growth does not occur as expected.

The markets for communications networks and network equipment are cyclical and characterized by rapid technological change, price erosion, evolving standards and wide fluctuations in product supply and demand. In the past, including recently to varying degrees in China, the U.S. and Europe, these markets have experienced significant downturns,

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often connected with, or in anticipation of, the maturation of product cycles for both manufacturers’ and their customers’ products or in response to over or under purchasing of inventory by our customers relative to end user demand, and with declining general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Our historical results of operations have been subject to substantial fluctuations as a result of market downturns and changes in capital spending, and we may experience substantial period-to-period fluctuations in future results of operations.

Risks associated with international sales and operations could adversely affect our business and financial results.

We derive a significant portion of our revenue from international sales in various markets, and we have substantial operations in China, Japan and Thailand in addition to the U.S. Our international revenue and operations are subject to a number of material risks, including, but not limited to:

• Difficulties in staffing, managing and supporting operations across different jurisdictions;

• Difficulties in enforcing agreements and collecting receivables through foreign legal systems;

• Fewer legal protections for intellectual property in foreign jurisdictions;

• International trade restrictions;

• Difficulties in obtaining any necessary governmental authorizations for the export of our products to certain foreign jurisdictions;

• Imposition of regulatory restrictions on sales to any of our major customers;

• Fluctuations in foreign economies and fluctuations in the value of foreign currencies and interest rates;

• Major health events, such as outbreaks of contagious disease;

• Domestic and international economic or political changes, hostilities and other disruptions; and

• Difficulties and increased expenses in complying with a variety of U.S. and foreign laws, regulations and trade standards, including the Foreign Corrupt Practices Act and international labor standards.

Negative developments in any of these areas in China, Japan, Canada, Thailand or other countries could result in a reduction in demand for our products, the cancellation or delay of orders already placed, difficulties in producing and delivering our products, threats to our intellectual property, difficulty in collecting receivables, higher labor costs and a higher cost of doing business.

In addition, although we maintain an anti-corruption compliance program throughout our company, violations of our compliance program may result in criminal or civil sanctions, including material monetary fines, penalties and other costs against us or our employees, and may have a material adverse effect on our business.

Our revenues and costs will fluctuate over time, making it difficult to predict our gross margins and future results of operations.

Our revenue, gross margin and results of operations have varied significantly and are likely to continue to vary from quarter-to-quarter due to a number of factors, many of which are not within our control. We may not be able to maintain or improve our gross margins because of slow introductions of new products, pricing pressure from increased competition, failure to effectively reduce the cost of existing products, failure to improve our product mix, future macroeconomic or market volatility reducing sales volumes, changes in customer demand (including a change in product mix among different areas of our business) or other factors. Our gross margins can also be adversely affected for reasons including, but not limited to, fixed manufacturing costs that would not be expected to decrease in proportion to any decrease in revenues; unfavorable production yields or variances; increases in costs of input parts and materials; the timing of movements in our inventory balances; warranty costs and related returns; changes in foreign currency exchange rates; possible exposure to inventory valuation reserves; and other increases in our costs and expenses, including as a result of rising labor costs. Such significant increases in costs without corresponding increases in revenue would materially and adversely affect our business, our results of operations and our financial condition and our gross margins.

We may be involved in intellectual property disputes, which could divert management’s attention, cause us to incur significant costs and prevent us from selling or using the challenged technology.

Participants in the markets in which we sell our products have experienced frequent litigation regarding patent and other intellectual property rights. Numerous patents in these industries are held by others, including our competitors. In

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addition, from time to time, we have been notified that we may be infringing certain patents or other intellectual property rights of others (for example, see our discussion on the Finisar dispute). Regardless of their merit, responding to such claims can be time consuming, divert management’s attention and resources and may cause us to incur significant expenses. In addition, there can be no assurance that third parties will not assert infringement claims against us, whether or not such claims are valid. While we believe that our products do not infringe in any material respect upon intellectual property rights of other parties and/or meritorious defense would exist with respect to any assertions to the contrary, we cannot be certain that our products would not be found infringing the intellectual property rights of others.

Although we believe that we would have meritorious defenses to infringement allegations and intend to defend any new lawsuit vigorously, there can be no assurance that we will be successful in our defense. Even if we are successful, we may incur substantial legal fees and other costs in defending the lawsuit. Further, a new lawsuit, if brought by either party, would be likely to divert the efforts and attention of our management and technical personnel, which could harm our business.

If we fail to protect our intellectual property and other proprietary rights, our business and results of operations could be materially harmed.

Our success depends to a significant degree on our ability to protect our intellectual property and other proprietary rights. We rely on a combination of patent, trademark, copyright, trade secret and unfair competition laws, as well as license agreements and other contractual provisions, to establish and protect our intellectual property and other proprietary rights. We have applied for patent registrations in the U.S. and in other foreign countries, some of which have been issued. We cannot guarantee that our pending applications will be approved by the applicable governmental authorities. Additionally, over time, our patents may expire, and we may be unable to secure other intellectual property protections for the technology covered by the expired patents.

Similarly, we must protect all company data as it pertains to customers, products and product designs, technology and technology related trade secrets, plus customer and supplier and personal data of suppliers, customers and personnel. We rely on a combination of these important data elements to establish and protect multiple aspects of our business, and loss of data, breaching of data or stealing of such data could hard our business.

Policing unauthorized use of our technology is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation, unauthorized use or other infringement of our intellectual property rights. Further, we may not be able to effectively protect our intellectual property rights from misappropriation or other infringement in foreign countries where we have not applied for patent protections, and where effective patent, trademark, trade secret and other intellectual property laws may be unavailable, or may not protect our proprietary rights as fully as U.S. or Japan law. Particularly, our U.S. patents do not afford any intellectual property protection in China, Japan, Canada, Russia or other Asia locations.

In the future, we may need to take legal actions to prevent third parties from infringing upon or misappropriating our intellectual property or from otherwise gaining access to our technology. Protecting and enforcing our intellectual property rights and determining their validity and scope could result in significant litigation costs and require significant time and attention from our technical and management personnel. If we fail to protect our intellectual property and other proprietary rights, or if such intellectual property and proprietary rights are infringed or misappropriated, our business, results of operations or financial condition could be materially harmed.

It could be discovered that our products contain defects that may cause us to incur significant costs, divert our attention, result in a loss of customers and result in product liability claims.

Our products are complex and undergo quality testing as well as formal qualification, both by our customers and by us. For various reasons, such as the occurrence of performance problems that are unforeseeable in testing or that are detected only when products age or are operated under peak stress conditions, our products may fail to perform as expected long after customer acceptance. Failures could result from faulty components or design, problems in manufacturing or other unforeseen reasons. As a result, we could incur significant costs to repair or replace defective products under warranty, particularly when such failures occur in installed systems. Any significant product failure could result in lost future sales of the affected product and other products, as well as customer relations problems and litigation, which could harm our business.

Further, our products contain purchased components including electronic components. It is possible that such purchased items could contain quality defects, manufacturing defects, performance problems or even counterfeit substitutes. Any significant product failure that is the result of such defects could result in lost future sales as well as customer relations problems and litigation, which could harm our business.

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Our revenues are typically subject to seasonality.

Our first quarter revenue is typically seasonally lower than the rest of the year primarily due to annual price negotiations with customers that occur at the end of the prior year and lower capacity utilization during the annual new year holidays in China. This historical pattern typically adversely affects our revenues in the first quarter of each year and impacts the typical annual distribution of revenue from quarter-to-quarter through the year. That said, our first quarter revenue varies markedly year- to-year so should not be considered a reliable indicator of our future revenue or financial performance.

If we fail to obtain the right to use the intellectual property rights of others which are necessary to operate our business, and to protect their intellectual property, our business and results of operations will be adversely affected.

From time to time we may choose to, or be required to, license technology or intellectual property from third parties in connection with the development of our products. Failure to obtain a necessary third-party license required for our product offerings or to develop new products and product enhancements could adversely affect our business.

Similarly, from time to time, others may endeavor to infringe on our intellectual property or encroach on our trademarks or other intellectual property. Our failure to identify, recognize and/or action to protect such intellectual property could adversely affect our business.

Participation in standards setting organizations may subject us to intellectual property licensing requirements or limitations that could adversely affect our business and prospects.

In the course of our participation in the development of emerging standards for some of our present and future products, we may agree to grant to all other participants a license to our patents that are essential to the practice of those standards on reasonable and non-discriminatory, or RAND, terms. If we fail to limit to whom we license our patents, or fail to limit the terms of any such licenses, we may be required to license our patents or other intellectual property to others in the future, which could limit the effectiveness of our patents against competitors.

Any potential dispute involving our products, services or technology could also include our customers using our products, which could trigger our indemnification obligations to them and result in substantial expenses to us.

In any potential dispute involving allegations that our products, services or technology infringe the intellectual property rights of third parties, our customers could also become the target of litigation. Because we often indemnify our customers for intellectual property claims made against them for products incorporating our technology, any claims against our customers could trigger indemnification obligations in some of our supply agreements, which could result in substantial expenses such as increased legal expenses, product recalls, damages for past infringement or royalties for future use.

Rapidly changing standards and regulations could make our products obsolete, which would cause our revenue and results of operations to suffer.

We design our products to conform to regulations established by governments and to standards set by industry standards bodies worldwide, such as The American National Standards Institute, the European Telecommunications Standards Institute, the International Telecommunications Union and the Institute of Electrical and Electronics Engineers. Various industry organizations are currently considering whether and to what extent to create standards for elements used in 100Gbps and beyond systems. Because certain of our products are designed to conform to current specific industry standards, if competing or new standards emerge that are preferred by our customers, we would have to make significant expenditures to develop new products and our revenue and results of operations would suffer.

We may be unable to utilize our net operating loss carryforwards to reduce our income taxes, which could adversely affect our future financial results.

As of December 31, 2021, we had net operating loss ("NOL"), carryforwards for U.S. federal and state tax purposes of $334.2 million and $54.4 million, respectively. These net operating losses have not been utilized and may not be utilized prior to their expiration in the future. The utilization of the NOL and tax credit carryforwards are subject to a substantial limitation imposed by Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, and similar state provisions. We recorded deferred tax assets, net of valuation allowance, for the NOL carryforwards currently available after considering the existing Section 382 limitation. If we incur an additional limitation under Section 382, then the NOL carryforwards, as

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disclosed, could be reduced by the impact of any future limitation that would result in existing NOL carryforwards and tax credit carryforwards expiring unutilized and increases in future tax liabilities.

We are subject to environmental, health and safety laws and regulations, which could subject us to liabilities, increase our costs, or restrict our business or operations in the future.

Our manufacturing operations and our products are subject to a variety of federal, state, local and international environmental, health and safety laws and regulations in each of the jurisdictions in which we operate or sell our products. Our failure to comply with present and future environmental, health or safety requirements, or the identification of contamination, could cause us to incur substantial costs, including cleanup costs, monetary fines, civil or criminal penalties, or curtailment of operations, which could have a material adverse effect on our business, financial condition and results of operations.

Additionally, increasing efforts to control emissions of greenhouse gases ("GHG"), may also impact us. Additional climate change or GHG control requirements are under consideration at the federal level in the U.S. and in China. Additional restrictions, limits, taxes, or other controls on GHG emissions could increase our operating costs and, while it is not possible to estimate the specific impact any final GHG regulations will have on our operations, there can be no assurance that these measures will not have significant additional impact on us.

RISKS RELATED TO OUR OPERATIONS IN CHINA

Our business operations conducted in China are critical to our success. A significant portion of our revenue was recognized from customers for whom we shipped products to a location in China. Additionally, a substantial portion of our net property, plant and equipment, approximately 29% as of December 31, 2021, was located in China. We expect to make further investments in China in the foreseeable future. Therefore, our business, financial condition, results of operations and prospects are to a significant degree subject to economic, political, legal, and social events and developments in China.

Changes in China’s international trade policies may adversely impact our business and operating results.

The China government may change trade policies that impact our operations. Prior to early 2020, the China government imposed tariffs on certain of our products manufactured in our U.S. operations and imported into China from the United States. There has been exemption of these tariffs since then. We expect these tariffs, if applied without exemption, will increase our cost of goods sold. It is unknown if exemption, or any additional such tariffs or retaliatory actions, will be imposed or what impact they would have on us or our industry and customers. As new tariffs, legislation and/or regulations are implemented, or if existing trade agreements are renegotiated between China and the U.S. or other affected countries, such changes could have a material adverse effect on our business, financial condition, results of operations or cash flows. Furthermore, in response to such trade tensions, the Chinese government and/or individual Chinese customers may take steps to reduce their supply chain dependence on products from U.S. suppliers through their own internal developments or the selection of non-U.S. suppliers, placing us at a commercial disadvantage and potentially affecting our business.

A considerable portion of our business outside of the Cloud and data center market segments involves selling high-speed optical components in China and any move to local Chinese vendors for these products might adversely affect our results.

In December 2017, the Chinese Government Ministry of Industry and Information Technology announced a five-year optical component technology roadmap with the aim to reduce China’s dependency on non-domestic companies for high-end optical chips and sub-components, including some products manufactured and sold by us. This announcement continues an ongoing trend in China to build domestic industry in this area. While we believe local Chinese component suppliers do not currently have the capability to supply the highest performance optical chips and sub-components, those companies are actively investing in their development and may over time develop such capability and negatively impact our revenue and financial performance if we do not continue to innovate and maintain our lead in the highest speed and performance optical components.

Adverse changes in economic and political policies in China, or Chinese laws or regulations could have a material adverse effect on business conditions and the overall economic growth of China, which could adversely affect our business.

The Chinese government exercises significant control over China’s economy by way of the allocation of resources, control over foreign currency-denominated obligations and monetary policy and provision of preferential treatment to particular industries or companies. Moreover, the laws, regulations and legal requirements in China, including the laws that apply to foreign-invested enterprises are relatively new and are subject to frequent changes. The interpretation and enforcement of such

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laws is uncertain. Any adverse changes to these laws, regulations and legal requirements, including tax laws, or their interpretation or enforcement, or the creation of new laws or regulations relating to our business, could have a material adverse effect on our business. Furthermore, any slowdown or economic downturn, whether actual or perceived, in China could have a material adverse effect on our business, financial condition and results of operation.

Uncertainties with respect to China’s legal system could adversely affect the legal protection available to us.

Our operations in China are governed by Chinese laws and regulations. Our subsidiaries in China are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises. China's laws and regulations may not sufficiently cover all aspects of economic activities in China. Uncertainties in the Chinese legal system may impede our ability to enforce the contracts we have entered into with our distributors, business partners, customers and suppliers. In addition, protections of intellectual property rights and confidentiality in China may not be as effective as in the U.S. or other countries or regions. All of these uncertainties could limit the legal protections available to us and could materially and adversely affect our business and operations.

Restrictions on currency exchange may limit our ability to use our cash effectively.

In China, the State Administration of Foreign Exchange ("SAFE") administers restrictions on currency exchange. These restrictions may limit our ability to use cash held in RMB to fund any business activities we may have outside China or to make dividend payments in U.S. dollars. SAFE or other Chinese regulatory authorities may impose more stringent restrictions on the convertibility of the RMB, especially with respect to foreign exchange transactions. If such restrictions are imposed, our ability to adjust our capital structure or engage in foreign exchange transactions may be limited.

If the Chinese government determines that we failed to obtain approvals of, or registrations with, the requisite Chinese regulatory authority with respect to our current and past import and export of technologies, or failed to obtain the necessary licenses to file patent applications outside China for inventions made in China, we could be subject to sanctions, which could adversely affect our business.

China imposes controls on technology import and export. The term “technology import and export” is broadly defined to include, without limitation, the transfer or license of patents, software and know-how, and the provision of services in relation to technology. Depending on the nature of the relevant technology, the import and export of technology to or from China requires either approval by or registration with, the relevant Chinese governmental authorities. Additionally, the Chinese government requires the patent application for any invention made at least in part in China to be filed first in China, then undergo a government secrecy review and obtain a license before such application is filed in other countries.

If the Chinese government determines that we failed to follow required procedures and obtain the appropriate license before filing a patent application outside China for an invention made at least in part in China, our China patents on such products may be invalidated, which could have a material and adverse effect on our business and operations.

We may be exposed to liabilities under the FCPA and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.

We are subject to the Foreign Corrupt Practices Act of 1977 ("FCPA") and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties and we make significant sales in China. China also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by our employees, consultants, sales agents or distributors, even though they may not always be subject to our control. Although we have implemented policies and procedures to discourage these practices by our employees, our existing safeguards and any future improvements may prove to be less than effective, and our employees, consultants, sales agents or distributors may engage in conduct for which we might be held responsible. Violations of the FCPA or anti-corruption laws in other countries may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition.

RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK

Our stock price may be volatile due to fluctuation of our financial results from quarter-to-quarter and other factors.

Our quarterly revenue and results of operations have varied in the past and may continue to vary significantly from

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quarter-to-quarter. This variability may lead to volatility in our stock price as research analysts and investors respond to these quarterly fluctuations. These fluctuations are due to numerous factors, including:

• Developments or announcements regarding the Merger;

• Our ability to timely obtain adequate quantities of the components used in our products;

• Fluctuations in demand for our products;

• The timing, volume and product mix of sales of our products;

• Changes in our pricing and sales policies, particularly in the first quarter of the year, or changes in the pricing and sales policies of our competitors;

• Changes in government export and import laws, rules, and regulations that restrict our sales to key customers;

• Our ability to design, manufacture and deliver products to our customers in a timely and cost-effective manner and that meet customer requirements;

• Quality control, yield or other output-related problems in our manufacturing operations;

• Length and variability of the sales cycles of our products;

• Unanticipated increases in costs or expenses; and

• Fluctuations in foreign currency exchange rates.

The foregoing factors are difficult to forecast, and these, as well as other factors, could materially adversely affect our quarterly and annual results of operations in the future. In addition, a significant amount of our operating expenses is relatively fixed in nature due to our internal manufacturing, research and development, sales and general administrative efforts. Any failure to adjust spending quickly enough to compensate for a revenue shortfall could magnify the adverse impact of such revenue shortfall on our results of operations. Moreover, our results of operations may not meet our announced financial outlook or the expectations of research analysts or investors, in which case the price of our common stock could decrease significantly. There can be no assurance that we will be able to successfully address these risks.

The market price of our common stock could be subject to wide fluctuations in response to, among other things, the risk factors described in this section of this Annual Report on Form 10-K, and other factors beyond our control, such as fluctuations in the valuation of companies perceived by investors to be comparable to us.

The stock markets have experienced price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions, such as recessions, sovereign debt or liquidity issues, interest rate changes or international currency fluctuations, may negatively affect the market price of our common stock.

In the past, many companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may become the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

Our charter documents and Delaware law could prevent a takeover that stockholders consider favorable and could also reduce the market price of our stock.

Our amended and restated certificate of incorporation and our amended and restated bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include:

• Providing for a classified board of directors with staggered, three-year terms;

• Not providing for cumulative voting in the election of directors;

• Authorizing our board of directors to issue, without stockholder approval, preferred stock rights senior to those of common stock;

• Prohibiting stockholder action by written consent;

• Limiting the persons who may call special meetings of stockholders; and

• Requiring advance notification of stockholder nominations and proposals.

In addition, we are governed by the provisions of Section 203 of the Delaware General Corporate Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding common stock, from engaging in certain business combinations without approval of substantially all of our stockholders for a certain period of time. These and other provisions in our amended and restated certificate of incorporation, our amended and restated bylaws and

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under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions.

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware will be the exclusive forum for certain disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, or employees.

Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the sole and exclusive forum for the following types of actions or proceedings:

• Any derivative action or proceeding brought on our behalf;

• Any action asserting a breach of fiduciary duty;

• Any action asserting a claim against us arising under the Delaware General Corporation Law; and

• Any action asserting a claim against us that is governed by the internal-affairs doctrine.

This provision would not apply to suits brought to enforce a duty or liability created by the Exchange Act. Furthermore, Section 22 of the Securities Act of 1933, as amended, creates concurrent jurisdiction for federal and state courts over all such Securities Act actions. Accordingly, both state and federal courts have jurisdiction to entertain such claims. This exclusive forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers and other employees. If a court were to find the exclusive-forum provision in our amended and restated certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving the dispute in other jurisdictions, which could seriously harm our business.

GENERAL RISKS

If we fail to maintain effective internal control over financial reporting in the future, the accuracy and timing of our financial reporting may be adversely affected.

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Preparing our consolidated financial statements involves a number of complex manual and automated processes, which are dependent upon individual data input or review and require significant management judgment. One or more of these elements may result in errors that may not be detected and could result in a material misstatement of our consolidated financial statements. If we fail to maintain the adequacy of our internal controls over financial reporting, our business and operating results may be harmed and we may fail to meet our financial reporting obligations. If material weaknesses in our internal control are discovered or occur, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results.

Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. Any failure of our internal controls could adversely affect the results of the periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting. If we cannot provide reliable financial reports or prevent fraud, our business and results of operations could be harmed, investors could lose confidence in our reported financial information, and the trading price of our stock may decline.

Natural disasters, terrorist attacks or other catastrophic events could harm our operations and our financial results.

Our worldwide operations could be subject to natural disasters and other business disruptions, which could harm our future revenue and financial condition and increase our costs and expenses. For example, our corporate headquarters and wafer fabrication facility in Silicon Valley, California and our Tokyo, Japan facility are located near major earthquake fault lines, and our manufacturing facilities are located in Shenzhen and Dongguan, China, areas that are susceptible to typhoons. We are not insured against many natural disasters, including earthquakes. Similarly, our worldwide operations could be subject to secondary effects of natural disasters, terrorist attacks or other catastrophic events. Even if our facilities are not directly affected, any of these types of events could substantially disrupt the business of our suppliers or customers, which could have a material adverse effect on us.

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ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

OPERATIONS

You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying notes.

The following discussion contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed in the forward-looking statements. Please also see the cautionary language at the beginning of Part I of this Annual Report on Form 10-K regarding forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in “Risk Factors” of this Annual Report on Form 10-K.

Overview

We develop, manufacture and sell optoelectronic products that transmit and receive high-speed digital optical signals for Cloud and hyperscale data center internet content provider and telecom networks. We are the world's primary supplier of tunable lasers that emit the ultra-pure light that is required for the highest speed over distance fiber optic communications links.

Our products operate at the highest speed over distance, at speeds of 400 Gigabits per Second ("G"), 600G and 800G and beyond data rates in a single wavelength. Versions of these products have the speed, size, output power and low power consumption that enable interoperable pluggable transceivers in standard form factors which directly transmit data using industry standard Internet Protocol coding, or IP over DWDM wavelengths, greatly simplifying data networks, thereby lowering costs and reducing the total electrical power required.

We integrate our lasers and our high performance coherent optical components into transmit/receive modules, or transceivers. Our high speed transceiver modules, which can operate at data rates including 400G, for example our 400ZR and 400ZR+ coherent pluggable modules, enable new, lower cost network architectures using IP over DWDM protocols. The emergence of such 400ZR and 400ZR+ pluggable modules extends our capabilities to a new, rapidly expanding market segment. Such modules put full coherent transmission capabilities of a line card into the same form factor as a pluggable client side transceiver, enabling interconnects between data centers to be nearly as simple as interconnects within a data center, thereby substantially reducing costs.

Over the past decade we have been first to deliver commercial mass production volumes for each of the highest speed advances in coherent optical components and lasers, as maximum speeds have advanced for each wavelength, or color, from 100G to 200G, 400G, 600G and 800G. We are a specialist in developing and producing products for the highest speed over distance applications, where high baud rate, laser single clarity and high sensitivity are keys to achieving longer distances for a given speed.

We believe we are well positioned to attain and maintain industry leadership in these lasers, component and module solutions based on our leadership in the ultra-pure light lasers which power them and our comprehensive Silicon Photonics and compound semiconductor technologies for optical ICs.

Coherent is the technology of choice for high speed over distance data transmission in Cloud infrastructure and data center interconnection, in addition to telecom networks. The move to 400G and above transmission has been a fulcrum for the industry as it marked a major step-up in speed, as well as enabling new network architecture alternatives to dramatically lower costs by deploying 400ZR architectures in networks. 400G is now the basic building block for network deployments for all reaches from 40km to long haul distances of 2000kms or more, all of which require coherent transmission technology.

We believe we are a global leader in coherent transmission technology, based on our leadership in ultra-pure light lasers, Silicon photonics and optical integration for miniaturization and low power consumption. We sell to virtually all of the leading telecom network equipment companies such as ADVA, Arista Networks, Ciena, Cisco Systems, Fiberhome, Fujitsu, Huawei, Infinera, NEC, Nokia and ZTE.

Furthermore, we believe that use cases for 400ZR and 400ZR+ system-level modules will extend across data center interconnect, backhaul for 5G wireless networks and metro networks. Key attributes of power and power density, and interoperability of coherent pluggable solutions, drive this forecast. These architectures are now being deployed by hyperscale operators and will be adopted in metro telecom networks using 400ZR+ coherent pluggable modules in areas where reach and density make it the clear economic winner with much lower total costs. Furthermore, we believe that our high performance optics combined with next generation DSPs will enable 800ZR and 800ZR+ coherent pluggable modules with the next few years, followed by 1.6T implementations.

Extension of coherent modules into metro networks will be driven by substantially lower costs achieved through elimination of network equipment proprietary chassis, and the reduction in the number of ROADMs required, compared to current network architectures.

With 400G as a fulcrum for the expansion of the market for the highest speeds, we believe we are well positioned to take advantage of this rapidly developing, high growth market.

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Our High Speed Products for data rates of 100G and above, including 800G, were 93% of our 2021 revenues and were 92% of our 2020 revenues. Our sales concentration in High Speed Products has been increasing each year for more than 10 years. Products capable of data rates of 400G and above have accounted for more than 10 percent of our revenue since 2018 and have increased from $44 million in 2019 to $86 million in 2020, to $148 million in 2021, such that revenue from products for 400G and above applications have now reached 51% of revenues in 2021. (400G capable products are defined as products capable of 50 Gbaud and above operation plus lasers purchased specifically for systems with a maximum data rates of 400G or higher.) We believe that the market for 400G and above products will grow at a 5-year compound annual growth rate of 60 percent through 2025. We therefore expect our 400G and above revenues will continue to grow at an accelerated rate over the immediate and longer term.

With adoption of coherent transmission using pluggable high speed optical modules in Cloud and hyperscale data centers, we believe our total addressable market is rapidly expanding.

Proposed Merger with Lumentum Holdings, Inc.

On November 4, 2021 we announced our planned merger with a subsidiary of Lumentum Holdings, Inc. We expect this transaction will close in the second half of 2022.

Our Solutions

Three critical optical components are required to make a coherent transceiver: (1) a laser with a very narrow linewidth for very pure light; (2) a coherent modulator capable of changing both the intensity and phase of the optical signal to code data onto it; and (3) a coherent receiver capable of detecting both the intensity and phase of the received optical signal to “understand” its content, plus an electronic digital signal processor IC (DSP).

We have been a leading volume supplier of these optical components since coherent systems were first deployed in volume for telecommunications networks a decade ago, in 2010. We are now the leading supplier of narrow linewidth tunable lasers and other coherent components for 400G, 600G and above applications.

The capabilities of coherent optics continue to grow with increasing photonic integration for higher performance and smaller size. These are core capabilities of NeoPhotonics and therefore open further opportunities for us in adjacent markets. Outside of communications, coherent technology improves sensitivity and performance for a variety of applications including inter-satellite communication links including for low earth orbit (LEO) satellites, plus industrial applications, 3D sensing for autonomous vehicle navigation, and medical imaging.

Macroeconomic Factors

We continue to manage through two external macro situations that have had a material impact on our business: The Covid-19 Pandemic and the U.S. Department of Commerce restrictions on Huawei Technologies .

The Covid-19 pandemic continues to impact our business, the business of our customers and suppliers and how we execute our business. The pandemic is currently causing industry wide supply chain shortages, particularly for semiconductor chips. In the fourth quarter of 2021, these shortages had a negative impact on our revenue of approximately $15 million. We expect the supply chain disruption will continue at some level for several quarters. Our priorities to address the impacts of the global pandemic on our operations are as follows:

• The health and well-being of our employees and supply chain partners is our top priority.

• We have implemented strict measures to ensure and maintain safety, including working remotely where possible, social distancing and enhanced protocols in each of our global facilities.

• We closely monitor evolving conditions and adhere to local and federal guidelines in each location in which we operate.

Business Continuity

• Our operations and products support essential communications networks globally.

• We have implemented and continue to adjust comprehensive business continuity plans in response to the global pandemic to ensure that we are able to deliver for our customers.

• We are working closely with our supply chain partners globally to secure sufficient inventory and to support the health and safety of their employees.

• We have seen strong demand for products that facilitate increasing network bandwidth; we are working to ensure continuity between us, our supply partners and forward to our customers and their contract manufacturing partners around the world.

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Financial Structure

• We believe our balance sheet and liquidity position provide the flexibility needed to support our operations during this pandemic.

On May 16, 2019, the BIS added Huawei and certain affiliates to the Entity List, with an effective date of May 21, 2019. This denies Huawei the ability to purchase products, software and technology that are subject to U.S. Export Administration Regulations ("EAR").

In May 2020, BIS added Fiberhome Technologies Group to the Entity List, with an effective date of June 5, 2020. This denies Fiberhome the ability to purchase products, software and technology that are subject to EAR.

We are committed to EAR compliance in each of the locations in which we do business. We subsequently determined that certain of our products were not subject to EAR regulations and could lawfully be sold to Huawei. Further, in 2019 we applied for licenses for certain technology subject to EAR, and we were granted a license to ship limited, but not material, volumes of U.S.-manufactured lasers to Huawei. Similarly, in 2020 we determined that a significant portion of our shipments to Fiberhome were not subject to EAR and shipments of certain of those products continued .

On August 17, 2020, BIS increased restrictions on Huawei and its affiliates on the Entity List related to items produced domestically and abroad that use U.S. technology or software and imposed additional requirements for items subject to Commerce export control. On October 5, 2020, we announced that we will manage the business without relying on future revenue contributions from Huawei. We have subsequently determined that a limited number of one product category are not produced with U.S. technology and have subsequently resumed some shipments to Huawei. These shipments were approximately $30 million in 2021 and are expected to decline in 2022 as Huawei moves to other sources.

We have taken actions to better align capacity and production infrastructure with expected demand levels, with the goal of returning to profitability while still meeting customer demand. We have consolidated our Indium Phosphide production into our Japan water fabrication plant and are continuing to build inventory, where possible, to meet demand.

Revenue was $290.3 million in the year ended December 31, 2021, compared to $371.2 million in 2020, a 21.8% decrease due primarily to the EAR export restrictions, with some impact of the global semi-conductor supply chain shortage. Our gross profit was 23.3% of revenue in the year ended December 31, 2021, compared to 27.8% of revenue in 2020. The decrease in gross profit was mainly due to lower volumes resulting in decreased leverage of our manufacturing base.

In the year ended December 31, 2021, High Speed Products represented approximately 93% of total revenue, or $271.3 million and Network Products and Solutions represented approximately 7% of total revenue, or $19.0 million. In the year ended December 31, 2020, High Speed Products were 92% of total revenue, or $340.0 million and Network Products and Solutions represented approximately 8% of total revenue, or $31.1 million. We expect our High Speed Product market group will continue to grow with accelerating market adoption and deployments, and related market share gains operating at 400G and beyond data rates.

We have invested and expect to continue to invest significant time and capital into our research and development operations. Our research and development activities continue to push the performance leadership boundaries in high speed digital optics, silicon photonics and hybrid photonic integration, optoelectronics control and in signal processing.

Research and development expenses were $56.5 million, $56.1 million and $57.6 million in 2021, 2020 and 2019, respectively.

We have research and development and wafer fabrication facilities in Silicon Valley, California and in Tokyo, Japan that coordinate with our research and development and manufacturing facilities in Dongguan, Shenzhen and Wuhan, China and Ottawa, Canada. We use proprietary design tools and design-for-manufacturing techniques to align our design process with our precision nanoscale, vertically integrated manufacturing and testing. We believe we are one of the highest volume manufacturers of photonic integrated circuits ("PIC") in the world and that we can further expand our manufacturing capacity to meet market needs.

Demand for certain of our High Speed Products that are used in metro and DCI applications in North America and Europe is increasing rapidly. DCI deployments in North America have been strong over the past two years, and our products for these applications generally ship to contract manufacturers for our system manufacturer customers.

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Critical accounting policies and estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”). These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses and cash flow, and related disclosure of contingent assets and liabilities. Our critical accounting policies and estimates include those related to revenue recognition, valuation of inventory, impairment analysis of long-lived assets, stock-based compensation expense, and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

We believe that of our significant accounting policies, which are described in Note 2 of Notes to Consolidated Financial Statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe these are the most critical to fully understand and evaluate our financial condition and results of operations.

Revenue recognition

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We generally bear all cost, risk of loss or damage and retain title to the goods up to the point of transfer of control of promised products to customer. Revenue related to the sale of consignment inventories at customer vendor managed locations is not recognized until the products are pulled from consignment inventories by customers. In instances where acceptance of the product or solutions is specified by the customer, revenue is deferred until such required acceptance criteria have been met. Shipping and handling costs are included in the cost of goods sold. We present revenue net of sales taxes and any similar assessments.

Inventories

Our inventories consist of on-hand raw materials, work-in-progress inventories and finished goods. Raw materials and work-in-progress inventories are stored mainly on our premises. Finished goods are stored on our premises as well as on consignment at certain customer sites.

Inventories are stated at the lower of standard cost, which approximates actual cost determined on the weighted average basis, or net realizable value. Inventories are recorded using the first-in, first-out method. We routinely evaluate quantities and values of inventories in light of current market conditions and market trends, and record a write-down for quantities in excess of demand and product obsolescence. The evaluation may take into consideration historic usage, expected demand, anticipated sales price, new product development schedules, the effect new products might have on the sale of existing products, product obsolescence, customer concentrations, product merchantability and other factors. Market conditions are subject to change and actual consumption of inventory could differ from forecasted demand. We also regularly review the cost of inventories against their estimated market value and record a lower of cost or market write-down for inventories that have a cost in excess of estimated market value, resulting in a new cost basis for the related inventories which is not reversed. In 2021, 2020 and 2019, inventory write-down charges were approximately $12.0 million, $9.4 million and $7.8 million, respectively.

Long-lived assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss would be recognized when the sum of the future net cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. The estimated future cash flows are based upon, among other things, assumptions about expected future operating performance and may differ from actual cash flows. If our estimates regarding future cash flows derived from such assets were to change, we may record an impairment to the value of these assets.

Stock-based compensation

Our stock-based compensation plans include stock options, stock appreciation units, restricted stock units, and performance-based restricted stock units. The assumptions used in calculating the fair value of share-based compensation awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. Valuations related to our stock-based plans are based on estimates involving assumptions of volatility, forfeitures and interest rates.

Performance-based restricted stock units include both market-based objectives, related to achieving stock price targets, and time-based vesting, related to achieving Company revenue targets sustainable over a period of time. These plans all require evaluation of the probability of achieving the stated objectives, and therefore actual expenses in subsequent periods can vary from the original estimates.

Accounting for income taxes

We record income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. In estimating future tax consequences, generally we consider all expected future events, other than enactments or changes in tax law or rates. We provide valuation allowances when necessary to reduce deferred tax assets to the amount expected to be realized.

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We operate in various tax jurisdictions and are subject to audit by various tax authorities. We provide for tax contingencies whenever it is deemed probable that a tax asset has been impaired or a tax liability has been incurred for events such as tax claims or changes in tax laws. Tax contingencies are based upon their technical merits, relevant tax law and the specific facts and circumstances as of each reporting period. Changes in facts and circumstances could result in material changes to the amounts recorded for such tax contingencies.

As part of the process of preparing our consolidated financial statements, we are required to estimate our taxes in each of the jurisdictions in which we operate. We estimate actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets.

We make estimates and judgments about our future taxable income that are based on assumptions that are consistent with our plans and estimates. Should the actual amounts differ from our estimates, the amount of our valuation allowance could be materially impacted. Any adjustment to the deferred tax asset valuation allowance would be recorded in the consolidated statement of operations in the period that the adjustment is determined to be required.

Results of operations

Our business is focused on the highest speed digital optics and signal processing communications applications.

In 2021, our High Speed Products for data rates of 100G and beyond comprised 93% of our revenues, increased from 92% in 2020 and 91% in 2019.

The following table presents certain consolidated statements of operations data for the periods indicated as a percentage of total revenue:

Years Ended December 31,

Revenue

Gross profit

Operating expenses

Income (loss) from operations

Interest and other income (expense), net

Loss before income taxes

Net loss

Revenue

% Change

% Change

(in thousands, except percentages)

Total revenue

We sell substantially all of our products to original equipment manufacturers ("OEMs") and their contract manufacturers. Revenue is recognized upon transfer of control of the product to the buyer. We price our products based on market and competitive conditions and may periodically reduce the price of our products as market and competitive conditions change or as manufacturing costs are reduced. Our first quarter revenue is typically seasonally lower than the rest of the year primarily due to the impact of annual price negotiations with customers that occur at the end of the prior year and lower capacity utilization during the holidays in China. Our sales transactions to customers are denominated primarily in U.S. dollars.

Customers accounting for more than 10% of our total revenue and revenue from our top five customers for the years ended December 31, 2021, 2020 and 2019 were as follows:

Years Ended December 31,

Cisco Systems, Inc.

Ciena Corporation

Nokia Corporation

Huawei Technologies Co., Ltd and their affiliates

Acacia Communications, Inc.

Percent of revenue from top five customers

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The following tables present share of revenue by product group and geographical region:

Years Ended December 31,

High Speed Products

Network Products and Solutions

Years Ended December 31,

China

Americas

Rest of world

Total revenue decreased by $80.9 million, or 22%, in 2021, due primarily to the combination of tightened BIS restrictions on sales to Huawei, along with a $15 million negative impact from the global semi-conductor supply chain shortage, compared to an increase of 4% in revenue for year ending 2020. Excluding Huawei, revenue in the year ending December 31, 2021 increased 17%, compared to a revenue increase of 5% in the year ending 2020 as the Company continued to expand with other customers and markets. Of this, our 400G and above product revenue grew 71% year-over-year and comprised 51% of revenue in 2021.

Total revenue increased by $14.4 million, or 4%, in 2020 compared to 2019, led by the solid growth in our tunable laser and coherent modulators businesses offset by a decrease in our integrated coherent receiver business in the U.S. market.

Huawei was a significant customer in the first three quarters of 2020, but as a result of the additional BIS restrictions, there was no revenue from Huawei in the fourth quarter.

Geographic revenue represents the shipment location and frequently changes based on the location of contract manufacturing, rather than end customer location. Shipments to the Americas and to the rest of the world are mainly to contract manufacturers for non-China based network equipment manufacturers ("NEMs").

We believe we will continue to be an industry leader for the highest speed over distance network solutions, supplying customers with components and modules which deliver the highest bandwidth per wavelength and per fiber for long distances. Our High Speed Product market segment consistently represents 90% or more of our business and, based on customer deployment data, out 400G and above capable products represent 51% of our revenue for FY2021. Since launching 400ZR and 400ZR+ pluggable coherent modules two years ago in the fourth quarter of 2019, we have shipped units for qualification to multiple hyper scale customers. In addition, we are shipping limited quantities of our newest 96Gbaud component suite for 800G DCI and 400G long-haul transmissions. We believe these high-performance products will bring accelerating revenue growth and our technology enables potential expansion into other adjacent markets. While we expect a significant portion of our revenue will continue to be derived from a limited number of customers, we are seeing some customer diversification with expansion of our high-performance products.

Cost of goods sold and gross margin

% Change

% Change

(in thousands, except percentages)

Cost of goods sold

Gross profit

Gross profit as a % of revenue

Our cost of goods sold consists primarily of the cost to produce wafers, modules and to manufacture and test our products. Additionally, our cost of goods sold includes stock-based compensation, write-downs of excess and obsolete inventory, royalty payments, amortization of certain purchased intangible assets, depreciation, acquisition-related fair value adjustments, restructuring charges, warranty costs, logistics and allocated facilities costs.

Gross profit as a percentage of total revenue, or gross margin, has been and is expected to continue to be affected by a variety of factors including the introduction of new products, production volume, factory utilization, the mix of products sold, inventory changes, changes in the average selling prices of our products, changes in the cost and volumes of materials purchased from our suppliers, changes in labor costs, changes in overhead costs or requirements, stock-based compensation, write-downs of excess and obsolete inventories and warranty costs. In addition, we periodically negotiate pricing with certain customers which can cause our gross margins to fluctuate, particularly in the quarters in which the negotiations occurred.

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As a manufacturing company, our margins are sensitive to changes in volume and factory utilization. When BIS announced additional restrictions on Huawei, and as the global semi-conductor supply chain shortage reduced the availability of raw materials, we took actions to better align capacity and production infrastructure while expanding out markets and customer base.

Our gross margin decreased 4.5% percentage points to 23.3% in 2021 compared to 27.8% in 2020 and 24.9% in 2019 on lower volumes due to the additional EAR restrictions on Huawei and the global semi-conductor supply shortage affecting factory utilization. Additionally, material costs are increasing as we purchase from higher cost sources to maximize supply. Gross profit decreased $35.5 million from $103.1 million in 2020 to $67.6 million in 2021, compared to an increase in gross profit in the prior year of $14.3 million from $88.8 million in 2019 to $103.1 million in 2020. We continue to drive operational changes to reduce costs and improve gross margin.

Operating expenses

Personnel costs are the most significant component of operating expenses and consist of costs such as salaries, benefits, bonuses, stock-based compensation and other variable compensation.

% Change

% Change

(in thousands, except percentages)

Research and development

Sales and marketing

General and administrative

Amortization of purchased intangible assets

Acquisition and asset sale related costs

Restructuring charges

Litigation settlements

Gain on asset sale

Total operating expenses

Research and development

We focus our research and development efforts on continuing to push the performance leadership boundaries. Research and development expense increased $0.4 million or 1% to $56.5 million, or 19% of revenue from 2020 to 2021 driven mostly by increased personnel costs as we continue to invest for the highest speeds.

Research and development expenses decreased $1.5 million or 3% to $56.1 million, or 15% of revenue, from 2019 to 2020 mainly from lower engineering service costs.

We believe that investments in research and development are important to help meet our strategic objectives. We plan to continue to invest in research and development activities, including new products that we believe will further enhance our competitive position and expand our revenue stream. Research and development expense consists of personnel costs, including stock-based compensation, for our research and development personnel, and product development costs, including engineering services, development software and hardware tools, depreciation of equipment and facility costs. We record all research and development expense as incurred. As a percentage of total revenue, our research and development expense may vary as our investment and revenue levels change over time.

Sales and marketing

Sales and marketing expense decreased by $1.1 million, or 7%, in 2021 compared to 2020, mainly from lower variable compensation expenses.

Sales and marketing expense decreased by $0.5 million, or 3%, in 2020 compared to 2019, mainly from lower levels of travel and fewer marketing events due to the Covid-19 pandemic.

We expect to continue to expand our high speed market focus and increase sales and marketing coverage of the DCI, Cloud and hyperscale data center markets, particularly the 400ZR and 400ZR+ products as well as the 64 Gbaud and 96 Gbaud component suites. Sales and marketing expense consists primarily of personnel costs, including stock-based compensation and sales commissions, costs related to sales and marketing programs and services and facility costs. As a percentage of total revenue, our sales and marketing expense may vary as our revenue changes over time.

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General and administrative

General and administrative expense consists of personnel costs, including stock-based compensation, for our finance, human resources and information technology personnel and certain executive officers, as well as professional services costs related to accounting, tax, banking, legal and information technology services, depreciation and facility costs.

General and administrative expense decreased by $0.1 million, or 0.3%, in 2021, compared to 2020, primarily from lower variable compensation expenses and consulting fees.

General and administrative expense increased by $0.8 million, or 3%, in 2020, compared to 2019, primarily from an increase in personnel costs from both headcount and higher variable compensation expenses, offset by decreases in consulting fees, depreciation and amortization and travel expenses.

Amortization of purchased intangible assets

Our intangible assets are being amortized over their estimated useful lives. Amortization expense relating to technology and patents and leasehold interests are included within cost of goods sold, while customer relationships and non-compete agreements are recorded within operating expenses.

In 2021, amortization of purchased intangible assets was $0.6 million included in the cost of goods sold. The decrease of $0.1 million from 2020 was due to certain intangible assets that have become fully amortized.

In 2020, amortization of purchased intangible assets was $0.7 million included in the cost of goods sold. The decrease of $0.1 million from 2019 was due to certain intangible assets that have become fully amortized.

In 2019, amortization of purchased intangible assets was $0.8 million, comprising of $0.7 million in cost of goods sold and $0.1 million in operating expenses. The decrease of $0.3 million from 2018 due to certain intangible assets have become fully amortized during 2019.

Acquisition and asset sale related costs

In 2021, we incurred $3.7 million primarily in advisory and support fees relating to the proposed merger that was announced on November 4, 2021.

In 2020, we incurred $0.8 million in strategic advisory fees and $0.2 million in legal fees related to a litigation settlement with APAT OE relating to the sale of our low speed transceiver product lines (See Note 14 of Notes to Consolidated Financial Statements in Item 8 of Part II of this Report).

In 2019, we incurred $0.4 million in legal and other professional fees related to our litigation with APAT OE relating to the sale of our low speed transceiver product lines (See Note 14 of Notes to Consolidated Financial Statements in Item 8 of Part II of this Report).

Restructuring and other related costs

In 2021, an immaterial amount of restructuring expense was charged to operating expenses and $0.3 million was charged to cost of goods related to the early exit of the Fremont, California facility as the second phase of the Company's consolidation of operations initiated in 2020.

We implemented restructuring actions in 2020 to better align capacity and production infrastructure with future expected demand levels due to additional BIS restrictions on Huawei, including inventory and equipment write-downs and a reduction in force. We incurred $10.1 million of total restructuring and other related charges with $9.9 million charged to cost of goods sold and $0.2 million charged to operating expenses in 2020.

We incurred $0.3 million in the year ended December 31, 2019 for follow-on expenses related to our 2018 restructuring focused on moving towards a lower break even revenue level.

Litigation settlement

In September 2018, we and Cisco signed a settlement agreement under which we agreed to pay Cisco $0.3 million in cash and $0.2 million in product credits which was issued in December 2019.

In January 2019, we and Lestina International Ltd. signed a settlement agreement under which we agreed to pay Lestina International Ltd. $2.2 million in cash. These payments were completed in two installments paid in February and June 2019. See Note 14 of Notes to Consolidated Financial Statements in Item 8 of Part II of this Report.

In October 2020, we and APAT OE signed a settlement agreement to settle all claims and release all property preservation orders. The settlement resulted in a recovery of previously recognized losses in the amount of $3.0 million, which was recognized in the fourth quarter of 2020.

Interest and other income (expense), net

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% Change

% Change

(in thousands, except percentages)

Interest income

Interest expense

Other income (expense), net

Total

Interest expense included in interest and other income (expense), net decreased by $0.2 million in 2021, as compared to 2020. The decrease in interest expense was due to a $1.1 million decrease in outstanding borrowings and lower interest rate on our Wells Fargo loan. Other income (expense), net included in interest and other income (expense), net, increased by $5.1 million in 2021, as compared to 2020, with a $5.2 million lower exchange loss from U.S. dollar depreciation against the Chinese Renminbi offset by a U.S dollar strengthening against the Japanese Yen.

Interest expense included in interest and other income (expense), net decreased by $0.7 million in 2020, as compared to 2019. The decrease in interest expense was due to a $10.1 million decrease in outstanding borrowings and lower interest rate on our Wells Fargo loan. Other income (expense), net included in interest and other income (expense), net, decreased by $6.4 million in 2020, as compared to 2019, with a $6.1 million higher foreign exchange loss from U.S. dollar depreciation against both the Chinese Renminbi and Japanese Yen and $0.3 million less China government subsidy granted.

Income taxes and effective tax rates

Years ended December 31,

(in thousands, except percentages)

Provision for income taxes

Effective tax rate

In 2021, our income tax provision was primarily related to the operating profit realized in our foreign subsidiaries in Japan and China. Historically, we have experienced net losses in the U.S. and in the short term, we expect this trend to continue.

The effective tax rate was (4)% in 2021 as compared to (38)% in 2020 mainly due to a decrease in earnings in foreign jurisdictions and an increase in net loss generated by the U.S. in 2021.

The effective tax rate was (38)% in 2020 as compared to (11)% in 2019 mainly due to a decrease in earnings in foreign jurisdictions and a decrease in net loss generated by the U.S. in 2020.

Liquidity and capital resources

As of December 31, 2021, we had working capital of $124.1 million, including total cash, cash equivalents, short-term investments and restricted cash of $105.6 million. Approximately 47% of our total cash, cash equivalents, short-term investments and restricted cash were held by our foreign entities, including approximately $42.1 million in accounts held by our subsidiaries in China, of which $0.1 million was in restricted cash, and approximately $7.5 million in accounts held by our subsidiary in Japan. Cash, cash equivalents, investments and restricted cash held outside of the U.S. may be subject to taxes if repatriated and may not be immediately available for our working capital needs.

Approximately $10.5 million of our retained earnings within our total accumulated deficit as of December 31, 2021 was subject to restrictions due to the fact that our subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year end to fund statutory common reserves as well as allocate a discretionary portion of their after-tax profits to their staff welfare and bonus fund. This restricted amount is not distributable as cash dividends, except in the event of liquidation.

In June 2021 we renewed our revolving line of credit agreement with Wells Fargo Bank, National Association ("Wells Fargo") as the administrative agent for a lender group (the "Wells Fargo Credit Facility" or "Credit Facility").

The Wells Fargo Credit Facility provides for borrowings equal to the lower of (a) a maximum revolver amount of $50.0 million, or (b) an amount equal to 80% - 90% of eligible accounts receivable plus 100% of qualified cash balances up to $15.0 million, less certain discretionary adjustments ("Borrowing Base"). The maximum revolver amount may be increased by up to $25.0 million, subject to certain conditions. At closing, $50.0 million was available, of which $20.1 million was drawn.

The Credit Facility matures on June 30, 2026 and borrowings bear interest at an interest rate option of either (a) the LIBOR rate, plus an applicable margin ranging from 1.50% to 1.75% per annum, or (b) the prime lending rate, plus an applicable margin ranging from 0.50% to 0.75% per annum. We are also required to pay a commitment fee equal to 0.25% of the unused portion of the Credit Facility.

The Credit Facility agreement requires prepayment of the borrowings to the extent the outstanding balance is greater than the lesser of (a) the most recently calculated Borrowing Base, or (b) the maximum revolver amount. The Borrowing Base calculation contains a customary provision that gives the lender the ability to reduce the Borrowing Base by reserves that are

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subjectively determinable, which is considered a subjective acceleration clause. We are required to maintain a combination of certain defined cash balances and unused borrowing capacity under the Credit Facility of at least $20.0 million, of which at least $5.0 million must be unused borrowing capacity. Borrowings under the Credit Facility are collateralized by substantially all of our assets.

On June 14, 2019, we entered into a First Amendment to the Credit Facility (the "Amended Credit Facility"). The Amendment removes Huawei from the list of “Eligible Accounts” as a basis for our borrowing while Huawei is on the Entity List. During the period of time while Huawei remains on the Entity List, the concentration limits of certain other customers are increased to partially offset the removal of Huawei. Additionally, until Huawei is no longer on the Entity List, we are required to maintain a temporary combination of certain defined unrestricted cash and unused borrowing capacity under the credit facility of at least $30.0 million in U.S. and $40.0 million world-wide, of which at least $5.0 million shall include unused borrowing capacity.

We were in compliance with the covenants of this Credit Facility as of December 31, 2021. As of December 31, 2021, the outstanding balance under the Credit Facility was $20.3 million and the weighted average rate under the LIBOR option was 1.94%. The remaining borrowing capacity as of December 31, 2021 was $12.7 million, of which $5.0 million is required to be maintained as unused borrowing capacity.

We regularly issue short-term notes payable to our suppliers in China in exchange for accounts payable. These notes are supported by non-interest bearing bank acceptance drafts and are due three to six months after issuance. As a condition of the notes payable arrangements, we are required to keep a compensating balance at the issuing banks that is a percentage of the total notes payable balance until the amounts are settled.

As of December 31, 2021, our subsidiaries in China had two line of credit facilities with banking institutions.

In June 2021, NeoPhotonics (China) Co., Ltd., ("NeoPhotonics China"), a subsidiary of the Company, entered into a credit line agreement with Shanghai Pudong Development Bank Shenzhen Branch (“SPDB”) providing for a line of credit to NeoPhotonics China in an amount of RMB 120,000,000 (approximately $18.9 million) for short-term loans at varying interest rates. As of December 31, 2021, there was $15.0 million outstanding under the NeoPhotonics China credit. The note payable bears interest at 3.0% (2.4% of which was charged to NeoPhotonics China as a loan fee and was paid in the fourth quarter of 2021). This note matures in March 2022.

In June 2021, NeoPhotonics Dongguan Co., Ltd (“NeoPhotonics Dongguan”), also a subsidiary of the Company, entered into a credit line agreement with SPDB providing for a line of credit to NeoPhotonics Dongguan in an amount of RMB 30,000,000 (approximately $4.7 million) for short-term loans at varying interest rates. As of December 31, 2021, there was no amount outstanding under this credit facility.

As of December 31, 2021 and 2020, there were no non-interest bearing bank acceptance drafts issued in connection with our notes payable to our suppliers in China under these line of credit facilities. There were no such balances as of December 31, 2021 and 2020, respectively. There were no compensating balances related to these credit facilities as of December 31, 2021 and 2020. Compensating balances are classified as restricted cash on our consolidated balance sheets. See Note 4 and Note 11 of Notes to Consolidated Financial Statements in Item 8 of Part II of this Report.

As of December 31, 2021, we had two term loan arrangements with MUFG Bank, Ltd. (collectively the “Mitsubishi Bank Term Loans”) and a third loan arrangement with the MUFG Bank, Ltd. and The Yamanashi Chou Bank, Ltd. One of the Mitsubishi Bank Term Loans requires equal monthly payments of principal equal to 8.3 million JPY until the maturity date of February 25, 2025, with a lump sum payment of the balance of 8.4 million JPY on the maturity date. Interest on this loan accrues and is paid monthly based upon the annual rate of the monthly Tokyo Interbank Offer Rate (TIBOR) plus 1.40% and is secured by real estate collateral. The second term loan of 690.0 million JPY (approximately $6.0 million) (the “2017 Mitsubishi Bank Loan”) was entered into in March 2017 to acquire manufacturing equipment for our Japanese subsidiary and has an annual interest rate of the monthly TIBOR rate plus 1.00%. The 2017 Mitsubishi Bank Loan requires monthly interest and principal payments over 72 months commencing in April 2018. This loan was available from March 31, 2017 to March 30, 2018 and 690.0 million JPY (approximately $6.0 million) under this loan was fully drawn in March 2017. In January 2018, we entered into a term loan agreement with MUFG Bank, Ltd. and The Yamanashi Chou Bank, Ltd. for a term loan in the aggregate principal amount of 850.0 million JPY (approximately $7.4 million) (the "Mitsubishi-Yamanashi Term Loan"). The Mitsubishi-Yamanashi Term Loan was available from January 29, 2018 to January 29, 2025. The full amount of the Mitsubishi-Yamanashi Term Loan was drawn on January 29, 2018. Interest on the Mitsubishi-Yamanashi Term Loan is based upon the annual rate of the three months TIBOR rate plus 1.00%. The Mitsubishi-Yamanashi Term Loan requires quarterly interest payments, along with the principal payments, over 82 months commencing in April 2018. As of December 31, 2021, our aggregate outstanding principal balance under Mitsubishi Bank Term Loans and Mitsubishi-Yamanashi Term Loan was 970 million JPY (approximately $8.4 million). See Note 11 of Notes to Consolidated Financial Statements in Item 8 of Part II of this Report.

From time to time we accept notes receivable in exchange for accounts receivable from certain of our customers in China. These notes receivable are non-interest bearing and are generally due within nine months. Historically, we have collected on the notes receivable in full at the time of maturity.

In 2021, we incurred operating losses of $37.8 million and cash flows used in operations of $(20.6) million. We had an accumulated deficit of $459.6 million as of December 31, 2021.

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During 2021 under the revolving line of credit we repaid $1.3 million to Wells Fargo. Additionally, we had $2.9 million of current portion of long-term debt as of December 31, 2021, which we plan to pay out of our existing available cash.

Lumentum has agreed to arrange for up to $50,000,000 in interim debt financing that is unsecured, subordinated to our existing secured credit facility with Wells Fargo, has a two-year term and bears interest at the prime rate.

We believe that our existing cash, cash equivalents and cash flows from our operating activities will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products, the costs to increase our manufacturing capacity and our foreign operations and the continuing market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

Rusnano Rights Agreement

In April 2019, we completed the sale of 100% interest in the operations of NeoPhotonics Corporation, LLC, our manufacturing operations in Russia, to Rusnano. In connection with the sale, we received $2.0 million in cash and settled a $2.0 million exit fee that would have otherwise been owed to Rusnano.

Cash flow discussion

The table below sets forth selected cash flow data for the periods presented:

Years ended December 31,

(in thousands)

Net cash provided by (used in) operating activities

Net cash used in investing activities

Net cash provided by (used in) financing activities

Effect of exchange rates on cash, cash equivalents and restricted cash

Net increase (decrease) in cash, cash equivalents and restricted cash

Operating activities

In 2021, net cash used in operating activities was $20.6 million, compared to $54.9 million net cash provided by operating activities in 2020. The decrease was primarily attributable to a $43.6 million increase in net loss and non-cash adjustments, a $32.7 million decrease in cash flows related to accounts receivable, a $17.0 million decrease in cash flows related to accrued and other liabilities, and a $10.6 million decrease in cash flows related to inventories. The decreases were offset by a $29.2 million increase in cash flows related to accounts payable.

In 2020, net cash provided by operating activities was $54.9 million, compared to $34.7 million in 2019. The increase was primarily attributable to a $12.7 million decrease in net loss, a $16.8 million increase in cash flows related to accounts receivables and a $3.3 million increase in cash flows related to prepaid expenses and other current assets. The increases were offset by a $14.9 million decrease in cash flows related to accounts payable.

Investing activities

In 2021, net cash used in investing activities was $10.1 million, a $23.3 million decrease compared to $33.4 million used in 2020. The decrease in net cash used in investment activities was primarily attributable to an increase in net cash provided by proceeds from sale of marketable securities totaling $27.0 million, and a net decrease of $2.4 million used to purchase property, plant and equipment. The decreases were offset by a $7.0 million increase to purchase marketable securities.

In 2020, net cash used in investing activities was $33.4 million, a $26.0 million increase compared to $7.4 million used in 2019. The increase in net cash used in investment activities was primarily attributable to an increase in net cash used totaling $19.9 million to purchase marketable securities, and a net increase of $4.3 million used to purchase property, plant and equipment.

Financing activities

In 2021, net cash provided by financing activities was $12.8 million, a $21.3 million increase compared to $8.5 million net cash used by financing activities in 2020. The increase in cash flows from investing activities was primarily attributable to a $14.4 million increase in net borrowings under our credit facilities and terms loans in China, and a $5.8 million decrease in repayment of bank loan.

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In 2020, net cash used in financing activities was $8.5 million, a $6.4 million decrease compared to $14.9 million net cash used by financing activities in 2019. The decrease in cash flows from investing activities was primarily attributable to a $7.7 million decrease in net borrowings under our credit facilities, terms loans and note payables in China, partially offset by a $1.0 million increase in withholding tax for restricted stock releases.

Material requirements from contractual and other obligations

Summarized in the table and text below are our short-term and long-term obligations as of December 31, 2021:

Payments due by period

(in thousands)

Total

Less than 1 Year

1-3 Years

3-5 Years

More than 5 Years

Notes payable and short-term borrowing (1)

Long-term debt (1)

Retirement obligations (2)

Operating leases (3)

Purchase commitments (4)

Asset retirement obligations (5)

Expected interest payments (6)

Finance lease

Total

Uncertainty in timing of future payments:

Restricted retained earnings

Deferred compensation plan

Total commitments

(1) See Note 11, Debt, in Notes to Consolidated Financial Statements in Item 8 of Part II of this Report for additional information regarding our debt.

(2) See Note 13, Pension Plans, in Notes to Consolidated Financial Statements in Item 8 of Part II of this Report for additional information regarding our retirement obligations.

(3) We have entered into various non-cancelable operating lease agreements for our offices in China, U.S. and Canada.

(4) This is an estimate of the amount outstanding under open purchase orders for the purchase of inventory and other goods at December 31, 2021. Certain of these open purchase orders may be cancellable without penalty.

(5) We have an asset retirement obligation of $3.8 million associated with our facility leases in California and $0.1 million in Japan, included in Accrued and other current liabilities and Other noncurrent liabilities in the consolidated balance sheets as of December 31, 2021.

(6) We calculate the expected interest payments based on our long-term debt at prevailing interest rates as of December 31, 2021.

Uncertain Tax Positions

As of December 31, 2021, there were no liabilities for uncertain tax positions.

Off-balance sheet arrangements

During the years ended December 31, 2021 and 2020, we did not have any significant off-balance sheet arrangements.

Recent accounting pronouncements

See Note 2, Summary of Significant Accounting Policies, in Notes to the Consolidated Financial Statements in Item 8 of Part II of this Report, for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on financial condition and results of operations, which is incorporated herein by reference.

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