TMCnet News
PROCERA NETWORKS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following is a discussion of our results of operations and current financial position. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 15, 2013. As used in this Quarterly Report on Form 10-Q, references to the "Company," "we," "us," "our" or similar terms include Procera Networks, Inc. and its consolidated subsidiaries. Cautionary Note Regarding Forward-Looking Statements Our disclosure and analysis in this Quarterly Report on Form 10-Q contain certain "forward-looking statements," as such term is defined in Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements set forth anticipated results based on management's plans and assumptions. From time to time, we also provide forward-looking statements in other materials we release to the public as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. We have attempted to identify such statements by using words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "will," "could," "initial," "future," "may," "predict," "potential," "should" and similar expressions in connection with any discussion of future events or future operating or financial performance or strategies. Such forward-looking statements include, but are not limited to, statements regarding: trends related to and management's expectations regarding future results of operations, required capital expenditures, revenues from existing and new products and sales channels, and cash flows, including but not limited to those statements set forth below in this Item 2; sales efforts, expenses, interest rates, foreign exchange rates, and the outcome of contingencies, such as legal proceedings; our services, including the development and deployment of products and services and strategies to expand our targeted customer base and broaden our sales channels; the operation of our company with respect to the development of products and services; our liquidity and financial resources, including anticipated capital expenditures, funding of capital expenditures and anticipated levels of indebtedness; and sales efforts, expenses, interest rates, foreign exchange rates, and the outcome of contingencies, such as legal proceedings. We cannot guarantee that any forward-looking statement will be realized. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. We also provide cautionary discussion of risks and uncertainties related to our businesses which are identified under the caption "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. We believe these factors, individually or in the aggregate, as well as general risks and uncertainties such as those relating to general economic conditions and demand for our products and services, could cause our actual results to differ materially from expected and historical results. We note these factors for investors as permitted by Section 21E of the Exchange Act. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. Overview We are a leading provider of Intelligent Policy Enforcement ("IPE") solutions that enable mobile and broadband network operators and entities managing private networks including higher education institutions, businesses and government entities (collectively referred to as network operators) to gain enhanced visibility into, and control of, their networks. Our solutions provide granular network intelligence intended to enable network operators to improve the quality and longevity of their networks, better monetize their network infrastructure investments, control security hazards and create and deploy new services for their users. We believe that the intelligence our products provide about users and their usage enables our network operator customers to make qualified business decisions. Our network operator customers include mobile service providers, broadband service providers, cable multiple system operators ("MSOs"), Internet Service Providers ("ISPs"), educational institutions, enterprises and government agencies. We sell our products directly to network operators; through partners, value added resellers and system integrators; and to other network solution suppliers for incorporation into their network solutions. 19 -------------------------------------------------------------------------------- Index Our IPE products are part of the high-growth market for mobile packet and broadband core products. The market for IPE products was expected to reach $601.7 million in 2012 and is expected to grow to $1.8 billion in 2016, a 2011-2016 compounded annual growth rate of 30.4%. Our bundled products deliver a solution that is a key element of the mobile packet and broadband core ecosystems. Our solutions are often integrated with additional elements in the mobile packet and broadband core including Policy Management and Charging functions, and are compliant with the widely adopted 3rd Generation Partnership Program ("3GPP") standard. In order to respond to rapidly increasing demand for network capacity due to increasing subscribers and usage, network operators are seeking higher degrees of intelligence, optimization, network management, service creation and delivery in order to differentiate their offerings and deliver a high quality of experience to their subscribers. We believe the need to create more intelligent and innovative mobile and broadband networks will continue to drive demand for our products. Our products are marketed under the PacketLogic and Network Application Visibility Library ("NAVL") brand names. We have a broad spectrum of products delivering IPE at the access, edge and core layers of the network. Our products are designed to offer maximum flexibility to our customers and enable differentiated services and revenue-enhancing applications, all while delivering a high quality of service for subscribers. We face competition from suppliers of standalone and integrated IPE and deep packet inspection ("DPI") products including Allot Communications Ltd., Tektronix (acquired Arbor Networks), Blue Coat Systems, Brocade Communications Systems, Cisco Systems, Inc., Citrix Systems (acquired Bytemobile), SAIC (acquired Cloudshield Technologies), Ericsson, F5 Networks, Huawei Technologies Company, and Sandvine Corporation. Some of our competitors supply platform products with different degrees of DPI functionality, such as switch/routers, routers, session border controllers and VoIP switches. Some of our competitors are also our customer. Most of our competitors are larger and more established enterprises with substantially greater financial and other resources. Some competitors may be willing to reduce prices and accept lower profit margins to compete with us. As a result of such competition, we could lose market share and sales, or be forced to reduce our prices to meet competition. However, we do not believe there is a dominant supplier in our market. Based on our belief in the superiority of our technology, we believe that we have an opportunity to increase our market share and benefit from what we believe will be growth in the DPI market. On January 9, 2013, we completed our acquisition of Vineyard Networks, Inc. ("Vineyard"), a privately held developer of Layer 7 Deep Packet Inspection (DPI) and application classification technology located in Kelowna, Canada. Vineyard's integrated DPI and application classification technology provides enterprise and service provider networking infrastructure vendors with these capabilities through its integrated software suite, primarily through a variety of subscription based Original Equipment Manufacturer and Partner agreements. This acquisition complements our hardware and application based software based IPE and DPI solutions, as well as expanding the way we sell solutions to customers, and therefore expanding our customer base, previously comprised primarily of network operators, allowing us to provide complementary technology and solutions to a greater number of customers. We were incorporated in 2002 and became a public company in October 2003. Our Company is headquartered in Fremont, California and we have key operating entities in Kelowna, Canada and Varberg, Sweden, as well as a geographically dispersed sales force. We sell our products through our direct sales force, resellers, distributors, systems integrators and other equipment manufacturers in the Americas, Asia Pacific and Europe. Critical Accounting Estimates Our discussion and analysis of our financial condition and results of operations are based upon financial statements which have been prepared in accordance with Generally Accepted Accounting Principles in the United States ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate these estimates. We base our estimates on historical experience and on assumptions that are believed to be reasonable. These estimates and assumptions provide a basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material. We believe the following critical accounting policies reflect our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements: Revenue Recognition; Valuation of Goodwill, Intangible and Long-Lived Assets; Allowance for Doubtful Accounts; Stock-Based Compensation; and Accounting for Income Taxes. 20-------------------------------------------------------------------------------- Index These critical accounting policies and related disclosures appear in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 15, 2013. Results of Operations Comparison of Three Months Ended March 31, 2013 and 2012 Revenue Revenue for the three months ended March 31, 2013 and 2012 was as follows (in thousands, except percentages): Three Months Ended March 31, 2013 2012 Increase Net product revenue $ 10,411 $ 9,829 6 % Net support revenue 3,760 2,503 50 % Total revenue $ 14,171 $ 12,332 15 % Our revenue is derived from two sources: 1) product revenue, which includes sales of our hardware appliances bundled with software licenses, separate software licenses or software upgrades; and 2) service revenue, which consists primarily of software maintenance and customer support revenue and secondarily of professional services. Maintenance and customer support revenue is recognized over the support period, which is typically twelve months. Total revenue in the three months ended March 31, 2013 was $14.2 million, an increase of 15% compared with $12.3 million in the three months ended March 31, 2012, and reflected a 6% increase in product revenue and a 50% increase in support revenue. The increase in product revenue in 2013 compared to the first quarter of 2012 reflected follow-on orders from existing customers and included increased sales to our newer network operator customers, including mobile service providers, fixed line service providers, and cable multiple system operators; and we continued to add new higher education customers. The increase in product revenue also continued to reflect increased sales of our mid-range PL8000 series products. Vineyard contributed $0.2 million in product and $0.2 million in support revenue for the three months ended March 31, 2013. The increase in support revenue in 2013 compared to the first quarter of 2012 reflected the continued expansion of the installed base of our product to which we have sold ongoing support services. In the three months ended March 31, 2013, sales to two customers, Cox Communications, Inc. and Shaw Communications, Inc., represented 22% and 17% of total net revenues, respectively. In the three months ended March 31, 2012, sales to three customers, Shaw Communications, Inc., Cox Communications, Inc. and a third customer, represented 21%, 20% and 12% of total net revenues, respectively. Sales to customers located in the Americas as a percentage of total revenues were 59% and 62% for the three months ended March 31, 2013 and 2012, respectively. We believe that our revenue will continue to grow in each of the remaining quarters of the fiscal year ending December 31, 2013, as compared with the fiscal year ended December 31, 2012. Cost of Sales Cost of sales includes material costs and direct labor for products sold, amortization of acquired developed technology, costs expected to be incurred for warranty, adjustments to inventory values, including the write-down of slow moving or obsolete inventory and costs for support and professional services personnel. The following table presents the breakdown of cost of sales by category for the three months ended March 31, 2013 and 2012 (in thousands, except percentages): Three Months Ended March 31, 2013 2012 Increase Product costs $ 6,087 $ 3,447 77 % Percent of net product revenue 58 % 35 % Support costs 715 222 222 % Percent of net support revenue 19 % 9 % Total costs of sales $ 6,802 $ 3,669 85 % Percent of total net revenue 48 % 30 % 21-------------------------------------------------------------------------------- Index Total cost of sales in the three months ended March 31, 2013 increased by $3.1 million compared to the three months ended March 31, 2012, and increased as a percentage of revenue by 18 percentage points. The increase in cost of sales in 2013 primarily reflected higher material costs associated with increased product sales and higher support costs for increased customer support and professional services personnel. The increase also reflected $0.3 million of amortization of developed technology intangible assets acquired as part of the Vineyard acquisition in January 2013. The increase in cost of sales as a percentage of revenue primarily reflected a higher proportion of hardware sales in the first quarter of 2013. Stock-based compensation recorded to cost of sales in the three months ended March 31, 2013 and 2012 was $0.1 million and $34,000, respectively. Gross Profit Gross profit for the three months ended March 31, 2013 and 2012 was as follows (in thousands, except percentages): Three Months Ended March 31, Increase/ 2013 2012 (Decrease) Total gross profit $ 7,369 $ 8,663 (15) % Total gross margin 52 % 70 % Our total gross profit margin for the three months ended March 31, 2013 decreased by 18 percentage points to 52% compared to 70% for the three months ended March 31, 2012. The decrease resulted from a higher proportion of hardware sales in the first quarter of 2013, higher support and service costs and amortization of acquired intangible assets. We expect our gross profit margin to increase in each of the remaining quarters of the fiscal year ending December 31, 2013, as compared with the first quarter of 2013. Operating Expense Operating expenses for the three months ended March 31, 2013 and 2012 was as follows (in thousands, except percentages): Three Months Ended March 31, 2013 2012 Increase Research and development $ 4,401 $ 1,691 160 % Sales and marketing 6,621 4,006 65 % General and administrative 3,637 2,360 54 % Total $ 14,659 $ 8,057 82 % In the first three months of 2013, our total operating expenses increased to support the scale of our operations as we have hired additional employees in each function of our company, invested in testing equipment for the development of our products, invested in infrastructure, and increased the use of outside services, including legal, audit and accounting services. Additionally, our costs have increased due to the integration of Vineyard personnel and related operating costs. We anticipate that this trend will continue in subsequent periods and that total operating expenses for the remainder of the year ending December 31, 2013 will exceed those incurred in the year ended December 31, 2012. Research and Development Research and development expenses include costs associated with personnel focused on the development or improvement of our products, prototype materials, initial product certifications, testing equipment and software costs. Research and development costs include sustaining and enhancement efforts for products already released and development costs associated with planned new products. Three Months Ended March 31, 2013 2012 Increase ($ in thousands) Research and development $ 4,401 $ 1,691 160 % As a percentage of total net revenue 31 % 14 % Research and development expenses for the three months ended March 31, 2013 increased by $2.7 million compared to the three months ended March 31, 2012 as a result of increased research and development personnel and the corresponding additional employee compensation costs, including the addition of Vineyard personnel, and amortization of deferred compensation of $0.7 million associated with the Vineyard acquisition. The additional personnel are expected to allow us to enhance our core product features and functionality in order to support new sales and to achieve follow-on sales to our current customers. Stock-based compensation recorded to research and development expenses in the three months ended March 31, 2013 and 2012 was $0.5 million and $0.1 million, respectively. 22 -------------------------------------------------------------------------------- Index Sales and Marketing Sales and marketing expenses primarily include personnel costs, sales commissions and marketing expenses, such as trade shows, channel development and literature. Three Months Ended March 31, 2013 2012 Increase ($ in thousands) Sales and marketing $ 6,621 $ 4,006 65 % As a percentage of total net revenue 47 % 32 % Sales and marketing expenses for the three months ended March 31, 2013 increased by $2.6 million compared to the three months ended March 31, 2012. The increase reflected the addition of sales and marketing personnel during 2012 and in the three months ended March 31, 2013, and the corresponding higher compensation costs and higher commission costs as a result of the increase in revenue. The increase also reflected the amortization of deferred compensation of $0.7 million and the amortization of acquired intangible assets of $0.1 million associated with the Vineyard acquisition. Stock-based compensation recorded to sales and marketing expenses in the three months ended March 31, 2013 and 2012 was $0.6 million and $0.3 million, respectively. General and Administrative General and administrative expenses consist primarily of personnel and facilities costs related to our executive, finance functions and service fees for professional services. Professional services include costs for legal advice and services, accounting and tax professionals, independent auditors and investor relations. Three Months Ended March 31, 2013 2012 Increase ($ in thousands) General and administrative $ 3,637 $ 2,360 54 % As a percentage of total net revenue 26 % 19 % General and administrative expenses for the three months ended March 31, 2013 increased by $1.3 million compared to the three months ended March 31, 2012, reflecting increased accounting and human resource personnel related costs, legal and audit fees, and increased use of contractors and outside services. The increase also reflected $1.0 million in business development costs for legal, accounting and investment banking fees associated with the Vineyard acquisition, compared to $0.6 million in business development costs in the three months ended March 31, 2012 associated with potential mergers, acquisitions and partnership agreements. Stock-based compensation recorded to general and administrative expense in the three months ended March 31, 2013 and 2012 was $0.4 million and $0.3 million, respectively. Interest and Other Income (Expense), Net Three Months Ended March 31, 2013 2012 ($ in thousands) Interest and other income (expense), net $ (50 ) $ 1 Interest and other income (expense) decreased in the three months ended March 31, 2013 compared to the three months ended March 31, 2012 mainly due to higher foreign currency transaction losses from our foreign subsidiaries in the first three months of 2013 versus 2012. Provision for Income Taxes Three Months Ended March 31, 2013 2012 ($ in thousands)Provision (benefit) for income taxes $ (623 ) $ 28 23 -------------------------------------------------------------------------------- Index We are subject to taxation primarily in the U.S., Australia, Canada, Japan, Singapore and Sweden as well as in a number of U.S. states, including California. The tax benefit for the three months ended March 31, 2013 primarily reflects the following Vineyard acquisition related items: reversal of Vineyard's pre-existing income tax valuation allowance upon acquisition, amortization of intangible assets acquired, and the tax impact of book/tax differences on deferred revenue. We have established a valuation allowance for substantially all of our deferred tax assets. We calculated the valuation allowance in accordance with the provisions of ASC 740, which requires that a valuation allowance be established or maintained when it is "more likely than not" that all or a portion of deferred tax assets will not be realized. We will continue to reserve for substantially all net deferred tax assets until there is sufficient evidence to warrant reversal. Adjustment to Previously Announced Preliminary Quarterly Results On May 2, 2013, we filed a Current Report on Form 8-K, which contained a press release announcing our financial results for the quarter ended March 31, 2013. In the press release, we reported stock-based compensation expense of approximately $938,000 for the quarter ended March 31, 2013. Subsequent to the issuance of our press release, we determined we needed to record a one-time stock compensation charge of approximately $660,000 related to the acceleration of unvested stock options to purchase common shares of Vineyard Networks Inc. in connection with our acquisition of Vineyard on January 9, 2013. The additional expense was allocated as follows: $52,000 for cost of sales, $297,000 for research and development, $267,000 for sales and marketing and $44,000 for general and administrative. As a result, the Condensed Consolidated Statements of Operations for the three months ended March 31, 2013 contained in our press release has been adjusted to increase stock-based compensation expense to $1.598 million for the three months ended March 31, 2013. Liquidity and Capital Resources Cash, Cash Equivalents and Investments The following table summarizes the changes in our cash balance for the periods indicated: Three Months Ended March 31, 2013 2012 ($ in thousands) Net cash (used in) provided by operating activities $ (4,580 ) $ 3,647 Net cash used in investing activities (9,414 ) (431 ) Net cash provided by (used in) financing activities (383 ) 835 Effect of exchange rate changes on cash and cash equivalents (20 ) 40 Net increase in cash and cash equivalents $ (14,397 ) $ 4,091 During the three months ended March 31, 2013, we utilized $4.6 million in cash from operating activities as compared to generating $3.6 million for the three months ended March 31, 2012. Cash used by operating activities during the three months ended March 31, 2013 primarily consisted of our net loss of $6.7 million and non-cash charges of $2.8 million. Non-cash charges consisted primarily of stock-based compensation of $1.6 million, amortization of intangible assets of $0.4 million, amortization of premium on investments of $0.3 million and depreciation expense of $0.4 million. Working capital sources of cash consisted primarily of a decrease in accounts receivable of $4.2 million due to strong collections. Working capital uses of cash consisted primarily of an advance payment to escrow of $2.7 million recorded as deferred compensation related to retention agreements with Vineyard's three founders which are payable after one year of continuous employment with the Company, and an increase in inventory of $1.1 million, resulting from material purchases in anticipation of future sales. Cash provided by operating activities during the three months ended March 31, 2012 primarily consisted of our net income of $0.6 million, non-cash charges of $1.0 million and net working capital sources of cash of $2.1 million. Non-cash charges consisted primarily of stock-based compensation of $0.7 million and depreciation expense of $0.1 million. Working capital sources of cash consisted primarily of a decrease in accounts receivable of $3.2 million due to strong collections. Working capital use of cash consisted primarily of an increase in inventory of $0.8 million, resulting from material purchases in anticipation of future sales. Net cash used in investing activities of $9.4 million during the three months ended March 31, 2013 consisted of net cash consideration associated with the acquisition of Vineyard of $9.0 million, and purchases of lab and testing equipment for use in research and development of $1.3 million, partially offset by proceeds from net sales and maturities of short-term investments of $0.8 million. Net cash used in investing activities of $0.4 million during the three months ended March 31, 2012 consisted of purchases of lab and testing equipment for use in research and development of $0.6 million, partially offset by proceeds from net sales and maturities of short-term investments of $0.2 million. Net cash used in financing activities of $0.4 million during the three months ended March 31, 2013 consisted of the repayment of debt acquired from Vineyard of $0.5 million, offset by proceeds from the exercise of stock options of $0.1 million. Net cash provided by financing activities of $0.8 million during the three months ended March 31, 2012 reflected proceeds from the exercise of stock options and warrants. Our cash, cash equivalents and short-term investments at March 31, 2013 consisted of bank deposits with third party financial institutions, money market funds, U.S. agency securities, certificates of deposit, commercial paper and corporate bonds. Our investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield in relationship to our investment guidelines and market conditions. Cash equivalents consist of highly liquid investments with remaining maturities of three months or less at the date of purchase. Short-term investments have a remaining maturity of greater than three months at the date of purchase and an effective maturity of less than one year. All investments are classified as available for sale. 24 -------------------------------------------------------------------------------- Index In January 2013, we acquired Vineyard Networks, Inc. in Kelowna, Canada. The aggregate total consideration of approximately $20.9 million consisted of $9.8 million in cash and 825,060 shares of our common stock. On December 10, 2009, we entered into a two-year loan and security agreement for a secured credit facility of $2.0 million for short-term working capital purposes with Silicon Valley Bank. Borrowings under the facility bore interest at the prime rate plus 1%, but not less than 5% per annum. On February 3, 2012, the agreement was amended and restated to increase the credit facility from $2.0 million to $10.0 million for an additional two-year period beginning on that date. Borrowings under the amended credit facility bear interest at the prime rate plus 1%, but not less than 4.25% on an annual basis. At March 31, 2013, we had no borrowings outstanding under this credit facility. Based on our current cash, cash equivalents and short-term investment balances, and anticipated cash flow from operations, we believe that our working capital will be sufficient to meet the cash needs of our business for at least the next twelve months. Our future capital requirements will depend on many factors, including our rate of growth, the expansion of our sales and marketing activities, development of additional channel partners and sales territories, the infrastructure costs associated with supporting a growing business and greater installed base of customers, introduction of new products, enhancement of existing products, and the continued acceptance of our products. We may also enter into arrangements that require investment such as entering into complementary businesses, service expansion, technology partnerships or acquisitions. Off-Balance Sheet Arrangements As of March 31, 2013, we had no off-balance sheet items as described by Item 303(a)(4) of Regulation S-K. We have not entered into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligations under a variable interest in an unconsolidated entity that provide us with financing, liquidity, market risk or credit risk support. Contractual Obligations We lease facility space under non-cancelable operating leases in California and Sweden that extend through 2016. The details of these contractual obligations are further explained in Note 12 of the Notes to Condensed Consolidated Financial Statements. We use third-party contract manufacturers to assemble and test our hardware products. In order to reduce manufacturing lead-times and ensure an adequate supply of inventories, our agreements with some of these manufacturers allow them to procure long lead-time component inventory based on rolling production forecasts provided by us. We may be contractually obligated to purchase long lead-time component inventory procured by certain manufacturers in accordance with our forecasts. In addition, we issue purchase orders to our third-party manufacturers that may not be cancelable at any time. As of March 31, 2013, we had open non-cancelable purchase orders amounting to approximately $12.3 million, primarily with our third-party contract manufacturers. |