Item 1A. Risk Factors
Item 1A. Risk Factors
Our business faces significant risks and uncertainties, which may have a material adverse effect on our business prospects, financial condition and results of operations, and you should carefully consider them. There have been no material changes in the nine months ended September 30, 2020 to the risk factors described in Part I, Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2019, with the exception of the risk factors below.
Risks Related to the ECI Telecom Group Ltd. Merger
Combining Ribbon and ECI may be more difficult, costly or time-consuming than expected and the anticipated benefits and cost savings of the ECI Merger may not be realized.
On March 3, 2020, we completed our previously announced merger transaction with ECI in accordance with the terms of the Agreement and Plan of Merger, dated as of November 14, 2019, by and among Ribbon, ECI, an indirect wholly-owned subsidiary of Ribbon ("Merger Sub"), Ribbon Communications Israel Ltd., ECI and ECI Holding (Hungary) kft, pursuant to which Merger Sub merged with and into ECI, with ECI surviving such merger as a wholly-owned subsidiary of Ribbon (the "Merger").
The success of the ECI Merger, including anticipated benefits and cost savings, will depend, in part, on our ability to successfully combine and integrate the businesses. It is possible that the integration process could result in the loss of key employees, higher than expected costs, diversion of management attention, the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company’s ability to maintain relationships with customers, vendors and employees or to achieve the anticipated benefits and cost savings of the ECI Merger.
We have incurred and will incur additional transaction fees, including legal, regulatory and other costs associated with closing the transaction, as well as expenses relating to formulating and implementing integration plans, including facilities and systems consolidation costs and employment-related costs. We continue to assess the magnitude of these costs, and additional
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unanticipated costs may be incurred in the ECI Merger and the integration of the two companies’ businesses. While we expect that the elimination of duplicative costs as well as the realization of other efficiencies related to the integration of the businesses should allow us to offset integration-related costs over time, this net benefit may not be achieved in the near term or at all. As part of the integration process, we may also attempt to divest certain assets of the combined company, which may not be possible on favorable terms, or at all, or if successful, may change the profile of the combined company. If we experience difficulties with the integration process, the anticipated benefits of the ECI Merger may not be realized fully or at all, or may take longer to realize than anticipated. The actual cost savings of the ECI Merger could be less than expected.
Risks Related to the COVID-19 Pandemic
The COVID-19 pandemic and resulting deteriorations in global economic conditions may have a material adverse impact on our business, financial position and results of operations.
In 2020, a novel strain of the coronavirus (COVID-19) was declared by the World Health Organization to be a global pandemic. The COVID-19 pandemic has had a negative effect on the global economy, disrupting the various manufacturing, commodity and financial markets and increasing volatility, and has impeded global supply chains, including that of our recently acquired subsidiary, ECI Telecom Group Ltd. Dampened global economic conditions as a result of the COVID-19 pandemic may cause our customers to restrict spending or delay purchases for an indeterminate period of time. In addition, our ability to deliver our solutions as agreed with our customers depends on the ability of our global contract manufacturers, vendors, licensors, and other business partners to deliver products or perform services we have procured from them. If the COVID-19 pandemic impairs the ability of our business partners to support us on a timely basis, or negatively impacts the demand for our customers’ other products and services, our ability to perform our customer contracts as well as the demand for our solutions may suffer. In addition, disruptions from the COVID-19 pandemic include the temporary closures of some of our facilities, as well as those of our contract manufacturers, vendors and suppliers, the inability to obtain key components of our products, the disruption of logistics necessary to import, export and deliver our solutions, limitations on the ability of our customers to perform or make timely payments, and/or workforce disruptions due to illness, quarantines, government actions, facility closures, partial work permits limiting the capacity of production facilities, or other restrictions.
Concerns over the economic impact of COVID-19 pandemic have also caused extreme volatility in financial and other capital markets which has and may continue to adversely impact our stock price. Such volatility may also adversely impact our ability to access capital markets if and when we would be required to do so.
Actions taken globally in response to the COVID-19 pandemic have created significant dislocation in demand and pricing for oil, which has subsequently impacted a variety of currencies around the world. These fluctuations in the relative value of currencies could have a significant impact on demand for our products and the net sales price and profitability.
The degree to which the COVID-19 pandemic ultimately impacts our business, financial position and results of operations will depend on future developments beyond our control, including the severity of the pandemic, including the frequency and duration of future waves of infection; the effectiveness and timing of any vaccines, the extent of actions to contain or treat the virus; how quickly and to what extent normal economic and operating conditions can resume; the health of and the effect on our workforce, particularly if members of our workforce are quarantined as a result of exposure, worker absenteeism as a result of illness or other factors, social distancing measures including work from home measures and other travel, health-related, business, government or other restrictions in connection with pandemics or disease outbreaks; and the severity and duration of the global economic downturn that results from the pandemic.
Risks Related to our Business and Industry
The terms of our credit agreement could adversely affect our operating flexibility and pose risks of default, which would negatively impact our liquidity and operations.
The terms of our credit agreement could adversely affect our operating flexibility and pose risks of default which would negatively impact our liquidity and operations. In addition, we may not be able to refinance our debt or obtain additional financing on favorable terms, or at all.
Our Senior Secured Credit Facility Credit Agreement entered into on March 3, 2020 (as amended on August 18, 2020, the “2020 Credit Agreement”) provides $500 million of commitments, comprised of a $325 million term A loan (the “Term A Loan”), a $75 million term B loan (the “Term B Loan”), a $100 million revolving facility (the “2020 Revolving Credit Facility”), a $30 million sublimit that is available for letters of credit and a $20 million sublimit that is available for swingline loans. The Term A Loan and the 2020 Revolving Credit Facility are scheduled to mature in March 2025. The Term B Loan is
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scheduled to mature in March 2026. Provisions in the 2020 Credit Agreement impose limitations on our ability to, among other things, incur additional indebtedness, create liens, make acquisitions or engage in mergers, enter into transactions with affiliates, dispose of assets, make certain investments and amend or repay certain junior debt.
In addition, we are required to meet certain financial covenants customary for financings of this type. Our failure to comply with these covenants may result in the declaration of an event of default, which could cause us to be unable to borrow under the credit facility or result in the acceleration of the maturity of indebtedness outstanding under the credit facility at such time. If the maturity of our indebtedness is accelerated, we may not have sufficient funds available for repayment or we may not have the ability to borrow or obtain sufficient funds to replace the accelerated indebtedness on terms acceptable to us, or at all.
The United Kingdom's Financial Conduct Authority, which regulates the London Inter-bank Offered Rate ("LIBOR"), has announced that it intends to stop encouraging or requiring banks to submit LIBOR rates after 2021, and it is unclear if LIBOR will cease to exist or if new methods of calculating LIBOR will evolve. We have the option under our current credit facility to determine our interest rate that includes either the LIBOR rate or the base rate. If LIBOR ceases to exist or the methods of calculating LIBOR change from their current form, we may no longer have the ability to elect the LIBOR rate option under our current credit facility, and our current or future indebtedness may be adversely affected. This could impact our interest costs and our ability to borrow additional funds under our current credit facility.
If we are prevented from borrowing or if we are unable to extend, renew or replace the credit facilities under the 2020 Credit Agreement by the maturity dates, on favorable terms, or at all, this could have a material adverse effect on our liquidity and cause our business, operations and financial condition to suffer. In addition, we may not have sufficient funds available for repayment or we may not have the ability to borrow or obtain sufficient funds to replace the indebtedness on terms acceptable to us, or at all.
We cannot be sure that our current cash and available borrowings under our 2020 Credit Agreement will be sufficient to meet our future needs. If we are unable to generate sufficient cash flows in the future, and if availability under our current facility is not sufficient to support our operations, we may need to refinance our debt or obtain additional financing. We may not be able to refinance our debt or obtain additional financing on favorable terms or at all.
Risks Related to ECI
If the market for 5G network solutions and Cloud-based applications does not evolve in the way the Company anticipates, it may not be able to realize a key part of its business strategy .
A material part of the Company’s research and development is invested in developing networking products and solutions to deliver major new features supported by the 5G standards, and a key part of the Company’s growth strategy depends on its ability to gain market share for these networking products and solutions. Deployment of wide-scale commercial 5G networks will occur at a variety of different timing depending on the unique attributes and priorities of each region, communication service provider, and government regulatory environment, if at all. For these reasons, the development of the market for the Company’s 5G networking products and solutions may be mis-timed with the market opportunity, and any significant delays could have a materially adverse effect on the Company’s growth strategy.
In addition, part of the Company’s growth strategy involves taking advantage of the shift towards Cloud-based applications and services. The Cloud-based service delivery paradigm continues to evolve and grow, and is beginning to include a new Mobile Edge Computing (MEC) approach that shifts the workload to the edge of the mobile network to take advantage of the speeds and reduce latency of the new 5G network. The pace at which these new architectures are adopted are difficult to predict and will have a direct impact on our growth. While it is expected that 5G will help accelerate the demand for and use of Cloud-based and MEC applications, this will only be known once 5G is widely implemented. If the market for 5G products and solutions or Cloud-based applications, or the impact of 5G on the demand for Cloud-based applications, does not evolve in the way the Company anticipates, or if customers do not adopt the Company’s 5G networking products and solutions or its Cloud-based applications, a key part of the Company’s growth strategy may not materialize which could have a material adverse effect on the Company’s business, results of operations, financial condition, cash flows and prospects.
The Israel Innovation Authority (IIA) government grants received by the Company's ECI subsidiary for research and development expenditures have been significantly reduced in the last few years and may be reduced further or eliminated due to government budget cuts or reallocation of the government’s resources. These grants also place certain limitations on the Company’s ability to manufacture products and transfer or license know-how outside of Israel and require the Company to satisfy specified conditions.
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The Company currently receives grants from the Government of Israel through the IIA for the financing of a portion of the Company’s research and development expenditures in Israel pursuant to the Encouragement of Research, Development and Technological Innovation in the Industry Law 5744-1984 (together with its predecessor legislation, the “Innovation Law”). In the last few years these grants have been substantially reduced, as a result of changes in the policy of the IIA. The IIA may reallocate or further reduce or eliminate these grants in the future, which could require the Company to directly fund a larger portion of research and development in Israel, reducing the overall profitability of the Company.
The Company is required to repay the grants received from the IIA in the form of royalties paid on proceeds from the sale of products that were developed using this funding and services associated with such products. The royalties are payable in an amount of up to 100% of the U.S. dollar-linked value of the amount of the grant (which may be increased under certain circumstances) (referred to as the “royalty ceiling”) plus interest at the rate of 12-month LIBOR on the date that the grant application is made. The Company’s royalty rates are generally between 1.3% and 5% of the proceeds from the sale of relevant products and services.
The terms of the IIA grants generally require that products developed with grants be manufactured in Israel, unless approval for transferring such manufacturing outside Israel is received from the IIA, however, such approval is not required for the transfer of manufacturing outside Israel of up to 10% of the manufacturing. Such approval may be provided by the IIA in connection with the approval of the grant application itself (as the Company has requested in its grant applications since 2013), in which case the royalty repayment rate is increased by 1% with respect to any such approved percentage. If manufacturing of IIA-funded products is transferred outside Israel (subject to IIA approval) in excess of the percentage approved by the IIA in connection with the grant approval, then the repayment rate is increased by 1% and the royalty repayment amount with respect to such products may be increased to up to three times the amount of the grants received (plus interest at the rate of 12-month LIBOR on the date that the grant application is made).
IIA prior approval is also required for the sale, licensing, distribution or other transfer (referred to as a transfer) of know-how created, in whole or in part, in connection with an IIA-funded project to a third party outside Israel. If such IIA approval is received and the know-how is transferred outside Israel, a redemption fee is typically required to be paid to the IIA, which is calculated according to a formula provided under the Innovation Law, up to a maximum redemption fee of no more than either (i) three times (if certain prescribed research and development activities are retained in Israel); or (ii) six times the amount of the grants received (plus accrued interest) for the applicable know-how being transferred, subject to the deduction of royalties previously paid to the IIA. If the IIA implements additional or more stringent restrictions on transfer of manufacturing activities and transfer of funded know-how outside Israel under the Innovation Law, it could have a material adverse effect on the Company’s business, results of operations, financial condition, cash flows and prospects.
Risks Relating to our International Operations
Conditions in Israel may materially and adversely affect the Company’s business.
ECI Telecom Ltd., is organized under Israeli law, and a material number of the Company’s employees are located in Israel. Accordingly, political, economic and military conditions in Israel may directly affect the Company’s business. Since Israel was established in 1948, a number of armed conflicts have occurred between Israel and its neighboring countries. In recent years, these have included hostilities between Israel and Hezbollah in Lebanon and Hamas in the Gaza Strip, both of which resulted in rockets being fired into Israel, causing casualties and disruption of economic activities. Popular uprisings in various countries in the Middle East and North Africa are affecting the political stability of those countries and have led to a decline in the regional security situation. Such instability may also lead to deterioration in the political and trade relationships that exist between Israel and these countries. Any armed conflicts, terrorist activities or political instability involving Palestinian entities or other countries in the region could adversely affect the Company’s business, results of operations, financial condition, cash flows and prospects. Although the Israeli Government currently covers the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, the Company cannot assure prospective investors that this coverage will be maintained or will be adequate in the event the Company submits a claim.
A number of countries, principally in the Middle East, still restrict doing business with Israel and Israeli companies, and additional countries may impose restrictions on doing business with Israel and Israeli companies if hostilities in Israel or political instability in the region continue or increase. In addition, there have been increased efforts by activists to cause companies and consumers to boycott Israeli goods based on Israeli Government policies. Such actions, particularly if they become more widespread, may adversely impact the Company’s ability to sell its products. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners, or significant downturn in the economic or financial condition of Israel, could have a material adverse effect on the Company’s business, results of operations, financial condition, cash flows and prospects.
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The Company’s operations could also be disrupted by the absence for significant periods of one or more of its executive officers, key employees or a significant number of other employees because of military service. Some of the Company’s employees in Israel are obliged to perform military reserve duty, which generally accumulates over a period of three years from several days to up to a maximum of 84 days (and up to 108 days, in special circumstances specified under applicable law) and, in certain emergency circumstances, employees may be called to immediate and unlimited active duty. In response to increases in terrorist activity, there have been periods of significant call-ups of military reservists and it is possible that there will be similar large-scale military reserve duty call-ups in the future.
Any of these circumstances could have a material adverse effect on the Company’s business, results of operations, financial condition, cash flows and prospects.
Impact of Assessment of Adjusted Gross Revenue dues in India.
A dispute has arisen in India between the large telecommunications service providers and the Department of Telecommunications (“DoT”) regarding how to compute the Adjusted Gross Revenue (“AGR”) due from the former to the DoT. The service providers claim that AGR should only comprise of revenue accrued from core services. The DoT has argued that AGR includes all revenues (before discounts) from both telecommunications and non-telecommunications services. The Supreme Court of India recently issued a judgment accepting the position of the DoT, requiring private telecommunications service providers to pay out the higher sums towards license fee and spectrum usage fee, plus interest and penalties, which are dependent on the value of their AGR. The sums that the telecommunications operators owe the Indian government include substantial back charges, interest and penalties, which operators have ten years to pay, with the first 10% due March 31, 2021. The telecommunications service providers are still assessing the impact of this decision and the impact it may have on their capital investments in India.
Worldwide efforts to contain capital spending and global economic conditions and uncertainties in the geopolitical environment have been and may continue to be materially adverse to our business.
One factor that significantly affects our operating results is the impact of economic conditions on the willingness of our current and potential customers to make capital investments. Given the uncertainty regarding global economic conditions and uncertainties in the geopolitical environment, we believe that customers have tried to maintain or improve profitability through cost control and constrained capital spending, which places additional pressure on IT departments to demonstrate acceptable return on investment. Some of our customers have canceled or delayed, and current and prospective customers may continue to cancel and delay, spending on the development or roll-out of capital and technology projects with us due to economic uncertainty and, consequently, our results of operations have been, and may continue to be, adversely affected. In addition, current uncertain worldwide economic and political environments make it increasingly difficult for us, our customers and our suppliers to accurately forecast future product demand, which could result in an inability to satisfy demand for our products and a loss of market share. Our revenue is likely to decline in such circumstances, which may result in erosion of our profit margins and significant losses.
Moreover, economic conditions worldwide may contribute to slowdowns in the communications and networking industries, as well as to specific segments and markets in which we operate, particularly the wireline sector, resulting in, among other things:
• reduced demand for our products and services as a result of our customers choosing to refrain from building capital-intensive networks;
• increased price competition for our products, not only from our competitors, but also as a consequence of customers disposing of unutilized product;
• risk of excess and obsolete inventories;
• excess facilities and manufacturing capacity; and/or
• higher overhead costs as a percentage of revenue and higher interest expense.
Continuing turmoil in the geopolitical environment in many parts of the world, as well as changes implemented by the current U.S. presidential administration, may continue to put pressure on global economic conditions which in turn, could materially adversely affect our operating results. For example, following recent border clashes with China, India has enacted bans on the import of some goods manufactured in China. While the current import bans do not include our products, if India expands the bans to include the products we sell in India that are currently manufactured in China, we may be required to find new manufacturing locations for such products, which could impact our ability to sell such products or timely deliver the products, and could result in lower or lost sales in India. The need to move manufacturing of such products could also negatively impact the margin earned on the sale of such products.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.