ITEM 1. BUSINESS
Overview
We serve customers around the world by consistently delivering high performance intelligent Wi-Fi solutions that are designed to deliver an extraordinary mobility experience, especially in high density and bandwidth intensive environments. Our best-of-breed mobile access and virtualized Wi-Fi solutions are easy to deploy, operate and expand for our customers’ ever-changing mobility requirements. We enable enterprises to migrate their business-critical applications from wired networks to wireless networks, and become what we refer to as All-Wireless Enterprises.
The escalating device access demands brought on by the bring your own device, or BYOD, phenomenon and adoption of bandwidth hungry applications require a bolder, more flexible and scalable solution approach for Wi-Fi solutions to keep business mobile. We offer a wireless architecture designed to manage enterprise access networks for maximum flexibility and mobility. Our open architecture is designed to offer flexibility at each layer - policy, management, control and access - to help enterprises scale their mobile access network.
We were founded with the vision of enabling organizations to become All-Wireless Enterprises. We began commercial shipments of our products in 2003. Our products are sold worldwide primarily through value-added resellers, or VARs, and distributors, and have been deployed by approximately 12,500 customers worldwide.
Our Strategy
Our goal is to become the leading provider of mobile access networking solutions for the enterprise. Key elements of our strategy include:
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Increasing Awareness of Our Brand and Solution - We intend to continue to promote our brand and the effectiveness of our BYOD and virtualized wireless local area network, or WLAN, solutions. We also intend to expand market awareness of the strategic benefits and cost-savings of becoming an All-Wireless Enterprise. We expect to focus our sales and marketing activities in the key markets of education, healthcare and hospitality working with both our partners and customers through targeted marketing programs.
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Expanding Adoption across Markets - To date, we have focused on markets that have begun the transition from using wireless networks for casual use to using wireless networks for strategic advantages. These markets include education, healthcare and hospitality. We intend to continue to increase our sales within these markets and develop compelling solutions to help drive deeper penetration and growth in these markets.
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Expanding Distribution - We intend to expand and leverage our relationships with our VARs and distributors and provide the tools necessary to extend our market penetration and geographic reach in our target vertical markets.
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Extending Our Technological Advantage - We believe that we currently offer a mobile access and WLAN solution unlike any other widely-deployed access networking solution in the market today, with a virtualized networking architecture that is fundamentally different than the legacy networking architectures used in other solutions. We intend to enhance our position as a leader in mobile access and wireless networking through continued technological innovation.
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Enhancing Our Solution - We plan to enhance our current solution to address our customers’ evolving application and deployment requirements.
Our Solution
Our WLAN solution is designed to optimize the wireless enterprise network to cost-effectively deliver the performance, reliability, predictability and operational simplicity of a wired network. Our BYOD and virtualized WLAN solutions are designed to cost-effectively meet the increasing demands of users and enterprises for a mobile access network that delivers the performance, reliability, predictability and operational simplicity of a wired network, with the advantages of mobility. Our solution represents an innovative approach to wireless networking that utilizes virtualization technology to create a wireless network that is unimpeded by the architectural deficiencies of other wireless networking solutions. We have developed a wireless networking solution that enables enterprises to migrate their business-critical applications to a wireless network, and to become All-Wireless Enterprises.
Our BYOD and policy management solution automates secure guest access, BYOD on-boarding and mobile access policy enforcement for any client on any vendor’s network. Optimized for ease-of-use, our solution seeks to dramatically reduce IT workload and deliver a trouble-free end-user experience. Our BYOD solutions can be deployed on a VMware-based virtual appliance or on a Meru services appliance.
Our network management and security solutions provide single-console visibility and control over a Meru WLAN. This highly integrated, powerful wireless network management suite helps our customers proactively identify and prevent potential issues before they cause problems for users. It delivers a unified view of applications, devices and users, streamlining management with superior ease of use. We believe our solution can assure the highest level of application performance and excellent overall end-user experience by focusing on prediction rather than remediation. Our network management applications can be deployed on a VMware-based virtual appliance or on a Meru services appliance.
Our WLAN solution combines wireless resources into one virtual, seamless pool and partitions this virtual pool to match device and application requirements. Our use of virtualization technology for wireless networking has enabled us to deliver a solution that is designed to cost-effectively optimize the enterprise network. Our System Director Operating System limits the ability of the wireless device to select which physical access point to use, and instead shifts control of network connections to the wireless network infrastructure. When a wireless device enters the enterprise and attempts to connect with the wireless network, it is presented with a unique virtual connection point.
Further, our virtualized WLAN solution enables the network to monitor itself and provide predictive and proactive diagnosis of issues affecting network service. Our solution also provides comprehensive and centralized wireless management. It represents a novel approach to wireless network management, using continuous recording of key network events, as well as data collection and analysis to reduce the time spent by IT personnel troubleshooting user issues and minimize user downtime. Our solution offers access to real-time and cumulative performance metrics for both individual wireless user devices and access points, as well as the network as a whole. From a single interface, which can be accessed remotely, IT personnel can engage in focused and deep analysis of the entire wireless network and view activity details at each level of the infrastructure: controllers, access points and individual wireless user devices.
Our solution is based on our System Director, embedded with Virtual Cell technology. Our System Director coordinates all of the components of our solution, including our access points and controllers. Our software, controllers and access points are designed to be easily deployed and integrated into existing IT infrastructure. Our solution is designed to be easily managed and scalable across enterprises of all sizes. In addition, it provides comprehensive security capabilities to ensure that the wireless network
is at least as secure as a wired network. It has been deployed by enterprises in many markets, such as education, healthcare, hospitality, manufacturing, retail, technology, finance, government, telecom, transportation and utilities. We are targeting enterprises in these markets, which have been at the forefront of the transition from using wireless networks for casual use to using wireless networks for strategic advantages.
Our virtualized WLAN solution is designed to deliver the following benefits to users:
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Reliable Access to Applications - Our solution places control of wireless connections with the network instead of the wireless device. Through our virtualization process, our solution ensures that each wireless device, whether stationary or in motion, is optimally connected to the network, and provides a reliable experience for users regardless of the device or application they are using.
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High Performance - Our solution is designed specifically to leverage the capabilities of the ratified 802.11n and 802.11ac wireless communication standard; and the performance of wireless networks using our solution can surpass the performance delivered by widely-deployed wired access networks.
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Enhanced Ability to Run Converged Applications - The performance, reliability and predictability of our solution is designed to enable a wired-like experience that allows users to access their business-critical applications, including voice, video and data, on their wireless devices.
Further, enterprises can realize the following benefits by deploying our solution:
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Ability to Maximize the Benefits of Business-Critical Applications - Our products are designed to deliver a reliable and predictable solution that enables enterprises to run business-critical applications over a wireless network. By enabling their workforces to run business-critical applications in a mobile environment, enterprises can better serve their customers and increase the productivity of their workforces.
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Reduced Infrastructure Costs - Our solution is designed to enable enterprises to significantly reduce their network infrastructure expenses and enable enterprises to deploy a wireless network without expensive and detailed site surveys and configuration efforts. Further, we believe that creating new wireless connections is significantly less capital-intensive than creating new wired connections, because less hardware and labor is required to provide network connectivity. Additional cost savings are realized as enterprises add or move employees. Moreover, our solution typically requires fewer access points than other wireless networking solutions, thereby reducing the hardware and labor costs associated with installing a wireless network.
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Lower Operational Expenses - Our solution is designed to enable enterprises to significantly reduce their network infrastructure operational expenses. It is designed to reduce the need for maintenance and management of a wired network. Our solution also reduces the need for periodic site surveys and the physical redeployment of existing installed access points on an ongoing basis. Our solution coordinates the access points allowing them to operate at peak transmit power, thus achieving a greater range of coverage, and typically requires fewer access points than other wireless solutions. All of these factors enhance an IT department’s ability to maintain and manage the network in a cost-effective manner.
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Efficient Scalability - Our solution has been designed to easily increase the network’s capacity in response to the changing needs of the enterprise. In order to expand the wireless network coverage areas, an enterprise deploying our solution can easily add access points as necessary. For increases in the capacity of a wireless network, an enterprise operating our solution can easily add another radio frequency, or RF, channel and deploy additional access points on that added RF channel. With our solution, unlike with other wireless networking solutions, typically there is no need to re-survey the enterprise’s facilities or physically redeploy existing installed access points, which can significantly reduce the labor and material expenses of building out a wireless network.
Technology
We offer an intelligent wireless network solution. Our architecture is designed to help enterprises have the best mobility experience even in high density and bandwidth intensive environments. Our open architecture offers flexibility at each layer - policy, management, control and access - to help enterprises scale their mobile access network.
At the network access layer, our comprehensive access point/controller offerings are designed to deliver superior coverage: on campus, in remote locations, in-room, outdoors and in very client-dense environments. Unlike other vendors who offer only a single wireless deployment mode, our virtualized RF approach gives IT departments multiple wireless deployment options designed to optimize performance, mobility and the end-user experience, based on a variety of use cases. Virtualization also enables our single-channel architecture, which we believe will be critical in realizing the full benefit of an 802.11ac deployment because of the reduced number of available RF channels. As the industry continues to move forward with implementation of the 802.11ac wireless standard in 2014, we believe we have technology uniquely situated to take advantage of this new standard.
Similarly, at the control-plane layer, we leverage virtualization to give enterprises a choice: the simplicity of an on-premise controller appliance, the on-demand scalability of a VMware version of controller software or Wide Area Networks optimization of distributed mode deployment for remote locations.
It is, however, at the “policy” layer that we have one of the industry’s leading integrated BYOD/guest management solutions. Our Identity Manager solution can be integrated with any vendor’s wired or wireless infrastructure to help IT departments define and enforce BYOD and guest access policies. It is designed to enforce policies such as restricting users to limited domains within the intranet from their tablet, or restricting smartphones to internet and email access only. Staying true to our commitment to virtualization, we make all the policy and management solutions available on the VMWare platform. Identity Manager also allows us to address customers who have previously deployed competitors’ hardware, which we believe will give us an advantage against competitors in the current 802.11ac technology upgrade cycle.
At the application layer, our architecture is a platform that provides services to support industry-specific and broad enterprise mobility solutions. We believe the real value of a WLAN has always been the business value of the applications that the employee interacts with to accomplish their job.
In order to achieve wired-like performance, reliability, predictability and operational simplicity in a wireless network, our System Director Operating System integrates two key technologies: Virtual Cell and Virtual Port.
Virtual Cell - A Virtual Cell is created when wireless resources from multiple physical access points are pooled together to provide the abstraction of a single access point to a wireless device, with each physical access point operating on the same radio channel and offering identical services. This pooling completely masks the identities of individual access points from the perspective of users and their wireless devices. The physical access points become indistinguishable to wireless devices which only see one common network connection. The entire Virtual Cell has one common identity, and the wireless device effectively connects to the Virtual Cell and not to individual access points. As a wireless device moves, our System Director determines the best physical access point to serve the device and seamlessly migrates the wireless device to the appropriate access point.
The use of Virtual Cell technology can provide a number of key advantages over legacy wireless network architectures:
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Predictable Service through Network Control - In legacy wireless network architectures, the wireless device typically remains in control of its connection to the network and is allowed to make connection decisions based on its own needs, which can degrade the overall performance of the network. In a Virtual Cell, the network controls the connection decision for each device, ensuring optimum use of the network resources, independent of the hardware, software, or settings of the device. Virtual Cell technology is designed to convert wireless service from a device-controlled network to a network-controlled system, increasing the predictability of service available to each wireless device.
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Stable Coverage - The design of legacy wireless architectures typically requires that neighboring access points be placed on different channels to mitigate interference. This approach creates a complex optimization problem of ensuring that there are no gaps in wireless coverage while simultaneously minimizing coverage overlap between access points on the same channel - a difficult problem to solve since coverage is practically impossible to predict accurately. Virtual Cell takes a fundamentally different approach by pooling all access points together on the same channel. Our System Director is designed to coordinate each device’s access to the network, and through this coordination, mitigates interference across access points. Using this approach, coverage issues can be solved by simply adding access points to the Virtual Cell.
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Rapid and Cost-Effective Ease of Deployment - The deployment of other wireless networks often involves the cumbersome and iterative process of placing and tuning access points in an effort to maximize wireless coverage and minimize interference. Legacy wireless network architectures can require extensive channel planning and channel overlap may become a significant issue when considering adding new access points to a network. This often requires detailed and expensive site surveys and configuration efforts. Our Virtual Cell technology is designed to add or deploy new access points easily as a result of our single channel architecture. In addition, our solution is designed to minimize channel interference due to the single channel architecture. Our Virtual Cell technology is designed to allow enterprises to react quickly to significant increases in the number of wireless devices and to changes in the physical layout of a particular location by adding access points as necessary. Virtual Cell technology is designed to enable enterprises to avoid expensive and detailed site surveys and reconfiguration efforts often required to adapt to these changes on networks deploying other wireless networking solutions.
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Efficient Network Redundancy - In order to support business-critical applications over a network, enterprises require redundancy in the network infrastructure. We believe pooling wireless resources provides the most effective method for providing redundancy on a wireless network. Unlike legacy wireless architectures, which utilize multiple channels to provide basic coverage, a Virtual Cell occupies only one channel, leaving the remaining channels available. Adding a second Virtual Cell on one of these available channels can instantly double the capacity of the network, and also provides a redundant channel.
Virtual Port - Within the Virtual Cell, our patented System Director assigns each wireless device a unique identifier and a dedicated virtual link to the network, which we refer to as a Virtual Port. The Virtual Port is designed to allow our System Director to allocate resources to each individual device taking into account that particular device’s unique network needs and the applications running on that device. The Virtual Port is designed to remain with each wireless device for the life of its connection to the network, even as the wireless device moves. This allows the wireless network to deliver a dedicated and customized wireless service for each device. At the same time, our System Director continues to optimize the overall performance and reliability of the network.
Generating a unique Virtual Port for each wireless device can provide a number of key benefits:
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Optimized Allocation of Resources - Virtual Port is designed to allow our System Director to optimize the allocation of network resources among devices, thereby ensuring that the service for a device is not impacted by the behavior of any other device. This provides wire-like predictability and the ability to support diverse wireless devices.
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Improved Support for Converged Applications - Virtual Port is designed to provide an effective method for controlling the quality of service parameters for each device and application, thereby enabling the network to support multiple types of applications, including latency-sensitive voice and video applications.
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Enhanced Mobility - The Virtual Port is designed to always follow the wireless device and the associated network policies throughout the network. Our System Director seamlessly migrates the connection and associated network policies of the device to whichever physical access point can optimally service that device, thus providing the user with a predictable connection to the network.
Products
We provide a virtualized WLAN solution that is built around our System Director Operating System, which runs on our controllers and access points. We offer additional products designed to deliver centralized network management, predictive and proactive diagnostics, as well as enhanced security. Our products are designed to permit enterprises to leverage their investments in their existing IT infrastructures.
Meru System Director Operating System
Our patented System Director Operating System forms the core of our virtualized WLAN solution and is the common software foundation that runs on our scalable range of controllers and our line of Wi-Fi-certified wireless access points. It provides centralized coordination and control of all the access points on the network and delivers a set of services for optimization of the network, comprehensive security, high availability, flexible deployment and simple operations.
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Comprehensive Security - Our System Director delivers firewalling and policy enforcement of centralized security policies that manage network access by application type, by device and by user. Our System Director also provides strong authentication and encryption using the industry-standard WPA2 protocol, integration with enterprise authentication and authorization infrastructure, as well as guest access management for temporary users. Additional security features embedded within our System Director include wireless intrusion detection and mitigation capabilities, as well as user access logging and accounting capabilities.
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High Availability - Our System Director includes a redundancy feature that increases the availability of the wireless network in a cost-effective manner. It allows one of our controllers to serve as a backup to multiple controllers, providing cost-effective redundancy. Controller redundancy increases the reliability of wireless networks by mitigating the failure of a controller in the network. Our System Director is also designed to allow an additional layer of access points to be easily added by deploying an additional channel, providing another cost-effective redundancy alternative.
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Flexible Deployment - Our System Director has numerous capabilities that allow for the flexible deployment of a wireless network. It is designed to support the deployment of access points and controllers anywhere within an enterprise’s global infrastructure from headquarters to branch offices.
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Simplified Operations - Our System Director is designed to simplify the ongoing operation of wireless networks. It allows all management and security policies for the entire wireless network to be centrally configured and administered. Our System Director is designed to enable predictive and proactive diagnosis of service problems and rapid troubleshooting by recording and replaying network events. In addition, our System Director integrates with third-party enterprise IT management systems through industry-standard protocols.
Meru Controllers
We provide a family of scalable controllers that run our System Director Operating System and work in conjunction with our access points to provide high performance and reliable network service to wireless devices. Our controllers synchronize access points to optimize the user experience and manage all traffic on the network.
Our family of controllers, summarized in the following table, is designed to meet the scale and performance needs of different sized networks from small branch offices or small enterprises to large campus environments or enterprise headquarters. All of the controller platforms run our System Director Operating System and each controller delivers a common set of capabilities independent of the size of the network.
MC6000
MC4200
MC3200
MC1550
Maximum Number of Access Points
5,000
Typical Deployment
Large enterprise
Large enterprise
Mid-sized enterprise
Small enterprise
We also offer virtual controllers based on VMware’s virtualization software. The virtual controllers include the MC4200-VE, MC3200-VE and MC1550-VE. These virtual controllers operate on x86 computing platforms in VMware environments and can share hardware and processing resources with other virtualized applications.
Meru Access Points
Our 802.11a/b/g/n/ac industry-standard, Wi-Fi-certified access points provide network connectivity for wireless devices. Our access points are typically deployed in ceilings within buildings and automatically discover and connect to our controllers, providing wireless service to users based on the centralized policies configured for the network. Our access points also monitor the network and gather information that is used to provide enhanced security, centralized network management and proactive and predictive diagnostic capabilities.
We provide a comprehensive line of 802.11a/b/g/n/ac industry-standard access points that can be combined with a set of external antennae to support different coverage needs. We have access point models for deployment indoors and outdoors.
Guest Access and BYOD
Our BYOD and policy management solutions are designed to automate secure guest access, BYOD on-boarding and mobile access policy enforcement for any client on any vendor’s network. With our focus on optimizing for ease-of-use, our solution is designed to dramatically reduce IT department workload while delivering a trouble-free end-user experience.
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Identity Manager - Our Identity Manager is designed to simplify secure, scalable, flexible enterprise network access and identity management in dense wireless environments with a diversity of users and devices, including employees and their guests.
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The Meru Smart Connect module is designed to give users the power to easily connect to wireless and wired networks with any device while adhering to strict IT security requirements.
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The Meru Guest Management module is designed to provide easy-to-use, one-click self-provisioning capabilities with centralized, customizable portals for guest authentication to allow deployment of secure, scalable and flexible visitor networks to manage thousands of users.
Meru E(z)RF Application Suite
The Meru Networks E(z)RF Application Suite is designed to enable enterprises to configure, monitor, troubleshoot, secure and operate our virtualized WLAN solution. Each of the following software applications can be purchased separately:
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E(z)RF Network Manager - Our E(z)RF Network Manager is designed to provide a comprehensive, centralized wireless management and troubleshooting system designed to lower the total cost of ownership for an organization. It provides centralized management through network visualization, configuration, wireless performance dashboards and fault management. From a single interface, IT managers can rapidly view activity details at each level of the infrastructure: controllers, access points and individual wireless devices. It offers access to real-time and cumulative performance metrics covering both individual wireless devices or access points and the network as a whole. It is a highly scalable platform representing a new approach to WLAN management, using continuous recording of key network events, as well as data collection and analysis to reduce the time spent by IT personnel troubleshooting user issues and to minimize user downtime.
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E(z)RF Service Assurance Manager - Our E(z)RF Service Assurance Manager is designed to deliver end-to-end service assurance for the network and the applications that run on the wireless network. It creates virtual devices on existing access points, which actively inject traffic over the air to test and verify the performance of the network. This allows the system to quickly isolate faults or potential issues, whether they occur in the wireless network or in the backend wired infrastructure even before users experience them.
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Spectrum Manager - Our Spectrum Manager is designed to be a comprehensive spectrum analysis solution. It identifies sources of interference and interferer data and presents in rich graphical dashboards as well as detailed current and historical reports.
WLAN Appliances; Security and Management Applications
Security and Management Applications
Our SA250 and SA2000 Services Appliances provide the hardware platform for our applications focused on WLAN management and security. The SA200 is designed for small enterprises, and the SA2000 is designed for medium to large enterprises. We also offer virtualized versions of these products. The SA250-VE and SA2000-VE are virtual appliances that can be deployed in VMware environments. Our hardware and virtual (VE) SA appliances support the following applications:
Application
Designed To
E(z)RF® Network Manager
Provides wireless performance dashboards, RF visualization, centralized monitoring, configuration, fault management, visibility over long-term trends and centralized reporting.
Service Assurance Manager
Designed to deliver end-to-end service assurance for the network and its applications.
Spectrum Manager
Designed to detect and identify both Wi-Fi and non-Wi-Fi interference on all channels all the time.
Identity Manager
Designed to simplify secure guest access and device provisioning for any client on any vendor’s network (requires separate services appliance).
Wireless Intrusion prevention System
Detects wireless intrusions with predefined and custom signatures on an integrated platform with other WLAN management applications (SA2000 only).
Support and Services
We offer customer support and services based on the deployment needs of our customers. We offer support service contracts in varying lengths of up to five years.
MeruAssure, our customer support offering, is designed to maximize and protect the value of our customers’ WLAN investment with comprehensive services and support. By helping to keep network operations running efficiently, MeruAssure is designed to minimize disruption to business operations, combining incident detection, investigation and diagnosis with the monitoring, recovery and resolution needed to support business-critical network resources. Our customer support offering provides our customers with software upgrades, online access to our knowledge database of technical information related to our virtualized WLAN solution and access to our customer service personnel. In order to better serve our customers, we have support centers in Sunnyvale, California and Bangalore, India and a separate outsourced support center in India available to respond live 24 hours a day, every day. Our customers can also receive first level support through our VARs.
In addition, we may provide professional services to our customers. Our professional service offerings help our customers extract additional strategic value from our virtualized WLAN solution. With a team of experienced engineers and consultants, our professional services organization assists enterprises in deploying and operating our solution. We offer a variety of professional service engagements to meet the varying needs of our customers.
We also train our VARs and offer training to our customers. Our training department conducts basic and advanced courses online, onsite at customer locations and at our training facility in Sunnyvale, California. In addition to our standard training programs, we offer different levels of Meru certification programs, which certify participants upon successful completion of the program covering our products and wireless technologies.
Customers
Our virtualized WLAN solution has been deployed by approximately 12,500 customers worldwide in various markets, including education, healthcare, hospitality, manufacturing, retail, technology, finance, government, telecom, transportation and utilities. Our solution is deployed in a wide range of enterprises, from smaller enterprises with single locations to large global enterprises.
We derived 55%, 52% and 55% of our revenues from sales to customers located in the United States of America, or U.S. in the years ended December 31, 2013, 2012 and 2011, respectively, and 45%, 48% and 45% of our revenues from international sales in the years ended December 31, 2013, 2012 and 2011, respectively. See the discussion of international sales and operations under “Our international sales and operations subject us to additional risks that may materially and adversely affect our business and operating results” in Item 1A.
Item 1A. RISK FACTORS
Risks Related to Our Business and Industry
Our business is subject to many risks and uncertainties, which may affect our future financial performance. If any of the events or circumstances described below occurs, our business and financial performance could be harmed, our actual results could differ materially from our expectations and the market value of our stock could decline. The risks and uncertainties discussed below are not the only ones we face. There may be additional risks and uncertainties not currently known to us or that we currently do not believe are material that may harm our business and financial performance. Because of the risks and uncertainties discussed below, as well as other variables affecting our operating results, past financial performance should not be considered as a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods.
Our operating results may fluctuate significantly as a result of numerous factors, any one of which could cause our operating results to fall below expectations or guidance, making our future results difficult to predict.
Our quarterly and annual operating results have varied significantly in the past and could vary significantly in the future, which makes it difficult for us to predict our future operating results. Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing and volatile global economic environment, particularly in the U.S. and Europe, and any of which may cause our stock price to fluctuate. As a result, comparing our operating results on a period-to-
period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. A significant portion of our quarterly sales typically occurs during the last month of the quarter, often within the last few weeks or days of the quarter. As a result, our quarterly operating results are difficult to predict even in the near term and a delay in an anticipated sale past the end of a particular quarter may negatively impact our results of operations for that quarter, or in some cases, that year. A delay in the recognition of revenue, even from just one account, may have a significant negative impact on our results of operations for a given period. If our revenue or operating results fall below the expectations of investors or securities analysts or below any guidance we may provide to the market, as has occurred recently and at other times in the past, or if the guidance we provide to the market falls below the expectations of investors or securities analysts, as has occurred recently and at other times in the past, the price of our common stock could decline substantially. Such a stock price decline could occur, and has occurred in the past, even when we have met our publicly stated revenue and/or earnings guidance.
In addition to other risks listed in this “Risk Factors” section, factors that may affect our operating results include, but are not limited to:
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fluctuations in demand, including due to seasonality, for our products and services. For example, many companies in our industry experience adverse seasonal fluctuations in customer spending patterns, particularly in the first and third quarters; we have experienced these seasonal fluctuations in the past and expect that this trend will continue in the future;
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fluctuations in sales cycles, including the timing of large orders, and prices for our products and services;
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reductions in customers’ budgets for information technology purchases and delays in their purchasing cycles;
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general economic or political conditions in our domestic and international markets;
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limited visibility into customer spending plans;
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changing market conditions, including current and potential customer consolidation;
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variation in sales channels, product costs or mix of products sold;
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the timing of recognizing revenue in any given quarter as a result of revenue recognition accounting rules, including the extent to which sales transactions in a given period are unrecognizable until a future period or, conversely, the satisfaction of revenue recognition rules in a given period resulting in the recognition of revenue from transactions initiated in prior periods;
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the sale of our products in the timeframes we anticipate, including the number and size of orders, and the product mix within any such orders, in each quarter;
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our ability to develop, introduce and ship in a timely manner new products and product enhancements that meet customer requirements;
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the timing and execution of product transitions or new product introductions, including any related or resulting inventory costs;
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delays in customer purchasing cycles in response to our introduction of new products or product transitions;
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customer acceptance of new product introductions. For example, we recently introduced a new access point based on 802.11ac technology. This product may not achieve any significant degree of market acceptance or be accepted into our sales channel by our channel partners. Furthermore, many of our target customers might have recently purchased our 802.11n access points and are not ready to further invest in the newer 802.11ac technology. In addition, these target customers might not have previously purchased products based on 802.11ac technology and might not have a specific budget for the purchase of these products;
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unpredictability in the development of core, new or adjacent markets, including the public cloud computing market;
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the timing of product releases or upgrades by us or by our competitors;
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our ability to execute our sales strategy focusing primarily on customers in the three verticals of education, hospitality and healthcare;
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any significant changes in the competitive dynamics of our markets, including new entrants or substantial discounting of products;
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our ability to control costs, including our operating expenses and the costs of the components we purchase;
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our ability to establish and maintain successful relationships with channel partners, and the effectiveness of any changes we make to our distribution model;
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any increase or decrease in operating expenses in response to changes in the marketplace or perceived marketplace opportunities;
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the quality and level of our execution of our business strategy and operating plan;
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the effectiveness of our sales and marketing programs, including our ability to provide attractive incentives to our channel partners and customers through our pricing and discount programs; and,
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our ability to derive anticipated benefits from our investments in sales, marketing, engineering or other activities.
We have incurred significant losses since inception, and could continue to incur losses in the future.
We have incurred significant losses since our inception, including net losses of $12.4 million, $31.1 million and $26.7 million during the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, we had an accumulated deficit of $265.4 million. These losses have resulted principally from costs incurred in our research and development programs and sales and marketing programs. We may continue to incur operating losses in the future, including through fiscal year 2014, as a result of the expenses associated with the continued development and expansion of our business. Additionally, we may also be affected by the timing of litigation defense costs. Our ability to attain profitability in the future will be affected by, among other things, our ability to execute our business strategy, the continued acceptance of our products, the timing and size of orders, the average selling prices of our products, the costs of our products, and the level of investment in sales and marketing, research and development, and general and administrative resources. Even if we do achieve profitability, we may not be able to sustain or increase that profitability. As a result, our business could be harmed and our stock price could decline.
Fluctuations in our revenues and operating results could cause the market price of our common stock to decline.
Our revenues and operating results are difficult to predict, even in the near term. Our historical operating results have in the past fluctuated significantly, and may continue to fluctuate in the future, as a result of a variety of factors, many of which are outside of our control. As a result, comparing our revenues and operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. We may not be able to accurately predict our future revenues or results of operations. We base our current and future expense levels on our operating plans and sales forecasts, and our operating costs are relatively fixed in the short-term. As a result, we may not be able to reduce our costs sufficiently to compensate for an unexpected shortfall in revenues, and even a small shortfall in revenues could disproportionately and adversely affect financial results for that quarter. It is possible that our operating results in some periods may be below expectations. This would likely cause the market price of our common stock to decline. In addition to the other risk factors listed in this section, our operating results are affected by a number of factors, including:
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our sales volume;
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fluctuations in demand for our products and services, including seasonal variations;
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average selling prices and the potential for increased discounting of products by us or our competitors;
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the timing of revenue recognition in any given period as a result of revenue recognition guidance under accounting principles generally accepted in the U.S.;
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our ability to forecast demand and manage lead times for the manufacturing of our products;
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shortages in the availability of components used in our products, including components whose manufacturing lead times have increased significantly or may increase in the future;
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our ability to control costs, including our operating expenses and the costs of the components we purchase;
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our ability to develop and maintain relationships with our channel partners and to increase their sales;
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our ability to develop and introduce new products and product enhancements that achieve market acceptance;
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any significant changes in the competitive dynamics of our markets, including new entrants, or further consolidation;
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reductions in customers’ budgets for information technology purchases and delays in their purchasing cycles;
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changes in the regulatory environment for the certification and sale of our products;
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claims of intellectual property infringement against us and any resulting temporary or permanent injunction prohibiting us from selling our products or the requirement to pay settlements, damages or expenses associated with any such claims, together with the costs incurred in defending such claims;
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other claims made against us and the requirement to pay settlements, damages or expenses associated with any such claims, together with the costs incurred in defending such claims; and,
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general economic conditions in our domestic and international markets.
Further, as a result of customer buying patterns, historically we have received a substantial portion of a quarter’s sales orders and generated a substantial portion of a quarter’s revenues during the last two weeks of the quarter. If expected revenues at the end of any quarter are delayed for any reason, including the failure of anticipated purchase orders to materialize, our inability to deliver products prior to quarter-end to fulfill purchase orders received near the end of the quarter, our failure to properly manage inventory to meet demand, or our inability to release new products on schedule, our revenues for that quarter could be materially and adversely affected and could fall below market expectations.
As a result of the above factors, or other factors, our operating results in one or more future periods may fail to meet or exceed our expectations and the expectations of securities analysts or investors. In that event, the trading price of our common stock would likely decline.
Our future capital needs are uncertain and we may need to raise additional funds in the future, and if we require additional funds in the future, such funds may not be available on acceptable terms, or at all.
We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash requirements for the next 12 months. While we received $12.6 million of net proceeds from a secondary offering of our common stock in the first quarter of 2013, we may need to raise substantial additional capital due to changes in business conditions or other future developments or in order to:
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expand the commercialization of our products;
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fund our operations;
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continue our research and development;
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defend, in litigation or otherwise, any claims that we infringe third-party patents or violate other intellectual property rights;
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commercialize new products;
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service our debt obligations and avoid any restrictions on our operations that may result from a failure to do so; and,
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acquire companies and in-licensed products or intellectual property.
Our future funding requirements will depend on many factors, including:
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successful implementation of, and achieving benefits from, our marketing and sales activities;
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market acceptance of our products;
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the rate at which the markets for our products develop;
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the cost of our research and development activities;
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the cost of filing and prosecuting patent applications;
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the cost of defending, in litigation or otherwise, any claims that we infringe third-party patents or other intellectual property rights;
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the cost and timing of establishing additional sales, marketing and distribution capabilities;
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the cost and timing of establishing additional technical support capabilities;
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the effect of competing technological and market developments; and,
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the market for such funding requirements and overall economic conditions.
We may require additional funds in the future and we may not be able to obtain such funds on acceptable terms, or at all. If we raise additional funds by issuing equity securities, as we did in March 2013, our stockholders may experience dilution. The holders of new equity securities may also receive rights, preferences or privileges that are senior to those of existing holders of our common stock. Debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt or additional equity financing that we raise may contain terms that are not favorable to us or our stockholders. If we do not have, or are not able to obtain, sufficient funds, we would be required to modify our growth and operating plans to the extent of available funding, which would harm our ability to grow our business. In addition, we believe that the maintenance of cash balances at a level deemed adequate by our customers and potential customers is necessary to maintain and grow the level of our product sales. The unavailability of additional funding on acceptable terms could also result in our delaying development or commercialization of our products or licensing third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize in-house. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to our technologies or our products, or grant licenses on terms that are not favorable to us. If we are unable to raise adequate funds, we may have to liquidate some or all of our assets, or delay, reduce the scope of or eliminate some or all of our development programs. We also may have to reduce sales, marketing, customer support or other resources devoted to our products or cease operations. Any of these factors could harm our operating results.
We compete in highly competitive markets, and competitive pressures from existing and new companies may harm our business and operating results.
The markets in which we compete are highly competitive and are influenced by the following competitive factors:
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performance, quality, reliability and predictability of the solution;
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initial price and total cost of ownership;
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comprehensiveness of the solution;
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ability to provide quality customer service and support;
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interoperability with other devices;
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scalability of the solution;
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ability to provide secure mobile access to the network; and,
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ability to bundle the solution with other networking offerings.
Our primary competitors include Cisco Systems, Aruba Networks, Ruckus Wireless, Aerohive Networks, Motorola Solutions, Hewlett-Packard and Juniper Networks. We also face competition from a number of other companies, such as ADTRAN, AirTight Networks, Enterasys, Extricom, Ubiquiti Networks, and Xirrus. We expect competition to intensify in the future as other companies introduce new products into our markets. This competition could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and our failure to increase, or our loss of, market share, any of which could seriously harm our business, operating results or financial condition. If we do not keep pace with product and technology advances, it could materially and adversely affect our competitive position, revenues and prospects for growth.
A number of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we. As a result, our competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the promotion and sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisitions or other opportunities more readily, and more quickly develop and expand their product and service offerings. Our competitors with larger volumes of orders and more diverse product offerings may require our VARs and distributors to stop selling our products, or to reduce their efforts to sell our products, which could harm our business and results of operations. In addition, certain of our competitors offer, or may in the future offer, more diverse product offerings and may be able to bundle wireless products with other networking offerings. Potential customers may prefer to purchase all of their equipment from a single provider, or may prefer to purchase wireless networking products from an existing supplier rather than a new supplier, regardless of product performance or features.
We expect increased competition as our markets continue to expand. Conditions in our markets, including the vertical markets that we serve, could change rapidly and significantly as a result of technological advancements, funding constraints or other
factors. In addition, current or potential competitors may be acquired by third parties with greater available resources, such as Cisco’s acquisition of Meraki, Motorola Solutions’ acquisition of Symbol Technologies, Hewlett-Packard’s acquisition of Colubris Networks and Juniper Networks’ acquisition of Trapeze Networks. As a result of such acquisitions, our current or potential competitors might take advantage of the greater resources of the larger organization to compete with us. Continued industry consolidation may adversely impact customers’ perceptions of the viability of smaller and even medium-sized wireless networking companies and, consequently, customers’ willingness to purchase from such companies.
We compete in a rapidly evolving market, and the failure to respond quickly and effectively to changing market requirements could cause our business and operating results to decline.
The wireless networking market is characterized by rapidly changing technology, changing customer needs, evolving industry standards and frequent introductions of new products and services. In order to deliver a competitive WLAN, our virtualized WLAN solutions must be capable of operating with an ever increasing array of wireless devices and an increasingly complex network environment. In addition, our products are designed to be compatible with industry standards for communications over wireless networks. As new wireless devices are introduced and standards in the wireless networking market evolve, we may be required to modify our products and services to make them compatible with these new products and standards. Likewise, if our competitors introduce new products and services that compete with ours, we may be required to reposition our product and service offerings or introduce new products and services in response to such competitive pressure. For example, the Institute of Electrical and Electronics Engineers, or IEEE, recently approved a new standard, IEEE 802.11ac. This is a major upgrade of IEEE 802.11 technologies that is intended to enable very high throughput operation for stations in Wi-Fi networks. In July 2013, we announced an 802.11ac solution. However, we may not be successful in modifying our current products or introducing new ones in a timely or appropriately responsive manner, or at all, for future technologies. If we fail to address these changes successfully, our business and operating results could be materially harmed.
If we are unable to hire, integrate and retain qualified personnel, our business will suffer.
Our success is substantially dependent upon the continued service and performance of our management team. All of our executive officers are at-will employees, and therefore may terminate employment with us at any time. The loss of the service of any member of our management team, or any other key employee, may significantly delay or prevent the achievement of our product development and other business objectives and could harm our business.
Our future success depends, in part, on our ability to continue to attract, integrate and retain highly skilled personnel. Our inability to attract, integrate or retain qualified personnel, or delays in hiring required personnel, particularly in engineering and sales, may seriously harm our business, financial condition and results of operations. Competition for highly skilled personnel is frequently intense, especially in the San Francisco Bay Area and India where we have a substantial presence and need for highly-skilled personnel. Our CEO joined the Company in March 2012 and four senior members of our executive management team joined in the second and third quarters of 2013. If we are unable to successfully integrate, as well as retain, management (including senior management such as these recent hires), our business will be harmed. We also may not be successful in attracting qualified personnel to fulfill our current or future needs.
Often, significant amounts of time and resources are required to train technical, sales and other personnel. Qualified individuals are in high demand. We have no assurance that our field sales personnel will become fully productive in the time periods anticipated. We may incur significant costs to attract and retain them, and we may lose new employees to our competitors or other technology companies before we realize the benefit of our investment in recruiting and training them. We may be unable to attract and retain suitably qualified individuals who are capable of meeting our growing technical, operational and managerial requirements, on a timely basis or at all, and we may be required to pay increased compensation in order to do so. If we are unable to attract and retain the qualified personnel we need to succeed, our business would suffer.
Further, fluctuations or a sustained decrease in the price of our stock could affect our ability to attract and retain key personnel. When our stock price declines, our equity incentive awards may lose retention value, which may negatively affect our ability to attract and retain such personnel. We may not be successful in attracting and retaining key personnel on a timely basis, on competitive terms, or at all. The loss of, or the inability to recruit, key employees could have a material adverse effect on our business.
Our virtualized WLAN solution incorporates complex technology and may contain defects or errors, which could cause harm to our reputation and adversely affect our business.
Our virtualized WLAN solution incorporates complex technology and must operate with a significant number and types of wireless devices running new and complex applications in a variety of environments utilizing different wireless communication industry standards. Our products have contained and may in the future contain defects or errors. In some cases, these defects or errors have delayed the introduction of new products. Some errors in our products may only be discovered after a product has been installed
and used by customers. These issues are most prevalent when new products or new updates or upgrades are introduced. Any errors or defects discovered in our products after commercial release could result in loss of revenues or delay in revenue recognition, loss of customers, damage to our brand and reputation, diversion of engineering resources, and increased service and warranty cost, any of which could materially and adversely affect our business and operating results.
We could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products.
Although certain technical problems experienced by users may not be caused by our virtualized WLAN solution, our business and reputation may be harmed if users perceive our solution as the cause of a slow or unreliable network connection.
Our solution has been deployed in many different environments and is capable of providing wireless access to many different types of wireless devices operating a variety of applications. The ability of our virtualized WLAN solution to operate effectively can be negatively impacted by many different elements unrelated to our products. For example, a user’s experience may suffer from an incorrect setting in a wireless device, which is not a problem caused by the network. Even though certain technical problems experienced by users may not be caused by our solution, users often perceive the underlying cause to be the poor performance of the wireless network. This perception, even if incorrect, could harm our business and reputation.
Our ability to sell our products is highly dependent on the quality of our support and services offerings, and our failure to offer high-quality support and services could have a material and adverse effect on our business and results of operations.
Once our products are deployed within our customers’ networks, our customers depend on our support organization and our channel partners to assist in deploying and managing our products and to resolve any issues relating to our products. High-quality support is critical for the continued successful marketing and sale of our products. If we or our channel partners do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deployment issues, or provide effective ongoing support, it could adversely affect our ability to sell our products to existing customers and could harm our reputation with potential customers. In addition, as we expand our operations internationally, our support organization will face additional challenges including those associated with delivering support, training and documentation in languages other than English. Our failure or the failure of our channel partners to maintain high-quality support and services could have a material and adverse effect on our business and operating results.
We must increase market awareness of our brand and our solution and develop and expand our sales channels, and if we are unsuccessful, our business, financial condition and operating results could be adversely affected.
We must improve the market awareness of our brand and solution and expand our relationships with our channel partners in order to increase our revenues. Further, we believe that we must continue to develop our relationships with new and existing channel partners to effectively and efficiently extend our geographic reach and market penetration. Our efforts to improve sales of our solution could materially increase our sales and marketing expense and general and administrative expense, and there can be no assurance that such efforts will be successful. If we are unable to significantly increase the awareness of our brand and solution, expand our relationships with channel partners, or effectively manage the costs associated with these efforts, our business, financial condition and results of operations could be materially and adversely affected.
If we fail to develop new products and enhancements to our virtualized WLAN solution, we may not be able to remain competitive.
We must develop new products and continue to enhance our virtualized WLAN solution to meet rapidly evolving customer requirements. If we fail to develop new products or enhancements to our existing products, our business could be adversely affected, especially if our competitors are able to introduce products with enhanced functionality. In addition, as new mobile applications are introduced, our success may depend on our ability to provide a solution that supports these applications.
We are subject to a number of industry standards established by various standards bodies, such as the IEEE, and we design our products to comply with these standards. As new industry standards emerge, we could be required to invest a substantial amount of resources to develop new products that comply with these standards. For example, we devoted a substantial amount of our research and development resources to design a virtualized WLAN solution that could optimize the performance allowed by the 802.11n standard. In addition, the IEEE recently approved a new standard, IEEE 802.11ac. This is a major upgrade of IEEE 802.11 technologies that is intended to enable very high throughput operation for stations in Wi-Fi networks. In July 2013, we announced an 802.11ac solution. If our products do not comply with new or changing standards that are ratified by the IEEE or other standards bodies, our ability to sell our products may be adversely affected and we may not realize the benefits of our research and development efforts.
Our research and development efforts relating to new products and technologies are time-consuming, costly and complex. If we expend a significant amount of resources on research and development and our efforts do not lead to the successful introduction of products that are competitive in the marketplace, this could materially and adversely affect our business and operating results.
Our international sales and operations subject us to additional risks that may materially and adversely affect our business and operating results.
We derive a significant portion of our revenues from customers outside the U.S. During the years ended December 31, 2013, 2012 and 2011, 45%, 48% and 45% of our revenues were derived from customers outside of the U.S. While our international sales have typically been denominated in U.S. dollars, fluctuations in currency exchange rates could cause our products to become relatively more expensive to customers in a particular country, leading to a reduction in sales or profitability in that country.
In addition, we have a research and development facility located in India, and we expect to expand our offshore development efforts and general and administrative functions within India and possibly in other countries. We have sales and support personnel in numerous countries worldwide.
Our international operations subject us to a variety of risks, including:
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the difficulty of managing and staffing international offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;
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difficulties in enforcing contracts and collecting accounts receivable, and longer payment cycles, especially in emerging markets;
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tariffs and trade barriers, export regulations and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets;
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increased exposure to foreign currency exchange rate risk, against which we currently do not hedge;
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heightened exposure to political and economic instability, war and terrorism;
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reduced protection for intellectual property rights in some countries;
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costs of compliance with, and the risks and costs of non-compliance with, differing and changing regulatory and legal requirements in the jurisdictions in which we operate;
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heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of, and irregularities in, financial statements;
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multiple conflicting tax laws and regulations;
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the need to localize our products for international customers; and,
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increased cost of managing employees in foreign countries, including increased costs of terminating employees in certain jurisdictions.
As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, adversely affecting our business, operating results and financial condition.
Another significant risk resulting from our international operations is compliance with the U.S. Foreign Corrupt Practices Act, or FCPA, and other anti-bribery laws applicable to our operations, such as the U.K. Anti-Bribery Act of 2010. In many foreign countries, particularly in those with developing economies, it may be a local custom that businesses operating in such countries engage in business practices that are prohibited by the FCPA or other U.S. and foreign laws and regulations applicable to us. Although we have implemented training and procedures designed to ensure compliance with the FCPA and similar laws, there can be no assurance that all of our employees, agents and other channel partners, as well as those companies to which we outsource certain of our business operations, will not take actions in violation of our policies. Any such violation could have a material and adverse effect on our business.
Our product and service sales and our international operations may be subject to foreign governmental regulations, which vary substantially from country to country and change from time to time. Failure to comply with these regulations could adversely affect our business. Further, in many foreign countries it is common for others to engage in business practices that are prohibited by
our internal policies and procedures or U.S. regulations applicable to us. Although we implemented policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, channel partners and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, channel partners or agents could result in delays in revenue recognition, financial reporting misstatements, litigation, fines, penalties or the prohibition of the importation or exportation of our products and services and could have a material adverse effect on our business and results of operations.
Our use of and reliance on research and development resources in India may expose us to unanticipated costs or events.
We have a significant research and development center in Bangalore, India and, in recent years, have increased headcount and development activity at this facility. There is no assurance that our reliance upon research and development resources in India will enable us to achieve meaningful cost reductions or greater resource efficiency. Further, our research and development efforts and other operations in India involve significant risks, including:
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difficulty hiring and retaining appropriate engineering personnel due to intense competition for such resources and resulting wage inflation;
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the knowledge transfer related to our technology and resulting exposure to misappropriation of intellectual property or information that is proprietary to us, our customers and other third parties;
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heightened exposure to change in the economic, security and political conditions in India;
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differences in cultural expectations regarding various functions and policies;
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fluctuations in currency exchange rates and regulatory compliance in India; and,
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interruptions to our operations in India as a result of floods and other natural catastrophic events as well as manmade problems such as power disruptions or terrorism.
Difficulties resulting from the factors above and other risks related to our operations in India could expose us to increased expense, impair our development efforts and harm our competitive position.
If we fail to maintain an effective system of internal controls, our ability to produce accurate financial statements or comply with applicable regulations could be impaired.
As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations of The NASDAQ Stock Market. We expect that the requirements of these rules and regulations will continue to increase our legal, accounting and financial compliance costs, make some activities more difficult, time-consuming and costly, and place a significant burden on our personnel, systems and resources.
The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We are continuing to develop and refine our disclosure controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Our current controls and any new controls that we develop may become inadequate because of changes in conditions, and our degree of compliance with our policies or procedures may deteriorate. While we have conducted employee training and implemented various controls and procedures, weaknesses in our internal controls may be discovered in the future. Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our prior period financial statements. Any failure to implement and maintain effective internal controls also could adversely affect the results of periodic management evaluations regarding the effectiveness of our internal control over financial reporting that we are required to include in our periodic reports filed with the SEC under Section 404 of the Sarbanes-Oxley Act. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock.
In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we have expended, and anticipate that we will continue to expend, significant resources and provide significant management oversight and employee training, all of which may involve substantial accounting-related costs. Any failure to maintain the adequacy of our internal controls, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In the event that we are not able to continue to demonstrate compliance with Section 404 of the Sarbanes-Oxley Act in a timely manner, that our internal controls are perceived as
inadequate or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and our stock price could decline. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on The NASDAQ Global Market.
We have not yet implemented a complete disaster recovery plan or business continuity plan for our accounting and related information technology systems. Any disaster could therefore materially impair our ability to maintain timely accounting and reporting.
Claims by others that we infringe their proprietary technology could harm our business.
Our industry is characterized by vigorous protection and pursuit of intellectual property rights, which has resulted in protracted and expensive litigation for many companies. Third parties, including some of our competitors, have asserted and may in the future assert claims of infringement of intellectual property rights against us or against our customers or channel partners for which we may be liable. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, require us to enter into royalty or licensing agreements, or require expensive changes to our products. As a result, these claims could materially and adversely affect our business, results of operations, cash flows and financial position. For example:
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We previously received letters from, and had lengthy discussions with Motorola Solutions, one of our competitors with a large patent portfolio and substantial resources, concerning its allegations that our products infringe certain of its patents. Those negotiations ultimately resulted in us entering into a cross-license with Motorola Solutions in 2011 under which we paid Motorola Solutions a substantial settlement.
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In May 2010, Extricom Ltd., filed suit against us in the Federal District Court of Delaware asserting infringement of U.S. Patent No. 7,697,549. The litigation was dismissed after the parties entered into a settlement, license and release agreement on April 13, 2012, in which we agreed to a one-time payment of approximately $2.4 million to Extricom Ltd., and we and Extricom Ltd. each agreed to a cross-license of each other’s patents in exchange for a full release and settlement of the litigation.
In addition, we are currently subject to the lawsuits involving patent infringement as set forth under Note 11, Commitments and Contingencies, in Item 8 of Part II of this Annual Report on Form 10-K. Although no assurance may be given, we believe that we are not presently a party to any litigation of which the outcome, if determined adversely, would individually or in the aggregate be reasonably expected to have a material and adverse effect on our business, operating results, cash flows or financial position. We record litigation accruals for legal matters which are both probable and estimable. For legal proceedings for which there is a reasonable possibility of loss (meaning those losses for which the likelihood is more than remote but less than probable), we have determined that we do not have material exposure, or we are unable to develop a range of reasonably possible losses.
As our business expands and the number of products and competitors in our markets increases and overlaps occur, we expect that infringement claims may increase in number and significance. Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot be certain that we will be successful in defending ourselves against intellectual property claims. In addition, because we currently have a limited portfolio of issued patents compared to our major competitors, we may not be able to effectively utilize our intellectual property portfolio to assert defenses or counterclaims in response to patent infringement claims or litigation brought against us by third parties. Further, litigation may involve patent holding companies or other adverse patent owners who have no relevant product revenues and against whom our potential patents may provide little or no deterrence. Many of these potential litigants have the capability to dedicate substantially greater resources to enforce their intellectual property rights and to defend claims that may be brought against them. A successful claimant could secure a judgment that requires us to pay substantial damages or prevents us from distributing certain products or performing certain services. We may also be required to seek a license and pay royalties for the use of such intellectual property. Any such license may not be available on commercially acceptable terms or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful.
In addition, much of our business relies on, and many of our products incorporate, proprietary technologies of third parties, including third party commercial software and open source software. We may not be able to obtain, or continue to obtain, licenses from such third parties on reasonable terms, and such licensing may increase our exposure to claims of infringement by other third parties.
If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.
We depend on our ability to protect our proprietary technology. We protect our proprietary information and technology through licensing agreements, nondisclosure agreements and other contractual provisions, as well as through patent, trademark, copyright and trade secret laws in the U.S. and similar laws in other countries. These protections may not be available in all cases or may be inadequate to prevent our competitors from copying, reverse engineering or otherwise obtaining and using our technology, proprietary rights or products. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights may be inadequate. For example, the laws of India, where we conduct significant research and development activities, do not protect our proprietary rights to the same extent as the laws of the U.S. In addition, third parties may seek to challenge, invalidate or circumvent our patents, trademarks, copyrights and trade secrets, or applications for any of the foregoing. Our competitors may independently develop technologies that are substantially equivalent, or superior, to our technology or design around our proprietary rights. In each case, our ability to compete could be significantly impaired.
To prevent substantial unauthorized use of our intellectual property rights, it may be necessary to prosecute actions for infringement or misappropriation of our proprietary rights against third parties. Any such action could result in significant costs and diversion of our resources and management’s attention, and there can be no assurance that we will be successful in such action. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing or misappropriating our intellectual property.
We have a limited patent and trademark portfolio. To date, we have not applied for patent or trademark protection outside of the U.S. While we plan to protect our intellectual property with, among other things, patent protection, there can be no assurance that:
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current or future U.S. or future foreign patent applications will be approved;
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our issued patents will protect our intellectual property and will not be held invalid or unenforceable if challenged by third parties;
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we will succeed in protecting our technology adequately in all key jurisdictions in which we or our competitors operate;
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the patents of others will not have an adverse effect on our ability to do business; or,
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others will not independently develop similar or competing products or methods or design around any patents that may be issued to us.
The failure to obtain patents with claims of a scope necessary to cover our technology, or the invalidation or our patents, or our inability to protect any of our intellectual property, may weaken our competitive position and may materially and adversely affect our business and results of operations.
We might be required to spend significant resources to monitor and protect our intellectual property rights. We may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may adversely affect our business, operating results and financial condition.
If market demand for wireless networks does not continue to develop as we anticipate, demand for our virtualized WLAN solution may not grow as we expect.
The success of our business depends on enterprises continuing to adopt wireless networks for use with their business-critical applications. The market for enterprise-wide wireless networks has only developed in recent years as enterprises have deployed wireless networks to take advantage of the convenient access to the network that they provide. As businesses seek to run their business-critical applications on these wireless networks, they recognize the limitations of other wireless solutions and the need for our virtualized WLAN solution. Ultimately, however, enterprises may elect not to deploy wireless networks and may elect not to run their business-critical applications on a wireless network. Accordingly, demand for our solution may not continue to develop as we anticipate, or at all.
Our sales cycles can be long and unpredictable. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.
The timing of our sales is difficult to predict. Our sales efforts involve educating our customers about the use and benefits of our virtualized WLAN solution, including the technical capabilities of our products and the potential cost savings achievable by
organizations deploying our solution. Customers typically undertake a significant evaluation process, which frequently involves evaluating not only our products but also those of our competitors and can result in a lengthy sales cycle. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales. In addition, purchases of our virtualized WLAN solution are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, our operating results could be materially and adversely affected.
Our revenues may decline as a result of changes in public funding of educational institutions.
We have historically generated a substantial portion of our revenues from sales to educational institutions. Public schools receive funding from local tax revenue, and from state and federal governments through a variety of programs, many of which seek to assist schools located in underprivileged or rural areas. We believe that the funding for a substantial portion of our sales to educational institutions comes from federal funding, in particular the E-Rate program. E-Rate is a program of the Federal Communications Commission that subsidizes the purchase of approved telecommunications, Internet access, and internal connections costs for eligible public educational institutions. In the event that the federal government reduces the amounts dedicated to the E-Rate program in future periods, or eliminates the program completely, our sales to educational institutions may be reduced. Furthermore, if state or local funding of public education is significantly reduced because of legislative or policy changes or by reductions in tax revenues due to changing economic conditions, our sales to educational institutions may be negatively impacted by these changed conditions. Any reduction in spending on information technology systems by educational institutions would likely materially and adversely affect our business and results of operations.
Seasonality may cause fluctuations in our operating results.
We believe that our business is subject to significant seasonal factors that may cause the first and third quarters of our fiscal year to have relatively weaker products revenues than the second and fourth fiscal quarters. We believe that this seasonality results from a number of factors, including:
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customers with a December 31 fiscal year end may choose to spend remaining budgets before their year end resulting in a positive impact on our product revenues in the fourth quarter of our fiscal year;
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the structure of our direct sales compensation program may provide additional financial incentives to our sales personnel for exceeding their annual goals;
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many of our education customers have procurement and deployment cycles that can result in stronger order flow in our second fiscal quarter than in other quarters, subject to the availability of traditional funding sources, such as the E-Rate program in the United States; and
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seasonal reductions in business activity during the summer months in the United States, Europe and certain other regions may have a negative impact on our third quarter revenues.
We believe that our historical growth, variations in the amount of orders booked in a prior quarter but not shipped until a later quarter and other variations in the amount of deferred revenues may have overshadowed the nature or magnitude of seasonal or cyclical factors in the past. In addition, the timing of one or more large transactions may diminish the impact of seasonal factors in any particular quarterly period. Seasonal or cyclical variations in our operations may become more pronounced over time and may materially affect our results of operations in the future.
Our business, operating results and growth rates may be adversely affected by unfavorable economic or market conditions.
Our business depends on the overall demand for IT and on the economic health of our current and prospective customers. Our current business and operating plan assumes that economic activity in general, and IT spending in particular, will at least remain at close to current levels. However, we cannot be assured of the future level of IT spending and any deterioration in the level of such spending could have a material adverse effect on our results of operations and growth rates. The purchase of our products involves a significant commitment of capital and other resources, therefore, weak economic conditions, or a reduction in IT spending, even if economic conditions improve, would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and services, and reduced unit sales. For example, we believe that past economic downturns in the U.S. and international markets, especially in 2008 and 2009, adversely affected our business during that time period as customers and potential customers reduced costs by reducing or delaying purchasing decisions. Any unfavorable economic or market conditions could materially and adversely affect our results of operations.
We have a limited operating history, which makes it difficult to predict our future operating results.
We were incorporated in January 2002, began commercial shipments of our products in December 2003 and achieved significant levels of revenue commencing in 2008. As a result of our limited operating history, it is very difficult to forecast our future operating results. We face challenges in our business and financial planning as a result of the uncertainties resulting from having had a relatively limited time period in which to implement and evaluate our business strategies as compared to more mature companies with longer operating histories. These uncertainties make it difficult to predict our future operating results. If the assumptions we use to plan our business are incorrect or change in reaction to a change in our markets, our financial results could suffer.
The average sales prices of our products may decrease.
The average sales prices for our products may decline for a variety of reasons, including competitive pricing pressures, a change in our mix of products, anticipation of the introduction of new products or promotional programs. The markets in which we compete are highly competitive and we expect this competition to increase in the future, thereby leading to increased pricing pressures. Competitors with more diverse product offerings may reduce the price of products that compete with ours in order to promote the sale of other products or may bundle them with other products. For example, some of our competitors who provide network switching equipment may offer a wireless overlay network at very low prices or on a bundled basis. Furthermore, average sales prices for our products have typically decreased over product life cycles. A decline in our average selling prices in excess of our expectations may harm our operating results.
We expect our gross margin to vary over time, and our level of gross margin may not be sustainable.
Our level of gross margin may not be sustainable and may be adversely affected by numerous factors, including:
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increased price competition;
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changes in customer or product and service mix;
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introduction of new products;
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our ability to reduce production costs;
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increases in material or labor costs;
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increased costs of licensing third party technologies that are used in our products;
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excess inventory, inventory holding charges and obsolescence charges;
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the timing of revenue recognition and revenue deferrals;
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changes in our distribution channels or with our channel sales partners;
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increased warranty costs, including providing additional products at very low or no cost to our customers to resolve product performance issues; and,
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inbound shipping charges.
As a result of any of these factors, or other factors, our gross margin may be adversely affected, which in turn would harm our operating results.
We rely on channel partners to generate a substantial majority of our revenues. If our partners fail to perform, our operating results could be materially and adversely affected.
A substantial majority of our revenues is generated through sales by our channel partners, which are distributors and VARs. Sales through our channel partners accounted for 96%, 94% and 92% of our total net revenues during the years ended December 31, 2013, 2012 and 2011, respectively. To the extent our channel partners are unsuccessful in selling our products, or we are unable to obtain and retain a sufficient number of high-quality channel partners, our operating results could be materially and adversely affected.
Westcon Group, Scansource Catalyst, SiraCom and Ingram Micro distribute a significant amount of our products worldwide. Resale of product through Westcon Group, Catalyst Telecom, SiraCom and Ingram Micro accounted for 72% and 68% of our worldwide net revenues in the years ended December 31, 2013 and 2012, respectively. Resale of product through Westcon Group, Catalyst Telecom and SiraCom accounted for 53%, of our worldwide net revenues in 2011.
Our channel partners may be unsuccessful in marketing, selling and supporting our products and services. They may also market, sell and support our competitors’ products and services, and may devote more resources to the marketing, sales and support of those competitors’products. They may have incentives to promote our competitors’ products in lieu of our products, particularly for our competitors with larger volumes of orders, more diverse product offerings and a longer relationship with our VARs or distributors. In these cases, our channel partners may stop selling our products completely. New sales channel partners may take several months or more to achieve significant sales. Our reliance on our channel partners could subject us to lawsuits, potential liability and reputational harm if, for example, any of our channel partners misrepresents the functionality of our products or services to customers, or violates applicable law or our corporate policies. If we fail to effectively manage our existing or future sales channel partners, our business would be seriously harmed.
Our strategy to invest in sales and marketing programs and personnel may not generate the revenue increases anticipated or such revenue increases may only be realized over a longer period than currently expected.
We invest in sales and marketing programs and personnel based on the revenue that we anticipate they will generate, but our expectations may not be met in a timely fashion or at all. For example, we have in the past commenced a substantial expansion of our field sales organization to provide improved coverage of the growing number of business opportunities in our target markets, and approximately doubled our sales headcount in connection with the expansion. In addition, we have in the past made a variety of investments in marketing programs to complement the expansion of our field sales headcount. However, our revenue grew more slowly than we had anticipated as a result of that expansion of our sales organization, so we took steps to reduce our sales and marketing expenses to be more in line with our revenue expectations.
Market awareness of our capabilities and products is essential to our continued growth and our success in the markets in which we compete and intend to compete. If our marketing programs are not successful in creating market awareness of our company and products and the value and need for our products or if the timing and degree of increased revenues resulting from our increased sales and marketing efforts does not meet our expectations, our business, financial condition and results of operations may suffer materially, and we will not be able to achieve sustained growth.
We base our inventory purchase decisions on our forecasts of customers’ demand and, if our forecasts are inaccurate, our operating results could be materially harmed.
We place orders with our ODMs or manufacturers based on our forecasts of our customers’ demand for our products. Our forecasts are based on multiple assumptions, any of which may introduce errors into our estimates and affect our ability to service our customers. When demand for our products exceeds our forecast, we may not be able to meet demand for our products on a timely basis, and we may need to expend a significant amount of time working with our customers to allocate limited supply and maintain positive customer relations, or we may incur additional costs in order to expedite the manufacture and delivery of additional products. If we underestimate customer demand, our manufacturers may have inadequate materials and components required to produce our products and as a result, we may forego revenue opportunities, lose market share and damage our customer relationships. Conversely, if we overestimate customer demand, our manufacturers may assess charges and we may purchase more finished goods inventory than we are able to sell when we expect to or at all. As a result, we could have excess or obsolete inventory, resulting in a decline in the value of our inventory, which would increase our costs of revenues and reduce our liquidity and which could negatively affect our gross margins. Our failure to accurately manage inventory against demand would adversely affect our operating results.
We rely on third parties to manufacture our products, and depend on them for the supply and quality of our products.
We utilize ODMs to manufacture our products, and are subject to the risk that those manufacturers will not manufacture products with the quality and performance that our customers expect from our products. Our orders may represent a relatively small percentage of the overall orders received by our manufacturers from their customers. As a result, fulfilling our orders may not be a priority in the event our manufacturers are constrained in their ability to fulfill all of their customer obligations in a timely manner. Quality or performance failures of our products or changes in our manufacturers’ financial or business condition could disrupt our ability to supply quality products to our customers and thereby have a material and adverse effect on our business and operating results. Moreover, an increasing portion of our manufacturing is performed outside the United States, primarily in China and Taiwan, and is, therefore, subject to risks associated with doing business in foreign countries. This includes risks resulting from the perception that certain jurisdictions, including China, do not comply with internationally recognized rights of freedom of expression and privacy and may permit labor practices that are deemed unacceptable under evolving standards of social responsibility. If manufacturing or logistics in these foreign countries is disrupted for any reason, including natural disasters, information technology system failures, military or government actions or economic, business, labor, environmental, public health, or political issues, or if the purchase or sale of products from such foreign countries is prohibited or disfavored our business, financial condition and results of operations could be adversely affected.
Some of the components and technologies used in our products are purchased and licensed from a single source or a limited number of sources. The loss of any of these suppliers may cause us to incur additional transition costs, result in delays in the manufacturing and delivery of our products, or cause us to carry excess or obsolete inventory and could cause us to redesign our products.
While supplies of our components are generally available from a variety of sources, we currently depend on a single source or limited number of sources for several components used in our products. For example, the chipsets that we use in our products are currently available only from a limited number of sources, with whom neither we nor our manufacturers have entered into supply agreements.
We have also entered into license agreements with some of our suppliers for technologies that are used in our products, and the termination of these licenses, which can generally be done on relatively short notice, could have a material adverse effect on our business. For example, our access points incorporate certain technology that we license from Atheros. We have entered into a license agreement with Atheros, and such license agreement automatically renews for successive one-year periods unless the agreement is terminated prior to the end of the then-current term. In the event our license agreement with Atheros is terminated, we would be required to redesign some of our products in order to incorporate technology from alternative sources. The resulting redesign could require procuring additional licenses and incurring additional development costs, and materially and adversely affect our business.
As there may be no other sources for these components and technologies, the loss of any of these suppliers would require that we transition to a new component or technology, which could increase our costs, result in delays in the manufacturing and delivery of our products or cause us to carry excess or obsolete inventory, and we could be required to redesign our hardware and software in order to incorporate components or technologies from alternative sources.
In addition, for certain components for which there are multiple sources, we are still subject to potential price increases and limited availability due to market demand for such components. In the past, unexpected demand for communication products caused worldwide shortages of certain electronic parts. If such shortages occur in the future, our business would be adversely affected. We carry very little inventory of our products, and we and our manufacturers rely on our suppliers to deliver necessary components in a timely manner. We and our manufacturers rely on purchase orders rather than long-term contracts with these suppliers, and as a result, even if available, we or our manufacturers may not be able to secure sufficient components at reasonable prices or of acceptable quality to build products in a timely manner and, therefore, may not be able to meet customer demands for our products, which would have a material and adverse effect on our business, operating results and financial condition.
We rely on two third parties for the fulfillment of our customer orders, and the failure of these third parties to perform could have an adverse effect upon our reputation and our ability to distribute our products, which could cause a material reduction in our revenues.
We use two third party logistics providers to hold our inventory and fulfill our customer orders. If these third-party logistics providers fail to perform, our ability to deliver our products and to generate revenues would be adversely affected. The failure of our third-party logistics providers to deliver products in a timely manner could lead to the dissatisfaction of our channel partners and customers and damage our reputation, which may cause our channel partners or customers to cancel existing agreements with us and to stop doing business with us. In addition, this reliance on third-party logistics providers also may impact the timing of our revenue recognition if our logistics providers fail to deliver orders during the prescribed time period. Although we believe that alternative logistics providers are readily available in the market, in the event we are unexpectedly forced to change providers we could experience short-term disruptions in our delivery and fulfillment process that could adversely affect our business.
Our use of open source software could impose limitations on our ability to commercialize our products.
Our products contain software modules licensed for use from third-party authors under open source licenses, including the GNU Public License, the GNU Lesser Public License, the Apache License and others. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some open source licenses contain requirements that we make available source code for modifications or derivative works we create based upon the type of open source software we use and the manner in which we use it. If we combine our proprietary software with open source software in a certain manner, we could, under certain of those open source licenses, be required to release the source code of that proprietary software to the public. This could allow our competitors to create similar products with lower development effort and time and ultimately could result in a loss of product sales for us.
Although we monitor our use of open source closely, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event a license could not be obtained or re-engineering could not be accomplished on a timely and cost-effective basis, any of which could materially and adversely affect our business and operating results.
If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below our expectations and/or expectations of securities analysts and investors, resulting in a decline in our stock price.
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Management estimates include implicit service periods for revenue recognition, litigation and settlement costs, other loss contingencies, sales returns and allowances, allowance for doubtful accounts, inventory valuation, reserve for warranty costs, valuation of deferred tax assets, loss contingency estimates, fair value of common stock, stock-based compensation expense, fair value of warrants and fair value of earn-out consideration.
Our operating results may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, or if we are required to make revisions to our financial statements as a result of periodic regulatory review, which could cause our operating results to fall below market expectations, resulting in a decline in our stock price.
We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in international markets.
Our products incorporate encryption technology and are subject to United States export controls, and may be exported outside the U.S. only with the required level of export license or through an export license exception. In addition, various countries regulate the import of certain encryption technology and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations.
In addition, we have implemented limited procedures to ensure our compliance with export regulations, and if our export compliance procedures are not effective, we could be subject to civil or criminal penalties, which could lead to a material fine or sanction that could have an adverse effect on our business and results of operations.
If we do not appropriately manage any future growth, or are unable to improve our systems and processes, our operating results could be negatively affected.
Our future growth, if it occurs, could place significant demands on our management, infrastructure and other resources. We may need to increasingly rely on IT systems, some of which we do not currently have significant experience in operating, to help manage critical functions. To manage any future growth effectively, we must continue to improve and expand our information technology and financial infrastructure and our operating and administrative systems and controls, and we must continue to manage headcount, capital and processes in an efficient manner. We may not be able to successfully implement improvements to our infrastructure, systems and processes in a timely or efficient manner, which could result in additional operating inefficiencies and could cause unanticipated increases in our costs. If we do increase our operating expenses in anticipation of the growth of our business and this growth does not meet our expectations, our financial results may be negatively impacted. In addition, our systems and processes may not prevent or detect all errors, omissions or fraud. Our failure to improve our systems and processes, or their failure to operate in the intended manner, may result in our inability to manage the growth of our business and to accurately forecast our revenues, expenses and earnings, or to prevent certain losses. Any future growth would add complexity to our organization and require effective coordination within our organization. Failure to manage any future growth effectively could result in increased costs and harm our business.
We may engage in future acquisitions that could disrupt our business, cause dilution to our stockholders and harm our business, operating results and financial condition.
We completed our first acquisition, that of Identity Networks, in 2011. In the future we may acquire other businesses, products or technologies. If we do complete acquisitions, we may not ultimately strengthen our competitive position or achieve our goals, or such acquisitions may be viewed negatively by customers, financial markets or investors. We may also face additional challenges, because acquisitions entail numerous risks, including:
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difficulties in the integration of acquired operations, technologies, personnel and/or products;
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unanticipated costs associated with the acquisition transaction;
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the diversion of management’s attention from the regular operations of the business and the challenges of managing larger and more widespread operations;
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adverse effects on new and existing business relationships with suppliers and customers;
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risks associated with entering geographic or business markets in which we have no or limited prior experience;
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the potential loss of key employees of acquired businesses;
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an acquisition may result in a delay or reduction of customer purchases for both us and the company acquired due to customer uncertainty about continuity and effectiveness of products and services from either company; and,
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delays in realizing or failure to realize the benefits of an acquisition.
Competition within our industry for acquisitions of businesses, technologies, assets and product lines has been, and may in the future continue to be, intense. As such, even if we are able to identify an acquisition that we would like to consummate, we may not be able to complete the acquisition on commercially reasonable terms or because the target is acquired by another company. Furthermore, in the event that we are able to identify and consummate any future acquisitions, we could:
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issue equity securities which would dilute current stockholders’ percentage ownership;
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incur substantial debt;
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incur significant acquisition-related expenses;
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assume contingent liabilities; or,
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expend significant cash.
We invest in companies for both strategic and financial reasons, but may not realize a return on our investments in every instance.
We have made, and may continue to seek to make, investments in companies around the world to further our strategic objectives and support our key business initiatives. These investments may include equity or debt instruments of public or private companies, and may be non-marketable at the time of our initial investment. We do not restrict the types of companies in which we seek to invest. These companies may range from early-stage companies that are often still defining their strategic direction to more mature companies with established revenue streams and business models. If any company in which we invest fails, we could lose all or part of our investment in that company. If we determine that an other-than-temporary decline in the fair value exists for an equity or debt investment in a public or private company in which we have invested, we will have to write down the investment to its fair value and recognize the related write-down as an investment loss. The performance of any of these investments could result in significant impairment charges and gains (losses) on other equity investments. We must also analyze accounting and legal issues when making these investments. If we do not structure these investments properly, we may be subject to certain adverse accounting issues, such as potential consolidation of financial results.
Furthermore, if the strategic objectives of an investment have been achieved, or if the investment or business diverges from our strategic objectives, we may seek to dispose of the investment. Our non-marketable equity investments in private companies are not liquid, and we may not be able to dispose of these investments on favorable terms or at all. The occurrence of any of these events could harm our results. Gains or losses from equity securities could vary from expectations depending on gains or losses realized on the sale or exchange of securities and impairment charges related to debt instruments as well as equity and other investments.
The security of our computer systems may be compromised and harm our business.
A significant portion of our business operations is conducted through use of our computer network. Although we have implemented security systems and procedures to protect the confidential information stored on these computer systems, experienced computer programmers and hackers may be able to penetrate our network security and misappropriate our confidential information or that of third parties. As well, they may be able to create system disruptions, shutdowns or effect denial of service attacks. We have been the subject of a denial of service attack in the past, although it did not materially affect our operations. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our networks or client computers, or otherwise exploit any security vulnerabilities, or that misappropriate and distribute confidential information stored on these computer systems. It is also possible that computer programmers and hackers could penetrate the network security of customers using our solutions. Any of the foregoing could result in damage to our reputation and customer confidence in our products and services, and could require us to incur significant costs to eliminate or alleviate the problem. Additionally, our ability to transact business may be affected. Such damage, expenditures and business interruption could seriously impact our business, financial condition and results of operations.
We are exposed to the credit risk of our VARs, distributors and customers, which could result in material losses and negatively impact our operating results.
Most of our sales are on an open credit basis, with typical payment terms of net 30 days in the U.S. and, because of local customs or conditions, longer in some markets outside the U.S. If any of our VARs, distributors or customers becomes insolvent or suffers a deterioration in its financial or business condition and is unable to pay for our products, our results of operations could be harmed.
Our reported financial results may be adversely affected by changes in accounting principles applicable to us.
Generally accepted accounting principles in the U.S. are subject to interpretation by the Financial Accounting Standards Board, or FASB, the SEC, and other various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change. Any difficulties in the implementation of these pronouncements could cause us to fail to meet our financial reporting obligations, which could result in regulatory or administrative discipline, including the possibility of a restatement of our financial statements, or litigation.
New regulations or changes in existing regulations related to our products may result in unanticipated costs or liabilities, which could have a material and adverse effect on our business, results of operations and future sales, and could place additional burdens on the operations of our business.
Our products are subject to governmental regulations in a variety of jurisdictions. If any of our products becomes subject to new regulations or if any of our products becomes specifically regulated by additional government entities, compliance with such regulations could become more burdensome, and there could be a material adverse effect on our business and results of operations. For example, radio emissions are subject to regulation in the U.S. and in other countries in which we do business. In the U.S., various federal agencies including the Center for Devices and Radiological Health of the Food and Drug Administration, the Federal Communications Commission, the Occupational Safety and Health Administration and various state agencies have promulgated regulations that concern the use of radio/electromagnetic emissions standards. Member countries of the European Union have enacted similar standards concerning electrical safety and electromagnetic compatibility and emissions standards, as well as the Waste Electrical and Electronic Equipment, or WEEE, and Restriction of the Use of Certain Hazardous Substances in Electrical and Electric Equipment, or RoHS, regulations with which our products and operations in the European Union must comply. We are further required to evaluate compliance with various laws and regulations that may be applicable to our business, such as the conflict minerals disclosure rules promulgated by the SEC in August 2012. The rule requires investigation and disclosure of the use of certain “conflict minerals” in our products. These rules apply to our business, and we are expending resources to ensure compliance. We may face reputational challenges and the loss of sales if we are required to publicly state that we are unable to sufficiently verify the origins for the defined “conflict” metals used in our products. The failure to comply with these regulations could result in the assessment of fines or penalties or other relief against us.
In addition, our wireless communication products operate through the transmission of radio signals. Currently, operation of these products in specified frequency bands does not require licensing by regulatory authorities. Regulatory changes restricting the use of frequency bands or allocating available frequencies could become more burdensome and could have a material and adverse effect on our business and results of operations.
Our ability to use net operating losses to offset future taxable income is subject to certain limitations.
In general, under Section 382 of the Internal Revenue Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating losses, or NOLs, to offset future taxable income. Our existing NOLs are subject to limitations arising from previous ownership changes and it is possible that the recent March 2013 secondary stock offering could result in an ownership change. In addition, if we undergo an ownership change in the future, our ability to utilize NOLs could be further limited by Section 382 of the Internal Revenue Code. Future changes in our stock ownership, many of which are outside of our control, could result in an ownership change under Section 382 of the Internal Revenue Code. Our net operating losses may also be impaired under state law. As a consequence, we may not be able to utilize a material portion of our NOLs. At December 31, 2013, we had federal and state net operating loss carryforwards of approximately $146.2 million and $122.4 million, respectively, which begin to expire in 2022 and 2014, respectively.
Changes in our provision for income taxes or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.
Our provision for income taxes is subject to volatility and could be adversely affected by the following:
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earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates;
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changes in the valuation of our deferred tax assets and liabilities;
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expiration of, or lapses in, the research and development tax credit laws;
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transfer pricing adjustments including the effect of acquisitions on our intercompany research and development cost sharing arrangement and legal structure;
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tax effects of nondeductible compensation;
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tax costs related to intercompany realignments;
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changes in accounting principles; or,
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changes in tax laws and regulations including possible U.S. changes to the taxation of earnings of our foreign subsidiaries, and the deductibility of expenses attributable to foreign income, or the foreign tax credit rules.
Significant judgment is required to determine the recognition and measurement attributes prescribed in the accounting guidance for uncertainty in income taxes. The accounting guidance for uncertainty in income taxes applies to all income tax positions, including the potential recovery of previously paid taxes, which if settled unfavorably could adversely impact our provision for income taxes or additional paid-in capital. Further, as a result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries is subject to reduced tax rates. Our failure to meet these commitments could adversely impact our provision for income taxes. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. The outcomes from these examinations may have a material and adverse effect on our operating results and financial condition.
Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as power disruptions, network security breaches or terrorism.
Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity. We also have significant research and development activities in India and facilities in Japan, regions known for typhoons, floods and other natural disasters. A significant natural disaster, such as an earthquake, fire or a flood, occurring at our headquarters, our other facilities or where our ODMs and channel partners are located, could have a material adverse impact on our business, operating results and financial condition. In addition, acts of terrorism could cause disruptions in our or our customers’ businesses or the economy as a whole. We also rely on information technology systems to communicate among our workforce located worldwide, and in particular, our research and development activities that are coordinated between our corporate headquarters in the San Francisco Bay Area and our facility in India. Any disruption to our internal communications, whether caused by a natural disaster or by manmade problems, such as power disruptions or the penetration of our system by “hackers”, could delay our research and development efforts and affect our internal operations. To the extent that such disruptions result in delays or cancellations of customer orders, delay of our research and development efforts or the deployment of our products, or interrupt the orderly operation of our business, our business and operating results could be materially and adversely affected.
Risks Related to Our Common Stock
Our stock price may be volatile. Further, you may not be able to resell shares of our common stock at or above the price you paid.
The trading price of our common stock has been highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include:
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actual or anticipated variation in anticipated results of operations of us or our competitors;
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the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
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announcements by us or our competitors of new products, new or terminated significant contracts, commercial relationships or capital commitments;
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additional dilution to our existing shareholders due to new financing activities;
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failure of securities analysts to maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet the estimates or expectations of analysts or investors;
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developments or disputes concerning our intellectual property or other proprietary rights;
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commencement of, or our involvement in, litigation;
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announced or completed acquisitions of businesses or technologies by us or our competitors;
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changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular;
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price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole, such as the continuing volatility in the financial markets;
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rumors and market speculation involving us or other companies in our industry;
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any major change in our management;
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general economic conditions and slow or negative growth of our markets; and,
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other events or factors, including those resulting from war, incidents of terrorism or responses to these events.
In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. Such litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
If securities or industry analysts issue an adverse or misleading opinion regarding our stock or do not publish research or reports about our business, our stock price and trading volume could decline.
The trading market for our common stock relies in part on the research and reports that equity research and industry analysts publish about us, our business and our products. We do not control these analysts or the content and opinions included in their reports. The price of our common stock could decline if one or more equity research analysts downgrade our common stock or if an analyst issues other unfavorable commentary. Additionally, if one or more analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline. Further, securities analysts may elect not to initiate research coverage of our common stock and such lack of research coverage may adversely affect the market price of our common stock.
Future sales of shares underlying outstanding options, warrants and other rights to acquire our common stock could dilute our existing stockholders and cause our stock price to decline.
As of December 31, 2013, approximately 22.9 million shares of our common stock were issued and outstanding. At that date, we had outstanding options and other rights to acquire approximately 4.6 million shares of our common stock, including stock options, restricted stock units, restricted stock and shares anticipated to be purchased under our ESPP at the next purchase date, to the extent such securities become vested and are exercised as permitted by the provisions of the plans and agreements applicable to those securities. The weighted-average exercise price for options was $4.68 per share as of December 31, 2013. In addition, on December 31, 2013, there were outstanding warrants to purchase 3.2 million shares of our common stock at a weighted average exercise price of $9.48 per share. If a substantial amount of these additional shares are issued and are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. Additionally, our existing stockholders will suffer dilution of their percentage ownership of outstanding common stock.
We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.
We have never paid cash dividends on any of our classes of capital stock to date, and we have contractual restrictions against paying cash dividends that are contained in our loan agreements. We currently intend to retain our future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be the sole source of gain for our stockholders in the foreseeable future.
Certain provisions of our certificate of incorporation and bylaws and of Delaware law may make it difficult for stockholders to change the composition of our board of directors and may discourage hostile takeover attempts that some of our stockholders may consider to be beneficial.
Certain provisions of our certificate of incorporation and bylaws and of Delaware law may have the effect of delaying or preventing changes in control if our board of directors determines that such changes in control are not in the best interests of us and our stockholders. The provisions in our certificate or incorporation and bylaws include, among other things, the following:
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the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms, including preferences and voting rights, of those shares without stockholder approval;
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stockholder action can only be taken at a special or regular meeting and not by written consent;
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advance notice procedures for nominating candidates to our board of directors or presenting matters at stockholder meetings;
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allowing only our board of directors to fill vacancies on our board of directors; and,
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supermajority voting requirements to amend our bylaws and certain provisions of our certificate of incorporation.
While these provisions have the effect of encouraging persons seeking to acquire control of our company to negotiate with our board of directors, they could enable the board of directors to hinder or frustrate a transaction that some, or even a majority, of the stockholders might believe to be in their best interests by preventing or discouraging attempts to remove and replace incumbent directors. We are also subject to Delaware laws that could discourage hostile takeover attempts. One of these laws prohibits us from engaging in a business combination with a significant stockholder unless specific conditions are met.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable
ITEM 2.
ITEM 2. PROPERTIES
Our principal administrative, research and development, sales and marketing, and customer support office space is located in approximately 44,000 square feet leased facility in Sunnyvale, California. This lease expires in March 2015. We also lease approximately 35,000 square feet for a research and development facility in Bangalore, India pursuant to a lease that expires in November 2016, which is cancellable in 2014. We have the option to renew the Bangalore lease for an additional five years. In addition, we lease office space for sales offices and test facilities at various locations throughout the world under operating leases. These leases expire at various dates. We believe our facilities are either suitable and adequate for our needs for at least the next 12 months or that suitable and adequate additional or alternative space will be reasonably available to accommodate foreseeable expansion of our operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims arising in the ordinary course of business. Although no assurance may be given, we believe that we are not presently a party to any litigation of which the outcome, if determined adversely, would individually or in the aggregate be reasonably expected to have a material and adverse effect on our business, operating results, cash flows or financial position.
In October 2010, a complaint was filed by EON Corp. IP Holdings LLC against us and numerous other defendants, including Cisco, Sprint, HTC and Aruba Networks, in the United States District Court for the Eastern District of Texas, Marshall Division. The complaint alleges infringement by the defendants of U.S. Patent No. 5,592,491 (“491 Patent”). Our initial attempts at informally resolving the action were unsuccessful. The defendants filed a joint motion to transfer the case to the Northern District of California, and on January 9, 2012, the Texas court granted the motion to transfer. On August 13, 2012, we answered EON’s second amended complaint, denying the allegations, and asserting that the EON patent is not infringed and is invalid. The case was pending before the Honorable Jon S. Tigar. Pre-trial Markman claim construction hearings were held on May 10, 2013 and on July 8, 2013 and Judge Tigar issued a Markman Order construing and determining the validity of certain claims of the ‘491 Patent. On November 15, 2013, EON and we entered into an Agreement of Dismissal pursuant to which, among other things, EON dismissed its claims against us with respect to the ‘491 Patent. There was no financial impact to us as a result of the Agreement of Dismissal.
In May 2011, Linex Technologies, Inc. filed suit against us and Hewlett-Packard, Apple, Aruba Networks, and Ruckus Wireless in the United States District Court for the District of Delaware, asserting infringement of U.S. Patents No. 6,757,322 (“322 patent”) and RE42,219 (“219 patent”). On June 2, 2011, the United States International Trade Commission (“ITC”) instituted a Section 337 Investigation, based on Linex’s complaint that the ‘322 and ‘219 patents are infringed by 802.11n products imported and sold by us and by Hewlett-Packard, Apple, Aruba Networks, and Ruckus Wireless. The case in Delaware was stayed due to the pending ITC Investigation. Linex subsequently withdrew its ITC complaint and moved to lift the stay of the Delaware litigation, which was not opposed by the defendants and which was granted by the Delaware court. On December 12, 2012, Linex amended its complaint to add a third patent, U.S. Patent No. RE43,812 (“812 patent”). The defendants filed a motion to transfer the case to the Northern District of California, which was granted by the Delaware court on January 7, 2013. The case is now pending before the Honorable Claudia Wilken, and trial has been set for July 28, 2014. A responsive Markman brief and dispositive motions were filed by us on December 9, 2013. A court-ordered mediation session was held on December 20, 2013 and a settlement was not reached during the mediation. The court held a Markman hearing on January 23, 2014. Discovery is ongoing and there are unresolved questions of fact and law, including those with respect to claim construction, validity and infringement. In light of these unresolved factual and legal issues, while a loss is reasonably possible, the amount of any potential loss cannot be estimated. At this stage, we are unable to predict the outcome of this matter and, accordingly, cannot estimate the potential financial impact this action could have on our business, operating results, cash flows or financial position.
On August 15, 2012, ReefEdge Networks, LLC (“ReefEdge”) filed suit against us and CDW (an IT reseller) and filed suits separately against CDW and various other defendants, including Cisco Systems, Aruba Networks, Dell Computer, and Ruckus Wireless in the United States District Court of Delaware, asserting infringement of U.S. Patent No. 6,633,761; U.S. Patent No. 6,975,864; and U.S. Patent No. 7,197,308. We filed our answer to the complaint on October 8, 2012. The case is now pending before the Honorable Leonard P. Stark. On April 29, 2013, Brocade Communications Systems tendered to us a request for indemnity in a related case before the same judge in Delaware, ReefEdge Networks v. Motorola Solutions and Brocade Communications, based on our sales to Brocade and its predecessors in interest. We have accepted Brocade’s request. The court has scheduled a claim construction hearing for April 11, 2014. The court has not yet set a trial date. Discovery has just begun, and there are unresolved questions of fact and law, including those with respect to claim construction, validity and infringement. Additionally, no case-dispositive motions have been filed. In light of these unresolved factual and legal issues, while a loss is reasonably possible, the amount of any potential loss cannot be estimated. At this stage, we are unable to predict the outcome of this matter and, accordingly, cannot estimate the potential financial impact this action could have on our business, operating results, cash flows or financial position.
Third parties have from time to time claimed, and others may claim in the future that we have infringed their past, current or future intellectual property rights. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in our methods of doing business or could require us to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm our business, operating results, cash flows and financial position.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information for Our Common Stock
Our common stock has been traded on the NASDAQ Global Market under the symbol “MERU” since it began trading on March 31, 2010. At February 1, 2014, there were 110 stockholders of record of our common stock.
The following table sets forth the high and low closing prices by quarter for fiscal years 2013 and 2012:
Stock Performance Graph and Cumulative Total Return
The following graph shows a comparison from March 31, 2010 through December 31, 2013 of the cumulative total return on our common stock, the NASDAQ Composite Index and the NASDAQ Computer Index. The graph and table assume that $100 was invested on March 31, 2010 in Meru Networks, Inc. common stock, the NASDAQ Composite Index and the NASDAQ Computer Index with the reinvestment of all dividends, if any. Such returns are based on historical results and are not intended to suggest future performance.
Comparison of 45 Month Cumulative Total Return*
Among Meru Networks, Inc., the NASDAQ Composite Index, and
the NASDAQ Computer Index
* $100 invested on 03/31/2010 in stock or index, including reinvestment of dividends
Fiscal year ending December 31.
Dividend Policy
We have never declared or paid any cash dividends on our capital stock. We currently expect to retain future earnings, if any, and do not anticipate paying any cash dividends in the foreseeable future. In addition, our debt agreements contain certain affirmative and negative covenants, including restrictions with respect to payment of cash dividends. Any further determination to pay dividends on our capital stock will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements and other factors that our board of directors considers relevant.
Equity Compensation Plan Information
The following table summarizes information about our equity compensation plans as of December 31, 2013. All outstanding awards relate to our common stock.
(1) Prior to our Initial Public Offering, or IPO, we issued securities under our 2002 Stock Incentive Plan. Following our IPO, we issued securities under our 2010 Stock Incentive Plan, or 2010 Plan, and our 2010 Employee Stock Purchase Plan, or ESPP.
(2) For our Chief Executive Officer, we issued securities under an Inducement Stock Option Plan and Agreement, a Service-Based Restricted Stock Unit Plan and Agreement and a Performance-Based Restricted Stock Unit Plan and Agreement. We also issued securities under our 2013 New Employee Stock Inducement Plan, or the 2013 Plan.
Under the 2010 Plan we may issue stock awards, including but not limited to restricted stock awards, restricted stock units, stock bonus awards, stock appreciation rights and performance share awards. The 2010 Plan contains a provision that the number of shares available for grant and issuance will be increased on January 1 of each year from 2011 through 2020 by an amount equal to the lesser of 4% of our shares outstanding on the immediately preceding December 31 or the number of shares determined by our board of directors.
Under the ESPP, we may grant options for the purchase of our common stock. The ESPP contains a provision that the number of shares available for grant and issuance will be increased on January 1 of each of 2011 through 2020, by an amount equal to the lesser of 1% of our shares outstanding on the immediately preceding December 31 or the number of shares determined by our board of directors.
In March 2012, we granted to Dr. Bami Bastani, President and CEO, options to purchase 600,000 shares of common stock under an Inducement Stock Option Plan and Agreement, 50,000 shares of restricted stock units under a Service-Based Restricted Stock Unit Plan and Agreement and 50,000 shares of restricted stock units under a Performance-Based Restricted Stock Unit Plan and Agreement, each of which are separate from the 2010 Plan, as a material inducement to Dr. Bastani’s acceptance of employment with us. The grants were approved by our board of directors, as specified under the Listing Rules of the Nasdaq Stock Market.
On June 6, 2013, our Board of Directors approved our 2013 Plan, under which 500,000 shares of common stock were reserved for issuance. The 2013 Plan is designed to attract new employees by providing for awards in the form of restricted stock units, restricted stock awards, stock options (which shall be nonstatutory stock options) or stock appreciation rights. The grants were approved by our board of directors, as specified under the Listing Rules of the Nasdaq Stock Market.
Recent Sales of Unregistered Securities
For the quarter ended December 31, 2013, we did not sell any unregistered securities.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
We did not make any repurchases of our common stock and no purchases of common stock were made on our behalf during the fourth quarter and the fiscal year 2013.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data”, and related notes, schedules and information included in this Annual Report on Form 10-K. The selected consolidated financial data in this section is not necessarily indicative of the results of future operations.
* Includes stock-based compensation expense as follows:
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled “Risk Factors” included elsewhere in this Form 10-K.
Overview
We provide a virtualized WLAN solution that is designed to cost-effectively optimize the enterprise network to deliver the performance, reliability, predictability and operational simplicity of a wired network, with the advantages of mobility. Our solution represents an innovative approach to wireless networking that utilizes virtualization technology to create an intelligent and self-monitoring wireless network. We sell a virtualized WLAN solution built around our System Director Operating System, which runs on our controllers and access points. We also offer additional products designed to deliver centralized network management, predictive and proactive diagnostics and enhanced security.
We were founded in January 2002 with the vision of developing a virtualized WLAN solution that enables enterprises to deliver business-critical applications over wireless networks, and become what we refer to as All-Wireless Enterprises. From our inception through 2003, we were principally engaged in the design and development of our virtualized WLAN solution. We focused on developing technology that could reliably and predictably deliver business-critical applications using voice, video and data over wireless networks in dense environments. We began commercial shipments of our products in December 2003, and initially targeted markets where the wireless delivery of applications in dense environments is critical, such as healthcare and education. Since that time, we have broadened our focus to include organizations in more markets, and have significantly expanded our geographic reach. To date, our products have been deployed by approximately 12,500 customers worldwide in many markets, including education, healthcare, hospitality, manufacturing, retail, technology, finance, government, telecom, transportation and utilities.
We outsource the manufacturing of our hardware products, including all of our access points and controllers, to original design manufacturers and contract manufacturers. We also outsource the warehousing and delivery of our products to a third-party logistics provider in the United States for worldwide fulfillment.
Our products and support services are sold worldwide, primarily through value-added resellers, or VARs, and distributors, which serve as our channel partners. We employ a sales force that is responsible for managing sales within each geographic territory in which we market and sell our products.
Since inception, we have expended significant resources on our research and development operations. Our research and development activities were primarily conducted at our headquarters in Sunnyvale, California until 2005, when we significantly expanded our research and development operations in Bangalore, India. In 2006, we began developing products specifically to leverage the capabilities of a new wireless communication standard promulgated by the IEEE, the 802.11n standard, and began commercial shipments of our 802.11n products in the second half of 2007.
We believe several emerging trends and developments will be integral to the future growth of our business. The growing number of wireless devices and the increased expectations of the users of these devices are driving demand for better performing wireless networks. Enterprises increasingly view wireless networks as a means to deliver better service to their customers and increase
the productivity of their workforce, and as a result, they are shifting from the casual use of wireless networks to the strategic use of wireless networks for business-critical applications. Further, enterprises are increasingly realizing that wireless networks designed to optimize the 802.11n standard and the 802.11ac standard can deliver the capacity and performance to support their business-critical applications.
Our ability to capitalize on emerging trends and developments will depend, in part, on our ability to execute our growth strategy of increasing the recognition of our brand and the effectiveness of our solution, expanding the adoption of our solution across markets, and expanding and leveraging our relationships with the channel partners. We continue to evolve our entire organization to further capitalize on growth opportunities.
Our ability to achieve and maintain profitability as well as our other goals in the future will be affected by, among other things, the continued acceptance of our products, the timing and size of our orders, the average selling prices for our products and services, the costs of our products, and the extent to which we invest in our sales and marketing, research and development, and general and administrative resources.
Our revenues have grown from $1.1 million in 2005 to $105.7 million in 2013. It is difficult to predict our revenues in the near term. Our revenues have in the past fluctuated significantly, and may continue to fluctuate in the future. Further, our revenues during any given quarter depend on multiple factors, including, but not limited to, the amount of orders booked in a prior quarter but not shipped until the given quarter, new orders received and shipped in the given quarter, the amount of deferred revenue recognized in the given quarter and the amount of revenues that meet the accounting standards for revenue recognition. These factors could impact our revenues significantly in any given quarter.
In addition, we believe that there can be significant seasonal factors that may cause the first and third quarters of our fiscal year to have relatively weaker products revenues than the second and fourth fiscal quarters. We believe that this seasonality results from a number of factors, including:
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customers with a December 31 fiscal year end may choose to spend remaining budgets before their year end resulting in a positive impact on our products revenues in the fourth quarter of our fiscal year;
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the structure of our direct sales compensation program may provide additional financial incentives to our sales personnel the exceed their annual goals resulting in additional sales in the fourth quarter;
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the timing of our annual training for the entire sales force in our first fiscal quarter combined with the above fourth quarter factors can potentially cause our first fiscal quarter to be seasonally weak;
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many of our education customers have procurement and deployment cycles that can result in stronger order flow in our second fiscal quarter than other quarters as a result of the timing of customer funding ; and,
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seasonal reductions in business activity during the summer months in the United States, Europe and certain other regions may have a negative impact on our third quarter revenues.
We believe that our historical growth, variations in the number of orders booked in a prior quarter but not shipped until a later quarter and other variations in the amount of deferred revenues may have overshadowed the nature or magnitude of seasonal or cyclical factors that might have influenced our business to date. In addition, the timing of one or more large transactions may overshadow seasonal factors in any particular quarterly period. Seasonal or cyclical variations in our operations may become more pronounced over time and may materially affect our results of operations in the future.
We have incurred losses since inception as we grow our business and invest in research and development, sales and marketing, and administrative functions. As of December 31, 2013, we had an accumulated deficit of $265.4 million.
Vendor Specific Objective Evidence
Our recognition of revenues in a particular period depends on the satisfaction of specific revenue recognition criteria, which we describe in more detail below. We adopted two accounting standards for certain revenue arrangements at the beginning of fiscal year 2011 that include software elements and multiple deliverable revenue arrangements. Generally, upon establishing VSOE for support services for a customer or class of customers, our total recognized revenues from sales to these customers increased in subsequent periods because we were able to recognize all of the products revenues from these sales in these periods once all revenue recognition criteria were satisfied. We also continued to recognize ratable products and services revenues from sales to customers made prior to establishing VSOE for support services. This impact has decreased over time and ratable products and services are no longer material. We recognize the costs of revenues in the same period in which we recognize the associated revenues. When reviewing our financial performance and making period-to-period comparisons, you should consider the impact that the timing of the adoption of the two accounting standards and the establishment of VSOE had on our financial results, including the amount of our revenues and costs of revenues.
Key Metrics
We monitor the key financial metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies. We discuss product revenues, support and services revenues and the components of operating income below under “Components of Revenues, Cost of Revenues and Operating Expenses” and we discuss our cash and cash equivalents and short-term investments under “Liquidity and Capital Resources.”
Gross margin. We monitor gross margin to measure our cost efficiencies, including primarily whether our manufacturing costs and component costs are in line with our product revenues and whether our personnel costs associated with our technical support, professional services and training teams are in line with our support and services revenues.
Net cash used in operating activities. We monitor cash flow from operations as a measure of our overall business performance. Our primary uses of cash from operating activities are for personnel-related expenditures, purchases of inventory, costs related to our facilities and litigation reserve expense. Monitoring cash flow from operations enables us to analyze our financial performance without the non-cash effects of certain items such as depreciation and amortization, stock-based compensation expenses, accrued interest on long-term debt, and amortization of issuance costs and warrant expense, thereby allowing us to better understand and manage the cash needs of our business.
Components of Revenues, Costs of Revenues and Operating Expenses
Revenues. We derive our revenues from sales of our products, and support and services. Our total revenues are comprised of the following:
•
Products Revenues - We generate products revenues from sales of our software and hardware products, which primarily consist of our System Director Operating System running our access points and controllers, as well as additional software applications.
•
Support and Services Revenues - We generate support and services revenues primarily from service contracts for our MeruAssure customer support program, which includes software updates, maintenance releases and patches, telephone and internet access to our technical support personnel and hardware support. We also generate support and services revenues from the professional and training services that we provide to our customers.
•
Ratable Products and Services Revenues - Prior to January 1, 2009, we recognized ratable products and services revenues from sales of our products and services in circumstances where VSOE for support services being provided could not be segregated from the value of the entire sales arrangement, or where we provided technical support or unspecified software upgrades outside of contractual terms. In these cases, revenues were deferred and recognized ratably over either the economic life of the product or the contractual period. As of January 1, 2009, we established VSOE for support services for all our channel partners and customers, and we no longer offer support outside of contractual terms, and therefore, we are able to recognize products revenues and support and services revenues separately.
Costs of Revenues. Our total costs of revenues are comprised of the following:
•
Costs of Products Revenues - A substantial majority of the costs of products revenues consists of third-party manufacturing costs and component costs. Our costs of products revenues also include shipping costs, third-party logistics costs, write-offs for excess and obsolete inventory and warranty costs.
•
Costs of Support and Services Revenues - Costs of support and services revenues are primarily comprised of personnel costs associated with our technical support, professional services and training teams.
•
Costs of Ratable Products and Services Revenues - Costs of ratable products and services revenues are comprised primarily of deferred costs of products revenues and an allocation of costs of services revenues.
Operating Expenses. Our operating expenses consist of research and development, sales and marketing, general and administrative expenses and litigation reserve expense. The largest component of our operating expenses is personnel costs. Personnel costs consist of salaries, commissions, bonuses and benefits for our employees. We grant our employees and members of our executive advisory board and board of directors equity awards and recognize stock-based compensation cost as part of operating expenses. We expect to continue to incur significant stock-based compensation expense as our employee base grows.
•
Research and Development Expenses. Research and development expenses primarily consist of personnel, engineering, testing and compliance, facilities and professional services costs. We expense research and development costs as incurred. We are devoting a substantial amount of our resources to the continued development of additional functionality for our existing products and the development of new products.
•
Sales and Marketing Expenses. Sales and marketing expenses represent the largest component of our operating expenses and primarily consist of personnel costs, sales commissions, travel costs, costs for marketing programs and facilities costs.
•
General and Administrative Expenses. General and administrative expenses primarily consist of personnel, professional services and facilities costs related to our executive, finance, human resource and information technology functions. Professional services consist of outside legal and accounting services and information technology consulting costs. We have incurred additional accounting and legal costs related to compliance with rules and regulations enacted by the SEC, including the additional costs of complying with Section 404 of the Sarbanes-Oxley Act, as well as additional insurance, investor relations and other costs associated with being a public company.
•
Litigation Reserve Expense. Litigation reserve expense consists of settlements or anticipated settlements of litigation. In 2012, the litigation reserve expense was related to the settlement, license and release agreement with Extricom Ltd. As part of this agreement, we paid Extricom Ltd. $2.4 million and expensed the full amount in 2012. In 2011, we entered into a license agreement with Motorola Solutions and, as part of which, we agreed to pay Motorola Solutions $7.3 million and expensed the full amount in 2011. We record litigation accruals for legal matters which are both probable and estimable. For potential losses for which there is a reasonable possibility (meaning the likelihood is more than remote but less than probable) that a loss exists, we will disclose an estimate of the potential loss or range of such potential loss or include a statement that an estimate of the potential loss cannot be made.
Interest Expense, Net. For 2013, interest expense, net consists primarily of interest expense on debt. For 2012, interest expense, net consists primarily of interest expense on debt and customer prompt payment discounts. For 2011, interest expense, net consists primarily of interest expense on debt, prompt payment discounts and interest income on cash, cash equivalents and short-term investments balances. As of December 31, 2013, we had $6.7 million of outstanding debt before debt discounts.
Other Income (Expense), Net. Other income (expense), net consists primarily of gains and losses on foreign currency transactions.
Major Channel Partners
We sell products and services directly to our channel partners, including VARs and distributors. The following table sets forth our channel partners representing greater than 10% of revenues in the periods presented (in percentages):
* Less than 10%
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.
We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, could potentially have a significant impact on our consolidated financial statements: revenue recognition; stock-based compensation; fair value of financial instruments; inventory valuation; allowance for doubtful accounts; income taxes and loss contingencies.
Revenue Recognition
Our revenues are derived primarily from hardware and software products and related support and services. We often enter into multiple deliverable arrangements and as such the elements of these arrangements are separated and valued based on their relative fair value. The majority of our products are networking communications hardware with embedded software components such that the software functions together with the hardware to provide the essential functionality of the product. Therefore, our hardware deliverables are considered to be non-software elements and are excluded from the scope of industry-specific software revenue recognition guidance. Our products revenues also include revenues from the sale of stand-alone software products. Stand-alone software products may operate on our networking communications hardware, but are not considered essential to the functionality of the hardware. Sales of stand-alone software generally include a perpetual license to our software. Sales of stand-alone software continue to be subject to the industry-specific software revenue recognition guidance. Product support typically includes software updates on a when and if available basis, telephone and internet access to our technical support personnel and hardware support. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.
Certain arrangements with multiple deliverables continued to have stand-alone software elements that are subject to the existing software revenue recognition guidance along with non-software elements that are subject to the amended revenue accounting guidance. The revenue for these multiple deliverable arrangements is allocated to the stand-alone software elements as a group and the non-software elements based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy in the amended revenue accounting guidance.
For sales of stand-alone software after December 31, 2010 and for all transactions entered into prior to January 1, 2011, we recognize revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, we use the residual method to recognize revenue when a product agreement includes one or more elements to be delivered at a future date and VSOE of all undelivered elements exists. We establish VSOE for these arrangements based on sales of multi-year support services arrangements on a stand-alone basis. The normal pricing for multi-year support services arrangements was based on the normal price of a one year support services arrangement multiplied by the number of years of support services which was then adjusted for the time value of money and the decreased sales and fulfillment effort for support service periods of longer than one year. In the majority of our contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as products revenues. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered element for which we do not have VSOE is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.
VSOE for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately. In determining VSOE, we require that a substantial majority of the selling prices for an element falls within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates.
Third-party evidence of selling price, or TPE, is determined based on competitor prices for similar deliverables when sold separately. However, we are typically not able to determine TPE for our products or services. Generally, our go-to-market strategy differs from that of its peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis. We establish estimated selling prices, or ESP, for support services based on our normal pricing and discounting practices for support services. This ESP analysis requires that a substantial majority of the support services selling prices fall within a reasonably narrow pricing range, which is typically broader than the range used to evidence VSOE. We believe that this is the price that we would sell support services if support services were regularly sold on a stand-alone basis.
When we are unable to establish the selling price of our non-software elements using VSOE or TPE, we use ESP in the allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine ESP for a product or service by considering multiple factors including, but not limited to, pricing policies, internal costs, gross margin and discount from the list prices.
We regularly review VSOE and ESP and maintain internal controls over the establishment and updates of these estimates. There was no material impact during the year, nor do we currently expect a material impact in the near term, from changes in VSOE or ESP.
We recognize revenues when all of the following have occurred: (1) we have entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is probable. The sales prices for our products are typically considered to be fixed or determinable at the inception of an arrangement. Delivery is considered to have occurred when product title has transferred to the customer, when the service or training has been provided, when software is delivered, or when the support period has lapsed. To the extent that agreements contain rights of return or acceptance provisions, revenues are deferred until the acceptance provisions or rights of return lapse.
The majority of our sales are generated through distributors. Revenues from distributors with return rights are recognized when the distributor reports that the product has been sold through, provided that all other revenue recognition criteria have been met. We obtain sell-through information from these distributors. For transactions with other distributors, we do not provide for rights of return and recognize products revenues at the time of shipment, assuming all other revenue recognition criteria have been met. Sales to certain distributors were made pursuant to price discounts based on certain criteria, we accrue the estimated price discount as a reduction to both accounts receivable and net revenues.
Revenues for support services are recognized on a straight-line basis over the support period, which typically ranges from one year to five years.
Shipping charges billed to customers are included in products revenues and the related shipping costs are included in costs of products revenues.
Stock-Based Compensation
We recognize stock-based compensation for equity awards on a straight-line basis over the requisite service period, usually the vesting period, based on the grant date fair value. We calculate the fair value of our restricted stock based on the fair market value on the date of grant. We use the Black-Scholes option-pricing model to estimate the fair value of our stock options and shares under our employee stock purchase plan. The determination of the fair value of these awards on the date of grant using the Black-Scholes option-pricing model is affected by our stock price, the expected holding period of the awards, the risk-free interest rate and the expected stock price volatility. Further, the forfeiture rate also affects the amount of aggregate compensation that we are required to record as an expense. These inputs are subjective and generally require significant judgment. If any of the assumptions used in the Black-Scholes option-pricing model change significantly, stock-based compensation for future awards may differ materially from the awards granted previously.
Fair Value of Financial Instruments
We measure the fair value of financial instruments using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
Level I-Inputs used to measure fair value are observable inputs such as quoted prices in active markets.
Level II-Pricing is provided by inputs other than the quoted prices in active markets that are observable either directly or indirectly. We consider the most reliable information available for the valuation of our Level II securities, which includes pricing data from our investment advisors and other independent sources.
Level III-Unobservable inputs in which there is little or no market data that requires us to develop our own assumptions. The determination of fair value for Level III investments and other financial instruments involves the most management judgment and subjectivity.
Inventory Valuation
Inventory consists of hardware and related component parts and is stated at the lower of cost or fair market value. We record inventory write-downs for potentially excess inventory based on forecasted demand, economic trends and technological obsolescence of our products. If future demand or market conditions are less favorable than our projections, additional inventory write-downs could be required and would be reflected in costs of product revenues in the period the revision is made. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. If actual demand and market conditions are less favorable than anticipated, additional inventory adjustments could be required in future periods.
Allowances for Doubtful Accounts
We record a provision for doubtful accounts based on historical experience and a detailed assessment of the collectibility of our accounts receivable. To assist with the estimate, our management considers, among other factors, (1) the aging of the accounts receivable, including trends within the age of the accounts receivable, (2) our historical write-offs, (3) the credit-worthiness of each purchaser, (4) the economic conditions of the purchaser’s industry, and (5) general economic conditions. In cases where we are aware of circumstances that may impair a specific purchaser’s ability to meet their financial obligations to us, we record a specific allowance against amounts due from the customer, and thereby reduce the net recognized receivable to the amount we reasonably believe will be collected. There is significant judgment involved in estimating the allowance for doubtful accounts.
During the years ended December 31, 2013, 2012 and 2011, we recorded bad debt expense of $30,000, $44,000 and $143,000. We collected previously written-off bad debt expense of $8,000 and $54,000 during the years ended December 31, 2013 and 2012. We did not collect previously written-off bad debt expense in 2011. Write-offs of previously reserved bad debts were approximately $8,000, $110,000 and $375,000 during the years ended December 31, 2013, 2012 and 2011.
Income Taxes
Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We make these estimates and judgments about our future taxable income that are based on assumptions that are consistent with our future plans. As of December 31, 2013, 2012 and 2011, we have recorded a full valuation allowance on our net deferred tax assets due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future. These deferred tax assets primarily consist of certain net operating loss carryforwards and research and development tax credits. Should the actual amounts differ from our estimates, the amount of our valuation allowance could be materially impacted.
Since inception, we have incurred operating losses, and, accordingly, we have not recorded a provision for income taxes for any of the periods presented other than foreign and state provisions for income tax. Accordingly, there have not been significant changes to our provision for income taxes during the years ended December 31, 2013, 2012 or 2011, and we do not expect any significant changes until we are no longer incurring losses.
As of December 31, 2013, we had federal net operating loss carryforwards of $146.2 million and state net operating loss carryforwards of $122.4 million. We also had federal and state research credit carryforwards of $4.1 million and $4.5 million and foreign tax credits of $0.7 million. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. If not utilized, the federal net operating loss and tax credit carryforwards will expire beginning in 2022 and 2018, respectively, and the state net operating loss carry forwards began expiring in certain jurisdictions in 2014. Utilization of these net operating losses and credit carryforwards is subject to an annual limitation due to applicable provisions of the Internal Revenue Code of 1986, as amended, and state and local tax laws if we have experienced an “ownership change” in the past, or if an ownership change occurs in the future, including, for example, as a result of the shares issued in our initial public offering aggregated with certain other sales of our stock before or after the offering.
Significant judgment is also required in evaluating our uncertain tax positions. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves are established when we believe that certain positions might be challenged despite our belief that our tax return positions are in accordance with applicable tax laws. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, new tax legislation, or the change of an estimate based on new information. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest and penalties.
Loss Contingencies
We are or have been subject to proceedings, lawsuits and other claims arising in the ordinary course of business. We evaluate contingent liabilities, including threatened or pending litigation, for potential losses. If the potential loss from any claim or legal proceedings is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based upon the best information available. For potential losses for which there is a reasonable possibility (meaning the likelihood is more than remote but less than probable) that a loss exists, we will disclose an estimate of the potential loss or range of such potential loss or include a statement that an estimate of the potential loss cannot be made. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise its estimates, which could materially impact our results of operations, financial position and cash flows.
Results of Operations
Year ended December 31, 2013 compared to the year ended December 31, 2012
The following table presents our historical operating results in dollars (in thousands) and as a percentage of revenues for the periods presented:
* The following table sets forth the stock-based compensation expense included in the Consolidated Statements of Operations for the periods presented (in thousands):
Revenues
Our total revenues increased by $8.2 million, or 8.4%, to $105.7 million in 2013, from $97.5 million in 2012. This increase was primarily the result of increased demand for our products, particularly in the Americas region.
Products revenues. Products revenues increased by $6.4 million, or 7.9%, to $87.2 million in 2013, from $80.8 million in 2012. The increase was primarily a result of an increase in unit shipments particularly in the Americas region.
Support and services revenues. Support and services revenues increased by $1.9 million, or 11.6%, to $18.5 million in 2013, from $16.6 million in 2012. The increase in support and services revenues is a result of increased product sales, particularly in the Americas region, resulting in first-year support sales, and the renewal of support contracts by existing customers. As our customer base grows over time, we expect our support revenues to increase.
Ratable products and services revenues. Ratable products and services revenues decreased by $87,000, or 48.6%, to $92,000 in 2013, from $0.2 million in 2012. This ratable revenue is being amortized from transactions initiated prior to 2009, declined over time and depleted through 2013 as the related deferred revenue balance has been depleted as of December 31, 2013.
Costs of Revenue and Gross Margin
Total costs of revenues increased by $2.0 million, or 5.7%, to $37.5 million in 2013 from $35.4 million in 2012. Overall gross margins, as a percentage of total revenues, increased to 64.6% in 2013 from 63.6% in 2012. Our product gross margins, as a percentage of product revenues, increased to 65.3% in 2013 from 64.2% in 2012. This increase in the product gross margin was primarily the result of product mix consisting of higher margin items. Our support and services gross margins, as a percentage of support and services revenues, increased to 61.3% in 2013 from 61.0% in 2012. This increase in the support and services gross margin was primarily the result of increased revenues in support and services.
Operating Expenses
Our operating expenses decreased by $12.8 million, or 14.1%, to $78.2 million in 2013 from $91.0 million in 2012. Our operating expenses decreased as a percentage of revenue from 93.3% in 2012 to 74.0% in 2013
Research and Development Expenses
Research and development expenses increased by $0.7 million, or 4.4%, to $15.7 million in 2013 from $15.1 million in 2012. This increase is primarily the result of an increase of $0.8 million in research and development personnel costs as a result of increased headcount and an increase of $0.2 million in travel expenses, partially offset by a decrease of $0.3 million in stock-based compensation expense as compared to 2012.
Sales and Marketing Expenses
Sales and marketing expenses decreased by $9.1 million, or 15.5%, to $49.6 million in 2013 from $58.8 million in 2012. In 2013, we continued to take steps to bring our sales and marketing expenses in line with our revenue expectations. This resulted in a decrease of $7.2 million in sales and marketing personnel costs as a result of lower headcount, a decrease of $1.0 million in sales and marketing program expenses, a decrease of $0.4 million in stock-based compensation expense and a decrease of $0.3 million in travel expenses as compared to 2012.
General and Administrative Expenses
General and administrative expenses decreased by $2.0 million, or 13.4%, to $12.9 million in 2013 from $14.8 million in 2012. This decrease is primarily the result of a decrease of $0.9 million in one-time costs related to our former CEO’s transitional employment agreement and the executive search fees for the current CEO in 2012, a decrease of $0.6 million in legal fees related to the settlement of certain litigation matters in 2012, a decrease of $0.3 million in stock-based compensation expense and a decrease of $0.2 million in general and administrative personnel costs as compared to 2012.
Litigation Reserve Expense
We entered into a settlement, license and release agreement with Extricom Ltd. in 2012 and recorded $2.4 million in 2012 as expense as we do not believe the agreement provides any future value.
Interest Expense, Net
Interest expense, net increased by $0.4 million, or 21.4%, to $2.0 million in 2013, from $1.7 million in 2012. This increase is primarily due to a result of an increase in interest expense related to the $12.0 million loan agreement entered into with Venture Lending and Leasing VI, Inc., or VLL, in June 2012. See the discussion of the arrangements with VLL under “Liquidity and Capital Resources.”
Provision for Income Taxes
Our income taxes decreased by $0.1 million, or 19.3%, to $0.4 million in 2013 from $0.5 million in 2012. This decrease in the provision for income taxes was due to our expense reduction leading to lower operating income in our international entities.
Year ended December 31, 2012 compared to the year ended December 31, 2011
The following table presents our historical operating results in dollars (in thousands) and as a percentage of revenues for the periods presented:
* The following table sets forth the stock-based compensation expense included in the Consolidated Statements of Operations for the periods presented (in thousands):
Revenues
Our total revenues increased by $7.0 million, or 7.8%, to $97.5 million in 2012, from $90.5 million in 2011. Our products and support and services revenues, or total revenues excluding ratable revenues, increased by $10.1 million, or 11.6%, to $97.3 million in 2012, from $87.2 million in 2011. This increase was primarily the result of increased demand for our products, particularly in the United Kingdom and Asia Pacific regions.
Products revenues. Products revenues increased by $6.5 million, or 8.7%, to $80.8 million in 2012, from $74.3 million in 2011. The increase was primarily a result of an increase in unit shipments particularly in the United Kingdom and the Asia Pacific regions in 2012.
Support and services revenues. Support and services revenues increased by $3.6 million, or 27.8%, to $16.6 million in 2012, from $13.0 million in 2011. The increase in support and services revenues is a result of increased product sales, particularly in the United Kingdom and Asia Pacific regions, resulting in first-year support sales, and the renewal of support contracts by existing customers. As our customer base grows over time, we expect our support revenues to increase.
Ratable products and services revenues. Ratable products and services revenues decreased by $3.1 million, or 94.5%, to $0.2 million in 2012, from $3.2 million in 2011. This ratable revenue is being amortized from transactions initiated prior to 2009, declined over time and depleted through 2013 as the related deferred revenue balance has been depleted as of December 31, 2013.
Costs of Revenue and Gross Margin
Total costs of revenues increased by $2.6 million, or 7.9%, to $35.4 million in 2012 from $32.9 million in 2011. Overall gross margins, as a percentage of total revenues, decreased to 63.6% in 2012 from 63.7% in 2011. Our product gross margins, as a percentage of product revenues, decreased to 64.2% in 2012 from 64.4% in 2011. Our support and services gross margins, as a percentage of support and services revenues, decreased to 61.0% in 2012 from 64.6% in 2011. These decreases were primarily the result of our increased headcount related to customer support and professional services and a reduction in the amount of support costs allocated to ratable revenues. Our ratable gross margins, as a percentage of ratable revenues, increased to 42.5% in 2012 from 42.4% in 2011.
Operating Expenses
Our operating expenses increased by $7.3 million, or 8.8%, to $91.0 million in 2012 from $83.7 million in 2011. Our operating expenses increased as a percentage of revenue from 92.5% in 2011 to 93.3% in 2012. This increase is primarily the result of an increase of $10.6 million in personnel costs as a result of increased headcount, an increase of $1.4 million in stock-based compensation expense, an increase of $0.8 million in facility expenses and an increase of $0.3 million in depreciation expenses related to our expansion, an increase of $0.5 million in sales and marketing program expenses, an increase of $0.4 million in travel expenses offset partially by a decrease of $4.9 million in litigation reserve expense, a decrease of $0.9 million in legal fees related to the settlement of certain litigation matters and a decrease of $0.7 million in other related engineering expenses as compared to 2011.
Research and Development Expenses
Research and development expenses increased by $1.1 million, or 7.8%, to $15.1 million in 2012 from $14.0 million in 2011. This increase is primarily the result of an increase of $1.1 million in research and development personnel costs, an increase of $0.5 million in facility expenses and an increase of $0.2 million in depreciation expenses related to our expansion in India partially offset by a decrease of $0.7 million in other related engineering expenses as compared to 2011.
Sales and Marketing Expenses
Sales and marketing expenses increased by $11.1 million, or 23.2%, to $58.8 million in 2012 from $47.7 million in 2011. This increase is primarily the result of an increase of $9.2 million in sales and marketing personnel costs as a result of increased headcount, an increase of $0.5 million in stock-based compensation expense, an increase of $0.5 million in sales and marketing program expenses, an increase of $0.4 million in travel expenses and an increase of $0.4 million in facility expense related to our expansion in the U.S. as compared to 2011.
General and Administrative Expenses
General and administrative expenses remained flat at $14.8 million in 2012 as compared to 2011. During the year ended December 31, 2012, there was an increase of $0.9 million in stock-based compensation expense and an increase of $0.2 million in personnel costs as a result of increased headcount were offset by a decrease of $0.9 million in legal fees related to the settlement of certain litigation matters and a decrease of $0.2 million in costs related to our former CEO’s transitional employment agreement and the executive search fees for the current CEO as compared to 2011.
Litigation Reserve Expense
Our litigation reserve expense decreased by $4.9 million, or 67.6%, from approximately $7.3 million 2011 to approximately $2.4 million in 2012. We entered into a settlement, license and release agreement with Extricom Ltd. in 2012 and recorded $2.4 million as expense as we do not believe the agreement provides any future value. We entered into a license agreement with Motorola Solutions in 2011. As part of the Motorola Solutions License Agreement, we agreed to pay Motorola Solutions $7.3 million and expensed the full amount in 2011.
Interest Expense, Net
Interest expense, net increased by $1.4 million, or 554.5%, to $1.7 million in 2012, from $0.3 million in 2011. This increase is primarily due to a result of an increase in interest expense related to the $12.0 million loan agreement entered into with Venture Lending and Leasing VI, Inc., or VLL, in June 2012. See the discussion of the arrangements with VLL under “Liquidity and Capital Resources.”
Provision for Income Taxes
Our income taxes increased by $0.1 million, or 33.6%, to $0.5 million in 2012 from $0.4 million in 2011. This increase in the provision for income taxes was due to the growth of our international entities.
Liquidity and Capital Resources
Since inception, we have funded our operations primarily with proceeds from issuances of convertible preferred stock, common stock, long-term debt and our credit facilities. From 2007 through 2009, we raised an aggregate of $62.3 million from the sale of our convertible preferred stock, including amounts received through the conversion of promissory notes. We also funded purchases of equipment and other general corporate services with proceeds from our long-term debt in the amount of $16.5 million during that period. In 2010, we received $57.1 million from our initial public offering, representing the net proceeds of the offering after deducting underwriters’ commissions and discounts and other issuance costs. In 2013, we received $12.6 million, representing the net proceeds from the follow-on offering of our common stock after deducting underwriters’ commissions, discounts and other issuance costs.
During June 2012, we entered into a term loan and security agreement with VLL, or the VLL Term Loan Agreement, pursuant to which we borrowed an aggregate principal amount of $11.7 million before debt discounts. We repay the term loan in 39 monthly installments of principal plus accrued interest beginning on June 6, 2012 and ending on August 1, 2015. Amounts borrowed under the loan agreement bear interest per annum at a fixed rate equal to 12.0%. We may voluntarily prepay the term loan in full by tendering a cash payment equal to the sum of: (i) the accrued and unpaid interest on the term loan as of the date of the prepayment; (ii) the unpaid principal balance of the term loan as of the date of the prepayment, and (iii) the interest that would have accrued and been payable from the date of the prepayment through the stated date of maturity of such term loan had it remained outstanding and been paid in accordance with the terms of the related note (multiplied by 0.80 in the case of repayment after January 1, 2014). We will also be required to make a payment in an amount equal to $2.0 million at the earlier of (i) a change of control and (ii) September 1, 2015. As security for amounts outstanding under the loan agreement, we have granted VLL a security interest in substantially all of our assets.
The VLL Term Loan Agreement contains customary affirmative and negative covenants. Pursuant to the terms of the loan agreement, and subject to certain exceptions, we are not permitted, without VLL’s prior written consent, among other things, to:
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incur additional indebtedness except for specified permitted indebtedness;
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incur any liens on our property, except for specified permitted liens;
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change our business from that in which we were engaged or reasonably related businesses at the time of the loan agreement;
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merge or consolidate, or permit any of our subsidiaries to merge or consolidate, with any person, or acquire, or permit any of our subsidiaries to acquire, all or substantially all of the capital stock or property of another person; or
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pay any dividends or make any distributions on our equity securities or repurchase any of our equity, except we may pay dividends payable solely in common stock and may repurchase securities from employees and consultants in a limited manner.
Amounts outstanding under the VLL Term Loan Agreement may become due and payable on demand upon the occurrence of certain customary events of default, including our failure to make payments when due, failure to observe the covenants in the loan agreement (subject to a designated grace period in certain cases), our bankruptcy and certain adverse judgments or adverse regulatory actions or determinations against us. A default interest rate equal to 5.0% plus the otherwise applicable interest rate applies from and after the occurrence of any event of default. As of December 31, 2013 and 2012, the Company was in compliance with all of its loan covenants. As of December 31, 2013, we had debt outstanding under the loan in the amount of $6.7 million, before debt discounts, that bears a fixed interest rate of 12% per year.
We were party to a Loan and Security Agreement with Silicon Valley Bank, dated January 29, 2007 (as amended, the “SVB Agreement”), which provided a working capital line of credit of $7.0 million based on eligible accounts receivable. On July 31, 2012, the Company renewed the line of credit for twelve months pursuant to an amendment to the SVB Agreement. This working capital line of credit under the SVB Agreement expired on July 31, 2013.
As of December 31, 2013, we had cash and cash equivalents of $30.9 million as compared to $22.9 million as of December 31, 2012.
Cash Flows from Operating Activities
Our primary uses of cash from operating activities have been related to personnel-related and other operating expenditures as well as increased accounts receivable and accounts payable due to the growth and expansion of our business. Our cash flows from operating activities will continue to be impacted by working capital requirements as well as the level of operating expenses and revenues. Total cash used in operating activities was $0.3 million, $25.4 million and $22.4 million in fiscal years 2013, 2012 and 2011, respectively.
Cash used in operating activities of $0.3 million in 2013 reflected a net loss of $12.4 million, partially offset by non-cash charges of $9.2 million and changes in our net operating assets and liabilities of $2.8 million. The non-cash charges were mainly comprised of $6.5 million in stock-based compensation, $1.6 million in depreciation and amortization and $0.8 million in accrued interest on long-term debt. The changes in our net operating assets and liabilities were comprised of a net increase of $2.1 million in accounts payable and accrued liabilities, a decrease of $1.6 million in inventory and an increase of $1.3 million in deferred revenues that was partially offset by an increase of $2.1 million in accounts receivable.
Cash used in operating activities of $25.4 million in 2012 reflected a net loss of $31.1 million and changes in our net operating assets and liabilities of $3.8 million, partially offset by non-cash charges of $9.6 million. The non-cash charges were mainly comprised of $7.5 million in stock-based compensation, $1.2 million in depreciation and amortization and $0.6 million in accrued interest on long-term debt. The changes in our net operating assets and liabilities were comprised of an increase of $2.3 million in inventory, a net decrease of $1.8 million in accounts payable and accrued liabilities and an increase of $2.0 million in accounts receivable, net that was partially offset by an increase of $2.0 million in deferred revenues.
Cash used in operating activities of $22.4 million in 2011 reflected a net loss of $26.7 million and changes in our net operating assets and liabilities of $2.8 million, partially offset by non-cash charges of $7.1 million, $6.2 million of which relates to stock-based compensation in 2011. The change in our net operating assets and liabilities was comprised of an increase of $4.3 million in accounts receivable, net due to larger than usual concentration of sales in December 2011 and an increase of $1.9 million in inventory that was partially offset by a net increase of $2.9 million in accounts payable and accrued liabilities and a decrease of $0.9 million in prepaid expenses and other assets.
Cash Flows from Investing Activities
The cash used in investing activities of $1.4 million in 2013 solely consisted of $1.4 million in capital expenditures.
Our investing activities in 2012 consisted of our short-term investments, capital expenditures and the payment of remaining earnouts from our acquisition of Identity Networks. The cash provided by investing activities of $2.8 million in 2012 reflected $5.0 million in proceeds from the maturities of short-term investments that was partially offset by $1.9 million of capital expenditures.
In 2011, our investing activities consisted of our short-term investments, our acquisition of Identity Networks, investment in non-marketable securities, and capital expenditures. The purchase of $10.0 million of short-term investments was offset by the maturity of $10.0 million of short-term investments. We used $1.4 million for capital expenditures. In addition, we acquired Identity Networks for a purchase price of $2.5 million, of which $2.2 million was paid in 2011 and the remaining $0.3 million earnout was paid in 2012. Further, we invested $1.3 million in a non-public company.
Cash Flows from Financing Activities
To date, we have financed our operations primarily with proceeds from the sale of our common stock in our initial public offering and our secondary offering, which occurred during the year ended December 31, 2013, issuance of common stock in conjunction with the exercise of options to purchase our stock, the sale of convertible preferred stock, the incurrence of debt and the use of our line of credit facility. As of December 31, 2013, we had outstanding debt in the amount of $6.7 million before debt discounts.
Cash provided by financing activities was $9.9 million in 2013, which was primarily comprised of the net proceeds from the secondary offering of our common stock in the amount of $12.6 million, and net proceeds from the exercise of stock options and the purchases under the employee stock purchase plan of $0.8 million, partially offset by payments on our long-term debt of $3.4 million.
Cash provided by financing activities was $10.3 million in 2012 primarily as a result of net proceeds of $11.5 million from our debt financing in June 2012 and proceeds from the exercise of stock options and the purchases under the employee stock purchase plan in the amount of $0.4 million, which were partially offset by payments on our long-term debt of $1.6 million.
Cash provided by financing activities was $0.4 million in 2011 primarily as a result of the proceeds from the exercise of stock options and the purchases under the employee stock purchase plan in the amount of $3.2 million offset by the principal payments on our long-term debt of $2.9 million.
Capital Resources
We believe our existing cash and cash equivalents will be sufficient to meet our working capital and capital expenditure needs for the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including, among other things, market acceptance of our products, the cost of our research and development activities and overall economic conditions.
If our cash sources are insufficient to satisfy our cash requirements, we may be required to sell debt or equity securities to raise additional capital or to borrow or increase the amount available to us for borrowing under our credit facility. We may be unable to raise additional capital through the sale of securities, or to do so on terms that are favorable to us, particularly if capital market and overall economic conditions change adversely. Any sale of convertible debt securities or additional equity securities could result in substantial dilution to our stockholders. Additionally, the terms of our existing term loan and line of credit may prevent us from borrowing under or increasing the size of our credit facility, or to do so on terms that are acceptable to us, particularly if credit market conditions change adversely.
Contractual Obligations
The following summarizes our contractual obligations as of December 31, 2013:
(1) Our long-term debt carries a fixed interest rate of 12%. As of December 31, 2013, our obligation to make principal, interest and other payments on our debt totaled $9.4 million.
Off-Balance Sheet Arrangements
As of December 31, 2013, we did not have any off balance sheet arrangements as defined in Item 303(a)(4) of the SEC’s Regulation S-K.
Debt and Interest
As of December 31, 2013 and 2012, the principal amount of our long-term debt before debt discounts was $6.7 million and $10.1 million, respectively. During 2013, a 10% appreciation or depreciation in the prime rate would not have a material impact on our interest expense.
Recent Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists - a consensus of the FASB Emerging Issues Task Force, which requires an entity to present an unrecognized tax benefit as a reduction to a deferred tax asset for a net operating loss (NOL) or similar tax loss or tax credit carryforward, unless the uncertain tax position is not available to reduce, or would not be used to reduce, the NOL or carryforward under the tax law in the same jurisdiction; otherwise, the unrecognized tax benefit should be presented gross as a liability. The guidance is effective prospectively for fiscal years, and interim periods beginning after December 15, 2013 for public entities. Early adoption and retrospective application are permitted. We will adopt this standard in the first quarter of 2014 and do not expect the adoption to have a material impact on our consolidated financial position, results of operations or cash flows.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and interest rates. We do not hold financial instruments for trading purposes.
Foreign Currency Risk
Our sales are denominated in U.S. dollars, and therefore, our revenues are not currently subject to significant foreign currency risk. Our operating expenses are denominated in the currencies of the countries in which our operations are located, and may be subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Indian rupee, Euro, British pound sterling and Japanese yen relative to the U.S. dollar. To date, we have not entered into any hedging contracts. During 2013, a 10% appreciation or depreciation in the value of the U.S. dollar relative to the other currencies in which our expenses are denominated would not have had a material impact on our earnings, fair values, or cash flows.
Interest Rate Sensitivity
We had cash and cash equivalents of $30.9 million and $22.9 million as of December 31, 2013 and 2012, respectively. These amounts were held primarily in cash deposits, money market funds and U.S. government securities. Cash and cash equivalents are held for working capital purposes. We do not use derivative financial instruments to hedge the risk of interest rate volatility. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, will reduce future interest income. During 2013, a 10% appreciation or depreciation in overall interest rates would not have had a material impact on our earnings, fair values, or cash flows.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Quarterly Results of Operations
The following table sets forth our unaudited quarterly consolidated statements of operations data for each of the four quarters in the years ended December 31, 2013 and 2012. In management’s opinion, the data below has been prepared on the same basis as the audited consolidated financial statements included elsewhere in this Form 10-K, and reflects all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of this data. The results of historical periods are not necessarily indicative of the results of operations for a full year or any future period.
Our operating results may fluctuate due to a variety of factors, many of which are outside our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance.
Index to Consolidated Financial Statements
Page No.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Loss
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
of Meru Networks, Inc.
We have audited the accompanying consolidated balance sheets of Meru Networks, Inc. and its subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in Item 15(a)(2). These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Meru Networks, Inc. and its subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992 Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2014 expressed an unqualified opinion thereon.
/s/ Burr Pilger Mayer, Inc.
San Jose, California
February 28, 2014
MERU NETWORKS, INC.
Consolidated Balance Sheets
(in thousands, except for share and per share amounts)
See notes to consolidated financial statements.
MERU NETWORKS, INC.
Consolidated Statements of Operations
(in thousands, except for share and per share amounts)
See notes to consolidated financial statements.
MERU NETWORKS, INC.
Consolidated Statements of Comprehensive Loss
(in thousands)
See notes to consolidated financial statements
MERU NETWORKS, INC.
Consolidated Statements of Stockholders’ Equity
(in thousands, except for share amounts)
See notes to consolidated financial statements.
MERU NETWORKS, INC.
Consolidated Statements of Cash Flows
(in thousands)
See notes to consolidated financial statements.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business and Summary of Significant Accounting Policies
Business - Meru Networks, Inc. (“Meru”) was incorporated in Delaware in January 2002. Meru and its wholly owned subsidiaries (collectively, the “Company”) develop and market a virtualized Wireless Local Area Network (“WLAN”) solution. The Company’s solution is built around its System Director Operating System which runs on its controllers and access points. The Company offers additional products designed to deliver network management, diagnostics and security. The Company also offers support services related to its products, professional services, and training. Products and services are sold through value added resellers, and distributors, as well as the Company’s sales force.
Basis of Presentation - These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and include the accounts of Meru and its wholly owned subsidiaries. The Company has wholly owned subsidiaries in India, Japan, Netherlands, Canada, Singapore, United Kingdom, Hong Kong, Germany and Sweden. These subsidiaries use their local currency as their functional currency. All intercompany transactions and balances have been eliminated. Certain reclassifications have been made to prior period amounts to conform to the current period presentation.
Use of Estimates - The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Such management estimates include litigation and settlement costs, other loss contingencies, sales returns and allowances, allowance for doubtful accounts, inventory valuation, reserve for warranty costs, valuation of deferred tax assets, stock-based compensation expense and fair value of warrants. The Company bases its estimates on historical experience and also on assumptions that it believes are reasonable. The Company assesses these estimates on a regular basis; however, actual results could materially differ from those estimates.
Certain Significant Risks and Uncertainties - The Company is subject to certain risks and uncertainties that could have a material and adverse effect on the Company’s future financial position or results of operations. Many of these risks and uncertainties are described in “Risk Factors” in Part I, Item 1A of this Annual Report, which risks and uncertainties include, among others: the Company may experience fluctuations in its revenues and operating results, which makes it difficult to predict future results and which may cause its stock price to decline; the Company has a limited operating history; the Company could continue to incur operating losses throughout 2014; fluctuations in operating results could cause the price of the Company’s common stock to decline; the Company may be unable to raise additional funds or to do so on favorable terms; the Company competes in highly competitive markets and is subject to various competitive pressures; the Company may be unable to compete in a rapidly evolving market and to respond quickly and effectively to changing market requirements; the Company must hire, integrate and retain qualified personnel; the Company’s investments may not generate anticipated revenues; the Company’s products may contain defects or errors; the Company’s failure to provide high-quality support and services could have a material and adverse effect on its business and results of operations; the Company may be unable to increase market awareness of its brand and products and develop and expand its sales channels; the Company’s international operations subject the Company to additional risks; the Company’s failure to maintain effective systems of internal controls could affect the Company’s ability to produce accurate financial results; others may claim that the Company infringes their intellectual property rights; the Company may be unable to protect its intellectual property rights; the continued development of demand for wireless networks is uncertain; the Company’s sales cycle is long and unpredictable and subject to seasonal fluctuation; the Company’s revenues may decline as a result in changes in public funds of educational institutions; the Company may be unable to forecast customer demand accurately in making purchase decisions; average sales prices for the Company’s products may decline; gross margins for the Company’s products and services may vary; the Company relies on channel partners to generate a substantial majority of its revenues and these partners may fail to perform; the Company relies on third parties to manufacture its products and fulfill customer orders and the failure of these third parties to perform could have an adverse effect on the Company’s reputation and ability to manufacture and distribute products; and, the Company may be required comply with new or modified regulations or standards related to its products.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Concentration of Supply Risk - The Company relies on third parties to manufacture its products, and depends on them for the supply and quality of its products. Quality or performance failures of the Company’s products or changes in its manufacturers’ financial or business condition could disrupt the Company’s ability to supply quality products to its customers and thereby have a material and adverse effect on its business and operating results. Some of the components and technologies used in the Company’s products are purchased and licensed from a single source or a limited number of sources. The loss of any of these suppliers may cause the Company to incur additional transition costs, result in delays in the manufacturing and delivery of its products, or cause it to carry excess or obsolete inventory and could cause it to redesign its products. The Company relies on third parties for the fulfillment of its customer orders, and the failure of these third parties to perform could have an adverse effect upon the Company’s reputation and its ability to distribute its products, which could adversely affect the Company’s business.
Concentration of Credit Risk - Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and accounts receivable. The Company maintains its cash and cash equivalents in fixed-income securities with financial institutions and invests in only high-quality credit instruments. Deposits held with banks may exceed the amount of insurance provided on such deposits.
Credit risk with respect to accounts receivable in general is diversified due to the number of different entities comprising the Company’s customer base and their location throughout the world. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company maintains reserves for estimated potential credit losses. As of December 31, 2013, two distributor customers accounted for 53% of the Company’s net accounts receivable. As of December 31, 2012, three distributor customers accounted for 68% of the Company’s net accounts receivable. As of December 31, 2013 and 2012, the allowance for doubtful accounts was $28,000 and $14,000, respectively.
No end customer accounted for more than 10% of the Company’s net revenues in the years ended December 31, 2013, 2012 or 2011.The Company relies on its channel partners for end customer information. The Company’s channel partners representing greater than 10% of revenues for the periods presented were as follows (in percentages):
* Less than 10%
Cash Equivalents- The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents may consist of cash on hand, balances with banks, and highly liquid investments in money market funds, commercial paper, government securities, certificates of deposit and corporate debt securities.
Foreign Currency - The Company’s non-U.S. subsidiaries in India, Japan, Netherlands, Canada, Singapore, United Kingdom, Hong Kong, Germany and Sweden use the local currency as their functional currency. The assets and liabilities of the non-U.S. subsidiaries are, therefore, translated into U.S. dollars at exchange rates in effect at the balance sheet date, with the resulting translation adjustments recorded to a separate component of accumulated other comprehensive loss within stockholders’ equity. Income and expense accounts are translated at average exchange rates during the year. Transaction gains and losses were not material during the years ended December 31, 2013, 2012 and 2011.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Inventory - Inventory is stated at the lower of cost or market value. Inventory is determined to be salable based on a demand forecast within a specific time horizon, generally eighteen months or less. Inventory in excess of salable amounts and inventory which is considered obsolete based upon changes in existing technology is written off. At the point of loss recognition, a new lower cost basis for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in that new cost basis.
Channel Inventory - Products shipped to certain distributors are considered channel inventory until acceptance provisions are met and return rights lapse. The Company includes channel inventory within inventory on the consolidated balance sheets.
Advertising Costs - The Company expenses advertising costs as incurred. The Company incurred advertising costs of $71,000, $0.7 million and $28,000 during the years ended December 31, 2013, 2012 and 2011, which is included within sales and marketing expense on the consolidated statements of operations.
Property and Equipment - Property and equipment, including leasehold improvements, is stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which is generally three to five years. Internal test units are transferred from inventory at the stated cost and are amortized over the estimated service life of one year from the date of transfer. Leasehold improvements are amortized over the shorter of the estimated useful life of the improvements or the lease term.
Revenue Recognition - The Company’s revenues are derived primarily from hardware and software products and related support and services. The Company often enters into multiple deliverable arrangements and, as such, the elements of these arrangements are separated and valued based on their relative fair value. The majority of the Company’s products are networking communications hardware with embedded software components such that the software functions together with the hardware to provide the essential functionality of the product. Therefore, the Company’s hardware deliverables are considered to be non-software elements and are excluded from the scope of industry-specific software revenue recognition guidance. The Company’s products revenues also include revenues from the sale of stand-alone software products. Stand-alone software products may operate on the Company’s networking communications hardware, but are not considered essential to the functionality of the hardware. Sales of stand-alone software generally include a perpetual license to the Company’s software. Sales of stand-alone software continue to be subject to the industry-specific software revenue recognition guidance. Product support typically includes software updates on a when and if available basis, telephone and internet access to the Company’s technical support personnel and hardware support. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.
Certain arrangements with multiple deliverables have stand-alone software elements that are subject to the existing software revenue recognition guidance along with non-software elements that are subject to the amended revenue accounting guidance. The revenue for these multiple deliverable arrangements is allocated to the stand-alone software elements as a group and to the non-software elements based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy in the amended revenue accounting guidance.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For sales of stand-alone software, the Company uses the residual method to recognize revenue when an agreement includes one or more elements to be delivered at a future date and vendor specific objective evidence (“VSOE”) of all undelivered elements exists. The Company establishes VSOE for these arrangements based on sales of support services arrangements on a stand-alone basis. The normal pricing for multi-year support services arrangements is based on the normal price of a one year support services arrangement multiplied by the number of years of support services which is then adjusted for the time value of money and the decreased sales and fulfillment effort for support service periods of longer than one year. In the majority of the Company’s contracts, the only element that remains undelivered at the time of delivery of the software product is support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenues. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered element for which the Company does not have VSOE is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.
VSOE for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately. In determining VSOE, the Company requires that a substantial majority of the selling prices for an element falls within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates.
Third-party evidence (“TPE”) of selling price is determined based on competitor prices for similar deliverables when sold separately. However, the Company is typically not able to determine TPE for its products or services. Generally, the Company’s go-to-market strategy differs from that of its peers and the Company’s offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, the Company is unable to reliably determine the selling prices for similar products from competitors on a stand-alone basis. The Company establishes estimated selling prices (“ESP”) for support services based on its normal pricing and discounting practices for support services. This ESP analysis requires that a substantial majority of the support services selling prices fall within a reasonably narrow pricing range, which is typically broader than the range used to evidence VSOE. The Company believes that this is the price at which it would sell support services if support services were regularly sold on a stand-alone basis.
When the Company is unable to establish the selling price of its non-software elements using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. The objective of ESP is the estimated price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. The Company determines ESP for a product or service by considering multiple factors including, but not limited to, pricing policies, internal costs, gross margin objectives and discount from the list prices.
The Company regularly reviews VSOE and ESP and maintains internal controls over the establishment and updates of these estimates. There was no material impact during 2013, nor does the Company currently expect a material impact in the near term, from changes in VSOE or ESP.
The Company recognizes revenues when all of the following have occurred: (1) the Company has entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is probable. The sales prices for the Company’s products are typically considered to be fixed or determinable at the inception of an arrangement. Delivery is considered to have occurred when product title has transferred to the customer, when the service or training has been provided, when software is delivered, or when the support period has lapsed. To the extent that agreements contain rights of return or acceptance provisions, revenues are deferred until the acceptance provisions or rights of return lapse.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The majority of the Company’s sales are generated through its distributors. Revenues from distributors with return rights are recognized when the distributor reports that the product has been sold through, provided that all other revenue recognition criteria have been met. The Company obtains sell-through information from these distributors. For transactions with other distributors, the Company does not provide for rights of return and recognizes products revenues at the time of shipment, assuming all other revenue recognition criteria have been met. Sales to certain distributors were made pursuant to price discounts based on certain criteria, the Company accrues the estimated price discount as a reduction to both accounts receivable and net revenues.
Revenues for support services are recognized on a straight-line basis over the support period, which typically ranges from one year to five years.
Shipping charges billed to customers are included in products revenues and the related shipping costs are included in costs of products revenues.
Impairment of Long-Lived Assets - The Company evaluates its long-lived assets for indicators of possible impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Impairment exists if the carrying amounts of such assets exceed the estimates of future net undiscounted cash flows expected to be generated by such assets. Should impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s estimated fair value. The Company has not incurred any impairment expense related to its long-lived assets during the years ended December 31, 2013, 2012 or 2011.
Goodwill - Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. The Company reviews goodwill for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value may not be recoverable. The Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. If, after assessing the totality of circumstances, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then it is required to perform the two-step impairment test. It does not require an entity to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying value. However, an entity also has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. The Company has determined that it has a single reporting unit for purposes of performing its goodwill impairment test. As the Company uses the market approach to assess impairment, its common stock price is an important component of the fair value calculation. If the Company’s stock price continues to experience significant price and volume fluctuations, this will impact the fair value of the reporting unit and can lead to potential impairment in future periods. The Company performed its annual impairment test in June 2013 and determined that its goodwill was not impaired. As of December 31, 2013, the Company had not identified any factors that indicated there was an impairment of its goodwill and determined that no additional impairment analysis was then required.
Fair Value of Financial Instruments - Due to their short-term nature, the carrying amounts of the Company’s financial instruments reported in the consolidated financial statements, which include cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of the long-term debt approximates fair value.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Income Taxes - As part of the process of preparing the Company’s consolidated financial statements, the Company is required to estimate its taxes in each of the jurisdictions in which it operates. The Company estimates actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. In general, deferred tax assets represent future tax benefits to be received when certain expenses previously recognized in the Company’s consolidated statements of operations become deductible expenses under applicable income tax laws or loss or credit carryforwards are utilized. Accordingly, realization of the Company’s deferred tax assets is dependent on future taxable income against which these deductions, losses, and credits can be utilized.
The Company must assess the likelihood that the Company’s deferred tax assets will be recovered from future taxable income, and to the extent the Company believes that recovery is not likely, the Company establishes a valuation allowance. Management judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against the net deferred tax assets. The Company recorded a full valuation allowance as of December 31, 2013, 2012 and 2011. Based on the available evidence, the Company believes it is more likely than not that it will not be able to utilize its deferred tax assets in the future. The Company intends to maintain valuation allowances until sufficient evidence exists to support the reversal of such valuation allowances. The Company makes estimates and judgments about its future taxable income that are based on assumptions that are consistent with its plans. Should the actual amounts differ from the Company’s estimates, the carrying value of the Company’s deferred tax assets could be materially impacted.
The Company recognizes in the financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company does not believe there are any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date.
Stock-Based Compensation - Compensation costs related to employee stock awards that were either granted or modified during the years ended December 31, 2013, 2012 and 2011 are based on the fair value of the awards on the date of grant or modification, net of estimated forfeitures. The Company calculates the fair value of its restricted stock based on the fair market value on the date of grant. The Company determines the grant date fair value of its options and shares under its employee stock purchase plan using the Black-Scholes option-pricing model. The Company recognizes stock-based compensation expense on a straight-line basis over the vesting period of the respective option grants.
Research and Development Costs - Research and development costs are expensed as incurred.
Software Development Costs - The costs to develop software have not been capitalized as the Company believes its current software development process is essentially completed concurrent with the establishment of technological feasibility.
Accounts Receivable - Trade accounts receivable are recorded at the invoiced amount, net of allowances for doubtful accounts. The allowance for doubtful accounts is based on the Company’s assessment of the collectibility of customer accounts. The Company regularly reviews the allowance by considering certain factors such as historical experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. During the years ended December 31, 2013, 2012 and 2011, the Company recorded bad debt expense of $30,000, $44,000 and $143,000. The Company collected previously written-off bad debt expense of $8,000 and $54,000 during the years ended December 31, 2013 and 2012. The Company did not collect previously written-off bad debt expense in 2011. Write-offs of previously reserved bad debts were approximately $8,000, $110,000 and $375,000 during the years ended December 31, 2013, 2012 and 2011.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Comprehensive Loss - Comprehensive loss is comprised of net loss and other comprehensive loss. For the Company, other comprehensive loss includes foreign currency translation adjustments. Total comprehensive loss for all periods presented has been disclosed in the consolidated statements of comprehensive loss.
Warranty - The Company provides a warranty on product sales and estimated warranty costs are recorded during the period of sale. The Company establishes warranty reserves based on estimates of product warranty return rates and expected costs to repair or to replace the products under warranty. The warranty provision is recorded as a component of costs of products revenues in the consolidated statements of operations.
Accrued warranty, which is included in accrued liabilities on the consolidated balance sheets, is summarized for the years ended December 31, 2013, 2012 and 2011 as follows (in thousands):
Loss Contingencies - The Company is or has been subject to proceedings, lawsuits and other claims arising in the ordinary course of business. The Company evaluates contingent liabilities, including threatened or pending litigation, for potential losses. If the potential loss from any claim or legal proceedings is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based upon the best information available. For potential losses for which there is a reasonable possibility (meaning the likelihood is more than remote but less than probable) that a loss exists, the Company will disclose an estimate of the potential loss or range of such potential loss or include a statement that an estimate of the potential loss cannot be made. As additional information becomes available, the Company reassesses the potential liability related to pending claims and litigation and may revise its estimates, which could materially impact its consolidated financial statements.
2. Recently Issued Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists - a consensus of the FASB Emerging Issues Task Force, which requires an entity to present an unrecognized tax benefit as a reduction to a deferred tax asset for a net operating loss (NOL) or similar tax loss or tax credit carryforward, unless the uncertain tax position is not available to reduce, or would not be used to reduce, the NOL or carryforward under the tax law in the same jurisdiction; otherwise, the unrecognized tax benefit should be presented gross as a liability. The guidance is effective prospectively for fiscal years, and interim periods beginning after December 15, 2013 for public entities. Early adoption and retrospective application are permitted. The Company will adopt this standard in the first quarter of 2014 and does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Inventory
Inventory as of December 31, 2013 and 2012 is as follows (in thousands):
4. Net Loss Per Share of Common Stock
The Company’s basic net loss per share of common stock is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. The weighted-average number of shares of common stock used to calculate the Company’s basic net loss per share of common stock excludes stock awards prior to vesting and also those shares subject to repurchase related to stock options that were exercised prior to vesting as these shares are not deemed to be issued for accounting purposes until they vest. The diluted net loss per share of common stock is calculated by giving effect to all potential common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of the diluted shares outstanding calculation, restricted stock units, stock options to purchase common stock, common stock subject to repurchase, and warrants to purchase common stock are considered to be common stock equivalents. In periods in which the Company has reported a net loss, the common stock equivalents have been excluded from the calculation of diluted net loss per share of common stock as their effect is antidilutive under the treasury stock method.
The following outstanding shares of common stock and common stock equivalents were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been antidilutive:
* Includes 195,370, 171,070 and 169,383 shares, which were expected to be issued pursuant to the Company’s Employee Stock Purchase Plan as of December 31, 2013, 2012 and 2011, respectively, based on employee enrollment.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. Fair Value of Financial Instruments
As a basis for determining the fair value of certain of the Company’s assets and liabilities, the Company established a three-tier value hierarchy which prioritizes the inputs used in measuring fair value as follows: (Level I) observable inputs such as quoted prices in active markets; (Level II) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level III) unobservable inputs in which there is little or no market data and that require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The Company’s financial assets that are measured at fair value on a recurring basis consist of cash equivalents. The Company did not have any financial liabilities that are measured at fair value on a recurring basis as of December 31, 2013 and 2012.
Level I instrument valuations are obtained from quotes for transactions in active exchange markets involving identical assets. The Company’s cash equivalents are valued using market prices on active markets (Level I). Pricing is provided by third party sources of market information obtained through the Company’s investment advisors rather than models. The Company does not adjust for or apply any additional assumptions or estimates to the pricing information it receives from its advisors. The Company considers this the most reliable information available for the valuation of the securities. The Company had no transfers between Level I and Level II during the years ended December 31, 2013 and 2012.
As of December 31, 2013, the Company’s fair value hierarchy for its financial assets was as follows (in thousands):
As of December 31, 2012, the Company’s fair value hierarchy for its financial assets was as follows (in thousands):
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. Goodwill and Intangible Assets
On August 31, 2011, the Company acquired all of the outstanding shares of Identity Networks (“Identity”), a privately-owned provider of complete guest and device access management solutions located in the United Kingdom. The Company recorded $1.7 million goodwill as a consequence of that acquisition. Intangible assets acquired are accounted for based on the fair value of assets purchased and are amortized over the period in which economic benefit is estimated to be received.
As of December 31, 2013, identifiable intangible assets were as follows (in thousands):
As of December 31, 2012, identifiable intangible assets were as follows (in thousands):
The Company recorded amortization expense related to these identified intangible assets in the consolidated statements of operations as follows (in thousands):
As of December 31, 2013, the estimated aggregate future amortization expense in future years is as follows (in thousands):
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. Cost Method Investments
During the year ended December 31, 2011, the Company invested $1.3 million in a company which is developing value-added applications that are designed to allow its customers to achieve greater benefit from wireless networks such as those offered by the Company. The investment of $1.3 million is included in other assets in the consolidated balance sheets as of December 31, 2013 and 2012. The investee was co-founded by Dr. Vaduvur Bharghavan, a co-founder of the Company who served as a member of the Company’s board of directors until May 2012.
Equity investments, especially equity investments in private companies, are inherently risky. Many factors, including technical and product development challenges, market acceptance, competition, additional funding availability and the overall economy, could cause the investment to be impaired. The Company monitors the indicators of impairment of its investments. In the event that the fair value of an investment is below its carrying value and the impairment is other-than-temporary, the Company writes down the investment to its fair value. There were no indicators of impairment during the years ended December 30, 2013, 2012 and 2011. The Company has not elected to use the fair value method for this investment.
8. Property and Equipment, net
Property and equipment, net as of December 31, 2013 and 2012 is as follows (in thousands):
Depreciation and amortization expense for property and equipment was $1.3 million, $0.9 million and $0.6 million during the years ended December 31, 2013, 2012 and 2011.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Accrued Liabilities
Accrued liabilities as of December 31, 2013 and 2012 consist of the following (in thousands):
10. Borrowings
In June 2012, the Company entered into a loan and security agreement (the “VLL Agreement”), with Venture Lending and Leasing VI, Inc. (“VLL”), pursuant to which VLL made a term loan to the Company in the aggregate principal amount of $12 million. The Company received proceeds of $11.7 million, less issuance costs paid of $162,000. The VLL Agreement is collateralized by substantially all assets and intellectual property of the Company and contains various covenants that include limitations, among others, on the Company’s ability to incur additional indebtedness; its ability to acquire, merge or consolidate with other businesses; and its ability to pay dividends on its equity securities. As of December 31, 2013 and 2012, the Company was in compliance with all of its loan covenants.
The VLL Agreement bears interest at an annual fixed rate of 12%, and is payable in 39 equal installments, including principal and interest, of $369,405 per month. In addition, the Company is required to make a payment of $2.0 million on the earlier of a change of control or September 1, 2015, which is the maturity date of the VLL Agreement. The Company recorded $0.8 million and $0.5 million as additional interest expense during the years ended December 31, 2013 and 2012, respectively, related to the $2.0 million payment. The Company will continue to accrue the balance of the $2.0 million cash payment over the remaining term of the loan using the effective interest rate method, unless a change of control occurs, at which time the full amount will become due and payable.
The Company may voluntarily prepay all but not less than the total outstanding principal balance plus interest at any time, provided the Company is not then in default, subject to prepayment penalties. A prepayment penalty in the amount of 100% of the remaining scheduled but unpaid interest through the maturity date is due if the prepayment occurs before January 1, 2014. A prepayment penalty in the amount of 80% of the remaining scheduled but unpaid interest through the maturity date is due if the prepayment is made on or after January 1, 2014.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In connection with the VLL Agreement, the Company issued Venture Lending & Leasing, LLC a warrant to purchase 468,293 shares of the Company’s common stock. The warrant was exercisable upon issuance, has an exercise price of $2.05 per share, and expires on June 1, 2017. Upon issuance, the relative fair value of the warrant was recorded as a debt discount on the consolidated balance sheets in the amount of $384,000. In addition, debt issuance costs of $162,000 were also recorded as a debt discount. The aggregate total of the debt discounts of $546,000 is being amortized to interest expense over the repayment period for the loan using the effective interest rate method. The Company recorded $226,000 and $169,000 to interest expense, net related to the debt discounts during the years ended December 31, 2013 and 2012, respectively. As of December 31, 2013, the remaining unamortized amount of the debt discounts was $151,000, of which $121,000 was classified as a current debt discount.
The scheduled principal payments for the Company’s long-term debt as of December 31, 2013 are as follows (in thousands):
The Company had a Loan and Security Agreement with Silicon Valley Bank, dated January 29, 2007 (as amended, the “SVB Agreement”), which provided a working capital line of credit of $7.0 million based on eligible accounts receivable. The Company also entered into a term agreement to provide an additional loan of $15.0 million. The Company paid off this debt in 2011. These debt agreements were collateralized by substantially all of the Company’s assets. In connection with these loan agreements in November 2007, the Company issued to the lender a warrant to purchase a total of 76,922 shares of the Company’s common stock. The warrant was exercisable upon issuance, had an exercise price of $8.32 per share, and was fully exercised utilizing a cashless exercise provision in 2010. Upon issuance, the relative fair value of the warrant was recorded as a debt discount on the consolidated balance sheet in the amount of $456,000. The debt discount was amortized to interest expense over the repayment period for the loan. The amortization expense related to the debt discount for the bank borrowings was $44,000 during the year ended December 31, 2011. On July 31, 2012, the Company renewed the line of credit for twelve months pursuant to an amendment to the SVB Agreement. As of December 31, 2012, the total amount outstanding under the line of credit was zero. This working capital line of credit under the SVB Agreement expired on July 31, 2013.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Commitments and Contingencies
Legal Matters
On April 13, 2012, the Company entered into a settlement, license and release agreement with Extricom Ltd. (“Extricom”). Pursuant to the agreement with Extricom, the Company and Extricom each agreed to provide one another with perpetual, fully paid up, non-exclusive worldwide licenses to each of our respective patent portfolios as of the settlement date. The Company and Extricom also agreed to release one another of certain claims based on infringement or alleged infringement of certain patent rights; including dismissal of the then-current litigation.
In evaluating the accounting treatment for this transaction, the Company identified the following specific items the Company received from the Extricom Agreement: (1) release of past infringement claims and (2) a license to Extricom technology. The Company does not believe the Extricom license will provide future value as the Company does not plan to utilize the underlying technology in any future product development. In addition, the Extricom Agreement released and avoided certain litigation for the Company, but provided no other future benefits to the Company. Therefore, the Company expensed the full $2.4 million in the year ended December 31, 2012.
On June 13, 2011, the Company entered into a Patent Cross License Agreement (the “Motorola Solutions License Agreement”) with Motorola Solutions, Inc., a Delaware corporation, and its affiliates, including Symbol Technologies, Inc., Wireless Valley Communications, Inc. and AirDefense, Inc. (collectively “Motorola Solutions”). Pursuant to the Motorola Solutions License Agreement, the Company and Motorola Solutions each agreed to provide one another with limited licenses through November 3, 2016 to certain of each of our respective 802.11 WLAN patent portfolios; release one another of certain claims based on infringement or alleged infringement of certain patent rights; and covenant not to assert patent claims against one another’s current products and certain commercially reasonable extensions thereof for three years. As part of the Motorola Solutions License Agreement, the Company agreed to pay Motorola Solutions $7.3 million.
In evaluating the accounting treatment for this transaction, the Company identified the following specific items the Company received from the Motorola Solutions License Agreement: (1) release of past infringement claims, (2) covenant by Motorola Solutions not to sue, and (3) limited license to certain Motorola Solutions technology. The Company does not believe this Motorola Solutions License Agreement will provide future value as the Company does not plan to utilize the underlying technology in any future product development or sales. The Motorola Solutions License Agreement released and avoided certain potential litigation for the Company, but provided no other future benefits to the Company. Therefore, the Company expensed the full $7.3 million in the year ended December 31, 2011.
Litigation- The Company is subject to various claims arising in the ordinary course of business. Although no assurance may be given, the Company believes that it is not presently a party to any litigation of which the outcome, if determined adversely, would individually or in the aggregate be reasonably expected to have a material and adverse effect on the business, operating results, cash flows or financial position of the Company. The Company records litigation accruals for legal matters which are both probable and estimable. For legal proceedings for which there is a reasonable possibility of loss (meaning those losses for which the likelihood is more than remote but less than probable), the Company has determined that it does not have material exposure, or it is unable to develop a range of reasonably possible losses.
For an additional discussion of certain risks associated with legal proceedings, see the section entitled “Legal Proceedings” in Part I, Item 3 of this Annual Report on Form 10-K.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Operating Leases - The Company leases approximately 44,000 square feet office space for its headquarters in Sunnyvale, California under a noncancelable operating lease that expires in 2015. In addition, the Company leases approximately 35,000 square feet space for a research and development facility in Bangalore, India pursuant to an operating lease that expires in 2016, which is noncancelable prior to 2014. The Company has the option to renew the lease for an additional five years. The Company also leases office space for sales offices and test facilities in multiple locations around the world under noncancelable operating leases that expire at various dates. Commitments under these operating leases are as follows (in thousands):
Rent expense related to these noncancelable operating leases was $1.8 million, $2.1 million, and $1.6 million for the years ended December 31, 2013, 2012 and 2011. Rent expense is recognized on a straight-line basis over the term of the lease. Other commitments as of December 31, 2013 totaled approximately $7.5 million and consisted of inventory and other non-cancelable purchase obligations, which are due within the next 12 months.
Indemnifications - Our customer agreements generally include certain provisions for indemnifying such customers against certain liabilities, including if our products infringe a third party’s intellectual property rights. From time to time, we receive requests for indemnification from our customers. We review these requests on a case-by-case basis and may choose to assume the defense of such litigation asserted against our customers. We have agreed in certain circumstances to indemnify certain suppliers and service providers in connection with liabilities they may incur in connection with the provision of services to us. To date, we have not incurred any material costs as a result of such indemnification provisions and we have not accrued any liabilities related to such obligations in the accompanying consolidated financial statements.
In addition, our Bylaws provide that we shall indemnify our directors, officers, employees and agents to the extent such person becomes a party or is threatened to become a party to litigation or other proceedings arise by reason of their service to the Company, subject to certain limitations . In addition, we have entered into indemnification agreements or other contractual arrangements with current and former executive officers and directors of the Company which contain provisions that may require us, among other things, to indemnify such officers and directors against certain liabilities that may arise by reason of their status or service as directors or officers and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. The Company also maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers.
In the event that one or more of these matters were to result in a claim against the Company, an adverse outcome, including a judgment or settlement, may cause a material adverse effect on the Company’s future business, operating results or financial condition. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement.
From time to time, the Company may receive indemnification claims in the normal course of business. The Company does not believe it is party to any currently pending claims the outcome of which will have a material adverse effect on its operations or financial position.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. Common Stock
Sale of Common Stock
On February 27, 2013, the Company entered into an Underwriting Agreement (the “Underwriting Agreement”) with William Blair & Company, L.L.C (the “Underwriter”), pursuant to which the Company agreed to offer and sell 3,000,000 shares of its common stock with a par value of $0.0005 per share, at a price of $4.00 per share (the “Offering”). Under the terms of the Underwriting Agreement, the Company granted the Underwriters a 30-day option to purchase an additional 450,000 shares of the Company’s common stock to cover overallotments, which the Underwriter exercised on March 4, 2013. The Company completed the sale of 3,450,000 shares of its common stock and received $12.6 million in proceeds, net of underwriting discount, commission and other issuance costs, on March 4, 2013, which was the closing date of the Offering.
Warrants for Common Stock
The Company issued a warrant to purchase 468,293 shares of the Company’s common stock in connection with the VLL Agreement entered into in June 2012. The warrant was exercisable upon issuance, has an exercise price of $2.05 per share, and expires on June 1, 2017. Upon issuance, the Company determined the fair value using the Black-Scholes option-pricing model with the following assumptions:
The relative fair value of the warrant was recorded as a debt discount on the consolidated balance sheet in the amount of $384,000. As of December 31, 2013, this warrant has not been exercised and was still outstanding.
In 2009, the Company issued warrants to purchase 4,007,432 shares of common stock. During 2010, the Company issued another warrant to purchase 36,582 shares of common stock. These common stock warrants are exercisable, have exercise prices ranging from $9.78 to $11.74 and expire in 2014. During the years ended 2011 and 2010, warrants to purchase 1,265,293 and 54,764 shares were exercised utilizing a cashless exercise provision. As a result, the Company issued 548,125 shares and 19,072 shares of common stock. There were no exercises in 2012 and 2013. As of December 31, 2013, the remaining warrants to purchase 2,723,957 shares of common stock at a weighted average exercise price of $10.76 per share have not been exercised and were still outstanding.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. Equity Incentive Plans
The Company’s equity incentive plans are broad-based retention programs. The plans are intended to attract talented employees, directors and non-employee consultants.
2013 New Employee Stock Inducement Plan
On June 6, 2013, the Company’s Board of Directors approved the Company’s 2013 New Employee Stock Inducement Plan (the “2013 Plan”), under which 500,000 shares of common stock were reserved for issuance. The 2013 Plan is designed to attract new employees by providing for awards in the form of restricted stock units, restricted stock awards, stock options (which shall be nonstatutory stock options) or stock appreciation rights. As of December 31, 2013, 315,000 shares of restricted stock units were issued and outstanding and 185,000 shares of common stock were available for future issuance under the 2013 Plan.
Inducement Plan and Agreement and Restricted Stock Unit Plan and Agreements with Chief Executive Officer
In March 2012, the Company granted options to purchase 600,000 shares of common stock under the Inducement Stock Option Plan (the “2012 Plan”) and Agreement, 50,000 shares of restricted stock units under the Service-Based Restricted Stock Unit Plan and Agreement and 50,000 shares of restricted stock units under the Performance-Based Restricted Stock Unit Plan and Agreement, to Dr. Bami Bastani, Chief Executive Officer (“CEO”), as a material inducement to the acceptance of employment with the Company. The grants were approved by the Company’s board of directors, as specified under the Listing Rules of the Nasdaq Stock Market. As of December 31, 2013, options to purchase 600,000 shares of common stock were issued and outstanding under the Inducement Stock Option Plan and Agreement and a total of 45,000 shares of restricted stock units were issued and outstanding under the Restricted Stock Unit Plans and Agreements.
Stock Incentive Plans
In March 2010, the Company’s board of directors and its stockholders approved the 2010 Stock Incentive Plan (the “2010 Plan”), effective upon the completion of the Company’s initial public offering (“IPO”) on April 6, 2010. The 2010 Plan provides for the granting of stock options, restricted stock, restricted stock units and stock appreciation rights. The number of shares reserved for issuance under the 2010 Plan is increased on the first day of each of the Company’s fiscal years by the lesser of 4% of the Company’s outstanding common stock on the last day of the immediately preceding fiscal year or the number of shares determined by the Company’s board of directors.
The Company’s stock-based compensation expense was $6.5 million, $7.5 million and $6.2 million during the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, the Company had accrued $0.6 million in accrued liabilities on the consolidated balance sheets for awards that were earned but not issued as of the balance sheet date.
Determining Fair Value of Stock Options
The fair value of stock options granted during the years ended December 31, 2013, 2012 and 2011 were determined by the Company using the methods and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgment to determine.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Valuation Method - The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model.
Expected Term - The expected term represents the period that the Company’s stock-based awards are expected to be outstanding. The expected term is derived from historical data on employee exercises and post-vesting employment termination behavior taking into account the contractual life of the award.
Expected Volatility - The expected volatility was calculated based on the historical stock volatilities of a peer group of publicly listed companies combined with the Company’s historical data over a period equal to the expected terms of the options as the Company did not have a sufficient trading history to use the volatility of its own common stock.
Risk-Free Interest Rate - The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to the option’s expected term.
Expected Dividend - The Company has never paid dividends and currently does not expect to pay dividends.
Forfeiture Rate - The Company estimates its forfeiture rate based on an analysis of its actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover, and other factors. The impact from a forfeiture rate adjustment will be recognized in full in the period of adjustment, and if the actual number of future forfeitures differs from that estimated by the Company, the Company may be required to record adjustments to stock-based compensation expense in future periods.
Summary of Assumptions - The fair value of each employee stock option was estimated at the date of grant using a Black-Scholes option-pricing model, with the following weighted-average assumptions for grants of options during the years ended December 31, 2013, 2012 and 2011:
The weighted-average grant date fair value of the Company’s stock options granted during the years ended December 31, 2013, 2012 and 2011 was $1.94, $2.88 and $4.96 per share. The aggregate grant date fair value of the Company’s stock options granted to employees for the years ended December 31, 2013, 2012 and 2011 was $0.7 million, $6.8 million and $6.8 million. The Company recognized stock-based compensation expense in the amount of $1.6 million, $3.5 million and $3.4 million for stock options in the years ended December 31, 2013, 2012 and 2011.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A summary of the Company’s stock award activity for the years ended December 31, 2013, 2012 and 2011 is presented below:
* Includes options to purchase 692,682 shares of common stock, which were issued pursuant to the Company’s Exchange Offer program.
** Includes options to purchase 960,443 shares of common stock, which were cancelled pursuant to the Company’s Exchange Offer program.
The aggregate intrinsic value of options exercised under the 2010 Plan was $0.1 million, $0.1 million and $7.6 million for the years ended December 31, 2013, 2012 and 2011, determined as of the date of option exercise.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Additional information regarding the Company’s stock options outstanding and vested as of December 31, 2013 is summarized below:
As of December 31, 2013, total compensation cost related to unvested stock-based awards granted to employees, but not yet recognized, was $7.6 million, net of estimated forfeitures. This cost will be amortized on a straight-line basis over a weighted-average remaining period of 2.3 years and will be adjusted for subsequent changes in estimated forfeitures. Future option grants will increase the amount of compensation expense that will be recorded.
Exchange Offer - On July 26, 2012, the Company commenced an offer to eligible employees to exchange certain options to purchase shares of the Company’s common stock outstanding on July 26, 2012, which had an exercise price greater than $2.00 per share (the “Eligible Options”), that were granted under the Company’s 2002 Stock Incentive Plan or the 2010 Plan and that do not vest upon the achievement of certain performance criteria for new nonqualified stock options to be granted under the 2010 Plan (the “New Options”) following the expiration of the offer. The Company’s CEO and its non-employee directors were not eligible to participate in the offer. Eligible Options tendered were exchanged for an equal number of New Options, except that certain eligible officers received a lesser number of New Options, depending on the exercise price of the Eligible Options tendered. Options to purchase 960,443 shares of common stock (the “Exchanged Options”) were cancelled and exchanged for options to purchase 692,682 shares of common stock with a new vesting schedule of 25% vest after the first year of service, and ratably monthly over the remaining 36 months contingent upon the employment with the Company on the date of vest. The offer expired on August 22, 2012. The New Options were granted following the expiration of the offer with an exercise price of $3.40 per share, the closing price of the Company’s stock as reported by the Nasdaq Global Market on August 23, 2012. This modification resulted in an incremental charge of $0.5 million being amortized over the 4-year service period of the New Options in addition to the unamortized expense related to the Exchanged Options.
Restricted Stock Awards and Restricted Stock Units - The Company has issued restricted stock awards (“RSAs”) and restricted stock units (“RSUs”) to employees and members of the board of directors. These restricted shares have vesting periods ranging from three months to four years from the date of issuance and vesting is subject to the recipient continuing to provide service to the Company for the duration of the vesting period. In addition, the vesting of some RSUs is performance based and the vesting of those RSUs is subject to the achievement of specific performance metrics in addition to continued service.
During the year ended December 31, 2013, the Company issued 1,764,352 RSUs, of which 315,000 RSUs were issued from the 2013 Plan and 1,449,352 RSU were issued from the 2010 Plan. During the year ended December 31, 2012, the Company issued 720,259 RSUs, of which 100,000 RSUs were issued from the 2012 Plan and 620,259 RSUs were issued from the 2010 Plan. The Company recognized stock-based compensation in the amount of $4.4 million, $3.6 million, $2.2 million for RSAs and RSUs awarded in the years ended December 31, 2013, 2012 and 2011, respectively.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A summary of the Company’s RSA activity for the years ended December 31, 2013, 2012 and 2011 is presented below:
A summary of the Company’s RSU activity for the years ended December 31, 2013, 2012 and 2011 is presented below:
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The majority of the RSUs that vested in the years ended December 31, 2013, 2012 and 2011 were net-share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld were based on the value of the RSUs on their vesting date as determined by the Company’s closing stock price. These net-share settlements had the effect of share repurchases by the Company as they reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company. For the year ended December 31, 2013, 624,896 shares of restricted stock units vested with an intrinsic value of approximately $2.3 million. The Company withheld 69,577 shares to satisfy approximately $0.3 million of employees’ minimum tax obligation on the vested restricted stock units. For the year ended December 31, 2012, 448,327 shares of restricted stock units vested with an intrinsic value of approximately $1.3 million. The Company withheld 77,778 shares to satisfy approximately $0.3 million of employees’ minimum tax obligation on the vested restricted stock units.
Common Stock Subject to Repurchase - Prior to the IPO, the Company allowed employees to exercise options prior to vesting. The Company has the right to repurchase these options at the original purchase price paid by the employee for any unvested (but issued) shares of common stock upon the termination of the employee. The consideration received for an exercise of an option is considered to be a deposit of the exercise price and the related dollar amount is recorded as a liability on the consolidated balance sheets. The shares and liability are reclassified into equity on a pro rata basis as the options vest. The shares subject to repurchase are not deemed to be issued for accounting purposes until those shares vest.
The shares of common stock subject to repurchase issued pursuant to the exercise of options prior to vesting for the years ended December 31, 2012 and 2011 are as follows:
Employee Stock Purchase Plan - In March 2010, the Company’s board of directors approved the 2010 Employee Stock Purchase Plan (“ESPP”). The price of the common stock purchased under the ESPP shall be the lower of 85% of the market value of the Company’s common stock at the beginning of the offering period or 85% of the market value of the Company’s common stock on the last trading day of the applicable offering period. On the first day of each of the Company’s fiscal years, beginning on January 1, 2011, additional shares equal to the lesser of 1% of the outstanding shares of the Company on such date or a lesser amount determined by the Company’s board of directors will be reserved for issuance under the ESPP; provided, however, that no annual increase shall be added after March 30, 2020.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company calculated the compensation expense for the ESPP using the Black-Scholes option-pricing model with the following weighted-average assumptions during the years ended December 31, 2013, 2012 and 2011:
The Company recognized compensation expense related to the ESPP in the amount of $0.5 million, $0.4 and $0.6 million for the years ended December 31, 2013, 2012 and 2011. The Company issued 397,080 shares of common stock for $0.8 million, 356,388 shares of common stock for $0.6 million and 178,150 shares of common stock for $1.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. The Company had 230,609 shares of its common stock available for future issuance under the ESPP as of December 31, 2013.
14. Income Taxes
The Company’s loss before provision for income taxes for the years ended December 31, 2013, 2012 and 2011 is as follows (in thousands):
The components of the provision for income taxes for the years ended December 31, 2013, 2012 and 2011 are as follows (in thousands):
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Reconciliations of the statutory federal income tax to the Company’s effective tax for the years ended December 31, 2013, 2012 and 2011 are as follows (in thousands):
Net deferred tax assets as of December 31, 2013 and 2012 consist of the following (in thousands):
A valuation allowance is provided when it is more likely than not that the deferred tax assets will not be realized. The Company has established a valuation allowance to offset net deferred tax assets at December 31, 2013 due to the uncertainty of realizing future tax benefits from its net operating loss carryforwards and other deferred tax assets.
The valuation allowance increased by $2.2 million, $12.4 million, and $10.2 million during the years ended December 31, 2013, 2012, and 2011.
At December 31, 2013, the Company has federal and state net operating loss carryforwards of approximately $146.2 million and $122.4 million, respectively, beginning to expire in 2022 and 2014, respectively.
As of December 31, 2013 the Company has federal and state research credit carryovers of approximately $4.1 million and $4.5 million, respectively, expiring beginning in 2022 for federal. California credits will carryforward indefinitely.
As of December 31, 2013, the Company has a foreign tax credit carryover of $0.7 million expiring beginning in 2018.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Internal Revenue Code section 382 places a limitation (the “Section 382 Limitation”) on the amount of taxable income can be offset by net operating (“NOL”) carryforwards after a change in control (generally greater than 50% change in ownership) of a loss corporation. California has similar rules. The Company’s capitalization described herein may have resulted in such a change. Generally, after a control change, a loss corporation cannot deduct NOL carryfowards in excess of the Section 382 Limitation.
The foreign subsidiaries are subject to cost-plus model based on their operating expenses. The Company has funded these subsidiaries since incorporation and the foreign companies have not repatriated any earnings nor does it intend to. The Company has not reflected income taxes that would be payable on unremitted foreign earnings of the controlled foreign corporations because such earnings are intended to be permanently reinvested in those countries.
The Company has made no provision for U.S. income taxes on undistributed earnings of certain foreign subsidiaries because it is the Company’s intention to permanently reinvest such earnings in its foreign subsidiaries. If such earnings were distributed, the Company would be subject to approximately $0.8 million additional U.S. tax expense.
Uncertain Tax Positions
The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company’s tax years for 2002 and forward are subject to examination by the U.S. tax authorities and various state tax authorities. These years are open due to net operating losses and tax credits unutilized from such years. The Company’s tax years for December 31, 2006 and forward are subject to examination by the major foreign taxing jurisdictions in which the Company is subject to tax.
As of December 31, 2013, the Company had $2.3 million of cumulative unrecognized tax benefits of which $0.2 million has an effect on the Company’s effective tax rate.
A reconciliation of the beginning and ending unrecognized tax benefit amounts since adoption is as follows (in thousands):
15. Employee Benefit Plan
The Company has established a 401(k) tax-deferred savings plan (the “401(k) Plan”) which permits participants to make contributions by salary deduction pursuant to Section 401(k) of the Internal Revenue Code. The Company is responsible for administrative costs of the 401(k) Plan and has made no contributions to the 401(k) Plan since inception.
MERU NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. Related-Party Transactions
In 2011, the Company invested in a private company that was considered a related party. The investee was co-founded by Dr. Vaduvur Bharghavan, who ceased being a member of the Company’s board of directors in May 2012. The total investment in this related party amounted to $1.3 million. See Note 7 for further discussion of this investment.
The Company has a reseller in Japan that is a related party by virtue of its ownership of shares of the Company’s stock during the years ended December 31, 2013, 2012 and 2011. The total revenue from this related party amounted to $0.6 million, $0.7 million and $0.9 million for the years ended December 31, 2013, 2012 and 2011. Accounts receivable from the reseller were $5,000 and $16,000 as of December 31, 2013 and 2012.
The Company has a distributor in Japan that was a related party by virtue of its ownership of shares of the Company’s stock during the years ended December 31, 2012 and 2011. However, as of December 31, 2012, this distributor is no longer a related party due to the fact that it no longer owns shares of the Company’s stock. The total revenue from this related party amounted to $1.9 million and $1.0 million for the years ended December 31, 2012 and 2011. Accounts receivable from this distributor were zero as of December 31, 2012.
17. Information about Geographic Areas
The Company considers operating segments to be components of the Company in which separate financial information is available that is evaluated regularly by the Company’s chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The chief operating decision maker for the Company is the CEO. The CEO reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region, for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations, operating results or plans for levels or components below the consolidated unit level. Accordingly, the Company has determined that it has a single reporting segment and operating unit structure which is the development and marketing of wireless infrastructure solutions.
Revenues
Revenues by geography are based on the billing address of the customer. The following table sets forth revenue by geographic area (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Long-Lived Assets
The following table sets forth long-lived assets by geographic area (in thousands):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation and supervision of our CEO and our chief financial officer (“CFO”), has evaluated the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based upon the aforementioned evaluation, our CEO and CFO have concluded that, as of December 31, 2013, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Management Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Under the supervision and with the participation of our management, including our CEO and our CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2013 based on the guidelines established in Internal Control-Integrated Framework (1992 Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on the results of this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2013 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. We reviewed the results of management’s assessment with the audit committee of our board of directors. The effectiveness of our internal control over financial reporting as of December 31, 2013 has been audited by Burr Pilger Mayer, Inc., an independent registered public accounting firm, as stated in their report which appears herein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
of Meru Networks, Inc.
We have audited the internal control over financial reporting of Meru Networks, Inc. and its subsidiaries (the “Company”) as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992 Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Meru Networks, Inc. and its subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992 Framework) by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Meru Networks, Inc. and its subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013, and the related financial statement schedule and our report dated February 28, 2014 expressed an unqualified opinion on those consolidated financial statements and the related financial statement schedule.
/s/ Burr Pilger Mayer, Inc.
San Jose, California
February 28, 2014
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated by reference to our Proxy Statement for our 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2013.
We maintain a Code of Business Conduct and Ethics that incorporates our code of ethics applicable to all employees, including all officers. Our Code of Business Conduct and Ethics is published on the Investor Relations section of our website at investors.merunetworks.com. We intend to disclose future amendments to certain provisions of our Code of Business Conduct and Ethics, or waivers of such provisions granted to executive officers and directors, on this website within four business days following the date of such amendment or waiver.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to our Proxy Statement for our 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2013.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to our Proxy Statement for our 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2013. For the information required by this item with respect to Item 201(d) of Regulation S-K regarding securities authorized for issuance under equity compensation plans, see “Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Equity Compensation Plan Information.”
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to our Proxy Statement for our 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2013.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to our Proxy Statement for our 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2013.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Financial Statements: the financial statements required by Item 15(a) are filed in Item 8 of this report, and listed on the index to financial statements.
(2) Financial Statement Schedules: the financial statement schedule required by Item 15(a) (Schedule II, Valuation and Qualifying Accounts) is included in this section of Form 10-K.
Schedule II “Valuation and Qualifying Accounts” should be read in conjunction with the Consolidated Financial Statements included in this report.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(3) Exhibits: the exhibits listed on the Exhibit Index are included or incorporated by reference as part of this Annual Report on Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: February 28, 2014
MERU NETWORKS, INC.
By:
/s/ Dr. Bami Bastani
Dr. Bami Bastani
President, Chief Executive Officer
and Director
(Principal Executive Officer)
MERU NETWORKS, INC.
By:
/s/ Brian R. McDonald
Brian R. McDonald
Chief Financial and Administrative Officer
(Principal Financial and
Accounting Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dr. Bami Bastani and Brian R. McDonald, and each of them, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934 this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
EXHIBIT INDEX
* Indicates management contract or compensatory plan or arrangement.