Ribbon Communications Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of the financial condition and results of operations of Ribbon Communications Inc. should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the U.S. Securities and Exchange Commission on March 11, 2022. Overview We are a leading global provider of communications technology to service providers and enterprises. We provide a broad range of software and high-performance hardware products, solutions and services that enable the secure delivery of data and voice communications for residential consumers and for small, medium and large enterprises and industry verticals such as finance, education, government, utilities and transportation. Our mission is to create a recognized global technology leader providing cloud-centric solutions that enable the secure exchange of information, with unparalleled scale, performance and elasticity. Headquartered in Plano, Texas, we have a global presence with research and development and/or sales and support locations in over thirty-five countries around the world. Impact of COVID-19 on Our Business 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 IP Optical Networks segment. Continued uncertain global economic conditions as a result of the continuing COVID-19 pandemic, particularly in areas experiencing higher case numbers as a result of new variants, may cause our customers to restrict spending or delay purchases for an indeterminate period of time and consequently cause our revenues to decline. In addition, our ability to deliver our solutions as agreed upon with our customers depends on the ability of our global contract manufacturers, vendors, licensors and other business partners to deliver products or perform services we have procured from them. The degree to which the continuing COVID-19 pandemic impacts our future business, financial position and results of operations will depend on developments beyond our control, including the effectiveness of vaccines over the long-term or with respect to new variants, the frequency and duration of future waves of infection, the extent of actions to contain or treat the virus, how quickly and to what extent normal economic and operating conditions can result after new future waves, and the severity and duration of the global economic downturn that has resulted from the pandemic. Presentation Unless otherwise noted, all financial amounts, excluding tabular information, in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") are rounded to the nearest million dollar amount, and all percentages, excluding tabular information, are rounded to the nearest percentage point. Reclassification of Amortization of Acquired Intangible Assets In 2021, we reclassified amounts recorded for amortization of certain acquired intangible assets in prior presentations from Total operating expenses under the caption "Amortization of acquired intangible assets" to Total cost of revenue under the caption "Amortization of acquired technology" in the consolidated statements of operations. Our management believes this presentation aids in the comparability of our financial statements to industry peers. These reclassifications did not impact our operating income (loss), net income (loss) or earnings (loss) per share for any historical periods. These reclassifications also did not impact our condensed consolidated balance sheets or statements of cash flows. This reclassification resulted in $10.1 million recorded to Amortization of acquired technology within Total cost of revenue and a decrease of $10.1 million to Amortization of acquired intangible assets within Total operating expenses in the three months ended March 31, 2021. The increase to Total cost of revenue decreased our gross profit as a percentage of revenue ("gross margin") by approximately five percentage points. Operating Segments Our Chief Operating Decision Maker assesses our performance based on the performance of two separate organizations within Ribbon: the Cloud and Edge operating segment ("Cloud and Edge") and the IP Optical Networks operating segment ("IP Optical Networks"). For additional details regarding our operating segments, see Note 12 - Operating Segment Information to our condensed consolidated financial statements. 34 Financial Overview Financial Results We reported losses from operations of $39.1 million and $12.6 million for the three months ended March 31, 2022 and 2021, respectively. Our revenue was $173.2 million and $192.8 million in the three months ended March 31, 2022 and 2021, respectively. Our gross profit and gross margin were $78.1 million and 45.1%, respectively, in the three months ended March 31, 2022, and $100.5 million and 52.1%, respectively, in the three months ended March 31, 2021. Revenue from our Cloud and Edge segment was $109.8 million and $125.4 million in the three months ended March 31, 2022 and 2021, respectively. Gross profit and gross margin for this segment were $62.7 million and 57.1%, respectively, in the three months ended March 31, 2022, and $77.5 million and 61.8%, respectively, in the three months ended March 31, 2021. Revenue from our IP Optical Networks segment was $63.4 million and $67.4 million in the three months ended March 31, 2022 and 2021, respectively. Gross profit and gross margin for this segment were $15.3 million and 24.2%, respectively, in the three months ended March 31, 2022, and $23.0 million and 34.1%, respectively, in the three months ended March 31, 2021. Our operating expenses were $117.1 million and $113.1 million in the three months ended March 31, 2022 and 2021, respectively. Operating expenses for the three months ended March 31, 2022 included $7.3 million of amortization of acquired intangible assets, $1.8 million of acquisition-, disposal- and integration-related expense, and $4.8 million of restructuring and related expense. Operating expenses for the three months ended March 31, 2021 included $5.8 million of amortization of acquired intangible assets, $1.2 million of acquisition-, disposal- and integration-related expense, and $6.0 million of restructuring and related expense. We recorded stock-based compensation expense of $4.3 million and $5.1 million in the three months ended March 31, 2022 and 2021, respectively. These amounts are included as components of both Cost of revenue and Operating expenses in our condensed consolidated statements of operations. See "Results of Operations" in this MD&A for a discussion of the changes in our revenue and expenses for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. Restructuring and Cost Reduction Initiatives 2022 Restructuring Plan . In February 2022, our Board of Directors approved a strategic restructuring program (the "2022 Restructuring Plan") to streamline the Company's operations in order to support the Company's investment in critical growth areas. The 2022 Restructuring Plan is expected to include, among other things, charges related to a consolidation of facilities and a workforce reduction. Any positions eliminated in countries outside the United States are subject to local law and consultation requirements. We recorded restructuring and related expense of $4.2 million for severance and related costs for approximately 50 employees in connection with the 2022 Restructuring Plan in the three months ended March 31, 2022. We anticipate that we will record future expense for severance and facility consolidations aggregating approximately $16 million in connection with the 2022 Restructuring Plan. 2020 and 2019 Restructuring Plans . In 2020, we implemented a restructuring plan to eliminate certain positions and redundant facilities, primarily in connection with the ECI Acquisition, to further streamline our global footprint and improve our operations (the "2020 Restructuring Plan"). The 2020 Restructuring Plan included facility consolidations and a reduction in workforce to eliminate redundant functions arising from our acquisition of ECI Telecom Group Ltd. in 2020 (the "ECI Acquisition") and support our efforts to integrate the two companies. At March 31, 2022, the 2020 Restructuring Plan had a remaining accrual of $0.8 million for severance costs that are expected to be paid out over the next year. In June 2019, we implemented a restructuring plan to streamline our global footprint, improve our operations and enhance our customer delivery (the "2019 Restructuring Plan"). The 2019 Restructuring Plan included facility consolidations, refinement of our research and development activities, and a reduction in workforce. At March 31, 2022, the 2019 Restructuring Plan had a remaining accrual of $1.4 million for facility costs that remain in the plan and which will be paid out over the various lease terms, which range from one to six years. 35 Accelerated Rent Amortization . Accelerated rent amortization is recognized from the date that we commence the plan to fully or partially vacate a facility, for which there is no intent or ability to enter into a sublease, through the final vacate date. We recorded $3.4 million for accelerated rent amortization in the three months ended March 31, 2021. We did not record accelerated rent amortization in the three months ended March 31, 2022. We continue to evaluate our properties included in our restructuring plans for accelerated amortization and/or right-of-use asset impairment. We may incur additional future expense if we are unable to sublease other locations included in these initiatives. Critical Accounting Policies and Estimates Management's discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment: revenue recognition, the valuation of inventory, the valuation of our investment in American Virtual Cloud Technologies Inc. (the "AVCT Investment"), warranty accruals, loss contingencies and reserves, stock-based compensation, business combinations, goodwill and intangible assets, accounting for leases, and accounting for income taxes. If actual results differ significantly from management's estimates and projections, there could be a material effect on our condensed consolidated financial statements. There were no significant changes to our critical accounting policies from January 1, 2022 through March 31, 2022. For a further discussion of our other critical accounting policies and estimates, please refer to our Annual Report on Form 10-K for the year ended December 31, 2021. Results of Operations Three months ended March 31, 2022 and 2021 Revenue. Revenue for the three months ended March 31, 2022 and 2021 was as follows (in thousands, except percentages): Three months ended Decrease from prior year March 31, 2022 March 31, 2021 $ % Product $ 81,990 $ 97,889 $ (15,899) (16.2) % Service 91,208 94,883 (3,675) (3.9) % Total revenue $ 173,198 $ 192,772 $ (19,574) (10.2) % Segment revenue for the three months ended March 31, 2022 and 2021 was as follows (in thousands): Three months ended March 31, 2022 Three months ended March 31, 2021 Cloud and Edge IP Optical Networks Total Cloud and Edge IP Optical Networks Total Product $ 37,635 $ 44,355 $ 81,990 $ 50,152 $ 47,737 $ 97,889 Service 72,171 19,037 91,208 75,270 19,613 94,883 Total revenue $ 109,806 $ 63,392 $ 173,198 $ 125,422 $ 67,350 $ 192,772 The decrease in our product revenue in the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was primarily the result of lower sales of our Cloud and Edge SBC products and network transformation products, coupled with lower sales of IP Optical Networks products. Revenue from indirect sales through our channel partner program was 29% and 21% of our product revenue in the three months ended March 31, 2022 and 2021, respectively. Revenue from sales to enterprise customers was 27% and 23% of our product revenue in the three months ended March 31, 2022 and 2021, respectively. These sales were made through both our direct sales team and indirect sales channel partners. 36 The timing of the completion of customer projects and revenue recognition criteria satisfaction may cause our product revenue to fluctuate from one period to the next. Service revenue is primarily comprised of hardware and software maintenance and support (“maintenance revenue”) and network design, installation and other professional services (“professional services revenue”). Service revenue for the three months ended March 31, 2022 and 2021 was comprised of the following (in thousands, except percentages): Three months ended Decrease from prior year March 31, 2022 March 31, 2021 $ % Maintenance $ 68,605 $ 68,705 $ (100) (0.1) % Professional services 22,603 26,178 (3,575) (13.7) % $ 91,208 $ 94,883 $ (3,675) (3.9) % Segment service revenue for the three months ended March 31, 2022 and 2021 was comprised of the following (in thousands): Three months ended March 31, 2022 Three months ended March 31, 2021 Cloud and Edge IP Optical Networks Total Cloud and Edge IP Optical Networks Total Maintenance $ 55,030 $ 13,575 $ 68,605 $ 54,673 $ 14,032 $ 68,705 Professional services 17,141 5,462 22,603 20,597 5,581 26,178 Total service revenue $ 72,171 $ 19,037 $ 91,208 $ 75,270 $ 19,613 $ 94,883 Maintenance revenue was essentially flat in the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The increase in our Cloud and Edge segment's maintenance revenue was virtually offset by the decrease in our IP Optical Networks segment's maintenance revenue. Professional services revenue from our Cloud and Edge segment decreased by $3 million in three months ended March 31, 2022 compared to the three months ended March 31, 2021 due to scheduling delays in several network transformation projects. We expect these delayed projects will be completed later in the current year. The following customer contributed 10% or more of our revenue in the three month periods ended March 31, 2022 and 2021: Three months ended Customer March 31, 2022 March 31, 2021 Verizon Communications Inc. 13% 16% Revenue from customers domiciled outside the United States comprised 56% and 59% of revenue in the three months ended March 31, 2022 and 2021, respectively. Due to the timing of project completions, we expect that the domestic and international components as a percentage of revenue may fluctuate from quarter to quarter and year to year. Our deferred product revenue was $9 million and $10 million at March 31, 2022 and December 31, 2021, respectively. Our deferred service revenue was $119 million and $120 million at March 31, 2022 and December 31, 2021, respectively. Our deferred revenue balance may fluctuate because of the timing of revenue recognition, customer payments, maintenance contract renewals, contractual billing rights and maintenance revenue deferrals included in multiple element arrangements. We expect that our total revenue will increase in 2022 compared to 2021 as a result of both increased customer spend and continued cross-selling opportunities. Cost of Revenue/Gross Margin. Our cost of revenue consists primarily of amounts paid to third-party manufacturers for purchased materials and services, royalties, inventory valuation adjustments, warranty costs, manufacturing and services personnel and related costs, and amortization of acquired technology. Our cost of revenue and gross margins for the three 37 months ended March 31, 2022 and 2021 were as follows (in thousands, except percentages): Three months ended Increase (decrease) from prior year March 31, 2022 March 31, 2021 $ % Cost of revenue: Product $ 51,209 $ 44,445 6,764 15.2 % Service 35,667 37,780 (2,113) (5.6) % Amortization of acquired technology 8,267 10,061 (1,794) (17.8) % Total cost of revenue $ 95,143 $ 92,286 2,857 3.1 % Gross profit $ 78,055 $ 100,486 $ (22,431) (22.3) % Gross margin 45.1 % 52.1 % Our segment cost of revenue and gross margins for the three months ended March 31, 2022 and 2021 were as follows (in thousands, except percentages): Three months ended March 31, 2022 Three months ended March 31, 2021 Cloud and Edge IP Optical Networks Total Cloud and Edge IP Optical Networks Total Product $ 16,999 $ 34,210 $ 51,209 $ 13,421 $ 31,024 $ 44,445 Service 24,899 10,768 35,667 27,839 9,941 37,780 Amortization of acquired technology 5,176 3,091 8,267 6,639 3,422 10,061 Total cost of revenue $ 47,074 $ 48,069 $ 95,143 $ 47,899 $ 44,387 $ 92,286 Total gross margin 57.1 % 24.2 % 45.1 % 61.8 % 34.1 % 52.1 % The decrease in our gross margin in the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was primarily due to higher component costs, expedite and production fees, and logistics expenses in both of our segments, product and customer mix, which decreased our gross margin by seven percentage points. We believe that our gross margin may decrease in 2022 compared to 2021 as a result of higher expected sales from IP Optical Networks, which has lower margins due to the higher hardware content in its products, and higher production costs resulting from ongoing worldwide supply chain issues. Research and Development Expenses. Research and development expenses consist primarily of salaries and related personnel expenses and prototype costs for the design, development, testing, and enhancement of our products. Research and development expenses for the three months ended March 31, 2022 and 2021 were as follows (in thousands, except percentages): Increase from prior year March 31, 2022 March 31, 2021 $ % Three months ended $ 52,690 $ 47,410 $ 5,280 11.1 % The increase in our research and development expenses in the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was primarily due to $4 million of higher product development costs and $3 million of higher employee-related expenses in our IP Optical Networks segment, partially offset by lower expenses in our Cloud and Edge segment aggregating $2 million. Some aspects of our research and development efforts require significant short-term expenditures, the timing of which may cause significant variability in our expenses. We believe that rapid technological innovation is critical to our long-term success, and we are tailoring our investments to meet the requirements of our customers and market. We believe that our research and development expense will increase modestly in 2022 compared to 2021, primarily due to our incremental investment in critical 38 growth areas, partially offset by cost savings from the 2022 Restructuring Plan. Sales and Marketing Expenses. Sales and marketing expenses primarily consist of salaries and related personnel costs, commissions, travel and entertainment expenses, promotions, customer trial and evaluations inventory, and other marketing and sales support expenses. Sales and marketing expenses for the three months ended March 31, 2022 and 2021 were as follows (in thousands, except percentages): Increase from prior year March 31, 2022 March 31, 2021 $ % Three months ended $ 37,619 $ 37,218 $ 401 1.1 % The increase in sales and marketing expenses in the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was attributable to higher expenses in our IP Optical Networks segment, partially offset by lower Cloud and Edge expenses, principally employee-related costs. We believe that our 2022 sales and marketing expenses will be consistent with 2021 levels. General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related personnel costs for executive and administrative personnel, and audit, legal and other professional fees. General and administrative expenses for the three months ended March 31, 2022 and 2021 were as follows (in thousands, except percentages): Decrease from prior year March 31, 2022 March 31, 2021 $ % Three months ended $ 12,862 $ 15,553 $ (2,691) (17.3) % The decrease in general and administrative expenses in the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was primarily attributable to lower employee-related expenses of $1.4 million and $1.1 million in our Cloud and Edge and IP Optical Networks segments, respectively, in the current year period. Although our general and administrative expenses decreased 17% in the three months ended March 31, 2022 compared to the three months ended March 31, 2021, we believe that our general and administrative expenses will decrease only slightly for the full year 2022 compared to our 2021 levels. Amortization of Acquired Intangible Assets. Amortization of acquired intangible assets included in Operating expenses for the three months ended March 31, 2022 and 2021 was as follows (in thousands, except percentages): Increase from prior year March 31, 2022 March 31, 2021 $ % Three months ended $ 7,275 $ 5,762 $ 1,513 26.3 % The increase in amortization of acquired intangible assets included in operating expenses ("Opex Amortization") in the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was primarily due to higher expense related to customer lists recorded in connection with the ECI Acquisition. Opex Amortization is not recorded on a straight-line basis; rather, it is recorded in relation to expected future cash flows. Accordingly, such expense may vary from one period to the next. Acquisition-, Disposal- and Integration-Related. Acquisition-, disposal- and integration-related expenses include those expenses related to acquisitions that we would otherwise not have incurred. Acquisition- and disposal-related expenses include professional and services fees, such as legal, audit, consulting, paying agent and other fees. Integration-related expenses represent incremental costs related to combining our systems and processes with those of acquired businesses, such as third-party consulting and other third-party services. Our acquisition-, disposal- and integration-related expenses were $1.8 million and $1.2 million in the three months ended 39 March 31, 2022 and 2021, respectively. The amount for the three months ended March 31, 2022 primarily relates to integration-related expenses. The amount for the three months ended March 31, 2021 was comprised of $1.0 million of integration-related expenses and $0.2 million for professional and services fees in connection with the sale of our Kandy Communications business to American Cloud Technologies, Inc. ("AVCT") on December 1, 2020 (the "Kandy Sale"). Restructuring and Related. We have been committed to streamlining our operations and reducing operating costs by closing and consolidating certain facilities and reducing our worldwide workforce. Please see the additional discussion of our restructuring initiatives in the "Restructuring and Cost Reduction Initiatives" section of the Overview of this MD&A. We recorded restructuring and related expense of $4.8 million and $6.0 million in the three months ended March 31, 2022 and March 31, 2021, respectively. Although we have eliminated positions as part of our restructuring initiatives, we continue to hire in certain areas that we believe are important to our future growth. Interest Expense, Net. Interest income and interest expense for the three months ended March 31, 2022 and 2021 were as follows (in thousands, except percentages): Three months ended Decrease from prior year March 31, 2022 March 31, 2021 $ % Interest income $ 39 $ 1,485 $ (1,446) (97.4) % Interest expense (4,040) (7,304) (3,264) (44.7) % Interest expense, net $ (4,001) $ (5,819) $ (1,818) (31.2) % We recorded nominal interest income in the three months ended March 31, 2022. We received debentures (the "Debentures") and warrants in connection with the Kandy Sale. The Debentures bore interest at 10% per annum. We recorded $1.5 million of interest income in the three months ended March 31, 2021, which was added to the principal amount of the Debentures, and which is included in Interest expense, net, in our condensed consolidated statement of operations for that period. The Debentures were converted to shares of AVCT common stock on September 8, 2021. Interest expense in the three months ended March 31, 2022 primarily represented interest and debt issuance costs in connection with the 2020 Credit Facility (as defined below). Interest expense in the three months ended March 31, 2021 was primarily comprised of interest and debt issuance costs in connection with the 2020 Credit Facility, including the write-off of $2.5 million of capitalized debt issuance costs in connection with the Third Amendment (as defined below). Other Expense, Net . We recorded other expense, net, aggregating $28.8 million and $25.4 million in the three months ended March 31, 2022 and 2021, respectively. The primary component in both periods was losses from the change in the fair value of the AVCT Investment, which were $27.0 million and $23.9 million in the three months ended March 31, 2022 and 2021, respectively. Income Taxes. We recorded an income tax benefit of $1.9 million in the three months ended March 31, 2022 and an income tax provision of $0.8 million in the three months ended March 31, 2021. These amounts reflect our estimates of the effective rates expected to be applicable for the respective full fiscal years, adjusted for any discrete events, which are recorded in the period that they occur. These estimates are reevaluated each quarter based on our estimated tax rate for the full fiscal year. The estimated effective tax rate includes the impact of valuation allowances in various jurisdictions. Beginning in 2022, the Tax Cuts and Jobs Act of 2017 (the "TCJA") eliminates the option to deduct research and development expenditures currently and requires taxpayers to amortize them over five years pursuant to IRC Section 174. Although Congress is considering legislation that would defer the amortization requirement to later years, we have no assurance that the provision will be repealed or otherwise modified. If this provision of the TCJA is not repealed or otherwise modified, it will materially reduce our operating cash flows in 2022. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial position, changes in financial position, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. 40 Liquidity and Capital Resources Our condensed consolidated statements of cash flows are summarized as follows (in thousands): Three months ended March 31, 2022 March 31, 2021 Change Net loss $ (69,975) $ (44,687) $ (25,288) Adjustments to reconcile net loss to cash flows provided by (used in) operating activities 45,568 52,700 (7,132) Changes in operating assets and liabilities 39,437 (14,225) 53,662 Net cash provided by (used in) operating activities $ 15,030 $ (6,212) $ 21,242 Net cash used in investing activities $ (3,471) $ (5,357) $ 1,886 Net cash used in by financing activities $ (22,395) $ (14,777) $ (7,618) Our cash and restricted cash aggregated $95 million at March 31, 2022 and $106 million at December 31, 2021. These amounts included cash and restricted cash aggregating $55 million at March 31, 2022 and $60 million at December 31, 2021 held by our non-U.S. subsidiaries. If we elected to repatriate all excess funds held by our non-U.S. subsidiaries as of March 31, 2022, we do not believe that the amounts of potential withholding taxes that would arise from the repatriation would have a material effect on our liquidity. We currently maintain the Senior Secured Credit Facilities Credit Agreement (as amended, the "2020 Credit Facility"), by and among us, as a guarantor, Ribbon Communications Operating Company, Inc., as the borrower ("Borrower"), Citizens Bank, N.A. ("Citizens"), as administrative agent, a lender, issuing lender, swingline lender, joint lead arranger and bookrunner, Santander Bank, N.A., as a lender, joint lead arranger and bookrunner, and the other lenders party thereto (each, together with Citizens Bank, N.A. and Santander Bank, N.A., referred to individually as a "Lender", and collectively, the "Lenders"). For additional details regarding the terms of the 2020 Credit Facility, see Note 9 to our condensed consolidated financial statements. On March 3, 2021 (the "Third Amendment Effective Date"), we entered into a Third Amendment to Credit Agreement (the "Third Amendment"), which further amended the 2020 Credit Facility. The Third Amendment provided for an incremental term loan facility to us in the original principal amount of $74.6 million, the proceeds of which were used on the Third Amendment Effective Date to consummate an open market purchase of all outstanding amounts under the Term B Loan. Upon the consummation of the open market purchase, the Term B Loans were assigned to the Borrower and immediately canceled, such that the outstanding amount under the Term A Loan and incremental term loan facility were combined and held by the Lenders (the "2020 Term Loan"). On March 10, 2022, we entered into a Fourth Amendment to the 2020 Credit Facility (the "Fourth Amendment") to increase the Maximum Consolidated Net Leverage Ratio (as defined in the 2020 Credit Facility) to 4.25:1.00 for the first quarter of 2022 and 4.50:1.00 for the second quarter of 2022, with reductions in subsequent quarters through the third quarter of 2023, when the ratio will be fixed at 3.00:1.00. In connection with the Fourth Amendment, we made a $15.0 million prepayment that was applied to the final payment due on the maturity date. Subsequent to the Fourth Amendment, we are required to make quarterly principal payments on the 2020 Term Loan aggregating approximately $20 million per year for the next two years and $30 million in the following year, with the final payment approximating $285 million due on the maturity date. At March 31, 2022, we had an outstanding 2020 Term Loan balance of $355.5 million at an average interest rate of 3.4% and $4.4 million of letters of credit outstanding with an interest rate of 2.5%. We were in compliance with all covenants of the 2020 Credit Facility at both March 31, 2022 and December 31, 2021. We are exposed to financial market risk related to foreign currency fluctuations and changes in interest rates. These exposures are actively monitored by management. To manage the volatility related to the exposure to changes in interest rates, we have entered into a derivative financial instrument. Management's objective is to reduce, where it is deemed appropriate to do so, fluctuations in earnings and cash flows associated with changes in interest rates. Our policies and practices are to use derivative financial instruments only to the extent necessary to manage exposures. We do not hold or issue derivative financial instruments for trading or speculative purposes. 41 As a result of exposure to interest rate movements, during March 2020, we entered into an interest rate swap arrangement, which effectively converted our $400 million term loan with its variable interest rate based upon one-month LIBOR to an aggregate fixed rate of 0.904%, plus a leverage-based margin as defined in the 2020 Credit Facility. The notional amount of this swap as of March 31, 2022 was $400 million, and the swap matures on March 3, 2025, the same date the 2020 Credit Facility matures. Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we are using an interest rate swap as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income in the condensed consolidated balance sheet and is subsequently reclassified into earnings in the period that the hedged forecasted transactions affect earnings. During the three months ended March 31, 2022 and 2021, such a derivative was used to hedge the variable cash flows associated with the 2020 Credit Facility. Any ineffective portion of the change in fair value of the derivative would be recognized directly in earnings. However, during the three months ended March 31, 2022 and 2021, we recorded no hedge ineffectiveness. Amounts reported in accumulated other comprehensive income related to our derivative will be reclassified to interest expense as interest is accrued on our variable-rate debt. Based upon projected forward rates, we estimate as of March 31, 2022 that $2.7 million may be reclassified as a decrease to interest expense over the next 12 months. We use letters of credit, performance and bid bonds in the course of our business. At March 31, 2022, we had letters of credit, bank guarantees, and performance and bid bonds outstanding (collectively, "Guarantees") aggregating $30.7 million, comprised of the $4.4 million of letters of credit under the 2020 Credit Facility described above (the "Letters of Credit") and $26.3 million of bank guarantees and performance and bid bonds (collectively, the "Other Guarantees") under various uncommitted facilities. At December 31, 2021, we had $30.1 million of Guarantees, comprised of $4.3 million of Letters of Credit and $25.8 million of Other Guarantees. At both March 31, 2022 and December 31, 2021, the Company had cash collateral of $2.6 million supporting the Guarantees, which are reported as Restricted cash in our condensed consolidated balance sheets. Cash Flows from Operating Activities Our primary source of cash from operating activities has been from cash collections from our customers. We expect cash flows from operating activities to be affected by increases and decreases in sales volumes and timing of collections, and by purchases and shipments of inventory. Our primary uses of cash for operating activities have been for personnel costs and investment in our research and development and in our sales and marketing, and general and administrative departments. Cash provided by operating activities in the three months ended March 31, 2022 was $15.0 million, primarily resulting from lower accounts receivable and certain non-cash expenses, such as the decrease in the fair value of the AVCT Investment, amortization of intangible assets, stock-based compensation, depreciation and amortization of property and equipment, and foreign currency losses. These amounts were partially offset by our net loss, higher inventory, lower accrued expenses and other long-term liabilities, and a non-cash adjustment to deferred income taxes. Our lower accounts receivable was primarily due to the collection in the quarter of seasonally higher amounts outstanding at December 31, 2021. Our operating activities used $6.2 million in the three months ended March 31, 2021, primarily the result of our net loss, lower accrued expenses and other long-term liabilities, lower accounts payable, and higher inventory. These amounts were partially offset by lower accounts receivable, higher deferred revenue, lower other operating assets, and certain non-cash expenses, such as the decrease in the fair value of the AVCT Investment, amortization of intangible assets, stock-based compensation, depreciation and amortization of property and equipment, and amortization of debt issuance costs. Our lower accounts receivable was primarily due to the collection in the quarter of seasonally higher amounts outstanding at December 31, 2020. The decrease in accrued expenses and other long-term liabilities was primarily due to the cash payments in the quarter related to our employee cash bonus program. Cash Flows from Investing Activities Our investing activities used $3.5 million and $5.4 million of cash in the three months ended March 31, 2022 and 2021, respectively, to purchase property and equipment. 42 Cash Flows from Financing Activities Our financing activities used $22.4 million of cash in the three months ended March 31, 2022, primarily due to $20.0 million of principal payments on the 2020 Credit Facility, including the $15.0 million incremental principal payment in connection with the Fourth Amendment, and $1.8 million for the payment of tax withholding obligations related to the net share settlement of restricted stock awards upon vesting. Payments of debt issuance costs and principal payments of finance leases totaled less than $1 million. Our financing activities used $14.8 million of cash in the three months ended March 31, 2021, primarily due to $74.6 million of proceeds from the incremental loan obtained in connection with the Third Amendment, which amount was used to consummate an open market purchase of all outstanding amounts under the Term B Loan, $11.2 million for the payment of tax withholding obligations related to the net share settlement of restricted stock awards upon vesting, and $77.1 million of principal payments of term debt, including the $74.6 million payoff of the Term B Loan in connection with the Third Amendment, $0.8 million of payments of debt issuance costs, and $0.3 million for principal payments of finance leases. Under the 2020 Credit Facility, we are required to maintain compliance with certain financial covenants. As of March 31, 2022, we were in compliance with our financial covenants. Due to the impact of market conditions on its forecast, including supply chain disruptions, higher costs, and other geopolitical instabilities and disputes, we project that we may not maintain compliance with our financial covenants under the 2020 Credit Facility, as amended, for the quarters ended June 30, 2022 and September 30, 2022. Failure to remain in compliance would be an event of default that would permit the Lenders to accelerate the maturity of the 2020 Credit Facility. As of the date of the issuance of our condensed consolidated financial statements, we currently do not have sufficient cash on hand or available liquidity to repay the outstanding balance of $355.5 million as of March 31, 2022, in the event the debt is accelerated. Management's plans to avoid any potential event of default include raising additional cash that would allow us to pay down debt in order to remain in compliance with our financial covenants. We have or are in the process of obtaining agreements with certain vendors and with certain lending institutions that allow us to factor additional trade receivables. In addition, we have the ability to sell our derivative financial instrument and our investment in equity securities, which had an aggregate fair market value of $34 million as of March 31, 2022. Lastly, we would evaluate the timing of our capital spending and extension of our payment terms with vendors as needed. In addition to the above plans, we have entered into discussions with our Lenders to seek a further amendment to the 2020 Credit Facility to adjust the covenants, and we believe the likelihood of completion is reasonably likely. However, an amendment has not been finalized and is not within our control. We believe our plans are probable of being successfully implemented, which will result in adequate cash to allow us to pay down debt to meet our financial covenant requirements. Based on our current expectations, we believe our current cash and available borrowings under the 2020 Credit Facility, along with management's plans as outlined above, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least twelve months. The rate at which we consume cash is dependent on the cash needs of our future operations, including our contractual obligations at March 31, 2022, primarily comprised of our debt principal and interest obligations as described above, and our operating lease and purchase obligations. Our operating lease obligations totaled $82 million at March 31, 2022, with payments aggregating $15 million in the remainder of 2022, $18 million in 2023, $10 million in 2024 and $39 million thereafter. Our purchase obligations for 2022 aggregate $139 million. We anticipate devoting substantial capital resources to continue our research and development efforts, to maintain our sales, support and marketing, to complete acquisition-related integration activities and for other general corporate activities. We further believe that our financial resources, along with managing discretionary expenses, will allow us to manage the anticipated impact of the COVID-19 pandemic on our business operations. Looking ahead, we have developed contingency plans to reduce costs further if the situation deteriorates. The challenges posed by the COVID-19 pandemic on our business continue to evolve rapidly. Consequently, we continue to evaluate our financial position in light of future developments, particularly those relating to the COVID-19 pandemic. However, it is difficult to predict future liquidity requirements with certainty, and our cash and available borrowings under the 2020 Credit Facility may not be sufficient to meet our future needs, which would require us to refinance our debt and/or obtain additional financing. We may not be able to refinance our debt or obtain additional financing on favorable terms or at all. 43 Recent Accounting Pronouncements In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers ("ASU 2021-08"), which amends ASC 805, Business Combinations (Topic 805) , to add contract assets and contract liabilities to the list of exceptions to the recognition and measurement principles that apply to business combinations and to require that an acquiring entity recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with ASC 606, Revenue from Contracts with Customers (Topic 606) ("ASC 606"). Under current GAAP, an acquirer generally recognizes such items at fair value on the acquisition date. While primarily related to contract assets and contract liabilities that were accounted for by the acquiree in accordance with ASC 606, ASU 2021-08 also applies to contract assets and contract liabilities from other contracts to which the provisions of ASC 606 apply, such as contract liabilities from the sale of nonfinancial assets within the scope of ASU 2017-05, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20) . ASU 2021-08 is effective for us January 1, 2023, with early adoption permitted. We believe that the adoption of ASU 2021-08 could have a material impact on our consolidated financial statements for periods including and subsequent to significant business acquisitions. In January 2021 the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope ("ASU 2021-01"), which refines the scope of ASC 848, Reference Rate Reform , and clarifies some of its guidance as part of the FASB's monitoring of global reference rate reform activities. ASU 2021-01 permits entities to elect certain optional expedients and exceptions when accounting for derivative contracts and certain hedging relationships affected by changes in the interest rates used for discounting cash flows, for computing variation margin settlements, and for calculating price alignment interest in connection with reference rate reform activities under way in global financial markets (the "discounting transition"). ASU 2021-01 is effective for us prospectively in any period through December 31, 2022 that a modification is made to the terms of the derivatives affected by the discounting transition. The adoption of ASU 2021-01 did not have a material impact on our consolidated financial statements.