TMCnet News

IMPERVA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[November 07, 2014]

IMPERVA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the (1) unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2013 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or the SEC, on February 28, 2014. This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled "Risk Factors," set forth in Part II, Item 1A of this Form 10-Q and in our other SEC filings, including our Annual Report on Form 10-K for the year ended December 31, 2013. You should review these risk factors for a more complete understanding of the risks associated with an investment in our securities. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.



Overview We are pioneering the third pillar of enterprise security, data center security, by directly protecting high-value applications and data assets in physical and virtual data centers. Built specifically for modern threats, our comprehensive suite of data center security offerings is designed to provide the visibility and control needed to neutralize attacks, theft and fraud from inside and outside the organization, mitigate risk, and streamline compliance. Our SecureSphere platform provides database, file and web application security across various physical and virtual systems in data centers, including traditional on-premise data centers as well as private, public and hybrid cloud computing environments. In addition, our cloud offerings are designed to protect against the unique threats created as enterprises increasingly shift to deploying their applications and storing their data in the cloud to take advantage of the flexibility and cost-efficiency offered by cloud-based solutions.

We believe that data center security is the third pillar of enterprise security because it fills the gaps between the first pillar of security, endpoint security, which blocks threats targeting devices, and the second pillar of security, network security, which blocks threats trying to access the network.


Our unique suite of offerings protects the high-value applications and data assets that endpoint and network solutions are not designed to protect, whether the applications and data reside within our customers' data center or the cloud.

Organizations are facing numerous challenges in providing the visibility and control required to protect high-value applications and data assets from attack, theft and fraud. Attacks, whether perpetrated by sophisticated hackers or malicious insiders, continue to increase in sophistication, scale and frequency, and organizations must comply with increasingly complex regulatory standards enacted to protect high-value applications and data. Adoption of new technologies and architectures, such as mobile applications, modern web applications and big data, increases the complexity of, and open access to, the data center; thereby exposing critical data assets to new vulnerabilities. The increased adoption of cloud delivery models and virtualization technologies is also forcing applications to operate outside of the traditional security model.

We believe that these challenges are driving the need for a comprehensive data center security solution to protect high-value applications and data assets in the data center.

We were incorporated as a Delaware corporation in 2002 with the vision of protecting high-value applications and data assets within the enterprise. Since that time we have been investing in our data center security solutions to meet the rapidly evolving demands of customers. We shipped our initial web application security and data security products in 2002; in 2006, we expanded our database security product to include compliance features. In 2010, we launched our file security offering. In addition, in 2010, we launched our cloud-based initiatives with ThreatRadar and, in 2011, we introduced our cloud-based offering for mid-market enterprises and small and medium-sized businesses ("SMB") that we provide through Incapsula, Inc., which was majority owned by us until March 2014 when we acquired the remaining portion of Incapsula that we did not already own in order to more fully integrate their operations with ours. In January 2014, we acquired certain assets and liabilities of Tomium Software, LLC to accelerate our mainframe data security solutions. In February 2014, we acquired Skyfence Networks Ltd. to further our Software as a Service ("SaaS") delivery models for internally facing corporate applications.

Our research and development efforts are focused primarily on improving and enhancing our existing data center security solutions and services, as well as developing new products and services and conducting advanced security research.

We conduct our research and development activities in Israel, and we believe this provides us with access to some of the best engineering talent in the security industry. As of September 30, 2014, we had 230 employees dedicated to research and development, including our advanced security research group, the Application Defense Center ("ADC"). Our research and development expense was $32.0 million for the nine months ended September 30, 2014 as compared to $19.7 million for the same period in 2013.

27-------------------------------------------------------------------------------- Table of Contents We derive our revenue from sales and licenses of our products and sales of our services. Products and license revenue is generated primarily from sales of perpetual software licenses installed on hardware appliances or virtual appliances for our SecureSphere Business Security Suite. Services revenue consists of maintenance and support, professional services and training and subscriptions. A majority of our revenue is derived from customers in the Americas region. In the nine months ended September 30, 2014, 57% of our total revenue was generated from the Americas, 27% from Europe, Middle East and Africa ("EMEA") and 16% from Asia Pacific ("APAC").

We market and sell our products through a hybrid sales model, which combines a direct touch sales organization and an overlay channel sales team that actively assist our extensive network of channel partners throughout the sales process.

We also provide our channel partners with marketing assistance, technical training and support. We primarily sell our products and services through our channel partners, including distributors and resellers, which sell to end-user customers, who we refer to in this Quarterly Report on Form 10-Q as our customers. We have a network of over 300 channel partners worldwide, including both resellers and distributors. In 2013, our channel partners originated over 40% and fulfilled almost 85% of our sales. We work with many of the world's leading security value-added resellers, and our partners include some of the largest hosting companies for cloud-based deployments.

As of September 30, 2014, we had over 3,500 customers in more than 90 countries, excluding direct customers of our Incapsula subsidiary. In addition, our solutions are used to protect thousands of organizations through cloud-based deployments with our SaaS customers and our managed security service provider ("MSSP") and hosting partners. Our customers include top telecommunications companies, commercial banks in the United States, global consumer financial service firms, computer hardware companies, as well as over 250 government agencies around the world and more than 350 Global 2000 companies.

Our net revenue has increased in each of the last three years, growing from $78.3 million in 2011 to $137.8 million in 2013. We have incurred net losses attributable to our stockholders of $46.5 million in the nine months ended September 30, 2014 and $25.2 million in the year ended December 31, 2013, respectively. As of September 30, 2014, we had an accumulated deficit of $145.2 million.

Opportunities, Challenges and Risks We believe that the growth of our business and our future success are dependent upon many factors, including our ability to maintain our technology leadership, improve our sales and marketing, address the needs of smaller enterprises and compete effectively in the marketplace for data center security solutions. While each of these areas presents significant opportunities for us, they also pose important challenges and risks that we must successfully address in order to sustain the growth of our business and improve our results of operations.

Maintain Technology Leadership. As a result of the rise in sophisticated attacks by hackers and malicious insiders, the difficulty in complying with regulations governing business data and the growing complexity of, and open access to, data centers, we believe that enterprises are struggling to provide visibility and control over high-value business applications and data assets that they need to protect. In addition, organizations are increasingly taking advantage of cloud-based services and virtualization technologies, and these new technologies and architectures are increasing the complexity of, and accessibility to, the data center. We believe these challenges are driving the need for a new protection layer positioned closely around the applications and data assets in the data center. We expect that as enterprises recognize the growing risk to high-value business data and the need to comply with increasing regulatory compliance mandates, their spending will increase on solutions designed to control and protect such data. We believe that traditional security and compliance products do not address the evolving needs of enterprises or do not do so adequately, and that this presents us with a large market opportunity. To capitalize on this opportunity, we have introduced and expect that in the future we will need to continue to introduce innovations to our broad business security solutions, including solutions to address data center security opportunities that arise as enterprises pursue cloud computing initiatives. We cannot assure you that our products will achieve widespread market acceptance or that we will properly anticipate future customer needs. Moreover, if our products do not satisfy evolving customer requirements, we will not capture the increase in spending that we expect will result from enterprises seeking to secure data across various systems in the data center.

Invest in Sales and Marketing. In order to capitalize on the anticipated increase in spending in the data center security market, we will need to continue to invest significant resources to further strengthen our existing relationships with channel partners, extend our global network by adding new channel partners and grow our sales and marketing team. Any investments that we make in our sales and marketing will occur in advance of our experiencing any benefits from such investments, and so it may be difficult for us to determine if we are efficiently allocating our resources in this area. We cannot assure you that the investments that we intend to make to strengthen our sales and marketing efforts will enable us to capitalize on the expected increase in spending in the data center security market or result in an increase in revenue or an improvement in our results of operations.

Address Needs of Smaller Enterprises. As market awareness of the benefits of a comprehensive data center security solution increases, we believe there is a significant opportunity to provide data center security solutions to smaller enterprises as they confront increasing security threats and compliance mandates. To capitalize on this opportunity, we intend to increase our business with mid-market enterprises and SMBs by expanding our cloud-based service offerings and our distribution channel. We have made, and may in the future continue to make, significant investments in our cloud-based security products to address the business security needs of mid-market enterprises and SMBs. If our cloud-based security products, which are relatively new, fail to gain broad acceptance with mid-market enterprises and SMBs, our revenue growth, results of operations and competitive position in our industry could suffer.

28-------------------------------------------------------------------------------- Table of Contents Compete Effectively. We operate in an intensely competitive market that has witnessed significant consolidation in recent years with large companies acquiring many of our competitors. We track our success rate in competitive sales opportunities against certain competitors, some of which generate higher revenues and have greater market capitalizations than we do, and many of which are more established or have greater name recognition within our industry. Based upon our internal tracking of the results of such competitive sales opportunities, we believe that we have historically competed favorably against our larger competitors, and that we have a proven track record of successfully competing against such larger competitors. Nonetheless, some of our larger competitors have numerous advantages, including, but not limited to, greater financial resources, broader product offerings and more established relationships with channel partners and customers. If we are unable to compete effectively for a share of the business security market, our business, results of operations and financial condition could be materially and adversely affected.

To date, we have incurred, and continue to incur, losses from operations and net losses. However, we believe that our existing cash, cash equivalents and short-term investments will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Further, we expect that, if we successfully execute our business plan and strategy, our loss from operations and our net losses will decline, and that we will reach profitability. Should we need additional cash in the future, we may utilize existing lines of credit, enter into additional lines of credit or raise funds through the sale of equity securities.

Key Metrics of Our Business We monitor the key financial metrics discussed below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies.

Net Revenue. We measure our net revenue to assess the acceptance of our products from our customers, our growth in the markets we serve and to help us establish our strategic and operating plans for future periods. We discuss the components of our net revenue in "-Financial Overview-Net Revenue" below.

Gross Margin. We monitor our gross margin to assess the impact on our current and forecasted financial results from any changes to the pricing and mix of products we are selling to our customers.

Loss from Operations. We track our loss from operations to assess how effectively we are planning and monitoring our operations as well as controlling our operational costs, which are primarily driven by headcount.

Cash, Cash Equivalents and Short-term Investments. We evaluate the level of our cash, cash equivalents and short-term investments to ensure we have sufficient liquidity to fund our operations, including the development of future products and product enhancements and the expansion into new sales channels and territories.

Number of Customers. We believe our customer count is a key indicator of our market penetration, the productivity of our sales organization and the value that our products bring to our customer base. We also believe our existing customers represent significant future revenue opportunities for us.

We discuss for the periods presented revenue, gross margin, the components of loss from operations and number of customers further below under "-Segments" and "-Results of Operations", as applicable, and we discuss our cash and cash equivalents under "-Liquidity and Capital Resources." 29-------------------------------------------------------------------------------- Table of Contents We also believe that deferred revenue and cash flow from operations are key financial metrics for our business. The components of deferred revenue and cash flow from operations, as well as our rationale for monitoring these metrics, are discussed immediately below this table: For the three months ended or For the nine months ended or As of September 30, As of September 30, 2014 2013 2014 2013 (in thousands, except number of customers and percentages) Net revenue $ 42,675 $ 35,102 $ 112,633 $ 95,026 Gross margin 77.7 % 79.2 % 76.7 % 77.8 % Loss from operations $ (13,476 ) $ (3,745 ) $ (46,575 ) $ (15,468 ) Total deferred revenue $ 68,947 $ 52,648 $ 68,947 $ 52,648 Cash, cash equivalents and short-term investments $ 101,196 $ 106,825 $ 101,196 $ 106,825 Net cash provided by (used in) operations $ 2,546 $ (4,648 ) $ (1,087 ) $ 2,249 Number of customers 3,540 2,774 3,540 2,774 Deferred Revenue Our deferred revenue consists of amounts that have been invoiced but that have not yet been recognized as revenue. The majority of our deferred revenue balance consists of the unamortized portion of services revenue from maintenance and support contracts. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods. We also assess the increase in our deferred revenue balance plus revenue we recognized in a particular period as a measure of our sales activity for that period. While the change in our deferred revenue and revenue recognized in a given period comprise the majority of our sales activity during that period, they do not constitute the entire sales activity during the period. Our total sales activity also includes sales of products and services for which we have not yet met the criteria to recognize revenue or add such amounts to our deferred revenue balance. Revenue and deferred revenue from these transactions is recognized or recorded in future periods when we have met the required criteria. We discuss for the periods presented deferred revenue further below under "-Results of Operations." Net Cash Flow Provided By Operations We monitor cash flow from operations as a measure of our overall business performance. Our cash flow from operations is driven primarily by sales of our products and licenses and, to a lesser extent, from up-front payments from customers under maintenance and support contracts. Our primary uses of cash in operating activities are for personnel-related expenditures, costs of acquiring the hardware used for our appliances, marketing and promotional expenses and costs related to our facilities. 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 and stock-based compensation expenses, thereby allowing us to better understand and manage the cash needs of our business.

Segments During the three months ended March 31, 2014, we revised our business segments in order to better align them with our strategic approach to the markets and customers we serve. As a result, we no longer separately report the Incapsula segment and we now operate our business in one reportable segment, which is the development, marketing, sales, service and support of data center security solutions that protect high value applications and data assets in physical and virtual data centers. Operating segments are defined as components of an enterprise that engage in business activities for which separate financial information is available and evaluated by the chief operating decision maker in deciding how to allocate resources and assessing performance. The chief operating decision maker is the Company's Chief Executive Officer.

Financial Overview Net Revenue We derive our revenue from sales and licenses of our products and sales of our services.

30 -------------------------------------------------------------------------------- Table of Contents Our net revenue is comprised of the following: • Products and License Revenue-Product and license revenue is generated from sales of perpetual software licenses installed on hardware appliances or virtual appliances for our SecureSphere Business Security Suite. Our SecureSphere Business Security Suite consists of database security, file security and web application security. We offer multiple hardware appliance versions that accompany our software, each with different throughput capacities. Perpetual software license revenue is generated from sales of our appliances, licenses for additional users and add-on software modules. We also generate a small amount of hardware revenue from sales of spares or replacement appliances, demonstration units, third-party OEM units and accessories.

• Services Revenue-Services revenue consists of maintenance and support, professional services and training and subscriptions. Maintenance and support revenue is generated from support services that are bundled with appliances and add-on software modules. There are three levels of maintenance and support-Standard, Enhanced and Premium-and these are offered through agreements for one to five-year terms. Maintenance and support includes major and minor if-and-when available software updates; customer care, which includes our designated support engineer program; content updates from our advanced security research group, the ADC, and hardware replacement. Subscription revenue is generated from sales of our cloud-based services. Professional services revenue consists of fees we earn related to implementation and consulting services we provide our customers. Training services revenue consists of fees we earn related to training customers and partners on the use of our products. We expect that the services revenue from maintenance and support contracts will continue to grow along with the increase in the size of our installed base.

Most of our products and services are sold to customers in the Americas, primarily in the U.S., however, a significant portion of our revenue is generated from international sales. See Note 13 of "Notes to Condensed Consolidated Financial Statements" for a discussion of our financial information by geographic region. Our revenue by geographic region is as follows: For the three months ended For the nine months ended September 30, September 30, 2014 2013 2014 2013 Americas $ 22,801 $ 19,941 $ 63,731 $ 58,168 EMEA 12,929 9,737 30,543 22,239 APAC 6,945 5,424 18,359 14,619 Total net revenue $ 42,675 $ 35,102 $ 112,633 $ 95,026 Cost of Revenue Our total cost of revenue is comprised of the following: • Cost of Products and License Revenue-Cost of products and license revenue is comprised primarily of third-party hardware costs and royalty fees. Our cost of products and license revenue also includes personnel costs related to our operations team, shipping costs and write-offs for excess and obsolete inventory.

• Cost of Services Revenue-Cost of services revenue is primarily comprised of personnel costs of our technical support team, our professional consulting services and training teams and our Security Operations Center ("SOC") team. Cost of services revenue also includes facilities costs, subscription fees and depreciation. We expect that our cost of services revenue will increase in absolute dollars as we increase our headcount.

Operating Expenses Our operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel costs are the most significant component of our operating expenses and consist of wages, benefits and bonuses and, with regard to the sales and marketing expense, sales commissions. Personnel costs also include stock-based compensation. We expect operating costs to continue to increase in absolute dollars given our recent acquisitions and the related costs associated with the acquired personnel and business.

Research and Development Our research and development is focused on maintaining and improving our existing products and on new product development. A majority of our research and development expenses are comprised of personnel costs and, to a lesser extent, facility costs, hardware prototype costs, laboratory expenses and depreciation.

We expense research and development costs as incurred. We expect our research and development expenses to increase in absolute dollars as we continue to enhance our existing products and develop or acquire new products and services that address the emerging market for business security and regulatory compliance.

31 -------------------------------------------------------------------------------- Table of Contents Sales and Marketing Sales and marketing expense is the largest component of our operating expenses and consists primarily of personnel costs, including commissions and travel expenses. Sales and marketing expenses also include costs related to marketing and promotional activities, third-party referral fees and, to a lesser extent, facilities costs and depreciation. We expect our sales and marketing expenses to increase in absolute dollars as we expand our sales and marketing efforts worldwide.

General and Administrative General and administrative expense consists primarily of personnel costs as well as professional fees, facilities costs and depreciation. General and administrative personnel costs include our executive, finance, purchasing, order entry, human resources, information technology and legal functions. Our professional fees consist primarily of accounting, external legal, information technology and other consulting costs.

Amortization of acquired intangible assets Intangible assets acquired through acquisitions are amortized in operating expenses.

Other Income (Expense), net Other income (expense), net is comprised of the following items: • Interest Income-Interest income consists of interest earned on our cash, cash equivalents and short-term investments. We expect interest income will vary each reporting period depending on our average investment balances during the period and market interest rates.

• Interest Expense-Interest expense consists of interest accrued or paid on debt obligations.

• Foreign Currency Forward Contract Gains (Losses)-Foreign currency forward contract gains and losses pertain to the ineffective portion of derivative instruments that we have entered into primarily to manage our exposure to the variability in expected future expenses resulting from changes in foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes. We expect our foreign currency forward contract gains (losses) to continue to fluctuate in the future due to changes in foreign currency exchange rates.

• Foreign Currency Exchange Gains (Losses)-Foreign currency exchange gains and losses relate to transactions denominated in currencies other than the U.S. Dollar.

Provision for Income Taxes We operate in several tax jurisdictions and are subject to taxes in each country or jurisdiction in which we conduct business including the United States and Israel. Earnings from our non-U.S. activities are subject to local country income tax and may be subject to U.S. income tax if such earnings are distributed to the U.S. To date, we have incurred net losses and have recorded insignificant U.S. federal income tax expense. Our tax expense to date relates to foreign income taxes, mainly from our Israeli and United Kingdom activities, and to a lesser extent, state income taxes.

Results of Operations The following table is a summary of our consolidated statements of operations in dollars and as a percentage of our total revenue. We have derived the data for the three and nine months ended September 30, 2014 and 2013 from our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

32 -------------------------------------------------------------------------------- Table of Contents For the three months ended For the nine months ended September 30, September 30, 2014 2013 2014 2013 % of Net % of Net % of Net % of Net Amount Revenue Amount Revenue Amount Revenue Amount Revenue Net revenue: Products and license $ 19,642 46.0 % $ 18,178 51.8 % $ 48,199 42.8 % $ 48,003 50.5 % Services: Maintenance and support 13,879 32.5 % 11,139 31.7 % 40,064 35.6 % 31,926 33.6 % Professional services and training 2,774 6.5 % 2,724 7.8 % 8,154 7.2 % 7,495 7.9 % Subscriptions 6,380 15.0 % 3,061 8.7 % 16,216 14.4 % 7,602 8.0 % Total Services 23,033 54.0 % 16,924 48.2 % 64,434 57.2 % 47,023 49.5 % Total net revenue 42,675 100.0 % 35,102 100.0 % 112,633 100.0 % 95,026 100.0 % Cost of revenue: Products and license 2,299 5.4 % 1,894 5.4 % 6,106 5.4 % 6,216 6.5 % Services 7,202 16.9 % 5,396 15.4 % 20,181 17.9 % 14,909 15.7 % Total cost of revenue 9,501 22.3 % 7,290 20.8 % 26,287 23.3 % 21,125 22.2 % Gross profit 33,174 77.7 % 27,812 79.2 % 86,346 76.7 % 73,901 77.8 % Operating expenses: Research and development 10,459 24.5 % 6,725 19.2 % 32,038 28.4 % 19,729 20.8 % Sales and marketing 26,853 62.9 % 20,135 57.4 % 74,953 66.5 % 55,963 58.9 % General and administrative 8,987 21.1 % 4,697 13.4 % 25,013 22.2 % 13,677 14.4 % Amortization of purchased intangibles 351 0.8 % - 0.0 % 917 0.9 % - 0.0 % Total operating expenses 46,650 109.3 % 31,557 90.0 % 132,921 118.0 % 89,369 94.1 % Loss from operations (13,476 ) -31.6 % (3,745) -10.8 % (46,575 ) -41.3 % (15,468 ) -16.3 % Other income (expense), net 48 0.1 % 113 0.3 % (321 ) -0.3 % 11 0.0 % Loss before provision (benefit) for income taxes (13,428 ) -31.5 % (3,632 ) -10.3 % (46,896 ) -41.6 % (15,457 ) -16.3 % Provision (benefit) for income taxes 190 0.4 % 288 0.8 % (216 ) -0.2 % 703 0.7 % Net loss (13,618 ) -31.9 % (3,920 ) -11.2 % (46,680 ) -41.4 % (16,160 ) -17.0 % Loss attributable to noncontrolling interest - 0.0 % 145 0.4 % 213 0.1 % 411 0.4 % Net loss attributable to Imperva, Inc. stockholders $ (13,618 ) -31.9 % $ (3,775 ) -10.9 % $ (46,467 ) -41.3 % $ (15,749 ) -16.6 % 33 -------------------------------------------------------------------------------- Table of Contents Comparison of the Three Months and Nine Months Ended September 30, 2014 and 2013 For the three months ended For the nine months ended September 30, Change September 30, 2014 2013 Amount % 2014 2013 Change (dollars in thousands) Net revenue: Products and license $ 19,642 $ 18,178 $ 1,464 8.1 % $ 48,199 $ 48,003 $ 196 0.4 % Percentage of net revenue 46.0 % 51.8 % 42.8 % 50.5 % Services: Maintenance and support 13,879 11,139 2,740 24.6 % 40,064 31,926 8,138 25.5 % Percentage of net revenue 32.5 % 31.7 % 35.6 % 33.6 % Professional services and training 2,774 2,724 50 1.8 % 8,154 7,495 659 8.8 % Percentage of net revenue 6.5 % 7.8 % 7.2 % 7.9 % Subscriptions 6,380 3,061 3,319 108.4 % 16,216 7,602 8,614 113.3 % Percentage of net revenue 15.0 % 8.7 % 14.4 % 8.0 % Total Services 23,033 16,924 6,109 36.1 % 64,434 47,023 17,411 37.0 % Percentage of net revenue 54.0 % 48.2 % 57.2 % 49.5 % Total net revenue $ 42,675 $ 35,102 $ 7,573 21.6 % $ 112,633 $ 95,026 $ 17,607 18.5 % Americas $ 22,801 $ 19,941 $ 2,860 14.3 % $ 63,731 $ 58,168 $ 5,563 9.6 % Percentage of net revenue 53.4 % 56.8 % 56.6 % 61.2 % EMEA 12,929 9,737 3,192 32.8 % 30,543 22,239 8,304 37.3 % Percentage of net revenue 30.3 % 27.7 % 27.1 % 23.4 % APAC 6,945 5,424 1,521 28.0 % 18,359 14,619 3,740 25.6 % Percentage of net revenue 16.3 % 15.5 % 16.3 % 15.4 % Total net revenue $ 42,675 $ 35,102 $ 7,573 21.6 % $ 112,633 $ 95,026 $ 17,607 18.5 % Three Months Ended September 30, 2014 Compared with Three Months Ended September 30, 2013 Our net revenue increased by $7.6 million, or 21.6%, to $42.7 million during the three months ended September 30, 2014 from $35.1 million during the three months ended September 30, 2013 primarily due to growth in services revenue. This revenue growth reflects the increasing demand for our subscription service offerings as well as a broader installed base of product and licenses which generate higher maintenance and support revenues. The EMEA region contributed the largest portion of this growth with a $3.2 million increase over the same period in 2013 while revenue for the Americas region grew by $2.9 million. The revenue growth in the EMEA region in the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 was primarily due to increased services revenue as we increased our customer base and continued to renew expiring customer maintenance agreements, and increased revenue from subscription sales of our cloud-based services. The Americas region experienced a similar increase in services revenue.

Products and license revenue increased by $1.5 million, or 8.1%, to $19.6 million during the three months ended September 30, 2014 from $18.2 million during the three months ended September 30, 2013. The change in product and license revenue was mostly driven by an increase in the APAC region in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. This increase was due to increased sales volume of our products.

Services revenue increased by $6.1 million, or 36.1%, to $23.0 million during the three months ended September 30, 2014 from $16.9 million during the three months ended September 30, 2013. During the three months ended September 30, 2014, our services revenue was comprised of $13.9 million in maintenance and support, $2.8 million in professional services and training and $6.4 million in subscriptions. The change in services revenue in the three months ended September 30, 2014 from the three months ended September 30, 2013 was primarily due to an increase of $3.3 million in subscriptions revenue resulting from our cloud-based security services and ThreatRadar, in addition to $2.7 million in maintenance and support revenue from our larger installed base.

34-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 Compared with Nine Months Ended September 30, 2013 Our net revenue increased by $17.6 million, or 18.5%, to $112.6 million during the nine months ended September 30, 2014 from $95.0 million during the nine months ended September 30, 2013 primarily due to growth in services revenue.

This revenue growth reflects the increasing demand for our subscription service offerings as well as a broader installed base of product and licenses which generate higher maintenance and support revenues. The EMEA region contributed the largest portion of this growth with an $8.3 million increase over the same period in 2013. Revenue growth in the EMEA region in the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013 was primarily due to increased services revenue as we increased our customer base and continued to renew expiring customer maintenance agreements, increased revenue from subscription sales of our cloud-based services, and, to a lesser extent, increased sales of both product and licenses.

Services revenue increased by $17.4 million, or 37.0%, to $64.4 million during the nine months ended September 30, 2014 from $47.0 million during the nine months ended September 30, 2013. During the nine months ended September 30, 2014, our services revenue was comprised of $40.1 million in maintenance and support, $8.2 million in professional services and training and $16.2 million in subscriptions. The change in services revenue in the nine months ended September 30, 2014 from the nine months ended September 30, 2013 was primarily due to an increase of $8.6 million in subscriptions revenue resulting from our cloud-based security services and ThreatRadar, $0.7 million in professional services and training revenues, and $8.1 million in maintenance and support revenue from our larger installed base.

Products and license revenue increased by $0.2 million, or 0.4%, to $48.2 million during the nine months ended September 30, 2014 from $48.0 million during the nine months ended September 30, 2013. The change in product and license revenue was primarily due to an increase of $1.8 million in the EMEA region and an increase of $1.5 million in the APAC region offset by a decrease of $3.1 million in the Americas region during the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The decrease in the Americas region product and license revenue was primarily due to extended sales cycles for orders resulting from a combination of sales execution challenges in the United States and intensifying competition for orders exceeding $100,000.

Gross Profit For the three months ended For the nine months ended September 30, September 30, 2014 2013 % Change 2014 2013 % Change (dollars in thousands) Products and license $ 17,343 $ 16,284 $ 42,093 $ 41,787 Gross Margin % 88.3 % 89.6 % -1.3 % 87.3 % 87.1 % 0.2 % Services gross profit 15,831 11,528 44,253 32,114 Gross Margin % 68.7 % 68.1 % 0.6 % 68.7 % 68.3 % 0.4 % Total gross profit $ 33,174 $ 27,812 $ 86,346 $ 73,901 Gross Margin % 77.7 % 79.2 % -1.5 % 76.7 % 77.8 % -1.1 % Three Months Ended September 30, 2014 Compared with Three Months Ended September 30, 2013 Total gross margin decreased 1.5 percentage points from 79.2% during the three months ended September 30, 2013 to 77.7% during the three months ended September 30, 2014 primarily due to a products and license gross margin decline of 1.3% to 88.3% for the three months ended September 30, 2014 as compared to 89.6% for the three months ended September 30, 2013, partially offset by an increase in services gross margin of 0.6% to 68.7% for the three months ended September 30, 2014 as compared to 68.1% for the three months ended September 30, 2013. The product and licenses gross margin decline was primarily attributable to a higher proportion of stand-alone hardware product revenues to total products and licenses revenues in the three months ended September 30, 2014 as compared to the comparable 2013 period.

Nine Months Ended September 30, 2014 Compared with Nine Months Ended September 30, 2013 Total gross margin decreased 1.1 percentage points from 77.8% during the nine months ended September 30, 2013 to 76.7% during the nine months ended September 30, 2014 primarily due to an increased proportion of services revenue to total revenues for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013.

35-------------------------------------------------------------------------------- Table of Contents Operating Expenses For the three months ended For the nine months ended September 30, Change September 30, Change 2014 2013 Amount % 2014 2013 Amount % (dollars in thousands) Operating expenses: Research and development $ 10,459 $ 6,725 $ 3,734 55.5 % $ 32,038 $ 19,729 $ 12,309 62.4 % Percentage of net revenue 24.5 % 19.2 % 28.4 % 20.8 % Sales and marketing 26,853 20,135 6,718 33.4 % 74,953 55,963 18,990 33.9 % Percentage of net revenue 62.9 % 57.4 % 66.5 % 58.9 % General and administrative 8,987 4,697 4,290 91.3 % 25,013 13,677 11,336 82.9 % Percentage of net revenue 21.1 % 13.4 % 22.2 % 14.4 % Amortization of purchased intangibles 351 - 351 100.0 % 917 - 917 100.0 % Percentage of net revenue 0.8 % 0.0 % 0.8 % 0.0 % Total operating expenses $ 46,650 $ 31,557 $ 15,093 47.8 % $ 132,921 $ 89,369 $ 43,552 48.7 % Results above include stock-based compensation expense of: For the three months ended For the nine months ended September 30, September 30, 2014 2013 Change 2014 2013 Change (dollars in thousands) Cost of revenues $ 569 $ 254 $ 315 $ 1,472 $ 722 $ 750 Research and development 2,353 835 1,518 6,335 2,221 4,114 Sales and marketing 3,730 1,620 2,110 9,369 4,596 4,773 General and administrative 4,123 704 3,419 8,930 2,319 6,611 $ 10,775 $ 3,413 $ 7,362 $ 26,106 $ 9,858 $ 16,248 Three Months Ended September 30, 2014 Compared with Three Months Ended September 30, 2013 Research and development expenses increased by $3.7 million, or 55.5%, to $10.4 million during the three months ended September 30, 2014 from $6.7 million during the three months ended September 30, 2013. The change was primarily attributable to an increase of $3.6 million in personnel costs, including stock-based compensation, due to additional research and development personnel being hired to support our ongoing product development efforts and also personnel costs related to our recently completed Skyfence and Tomium acquisitions.

Sales and marketing expenses increased by $6.7 million, or 33.4%, to $26.8 million during the three months ended September 30, 2014 from $20.1 million during the three months ended September 30, 2013. The change was principally related to an increase of $5.5 million in personnel costs, including stock-based compensation and contractor costs, due to increased headcount in all regions in an effort to help drive our overall revenue growth in addition to hiring related to our Skyfence acquisition. We also incurred increases in trade show, corporate marketing and seminar costs totaling $0.6 million.

General and administrative expenses increased by $4.3 million, or 91.3%, to $9.0 million during the three months ended September 30, 2014 from $4.7 million during the three months ended September 30, 2013. The change was primarily due to an increase of $3.9 million in personnel costs, including stock-based compensation, to build out our corporate level functions to support global growth in addition to headcount costs related to the acquisition of Skyfence. In addition, we incurred increased legal expenses of $0.5 million.

Amortization of purchased intangibles increased by $0.4 million during the three months ended September 30, 2014 related to the acquisitions of Skyfence and Tomium completed during the first quarter of 2014. There was no such amortization in the prior year.

Nine Months Ended September 30, 2014 Compared with Nine Months Ended September 30, 2013 Research and development expenses increased by $12.3 million, or 62.4%, to $32.0 million during the nine months ended September 30, 2014 from $19.7 million during the nine months ended September 30, 2013. The increase during the nine months ended September 30, 2014 was primarily attributable to an increase of $12.3 million in personnel costs, including stock-based compensation, due to additional research and development personnel being hired to support our ongoing product development efforts and also personnel costs related to our recently completed Skyfence and Tomium acquisitions.

36-------------------------------------------------------------------------------- Table of Contents Sales and marketing expenses increased by $19.0 million, or 33.9%, to $75.0 million during the nine months ended September 30, 2014 from $56.0 million during the nine months ended September 30, 2013. The change was principally related to an increase of $14.3 million in personnel costs, including stock-based compensation and contractor costs, due to increased headcount in all regions in an effort to help drive our overall revenue growth in addition to hiring related to our Skyfence acquisition. Increases in trade show, corporate marketing and seminar costs, travel, and costs totaling $4.9 million also contributed to the increase in the nine months ended September 30, 2014 as compared to the prior year comparable period.

General and administrative expenses increased by $11.3 million, or 82.9%, to $25.0 million during the nine months ended September 30, 2014 from $13.7 million during the nine months ended September 30, 2013. The change was primarily due to an increase of $8.4 million in personnel costs, including stock-based compensation, to build out our corporate level functions to support global growth in addition to headcount cost related to the acquisition of Skyfence. In addition, general and administrative expenses increased due to $2.7 million of legal and accounting costs related to the acquisitions of Skyfence, Tomium and the remaining interest in Incapsula that we did not previously own, all completed during the first quarter of 2014.

Amortization of purchased intangibles increased by $0.9 million during the nine months ended September 30, 2014 related to the acquisitions of Skyfence and Tomium completed during the first quarter of 2014. There was no such amortization in the prior year.

Loss from Operations Three months ended Nine months ended September 30, September 30, 2014 2013 Change % Change 2014 2013 Change % Change (dollars in thousands) $ (13,476) $ (3,745) $ (9,731) -259.8 % $ (46,575) $ (15,468) $ (31,107) -201.1 % Three Months Ended September 30, 2014 Compared with Three Months Ended September 30, 2013 Our loss from operations increased by $9.7 million, or 259.8%, to $13.4 million for the three months ended September 30, 2014 from $3.7 million for the three months ended September 30, 2013. Total operating expenses increased by $15.1 million during the three months ended September 30, 2014 when compared to the prior year period principally due to increases in personnel costs, including stock-based compensation expense, to support the increase in scope and global reach of our business and to incorporate the acquisitions of Skyfence and Tomium, which were closed in the first quarter of 2014. The increase in operating expenses was comprised of increased sales and marketing costs of $6.7 million to expand our global sales efforts, and an increase of $3.7 million of research and development costs to support our ongoing product development efforts and also new personnel associated with the Skyfence and Tomium acquisitions. In addition, we had increased general and administrative costs and amortization of purchased intangibles of $4.6 million, the majority of which was personnel expenses related to the acquired businesses. This increase in operating expenses was partially offset by an increase in our gross profit of $5.4 million during the three months ended September 30, 2014 due to higher net revenues.

Nine Months Ended September 30, 2014 Compared with Nine Months Ended September 30, 2013 Our loss from operations increased by $31.1 million, or 201.1%, to $46.6 million for the nine months ended September 30, 2014 from $15.5 million for the nine months ended September 30, 2013. Total operating expenses increased by $43.6 million during the nine months ended September 30, 2014 when compared to the prior year period principally due to increases in personnel costs, including stock-based compensation expense, to support the increase in scope and global reach of our business and to incorporate the recently completed acquisitions of Skyfence and Tomium. The increase in operating expenses was comprised of increased sales and marketing costs of $19.0 million to expand our global sales efforts, and an increase of $12.3 million of research and development costs to support our ongoing product development efforts and also new personnel associated with the Skyfence and Tomium acquisitions. In addition, we had increased general and administrative costs and amortization of purchased intangibles totaling $12.3 million, the majority of which were personnel and legal expenses associated with the acquisition completed during the first quarter of 2014. This increase in operating expenses was partially offset by an increase in our gross profit of $12.4 million during the nine months ended September 30, 2014 due to higher net revenues.

37-------------------------------------------------------------------------------- Table of Contents Other Income (Expense), net Three months ended Nine months ended September 30, Change September 30, Change 2014 2013 Amount % 2014 2013 Amount % (dollars in thousands) $ 48 $ 113 $ (65 ) -57.5 % $ (321) $ 11 $ (332) 3018.2 % Other income (expense), net changed by $65,000 during the three months ended September 30, 2014 when compared to the three months ended September 30, 2013.

The change was primarily due to an increase of $129,000 in foreign exchange gains, net, offset by a decrease of $69,000 in investment income due to lower yields earned on invested balances.

Other income (expense), net changed by $0.3 million during the nine months ended September 30, 2014 when compared to the nine months ended September 30, 2013.

The change was primarily due to a decrease of $0.2 million in investment income, net, due to lower yields earned on invested balances and an increase of $0.1 million in interest expense accrued for a cash holdback liability in connection with the Skyfence acquisition.

Provision (Benefit) for Income Taxes Three months ended Nine months ended September 30, Change September 30, Change 2014 2013 Amount % 2014 2013 Amount % (dollars in thousands) Provision (benefit) for income taxes $ 190 $ 288 $ (98 ) -34.0 % $ (216 ) $ 703 $ (919 ) -130.7 % Effective tax rate -1.4 % -7.9 % 0.5 % -4.5 % The provision (benefit) for income taxes for the three months ended September 30, 2014 and 2013 is comprised primarily of foreign income taxes. The decrease of $0.1 million in the provision during the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 is primarily attributable to the recognition of deferred tax assets for foreign losses.

The provision for income taxes for the nine months ended September 30, 2014 and 2013 is comprised primarily of foreign income taxes. During the nine months ended September 30, 2014, the benefit is primarily attributable to the recognition of deferred tax assets for foreign losses incurred totaling $1.0 million.

38 -------------------------------------------------------------------------------- Table of Contents Deferred Revenue As of September 30, Change 2014 2013 Amount % (dollars in thousands) Total deferred revenue $ 68,947 $ 52,648 $ 16,299 31.0 % Deferred revenue increased by $16.3 million, or 31.0%, to $68.9 million as of September 30, 2014 from $52.6 million as of September 30, 2013. The growth in our deferred revenue was primarily attributable to an increase in our installed base of products and licenses worldwide and resulting renewals of maintenance and support agreements, as well as new sales of maintenance and support, and subscription agreements.

Number of Customers As of September 30, Change 2014 2013 Amount % (dollars in thousands) Number of customers 3,540 2,774 766 27.6 % Our number of customers increased by 766, or 27.6%, to 3,540 as of September 30, 2014 from 2,774 as of September 30, 2013. Our growth in customer count was driven by increasing market acceptance of our products as well as an increase in our global sales and services and support organizations from 265 people as of September 30, 2013 to 316 as of September 30, 2014. The growth in our sales and services and support organizations was consistent with our plans to continue expanding our global sales and support coverage, in particular for our channel partner sales and support teams. The increase in our services and support organization allowed us to target new customers while continuing to support our existing customers across all of our geographies.

Liquidity and Capital Resources To date, we have satisfied our capital and liquidity needs through sales of our products and services, our initial public offering of common stock, and private placements of convertible preferred stock. We have incurred significant losses as we continue to expand our business. Our cash flows from operating activities will continue to be affected principally by the extent to which our revenue exceeds or does not exceed any increase in spending on personnel to support the growth of our business. Our largest source of operating cash flow is cash collections from our customers.

Capital Resources As of September 30, 2014, we had $101.2 million of cash, cash equivalents and short-term investments, $4.4 million of which is currently held outside of the United States and not presently available to fund domestic operations and obligations. If we were to repatriate cash held outside of the United States, it could be subject to U.S. income taxes on such amounts, less any previously paid foreign income taxes. Our cash, cash equivalents and short-term investments have increased from $17.7 million as of December 31, 2010 to $101.2 million as of September 30, 2014. This increase is primarily the result of our initial public offering of common stock in November 2011 in which we raised $86.2 million, after deducting underwriters' discounts and offering expenses. We believe our existing cash, cash equivalents and short-term investments will be sufficient to meet our working capital and capital expenditure needs for at least 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, the acquisition of other businesses and overall economic conditions.

As of September 30, 2014, we had no amounts outstanding under our credit facility agreement with a financial institution. The credit facility agreement, as amended, provides for borrowing capacity up to $6.0 million and contains a minimum cash and cash equivalents balance covenant of $3.0 million. The credit facility expires on May 1, 2015. As of September 30, 2014, we were compliant with the covenant of the credit facility.

39-------------------------------------------------------------------------------- Table of Contents Cash Flows The following summary of our cash flows for the periods indicated has been derived from our consolidated financial statements which are included elsewhere in this Quarterly Report on Form 10-Q: Nine months ended September 30 2014 2013 (dollars in thousands) Net cash provided by (used in) operating activities $ (1,087 ) $ 2,249 Net cash provided by (used in) investing activities $ (13,178 ) $ 4,721 Net cash provided by financing activities $ 3,362 $ 4,674 Cash Flows from Operating Activities Our largest uses of cash from operating activities are for employee related expenditures. Our primary source of cash flow from operating activities is cash receipts from customers. Our cash flow from operations will continue to be affected principally by the extent to which we grow our revenues and increase our headcount, primarily in our sales and marketing and research and development functions, in order to grow our business.

Net cash used in operating activities of $1.1 million for the nine months ended September 30, 2014 reflected a net loss of $46.7 million, adjusted for non-cash charges of $29.9 million, as well as a net change of $15.7 million in our net operating assets and liabilities. The net change in our operating assets and liabilities was primarily the result of a decrease in our accounts receivable of $8.9 million and an increase of deferred revenue of $5.9 million.

Net cash provided by operating activities of $2.2 million for the nine months ended September 30, 2013 reflected a net loss of $16.2 million, adjusted for non-cash charges of $12.3 million, as well as a net change of $6.1 million in our net operating assets and liabilities. The net change in our operating assets and liabilities was primarily the result of an increase in deferred revenue of $6.4 million, which represents unearned amounts billed to our customers, resulting from our larger installed base combined with strong maintenance and support renewal rates from our existing customers, and an increase in accrued compensation and benefits of $2.5 million. This increase was partially offset by an increase in our accounts receivable of $1.1 million, an increase in prepaid expenses and other assets of $0.7 million and a decrease in accounts payable of $0.7 million.

Cash Flows from Investing Activities Our investing activities consist primarily of cost of acquisitions, expenditures to purchase property and equipment and purchases and sales of short-term investments. Cash used in investing activities during the nine months ended September 30, 2014 was $13.2 million, primarily resulting from the acquisitions of Skyfence and Tomium for $12.1 million in addition to $3.7 million in capital expenditures, partially offset by net proceeds from the maturity of short-term investments of $2.9 million.

During the nine months ended September 30, 2013, cash provided by investing activities was $4.7 million, primarily as a result of $36.2 million in maturities of short-term investments partially offset by $1.8 million in capital expenditures and $29.8 in purchases of short-term investments.

Cash Flows from Financing Activities Net cash provided by financing activities was $3.4 million for the nine months ended September 30, 2014 primarily as a result of proceeds received from the exercise of stock options and sale of common stock under our employee stock purchase plan, net of repurchases.

Net cash provided by financing activities was $4.7 million for the nine months ended September 30, 2013 primarily as a result of proceeds received from the exercise of stock options and sale of common stock under our employee stock purchase plan.

40 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following summarizes our contractual obligations as of September 30, 2014: Payments Due by Period Contractual Obligations: 2014 2015 2016 2017 2018 Thereafter Total Operating lease obligations(1) $ 1,267 $ 5,240 $ 5,429 $ 4,775 $ 3,248 $ 378 $ 20,337 Severance Pay Fund(2) - - - - - - 4,331 Purchase commitments(3) - - - - - - 6,327 Total $ 1,267 $ 5,240 $ 5,429 $ 4,775 $ 3,248 $ 378 $ 30,995 (1) Operating lease agreements represent our obligations to make payments under our non-cancelable lease agreements for our facilities. During the nine months ended September 30, 2014, we made regular lease payments of $3.1 million under the operating lease agreements.

(2) Our consolidated balance sheet as of September 30, 2014 includes $4.3 million of non-current liabilities for our Israeli severance pay fund. The specific timing of any cash payments relating to this obligation cannot be projected with reasonable certainty and, therefore, no amounts for this obligation are included in the annual columns of the table set forth above.

(3) Purchase commitments are contractual obligations to purchase hardware appliances and related component parts from our vendors in advance of anticipated sales.

Off-Balance Sheet Arrangements Through September 30, 2014, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations is based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates, assumptions and judgments that can have significant impact on the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. We base our estimates, assumptions and judgments on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. On a regular basis we evaluate our estimates, assumptions and judgments and make changes accordingly.

We believe that the estimates, assumptions and judgments involved in revenue recognition, stock-based compensation, long-lived assets, and accounting for income taxes have the greatest potential impact on our Consolidated Financial Statements, so we consider these to be our critical accounting policies.

Historically, our estimates, assumptions and judgments relative to our critical accounting policies have not differed materially from actual results. The critical accounting estimates associated with these policies are described in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2013 Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Other than the change to our segment reporting and our policy for goodwill and acquired intangible assets, as more fully described in Note 1 to our Condensed Consolidated Financial Statements, there have been no material changes to our significant accounting policies as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2013.

Recent Accounting Pronouncements See Note 1 to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

[ Back To TMCnet.com's Homepage ]