UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

For the quarterly period ended March 31, 2014

OR

For the transition period from              to             

Commission file number: 001-36343

 

A10 NETWORKS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

(408) 325-8668

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

As of April 30, 2014 the number of outstanding shares of the registrant’s common stock, par value $0.00001 per share, was 60,054,483.

 

 

 

 

 

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TABLE OF CONTENTS

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

A10 NETWORKS, INC.

Condensed Consolidated Balance Sheets

(unaudited, in thousands, except par value)

 

See notes to condensed consolidated financial statements.

 

 

 

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A10 NETWORKS, INC.

Condensed Consolidated Statements of Operations

(unaudited, in thousands, except per share amounts)

 

See notes to condensed consolidated financial statements.

 

 

 

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A10 NETWORKS, INC.

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)

 

See notes to condensed consolidated financial statements.

 

 

 

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Notes to Condensed Consolidated Financial Statements

(unaudited)

 

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1. Description of Business and Summary of Significant Accounting Policies

Description of Business

A10 Networks, Inc. (together with our subsidiaries, the “Company”, “we”, “our” or “us”) was incorporated in the State of California in 2004 and subsequently reincorporated in the State of Delaware in March 2014.

Our solutions enable enterprises, service providers, Web giants and government organizations to accelerate, secure and optimize the performance of their data center applications and networks. We currently offer three software based advanced application networking solutions. These are Application Delivery Controllers, or ADCs, to optimize data center performance; Carrier Grade Network Address Translation, or CGN, to provide address and protocol translation services for service provider networks; and a Distributed Denial of Service Threat Protection System, or TPS, for network-wide security protection. We deliver these solutions both on optimized hardware appliances and as virtual appliances across our Thunder Series and AX Series product families.

Initial Public Offering

In March 2014, we completed our initial public offering (“IPO”), whereby 12,500,000 shares of common stock were sold to the public at a price per share of $15.00. We sold 9,000,000 common shares and selling stockholders sold 3,500,000 common shares. In April 2014, our underwriters exercised an overallotment available to them and an additional 345,000 shares were sold by our selling stockholders bringing the total shares sold to 12,845,000 for this offering. The total gross proceeds from the offering were $192.7 million. After deducting underwriting discounts and commissions, offering expenses payable by us, and net proceeds received by the selling stockholders, the aggregate net proceeds received by us totaled approximately $120.3 million. Upon the closing of the initial public offering, all shares of our outstanding redeemable convertible preferred stock and convertible preferred stock converted into 39,997,114 shares of common stock.

Reverse Stock Split

On March 6, 2014, the Company effected a 1-for-3.75 reverse stock split of our common stock and convertible preferred stock (collectively referred to as “Capital Stock”). Shares of the Company’s Series D redeemable convertible preferred stock were not subject to the split but instead the conversion price of the Series D redeemable convertible preferred stock was adjusted proportionally to reflect the split of the common stock issued upon conversion of the Series D redeemable convertible preferred stock. On  March 6, 2014 (i) each 3.75 shares of outstanding Capital Stock was combined into 1 share of Capital Stock; (ii) the number of shares of Capital Stock for which each outstanding option to purchase Capital Stock is exercisable was proportionately reduced on a 1-for-3.75 basis; (iii) the exercise price of each such outstanding option was proportionately increased on a 1-for-3.75 basis; (iv) each 3.75 shares of authorized Capital Stock was reduced to 1 share of Capital Stock; and (v) the conversion price of the Series D redeemable convertible preferred stock was adjusted from $2.2628 to $8.4855. All of the share and per share amounts have been adjusted, on a retroactive basis, to reflect this 1-for-3.75 reverse stock split.

Basis of Presentation and Consolidation

The accompanying unaudited condensed consolidated financial statements include the accounts of A10 Networks, Inc., and our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

The Company has had no comprehensive income (loss) other than its net loss.  Thus, comprehensive income (loss) is the same as the net loss for all periods presented.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and following the requirements of the Securities and Exchange Commission (“SEC”), for interim reporting. As permitted under those rules, certain notes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These financial statements have been prepared on the same basis as our annual financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments that are necessary for a fair statement of our financial information. The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the results to be expected for the year ending December 31, 2014 or for any other interim period or for any other future year. The balance sheet as of December 31, 2013 has been derived from audited financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements.

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The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto for the year ended December 31, 2013 included in our prospectus filed with the SEC on March 21, 2014 pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”).

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Those estimates and assumptions affect revenue recognition and deferred revenue, allowance for doubtful accounts, valuation of inventory, contingencies and litigation, and determination of fair value of stock-based compensation. These estimates are based on information available as of the date of the condensed consolidated financial statements; therefore, actual results could differ from management’s estimates.

Summary of Significant Accounting Policies

There have been no changes to the significant accounting policies described in the prospectus that have had a material impact on the Company’s condensed consolidated financial statements and related notes.

Concentration of Credit Risk and Significant Customers

Financial instruments that potentially subject us to concentrations of credit risk consist of cash, cash equivalents and accounts receivable. Our cash and cash equivalents are invested in high-credit quality financial instruments with banks and financial institutions. Management believes that the financial institutions that hold our cash and cash equivalents are financially sound and, accordingly, are subject to minimal credit risk. Such deposits may be in excess of insured limits provided on such deposits.

Our accounts receivable are unsecured and represent amounts due to us based on contractual obligations of our customers. We mitigate credit risk in respect to accounts receivable by performing periodic credit evaluations of our customers to assess the probability of accounts receivable collection based on a number of factors, including past transaction experience with the customer, evaluation of their credit history, limiting the credit extended and review of the invoicing terms of the contract. We generally do not require our customers to provide collateral to support accounts receivable. We have recorded an allowance for doubtful accounts for those receivables that we have determined not to be collectible.

Significant customers, including distribution channel partners and direct customers, are those which represent more than 10% of our total revenue or gross accounts receivable balance at each respective balance sheet date. For each significant customer, revenue as a percentage of total revenue and accounts receivable as a percentage of total net accounts receivable are as follows:

 

 

 

Recent Accounting Pronouncements

In July 2013, the FASB issued Accounting Standard Update (“ASU”) No. 2013-11, Income Taxes (Topic 740), Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. This new standard requires the netting of unrecognized tax benefits (“UTBs”) against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. UTBs will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the UTBs.  We adopted ASU-2013-11 on January 1, 2014, and the adoption did not have a material impact on our consolidated financial statements since ASU-2013-11 only impacts financial statement disclosure requirements for unrecognized tax benefits.

There have been no new accounting pronouncements issued but not yet adopted that are expected to have a material impact on the Company's consolidated financial statements.

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2. Fair Value Measurements

The following table sets forth the fair value of our financial assets measured on a recurring basis by level within the fair value hierarchy:

 

 

 

We did not have realized gains or losses for the three months ended March 31, 2014 or 2013 related to our financial assets.

 

3. Balance Sheet Components

Inventory

Inventory consists of the following:

 

 

Property and Equipment, Net

Property and equipment, net consists of the following:

 

 

Depreciation and amortization on our property and equipment for the three months ended March 31, 2014 and 2013 was $2.2 million and $1.3 million.

 

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Deferred Revenue

Deferred revenue consists of the following:

 

 

 

4. Commitments and Contingencies

Legal Proceedings

From time to time, we may be party or subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business, including proceedings and claims that relate to intellectual property matters. Some of these proceedings involve claims that are subject to substantial uncertainties and unascertainable damages. Accordingly, except as disclosed, we have not established reserves or ranges of possible loss related to these proceedings, as at this time in the proceedings, if any, the matters do not relate to a probable loss and/or amounts are not reasonably estimated. Although we believe that we have a strong defense for the litigation proceedings described below, there are many uncertainties associated with any litigation and these actions or other third-party claims against us may cause us to incur costly litigation and/or substantial settlement charges that could have a material adverse effect on our results of operations, financial position, or cash flows. In addition, the resolution of any future intellectual property litigation may require us to make royalty payments and/or settlement payments, which could adversely affect gross margin and operating expenses in future periods.

Radware  v. A10

In May 2013, Radware, Ltd., and Radware, Inc. (collectively, “Radware”) filed suit against the Company in the United States District Court for the Northern District of California, asserting that the Company’s AX Series and EX Series products infringe three of Radware’s U.S. patents. Radware has also asserted similar claims against F5 Networks, Inc. (“F5”). The Company responded to the complaint on June 24, 2013. No trial date has been set and the parties are in the process of conducting discovery.

Parallel v. A10

In November 2013, Parallel Networks, LLC (“Parallel Networks”), which we believe is a non-practicing patent holding company, filed a lawsuit against us in the United States District Court for the District of Delaware. In the lawsuit, Parallel Networks alleges that our AX and Thunder series products infringe two of their U.S. patents. Parallel Networks is seeking injunctive relief, damages and attorneys’ fees and costs. Parallel Networks has asserted similar claims against other companies, including Array Networks, Inc., Barracuda Networks, Inc., Brocade Communications Systems, Inc., Cisco Systems, Inc., Citrix Systems, Inc., F5, Radware, Ltd., Riverbed Technology, Inc. and SAP AG. No trial date has been set.

These matters are in the early stages, but the Company intends to vigorously defend the lawsuits. We are unable to reasonably estimate a possible loss or range of possible loss if any, in regards to these matters; therefore, no litigation reserve has been recorded in the accompanying consolidated balance sheet.

Lease and Other Commitments

Commencing in 2012, we entered into an equipment financing arrangement with a financial institution whereby the financial institution purchased and leased to us, equipment (primarily computer and network-related) for use in our business. Amounts financed under the leases are accounted for as capital leases. We financed $0.8 million under the arrangement in 2012. As of March 31, 2014 and December 31, 2013, we had outstanding borrowings of $0.2 million and $0.3 million under the arrangement.

We lease various operating spaces in California, Asia, and Europe under noncancelable operating lease arrangements that expire on various dates through January 2016. These arrangements require us to pay certain operating expenses, such as taxes, repairs, and insurance and contain renewal and escalation clauses. We recognize rent expense under these arrangements on a straight-line basis over the term of the lease.

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In 2008, we entered into a technology licensing arrangement that requires us to make payments over the life of the associated patents which are expected to expire in 2020.

 

We have entered into agreements with some of our customers that contain indemnification provisions in the event of claims alleging that our products infringe the intellectual property rights of a third party. Other guarantees or indemnification arrangements include guarantees of product and service performance and standby letters of credit for lease facilities and corporate credit cards. We have not recorded a liability related to these indemnification and guarantee provisions and our guarantees and indemnification arrangements have not had any significant impact on our consolidated financial statements to date.

 

5. Equity Award Plans

The total stock-based compensation recognized for stock-based awards granted under the 2014 Equity Incentive Plan (the “2014 Plan”), the 2014 Employee Stock Purchase Plan (the “2014 ESPP”), the 2008 Stock Plan (the “2008 Plan”) and the 2004 Stock Plan (the “2004 Plan”) in the consolidated statements of operations is as follows:

 

 

At March 31, 2014, total compensation expense related to unvested share-based awards granted to employees under our stock plans but not yet recognized was $17.4 million, net of estimated forfeitures. This expense is expected to be amortized on a straight-line basis over a weighted-average period of 3.1 years.

2004 and 2008 Plans

We adopted the 2004 Plan and 2008 Plan in 2004 and 2008 for the purpose of granting stock-based awards to eligible service providers. The 2004 Plan and 2008 Plan permitted awards to be granted to our employees, directors, and consultants and the employees and consultants of our subsidiaries (as well as employees and consultants of our parent, in the case of the 2008 Plan). Stock options granted under the 2004 Plan and 2008 Plan may be either incentive stock options (“ISOs”) or nonstatutory stock options (“NSOs”). ISOs were permitted to be granted only to employees, with a per share exercise price not less than the fair value of a share of our common stock on the grant date as determined by the board of directors (or a committee appointed by it). Under the 2004 and 2008 Plans, NSOs were permitted to be granted at a per share exercise price not less than 85% and 100% of the fair value of a share of our common stock on the grant date as determined by our board of directors (or a committee appointed by it). If, at the time we granted an ISO, the optionee who directly or by attribution owned stock possessing more than 10% of the total combined voting power of all classes of our stock or the stock of any parent or subsidiary, the per share exercise price was required to be at least 110% of the fair value of a share of our common stock on the grant date as determined by the board of directors (or a committee appointed by it) and the maximum term of the award could not exceed five years from the grant date. Any NSOs granted under the 2004 Plan to an optionee who directly or by attribution owned stock possessing more than 10% of the total combined voting power of all classes of our stock or the stock of any subsidiary was required to have a per share exercise price equal to at least 110% of the fair value of a share of our common stock on the grant date as determined by our board of directors (or a committee appointed by it) and the maximum term of the award could not exceed five years from the grant date. All other options were permitted to be granted with a maximum term of ten years from the grant date. The vesting terms of options were determined by the board of directors (or a committee appointed by it), and awards granted under the 2004 Plan and 2008 Plan generally vest over a period of four years.  With the establishment of the 2008 Plan, we terminated the 2004 Plan in 2008.  Upon such termination, we ceased granting any awards under the 2004 Plan. With the establishment of the 2014 Plan in March 2014, we terminated the 2008 Plan. Upon such termination, we ceased granting any awards under the 2008 Plan.

2014 Equity Incentive Plan

Our 2014 Plan was adopted by our board of directors and approved by the stockholders in March 2014 and was effective as of the business day immediately prior to the effectiveness of our registration statement for our initial public offering. The 2014 Plan replaced our 2008 Plan. Our 2014 Plan provides for the granting of stock options, restricted stock awards, restricted stock units, stock appreciation rights, performance units and performance shares to our employees, directors and consultants, and our parent and subsidiary corporations’ employees and consultants.

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A total of 7,700,000 shares of our common stock are reserved for issuance pursuant to the 2014 Plan. On the first day of each fiscal year, starting with January 1, 2015, the number of shares in the reserve will increase by the least of (i) 8,000,000 shares, (ii) 5% of the outstanding shares of common stock on the last day of our immediately preceding fiscal year, or (iii) such other amount as determined by our board of directors. As of March 31, 2014, 518,890 options to purchase common stock under the 2014 Plan were granted to our employees and consultants.

Awards granted under our 2014 Plan vest over the periods determined by the board of directors or other committee administering the 2014 Plan (referred to as the plan administrator). The plan administrator determines when awards granted under the 2014 Plan expire, provided that incentive stock options and stock appreciation rights granted under the 2014 Plan expire no more than ten years after the date of grant. In the case of an incentive stock option granted to an employee, who at the time of grant, owns stock representing more than 10% of the total combined voting power of all classes of stock, the exercise price shall be no less than 110% of the fair value per share on the date of grant, and expire five years from the date of grant, and for incentive stock options granted to any other employee, and nonstatutory stock options and stock appreciation rights granted to employees, directors or consultants, the per share exercise price shall be no less than 100% of the fair value per share on the date of grant.

Recipients of restricted stock generally will have voting and dividend rights with respect to such shares upon grant without regard to vesting, unless the administrator provides otherwise.

Restricted stock units granted under the 2014 Plan will be subject to vesting criteria which may be based on achievement of corporate or individual goals, including but not limited to continued services, applicable laws or any other basis that the plan administrator determines.

Performance units have an initial dollar value established by the plan administrator on or before the date of grant. Performance shares will have an initial value equal to the fair market value of a share on the date of grant. The plan administrator will establish (and may subsequently reduce or waive) performance goals or other vesting provisions in its discretion, which, depending on the extent to which they are met, will determine the number and/or the value of performance units and performance shares to be paid out to participants.

2014 Employee Stock Purchase Plan

Our 2014 ESPP was adopted by our board of directors and approved by the stockholders in March 2014 and was effective as of the business day immediately prior to the effectiveness of our registration statement for our initial public offering.

A total of 1,600,000 shares of our common stock are available for sale under the 2014 ESPP as of March 31, 2014. On the first day of each fiscal year, starting with January 1, 2015, the number of shares in the reserve will increase by the least of (i) 3,500,000 shares, (ii) 1% of the outstanding shares of our common stock on the last day of the immediately preceeding fiscal year, or (iii) such other amount as determined by our board of directors or other committee administering the 2014 ESPP.

The 2014 ESPP permits eligible employees to acquire shares of our common stock at 85% of the lower of the fair market value of our common stock on the first trading day of each offering period or on the exercise date that occurs at the end of a purchase period. Each offering period will be approximately twenty-four months in duration, starting on the first trading day on or after May 21 and November 21 of each year, except for the first offering period, which commenced on March 21, 2014 and will end on the last trading day on or before May 20, 2016. Each offering period generally consists of four purchase periods and each purchase period will begin after one exercise date and end with the next exercise date approximately six months later, except that the first purchase period of an offering period will begin on the enrollment date of each offering period and end on the next exercise date. If the fair market value of our common stock on the exercise date is less than the fair market value on the first trading day of the offering period, participants will be withdrawn from the then‑current offering period following their purchase of shares on the purchase date and automatically will be enrolled in the immediately following offering period. Participants may purchase shares of common stock through payroll deductions of up to 15% of their eligible compensation, subject to purchase limits of 1,500 shares during each six month purchase period or $25,000 worth of stock for each calendar year.

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Determination of Fair Value

Employee Stock Plans

The estimated grant-date fair value of our equity-based awards issued under our 2014 Plan and 2008 Plan to employees was calculated using the Black-Scholes option-pricing model, based on the following assumptions:

 

Employee Stock Purchase Plan

 

There were no stock purchase rights granted under the 2014 ESPP during the three months ended March 31, 2013.  The following table summarizes the assumptions relating to our 2014 ESPP:

 

Stock Option Activity

A summary of activity under our stock option plans and related information are as follows:

 

 

The total estimated fair value for stock-based compensation awards granted to employees for three months ended March 31, 2014 and 2013 was $7.1 million and $3.3 million. The weighted-average grant-date fair value of options granted to employees for three months ended March 31, 2014 and 2013 was $5.97 and $2.59 per share. The intrinsic value of options exercised for three months ended March 31, 2014 and 2013, was determined to be $6.7 million and $0.6 million. The aggregate intrinsic value represents the difference between our estimated fair value of our common stock, prior to the IPO, or the closing stock price of our common stock, following the IPO, compared to the exercise price of the outstanding, in-the-money options.

 

6. Earnings Per Share

For periods presented prior to the IPO, basic and diluted net income per common share is computed using the two-class method required for participating securities. Concurrent with the closing of the IPO in March 2014, all shares of outstanding preferred stock converted into shares of our common stock. Following the date of the IPO, the two-class method was no longer required. We currently have one outstanding class of securities.

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The following table sets forth the computation of our basic and diluted net loss per share:

 

 

The following outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share for the periods presented because including them would have been antidilutive:

 

 

7. Income Taxes

     The Company recorded income tax expense of $0.2 million for each of the three months ended March 31, 2014 and 2013, which was primarily comprised of state and foreign taxes. The provision for income taxes for these periods was determined using the annual effective tax rate method by excluding the entities that are not expected to realize tax benefit from the operating losses. As a result, and excluding the impact of discrete tax events during the quarter, the provision for income taxes was at a higher consolidated effective rate than would have resulted if all entities were profitable or if losses produced tax benefits.

The Company believes it is more likely than not that its federal and state net deferred tax assets will not be fully realized.  Accordingly, the Company maintains a valuation allowance against all of its net deferred tax assets as of March 31, 2014 and December 31, 2013. The Company will continue to maintain a full valuation allowance against its net federal and state deferred tax assets until there is sufficient evidence to support recoverability of its deferred tax assets.

The Company had $1.9 million of unrecognized tax benefits as of March 31, 2014.  The Company does not anticipate a material change to its unrecognized tax benefits over the next twelve months.  Unrecognized tax benefits may change during the next twelve months for items that arise in the ordinary course of business.

Accrued interest and penalties related to unrecognized tax benefits are recognized as part of the Company's income tax provision in its condensed consolidated statements of operations.  All tax years remain open and are subject to future examinations by federal, state and foreign tax authorities. The Company is not under examination in any jurisdiction.

          

 

8. Segment Information

Our chief operating decision maker (“CODM”) is our Chief Executive Officer. Our CODM reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. Accordingly, we were determined to have a single reportable segment and operating segment structure.

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The following table represents total revenue based on the customer’s location, as determined by the customer’s shipping address:

 

 

No other country outside of the United States and Japan comprised 10% or greater of our revenue for the three months ended March 31, 2014 and 2013.

Our long-lived assets, net by location are summarized as follows:

 

 

 

 

9. Subsequent Event

 

On May 6, 2014, the Company settled a contractual liability which was accrued on its balance sheet at March 31, 2014 with a vendor reducing the liability from approximately $12.0 million to $5.0 million.  As a result, the Company will reduce this liability by $7.0 million in its second quarter ended June 30, 2014.

 

 

 

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan” “expect,” and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements.

These forward-looking statements include, but are not limited to, statements concerning the following:

These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including those described in “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties, and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations, except as required by law.

Overview

We are a leading provider of application networking technologies. Our solutions enable service providers, enterprises, Web giants and government organizations to accelerate, secure and optimize the performance of their data center applications and networks. Our products are built on our Advanced Core Operating System, or ACOS, platform of advanced network technologies, which is designed to enable our products to deliver substantially greater performance and security relative to prior generation application networking products. Our software based ACOS architecture also provides the flexibility that enables us to expand our business to offer additional products to solve a growing array of networking and security challenges arising from increased Internet cloud and mobile computing.

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We currently offer three software based advanced application networking solutions. These are Application Delivery Controllers, or ADCs, to optimize data center performance, Carrier Grade Network Address Translation, or CGN, to provide address and protocol translation services for service provider networks, and a Distributed Denial of Service Threat Protection System, or TPS, for network-wide security protection. We deliver these solutions both on optimized hardware appliances and as virtual appliances across our Thunder Series and AX Series product families.

We derive revenue from sales of products and related support services. Products revenue is generated primarily by sales of hardware appliances with perpetual licenses to our software solutions. We generate services revenue primarily from sales of maintenance and support. End-customers predominantly purchase maintenance and support in conjunction with purchases of our products.

We sell our products globally to service providers and enterprises that depend on data center applications and networks to generate revenue and manage operations efficiently. Our end-customers operate in a variety of industries, including telecommunications, technology, industrial, retail, financial and education. Since inception, our customer base has grown rapidly. As of March 31, 2014, we had sold products to more than 3,100 customers across 66 countries, including three of the top four United States wireless carriers, seven of the top ten United States cable service providers, and the top three wireless carriers in Japan, in addition to other global enterprises, Web giants and governmental organizations.

 

We sell substantially all of our solutions through our high-touch sales organization as well as distribution channel partners, including distributors, value added resellers and system integrators, and fulfill nearly all orders globally through such partners. We believe this sales approach allows us to obtain the benefits of channel distribution, such as expanding our market coverage, while still maintaining face-to-face relationships with our end-customers. We outsource the manufacturing of our hardware products to original design manufacturers. We perform quality assurance and testing at our San Jose, California facilities, as well as at our manufacturers’ locations. We warehouse and deliver our products out of our San Jose warehouse. We also outsource warehousing and delivery to a third-party logistics provider in some regions.

During the three months ended March 31, 2014, 40% of our total revenue was generated from the United States, 38% from Japan, 9% from the Asia Pacific region, excluding Japan, 9% from EMEA, and 4% from other geographical regions. During the year ended December 31, 2013, 48% of our total revenue was generated from the United States, 28% from Japan, 11% from the Asia Pacific region, excluding Japan, 8% from EMEA, and 5% from other geographical regions.

As a result of the nature of our target market and the current stage of our development, a substantial portion of our revenue comes from a limited number of large end-customers, including service providers, in any period.  For example, sales to NTT DoCoMo, Inc., through a reseller, accounted for approximately 13% of our total revenue during the three months ended March 31, 2014 and year ended December 31, 2013 and approximately 32% of our total revenue during the year ended December 31, 2012.  In addition, during the three months ended March 31, 2014 and years ended December 31, 2013 and 2012, purchases from our ten largest end-customers accounted for approximately 54%, 43% and 49% of our total revenue.  The composition of the group of these ten largest end-customers changes from period to period, but often includes service providers, who accounted for approximately 56%, 47% and 53% of our total revenue during the three months ended March 31, 2014 and years ended December 31, 2013 and 2012.  Sales to these large end-customers have typically been characterized by large but irregular purchases with long sales cycles. The timing of these purchases and the delivery of the purchased product is difficult to predict.  As a consequence, any acceleration or delay in anticipated product purchases by or deliveries to our largest end-customers could materially impact our revenue and operating results in any quarterly period and cause our quarterly revenue and operating results to fluctuate from quarter to quarter and also be difficult to predict.

We believe our revenue during the three months ended March 31, 2013 was affected by the issuance of injunctions related to our now settled litigation with Brocade Communications Systems, Inc. Although such injunctions did not prevent us from selling our redesigned products, certain customers informed us that they would not purchase any of our products until we settled the dispute. Total revenue for the quarters ended March 31, 2013 and 2014 were $29.6 million and $45.7 million, a 55% percent increase from the same period in the prior year. We also incurred $3.0 million during the three months ended March 31, 2013 and $20,000 during the three months ended March 31, 2014 in Brocade related litigation expenses.

We intend to continue to invest for long-term growth. We have invested and expect to continue to invest heavily in our product development efforts to deliver new products and additional features in our current products to address customer needs. In addition, we expect to continue to expand our global sales and marketing organizations, expand our distribution channel partner programs and increase awareness of our solutions on a global basis. Additionally we will be investing in general and administration resources to meet the requirements to operate as a public company. Our investments in growth in these areas may affect short-term profitability.

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Key Components of Our Results of Operations and Financial Condition

Revenue

Our total revenue consists of the following:

Products Revenue

Our products revenue consists of revenue from sales of our hardware appliances upon which our software is installed. Such software includes our ACOS software platform plus one of our ADC, CGN or TPS solutions. Purchase of a hardware appliance includes a perpetual license to the included software. We recognize products revenue at the time of shipment, provided that all other revenue recognition criteria have been met. As a percentage of revenue, our products revenue may vary from quarter to quarter based on, among other things, the timing of orders and delivery of products, cyclicality and seasonality, changes in currency exchange rates and the impact of significant transactions with unique terms and conditions.

Services Revenue

We generate services revenue from sales of post contract support, or PCS, which is bundled with sales of products and professional services. We offer tiered PCS services under renewable, fee-based PCS contracts, primarily including technical support, hardware repair and replacement parts, and software upgrades on a when-and-if-released basis. We recognize services revenue ratably over the term of the PCS contract, which is typically one year, but can be up to five years. In absolute dollars, we expect our services revenue to increase as we expand our installed base.

Cost of Revenue

Our cost of revenue consists of the following:

Cost of Products Revenue

Cost of products revenue is comprised primarily of the cost of third-party manufacturing services and cost of component inventory for the hardware component of our products. Cost of products revenue also includes warehouse personnel costs, shipping costs, inventory write-downs, certain allocated facilities and information technology infrastructure costs, and expenses associated with logistics and quality control.

Cost of Services Revenue

Cost of services revenue is comprised primarily of personnel costs for our technical support, training and professional service teams. Cost of services revenue also includes the costs of inventory used to provide hardware replacements to end-customers under PCS contracts and certain allocated facilities and information technology infrastructure costs.

Gross Margin

Gross margin may vary and be unpredictable from quarter to quarter based on a variety of factors. These may include the mix of revenue from each of our regions, the mix of our products sold within a period, discounts provided to customers, discounts on early sales of new products to gain market penetration, write-downs of obsolete inventory and international currency exchange rates. As to currency, in general our sales are denominated in U.S. Dollars, however, in Japan they are denominated in Yen. Changes in the Dollar/Yen exchange rate will therefore affect the dollar value received and gross margin. Any of the factors noted above can generate either a positive or negative impact on gross margin as compared to another period.

Operating Expenses

Our operating expenses consist of sales and marketing, research and development, general and administrative and litigation. The largest component of our operating expenses, excluding litigation, is personnel costs. Personnel costs consist of wages, benefits, bonuses, and, with respect to sales and marketing expenses, sales commissions. Personnel costs also include stock-based compensation and travel expenses. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business.

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Sales and Marketing

Sales and marketing expenses are our largest functional category of total operating expense. These expenses primarily consist of personnel costs related to our employees engaged in sales and marketing activities. Sales and marketing expenses also include the cost of marketing programs, trade shows, consulting services, promotional materials, demonstration equipment, depreciation and certain allocated facilities and information technology infrastructure costs. We expect our sales and marketing expenses to continue to increase in absolute dollars as we increase the size of our sales and marketing organization and expand into new countries.

Research and Development

Research and development efforts are focused on new product development and on developing additional functionality for our existing products. These expenses consist of personnel costs, and to a lesser extent, prototype materials, depreciation and certain allocated facilities and information technology infrastructure costs. We expense research and development costs as incurred. We expect our research and development expenses to increase in absolute dollars as we continue to develop new products and enhance our existing products.

General and Administrative

General and administrative expenses consist primarily of personnel costs, professional fees and facility costs. General and administrative personnel costs include executive, finance, human resources, information technology, facility and legal (excluding litigation) related expenses. Professional fees consist primarily of fees for outside accounting, tax, legal, recruiting and other administrative services. We expect our general and administrative expenses to increase in absolute dollars in connection with the completion of our initial public offering due to the additional legal, accounting, insurance, investor relations and other costs that we will incur as a public company, as well as other costs associated with growing our business.

Litigation

Litigation is comprised of legal expenses and changes in our litigation reserve, primarily relating to our former litigation with Brocade Communications Systems, Inc. Legal expenses consist of professional fees incurred in defending ourselves against litigation matters and are expensed as incurred when professional services are provided. The litigation reserve consists of accruals we make for estimated losses in pending legal proceedings. Changes in the reserve are made as we change our estimates or make payments in damages or settlement. In May 2013, we entered into a settlement agreement with Brocade for $75.0 million, which we recognized in our consolidated statement of operations in the first quarter of 2012.  The settlement of the litigation provided additional evidence about conditions that existed at the date of the December 31, 2012 financial statements.  As the December 31, 2012 financial statements had not been issued at the time of the settlement, in accordance with ASC 855-10, Subsequent Events, the entire settlement amount was recorded in the first quarter of 2012.  With this settlement, we expect our litigation expenses to decrease in absolute dollars going forward; however, we cannot predict with certainty that this will occur.

Other Income (Expense), Net

Other income (expense), net is comprised of the following items:

Interest Expense

Interest expense consists primarily of interest expense on our debt obligations. At March 31, 2014, we did not have any outstanding balances on our credit facility.  We expect to incur commitment fees associated with the undrawn balance of our credit facility.  At such time we choose to draw down on the credit facility we would reduce the commitment fees accrued and increase the interest on outstanding balances.

Interest Income and Other Income (Expense), Net

Interest income consists primarily of interest income earned on our cash and cash equivalents balances. Other income (expense) consists primarily of foreign currency exchange gains and losses and, through February 2013, fair value adjustments related to then-outstanding warrants to purchase our convertible preferred stock. Foreign currency exchange gains and losses relate to transactions and asset and liability balances denominated in currencies other than the U.S. Dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.

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Provision for Income Taxes

Provision for income taxes consists of taxes from state and foreign jurisdictions.  For federal and state tax purposes the Company maintains a valuation allowance against all of its net deferred tax assets. The Company will continue to maintain a full valuation allowance against its net federal and state deferred tax assets until there is sufficient evidence to support recoverability of its deferred tax assets. As a result, the provision for income taxes primarily relates to state and foreign taxes.

Results of Operations

The following tables provide consolidated statements of operations data in dollars and as a percentage of our total revenue. We have derived the data for the three months ended March 31, 2014 and 2013 from our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

 

 

 

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