UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2018
Or
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 001-38270
AQUANTIA CORP.
(Exact Name of Registrant as Specified in its Charter)
Delaware | | 20-1199709 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
91 E. Tasman Drive, Suite 100
San Jose, CA 95134
(Address of principal executive offices)
Registrant’s telephone number, including area code: (408) 228-8300
Securities registered pursuant to Section 12(b) of the Act:
Title of Class | | Name of Exchange on Which Registered |
Common Stock, $0.00001 par value | | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☐ | | Accelerated filer | ☒ |
Non-accelerated filer | ☐ | | Small reporting company | ☐ |
Emerging growth company | ☒ | | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant on June 29, 2018 was $214,546,736, based on the last reported sale price of the common shares on The New York Stock Exchange on such date of $11.58 per share.
As of February 28, 2019, the registrant had 35,174,345 shares of common stock, $0.00001 par value per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates by reference certain information from the registrant’s definitive proxy statement for the 2019 Annual Meeting of Stockholders to be filed no later than 120 days after the conclusion of the registrant’s fiscal year ended December 31, 2018.
AQUANTIA CORP.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are subject to the ‘‘safe harbor’’ created by those sections. This report contains forward-looking statements. We may, in some cases, use words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of those terms, and similar expressions that convey uncertainty of future events or outcomes to identify these forward-looking statements. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. Forward-looking statements in this report include, but are not limited to, statements about:
| • | our ability to retain and expand our customer relationships and to achieve design wins; |
| • | the success, cost and timing of existing and future product designs; |
| • | our ability to address market and customer demands and to timely develop new or enhanced solutions to meet those demands; |
| • | the size and growth potential of the markets for our solutions, including as to the number of units to be sold and the price therefor that have been formulated based on current information and are subject to change as a result of the evolving technological landscape, competitive market dynamics and unforeseen developments; |
| • | our ability to serve our target markets; |
| • | anticipated trends, challenges and growth in our business and the markets in which we operate, including pricing expectations and effects of seasonality in our business; |
| • | our expectations regarding our revenue, gross margin and expenses; |
| • | our expectations regarding competition in our existing and new markets; |
| • | regulatory developments in the United States and foreign countries; |
| • | the performance of our third-party suppliers and manufacturers; |
| • | our and our customers’ ability to respond successfully to technological or industry developments; |
| • | our ability to attract and retain key management personnel; |
| • | the average selling prices of semiconductor solutions; |
| • | the accuracy of our estimates regarding capital requirements and needs for additional financing; |
| • | the industry standards to which our solutions conform; and |
| • | our expectations regarding our ability to obtain and maintain intellectual property protection for our technology. |
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These forward-looking statements reflect our management’s beliefs and views with respect to future events and are based on estimates and assumptions as of the date of this report and, while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. We discuss many of these risks in greater detail under the section titled “Risk Factors.” Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We cannot assure you that the forward-looking statements in this report will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame or at all. We expressly disclaim any and undertake no obligation to publicly update or revise any forward-looking statements contained herein, whether as a result of new information, future events or otherwise, except as required by law. You should read this report and the exhibits hereto and the documents incorporated by reference herein, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of the forward-looking statements in this report by these cautionary statements.
All references to “Aquantia,” “we,” “us” or “our” mean AQUANTIA CORP.
We have obtained or are in the process of obtaining registered trademarks for Aquantia, AQrate, AQcelerate and QuantumStream. This report contains references to our trademarks and to trademarks belonging to other entities. Solely for convenience, trademarks and trade names referred to in this report, including logos, artwork and other visual displays, may appear without the ® or ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensor to these trademarks and trade names. We do not intend our use or display of other companies’ trade names or trademarks to imply a relationship with, or endorsement or sponsorship of us by, any other companies.
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INDUSTRY AND MARKET DATA
Unless otherwise indicated, information contained in this report concerning our industry and the markets in which we operate, including our general expectations and market position, market opportunity, and market size, is based on information and data from various sources, on assumptions that we have made that are based on that information and data and other similar sources, and on our knowledge of the markets for our products and services. This information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such information. While we believe the market position, market opportunity and market size information included in this report is generally reliable, such information is inherently imprecise. In addition, projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate is necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in the section titled “Risk Factors” and elsewhere in this report. These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.
Certain information in this report is contained in:
| • | Dell’oro Group, Inc., WLAN CPE Forecast—July 2017; |
| • | Cisco Systems, Cisco Visual Networking Index: Forecast and Methodology, 2017-2022 White Paper— 2018; |
| • | IDC Worldwide Networking Technologies Embedded in PCs Forecast, 2017–2021—March 2017; |
| • | Strategy Analytics, The Connected, Automated Vehicle - Meeting the Challenges of Car 2.0—November 2017; |
| • | 650 Group LLC, Long-range Multi-Gig Forecast—Enterprise and SMB switches, plus WLAN APs, speeds from 1 to 10GbE—July 2018; |
| • | Crehan Research, Inc., Long-range Forecast—Data Center Switch Total—January 2018; and |
| • | Crehan Research, Inc., Long-range Forecast—Server-class Adapter & LOM_Controller—January 2018. |
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GLOSSARY
The following capitalized phrases and their acronyms are used throughout this report and have the meanings set forth below:
802.3bz, 802.3bx, 802.11b/g/n, 802.11ac, 802.11ax: the standards introduced by IEEE for Ethernet over twisted pair copper wire at speeds of 2.5GbE and 5GbE.
ADC: Analog-to-digital converter.
AFE: Analog Front-End, the portion of an integrated circuit that receives and processes external analog signals.
AP: Access Point, a networking hardware device that allows wireless devices to connect to a network using Wi-Fi.
AQrate: Aquantia’s proprietary technology that provides 2.5GbE and 5GbE transmission speeds.
ASIC: an application specific integrated circuit.
ASSP: an application specific standard product.
Attenuation: reduction in the strength of a signal.
BASE-T: an acronym used by IEEE to identify an Ethernet protocol characterized by a broadband modulation of a signal transmitted over a twisted-pair copper cabling.
Cat5e and Cat6: twisted-pair copper cabling; typically used in legacy enterprise infrastructure.
CMOS: Complementary Metal-Oxide Semiconductor, which is a transistor technology used for the fabrication of integrated circuits.
Crosstalk: a phenomenon by which a signal creates an undesired effect on another signal, a type of noise that is often experienced with analog signals transmitted over twisted-pair cables.
DAC: Digital-to-analog converter.
Data Center: a facility used to house computing and networking systems and associated components, such as storage systems.
Design Tool: a software application that is used to design, simulate, verify and implement the functionality of an integrated circuit. The final output of the design tool is used to create an IC mask set.
Die: a small block of semiconducting material on which a given functional circuit is fabricated.
Echo: a type of noise that corresponds to the reflection of the transmitted signal unintentionally coupled into the received signal.
Ethernet: the most widely installed local area network (LAN) technology, which is a link layer protocol, describing how networked devices can format data for transmission to other network devices on the same network segment, and how to put that data out on the network connection.
Enterprise: hardware and software designed to meet the demands of a large organization, rather than individual users.
Footprint: the amount of space that part or all of an integrated circuit occupies.
Foundry: an enterprise that manufactures ICs and related components.
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GbE: a term which describes various technologies that transmit Ethernet frames. GbE or 1GbE refers to such transmission at a rate of one Gbps, 5GbE refers to such transmission at a rate of five Gbps and 10GbE refers to such transmission at a rate of 10Gbps.
Gbps: a measure of bandwidth on digital transmission medium representing billions of bits per second.
IC: integrated circuit, which is a semiconductor device on which an electronic circuit is formed. This is also referred to as a “chip” or a microchip.
IEEE: Institute of Electrical and Electronic Engineers, a technical professional society, dedicated to the advancement of technology.
IP: Internet protocol, which is the method or protocol by which data is sent from one computer to another on the Internet.
LAN: Local Area Network.
MCSP: Our proprietary Multi-Core Signal Processing technology, which incorporates multiple customized units to more efficiently process digital signals.
MMSP: Our proprietary Mixed-Mode Signal Processing technology, which partitions signal processing across analog and digital domains.
nm: nanometer, which is a unit of length in the metric system, equal to one billionth of a meter.
OEM: an original equipment manufacturer.
OSI: Open Systems Interconnection model
PHY: an abbreviation for the physical layer circuitry. A PHY connects a link layer device (often called MAC as an abbreviation for media access control) to a physical medium such as an optical fiber or copper cable.
PLD: programmable logic device, which is an electronic component used to build reconfigurable digital circuits.
Process Nodes: the transistor width used to define a semiconductor manufacturing process. Smaller widths allow more transistors to be manufactured in the same silicon area. Process node is typically measured in nanometers, or nm (e.g., 28nm, 40nm, 90nm).
Serializer/Deserializer or SerDes: a pair of functional blocks commonly used in high speed communications, which convert data between serial and parallel interfaces.
SFP+: a small form factor module designed to operate at 10Gbps that is pluggable into a system.
WAN: Wide-Area Network.
WLAN: Wireless Local Area Network.
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PART I
Overview
We are a leader in the design, development and marketing of advanced high-speed communications integrated circuits, or ICs, for Ethernet connectivity in the data center, enterprise infrastructure, access and automotive markets. Our Ethernet solutions provide a critical interface between the high-speed analog signals transported over wired infrastructure and the digital information used in computing and networking equipment. Our products are designed to cost-effectively deliver leading-edge data speeds for use in the latest generation of communications infrastructure to alleviate network bandwidth bottlenecks caused by the exponential growth of global Internet Protocol, or IP, traffic. Many of our semiconductor solutions have established benchmarks in the industry in terms of performance, power consumption and density. Our innovative solutions enable our customers to differentiate their product offerings, position themselves to gain market share and drive the ongoing equipment infrastructure upgrade cycles in the data center, enterprise infrastructure, access and automotive markets.
Ethernet is a ubiquitous and evolving standard of network connectivity that is characterized by its reliability and backward compatibility, which enables easy upgrades and continuity of operation through upgrade cycles. One Gigabit Ethernet, or 1GbE, has been deployed as a mainstream wired connectivity standard for over a decade. However, 1GbE is increasingly insufficient to meet the bandwidth requirements that can accommodate the exponential growth of global IP traffic and demand for high-speed data transfer. As a result, the 1GbE infrastructure is currently undergoing an upgrade cycle that is driven by the need to alleviate bandwidth bottlenecks on the wired side of networking equipment, including the data center (servers and switches), the enterprise infrastructure (wireless access points, or APs, and switches), the access (client connectivity for personal computers, or PCs, and service provider carrier access) and automotive (in-vehicle networking, or IVN) markets. Based on projections by Crehan Research, Inc., 650 Group LLC, IDC, Dell’oro Group, Inc. and Strategy Analytics, we estimate that across these applications, the total available market for multi-gig Ethernet connectivity will reach about 2 billion ports annually by 2022. Historically, the transition to the next Ethernet generation has been led by the introduction of IC solutions that reliably and cost-effectively meet the new Ethernet standard. We believe that the current upgrade cycle will follow the same course.
As the data rate of PHY devices continues to increase, the technical challenges of designing high-speed communications ICs require a significantly new architectural approach. In order to meet next-generation performance requirements with low power consumption and a small footprint, our differentiated architecture combines our two fundamental innovations: Mixed-Mode Signal Processing, or MMSP, which partitions signal processing across analog and digital domains, and Multi-Core Signal Processing, or MCSP, which incorporates multiple customized units to more efficiently process digital signals. We also implement patented techniques in Analog Front-End, or AFE, algorithms, power management and programmability in the design of our products. Our Ethernet solutions are being developed by one of the most innovative design teams in the semiconductor industry, with deep expertise across multiple disciplines that range from analog and mixed-mode design to digital signal processing and communication theory. We leverage the expertise of our design team to achieve technological breakthroughs and bring what we believe to be best-in-class semiconductor solutions to market, anticipating the future technological needs of our customers and helping them shape their product roadmaps. Our best-in-class semiconductor solutions provide the functionalities that meet customers’ requirements, as well as the relevant Institute of Electrical and Electronics Engineers, or IEEE, standard. For example, in 2012 we created a novel technology that we call AQrate, which has since been adopted by the IEEE as the baseline for the IEEE 802.3bz standard that was ratified in September 2016 as the industry specifications for 2.5GBASE-T and 5GBASE-T products made by different manufacturers to be compatible with each other. This technology is currently being deployed in the enterprise infrastructure, access and automotive markets.
We are a fabless semiconductor company. We have shipped tens of millions of ports to customers across multiple advanced semiconductor process generations
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Industry Background
Exponential Growth of Global IP Traffic
Demands on global networking infrastructure are being driven by the exponential growth of data from video, social networking and advanced collaboration applications. The Cisco Visual Networking Index estimates that global IP traffic will grow at a compound annual growth rate, or CAGR, of 26% from 2017 to 2022. Globally, mobile data traffic is also estimated to increase at a CAGR of 46% from 2017 to 2022. The advent of the Internet of Things, or IoT, will also increase pressure on the network infrastructure as a wide variety of electronic devices become connected to the Internet in order to collect and exchange information.
Transition to 10 Gigabit Ethernet
Since its inception more than 40 years ago, Ethernet has grown into a global, widely-deployed communications protocol. More specifically, copper Ethernet cables and the associated Ethernet connector, have permeated the vast majority of Internet networks, including data center, enterprise, campus, small and medium-sized business, small-office and home-office (SOHO) and the home. We believe that each transition to higher speeds has enabled the semiconductor company that has been at the forefront of the technological transformation in each upgrade cycle to significantly scale its operations: from National Semiconductor Corporation in the early 1990s, with the transition to 10 Megabit Ethernet, or 10MbE; to Broadcom Corporation in the mid-1990s, with the transition to 100MbE; and to Marvell Semiconductor, Inc. in the early 2000s, with the transition to 1GbE. We believe a similar opportunity now exists with the transition to 10GbE and beyond in the data centers, enterprise infrastructure, access and automotive markets.
In the early 2000s, the transition from 100MbE to 1GbE was driven by the availability of the technology as a local-area network, or LAN, on motherboard, or LOM, solution for PC applications. A LOM solution allowed every PC manufacturer to offer a 1GbE port on desktops and laptops, which led to a very rapid transition to 1GbE in the entire networking ecosystem. Today, the 1GbE technology has reached broader markets beyond the traditional networking industry, extending into a wide variety of new applications and markets, including home and automotive networking, security camera, signage and smart television connectivity, and high-density wireless environments, such as stadiums and airports. Gigabit Ethernet has now been deployed as a mainstream wired connectivity standard for over a decade and is currently undergoing an upgrade cycle that is driven by the need to alleviate bandwidth bottlenecks on the wired side of networking equipment, including the data center and the enterprise.
Ethernet Connectivity Solutions
In order to connect Ethernet networking equipment, such as servers, switches, storage appliances, high-resolution sensors or routers, network engineers have generally used either optical-based glass or plastic fiber cabling or electrical-based copper cabling. Optical interconnect solutions involve the combination of electronics with optical components, such as optical transmitters, optical receivers, optical couplings, packaging and optical fibers. As a result, optical solutions generally have higher relative cost of materials compared to electrical interconnect solutions. Due to the extremely low absorption loss of optical fibers, optical signals can be sent through fiber over very long distances, which are typically hundreds of kilometers or more, making the higher cost of optical solutions a less significant concern for long-reach interconnects. However, for shorter distances within data centers, which are typically less than 100 meters, optical interconnect solutions can be cost-prohibitive. As a result, optical solutions are typically only used in data centers when a comparable electrical solution has not been developed or the distance is too great for the electrical solution to cover.
Electrical interconnect solutions involve the combination of only a silicon-based IC, a connector and a copper cable. The most prevalent copper interconnect is based on twisted-pair copper cables, also commonly known as Ethernet cables. These cables are relatively inexpensive, but present a number of technical challenges due to significant impairments suffered by the signal as it is transmitted, such as attenuation, crosstalk and echo. As transmission speeds continue to increase to keep up with the exponential growth of global IP traffic, the amount of processing required to be performed in the silicon layer to address these transmission impairments increases correspondingly, leading to greater design complexity and higher power consumption. In recent years, advancements in lithography and manufacturing process technologies have allowed for significantly reduced transistor geometries, resulting in considerably lower power consumption per IC and a greater level of integration. These advancements, as well as additional innovations in the area of digital signal processing, have enabled the use of copper cabling for high-speed data transmission.
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Ethernet cable, in its present form, was devised with the standardization by the Institute of Electrical and Electronics Engineers, or IEEE, of 1MbE in 1986, which was the first of a long line of standards that pushed the speed limits carried over copper cabling. Most recently, the standard evolved into a technology commonly referred to as BASE-T, which started with the introduction of 10BASE-T (speeds of 10 megabits per second, or Mbps) and eventually evolved into the current standard, 10GBASE-T (speeds of 10 gigabits per second, or Gbps). A unique characteristic of BASE-T is its backward compatibility with earlier Ethernet standards. A 10GBASE-T transceiver, for example, is capable of working at the lower speeds of the previous two standards, 1000BASE-T (speeds of 1000Mbps) and 100BASE-T (speeds of 100Mbps). As a result of this backward compatibility, network engineers and IT managers are able to install new equipment in phases and can, for example, purchase 10GBASE-T servers that connect to a legacy 1000BASE-T switch, with the links running at 1GbE. Then, once the switch is replaced with a new 10GBASE-T version, all the links would run at 10GbE.
The Data Center Market
Data centers can be categorized as corporate data centers and cloud, or hyperscale, data centers. For both corporate and hyperscale data centers, servers and switches are the two main components of the data center architecture. Traditionally, servers have been located in vertical racks placed side by side in long rows of equipment. Server ports are connected to Ethernet switches, which have the function of directing the traffic to either an upper layer of aggregation (typical of the older client server North-South traffic model) or to other server nodes (typical of the increasing server-to-server East-West traffic model). In the North-South model, traffic flows down to the lower levels for routing services and then back up to reach its destination. In the East-West model, traffic flows are spread across multiple server nodes, requiring hosts to traverse network interconnection points. In either case, the connectivity between the server and the switch ports in a data center is rather short, typically just a few meters, and at most 100 meters. In contrast, the connectivity between switches in the next layers can be quite long depending on the overall topology. As more data is consolidated and processed in data centers, the need for higher performance server nodes has been met with constant innovation in both processor computing power and increased use of server virtualization, both resulting in an increased demand for higher bandwidth connectivity in servers. According to Crehan Research, approximately 80% of all connections currently are between switches and servers (the two main components of data center architecture), and 80% of those connections are electrical, resulting in electrical interconnect solutions accounting for more than 60% of data center connections.
Corporate Data Centers
Corporate data centers are very cost sensitive and, as a result, have historically made use of Ethernet cabling. Crehan Research estimates that, in 2017, 64% of all server-class Ethernet networking connections shipped were 1GbE connections, 90% of which were 1000BASE-T. We believe that this significant penetration of 1GbE over twisted-pair copper cabling is directly correlated with the preference by corporate IT managers for this medium. In networking infrastructure, cost is a major driver for upgrade cycles and transitions to the newer interconnect technologies. Today, as the cost of 10GbE over twisted-pair copper cabling, or 10GBASE-T, is approaching twice that of 1000BASE-T, network engineers are transitioning their focus to purchasing equipment that supports the faster speed, allowing them to improve performance, increase work efficiency of their organizations and prepare their network for future improvements, which is driving the current upgrade cycle.
The Enterprise Infrastructure Market
In the early 2000s, the enterprise infrastructure market experienced a very rapid transition from 100MbE to 1GbE. The adoption of 1GbE as the preferred connectivity between PCs and the Ethernet switches located in server rooms was facilitated by the ease of deployment of Ethernet cables in the ceilings and walls of the enterprise. Category 5e, or Cat5e, and Category 6, or Cat6, cables were, and continue to be, widely deployed, representing more than 90% of the worldwide base of cables installed between 2003 and 2014. In the past 10 years, the enterprise infrastructure market has also seen an increasing number of wireless LAN, or WLAN, APs being deployed throughout buildings, airports, shopping malls and stadiums, driven by the proliferation of smartphones, laptops and other portable devices. These APs generally connect through a 1GbE infrastructure to the wiring closet or campus Ethernet switch using the same Ethernet cabling infrastructure, and often the same switches, used by desktop PCs.
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1GbE connections have historically been sufficient to carry the wireless traffic over the wired infrastructure due to the limited bandwidth of the WiFi standards 802.11 b/g/n and even the first wave of 802.11ac. However, WLAN AP manufacturers have commenced the deployment of the second wave of 802.11ac and more recently the following standard, 802.11ax, which has throughput of about 5 to 10Gbps. As a result, for the first time in over a decade, IT managers are faced with the challenge of carrying these bandwidths in excess of 1GbE, or Multi-Gig, over legacy Ethernet infrastructure that is designed to only support 1Gbps. Network administrators have traditionally had three options when confronted with this bottleneck: (1) leave the legacy infrastructure in place and aggregate data traffic over more cables; (2) upgrade to data center-class Ethernet cables that support 10GBASE-T; or (3) upgrade to optical interconnect solutions. The first option presents scalability challenges. The latter two pose significant cost barriers and entail considerable disruption to the physical plan of any building or campus. As a result, there is a need in the enterprise infrastructure market for a scalable, lower-cost alternative to support this network upgrade cycle.
The Access Market
The access market is composed of two sub-categories: client connectivity (PC) and service provider access gateways.
Client connectivity —As Multi-Gig technology starts permeating the enterprise infrastructure as a PHY solution, replacing the legacy 1GbE connections on Ethernet switches, the need for PCs to adopt this Multi-Gig solution has emerged. Despite the trends towards lighter and thinner machines such as notebooks and laptops, IDC projects that PCs will continue to be equipped with Ethernet ports for the foreseeable future, estimating that 194 million PCs, or approximately 80% of the total market, will ship with an Ethernet port by 2020, driven by enterprise buyers and gamers. Inside PCs, the PHY is typically integrated with an Ethernet data link layer function, as defined in the Open Systems Interconnection model, or OSI model, called a network controller or Media Access Control, or MAC, device. We believe that integrated solutions combining both the PHY and the controller are likely to become the preferred choice of PC original equipment manufacturers.
Carrier access —Our targeted carrier access market focuses on the last 100 meters between the carrier or service provider termination device, which is typically located in the basement of an apartment complex or the entry-door cabinet in an individual home, and the residential gateway box which is typically owned or leased by the consumer. This last 100 meters is also called wide-area-network, or WAN, and the local-area-network, or LAN, side of the gateway. As carriers and service providers deploy “last-mile” high bandwidth technologies, such as Passive Optical Network, or PON, Digital Subscriber Line, or DSL, and cable modem, the need has arisen to provide high-bandwidth, low-cost, easy-to-deploy solutions to connect termination devices and gateway boxes. The bandwidth requirement is now exceeding 1 Gbps in an increasing number of deployments, on distances that are typically within 100 meters between the termination device and the gateway box. In addition, we anticipate that the availability of Multi-Gig Ethernet on PCs, Network-Attach Storage, or NAS, as well as 802.11ac/ax WiFi extenders and wireless routers, will drive the need for gateways to migrate from 1GbE to Multi-Gig Ethernet on the LAN side as well.
The Automotive Market
The automotive market is undergoing a transformation with the development of self-driving cars. Developing a fully autonomous vehicle requires innovation in the areas of image processing, fast and multi-dimensional decision-making processes, and deep learning, similar to some of the most advanced facial recognition algorithms or complex model simulations being handled by super computers in hyperscale data centers today. As a result, systems that are being contemplated by the car industry to deliver such capabilities will likely need high-speed signaling connecting together end points such as cameras and other sensors, processing units, and an array of switches for rich connectivity and redundancy. Ethernet is one of the most promising technologies to deliver the high-speed connectivity required for making the self-driving car a reality. The car environment has its own very stringent set of requirements such as low weight, low power consumption, limited electro-magnetic emissions and susceptibility, ability to support higher spread of environmental temperature, and low cost. In terms of connectivity, this matrix of requirements is well served by high-speed Multi-Gig Ethernet over copper cabling. The potential market opportunity for Ethernet in the car is considerable, with shipment estimated to be in the hundreds of millions of ports by 2022, according to Strategy Analytics. We are currently shipping products into this market but do not expect significant volume production to occur before 2020.
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Our Solution
We have developed a differentiated architecture that leverages our deep technical design expertise to create integrated high-performance connectivity solutions that address the significant opportunities present in the data center, enterprise infrastructure, access and automotive markets. Our Ethernet PHY solutions provide a critical interface between the high-speed analog signals transported over wired infrastructure and the digital information used in computing and networking equipment. Our architecture combines our two fundamental innovations, MMSP and MCSP, as well as several other patented techniques in AFE design, algorithms, power management and programmability.
Key features of our highly integrated, mixed-signal ICs include:
| • | Advanced Analog Front-End Design. Our small form factor, low-power, high-speed and high-resolution data acquisition circuits include the analog-to-digital converter, or ADC, and digital-to-analog converter, or DAC, which provide the interface between the real-world signal coming from the cables and the digital processing engine. Our world-class team of analog engineers designed these complex AFE building blocks to be power efficient, highly reusable across many of our products, and easily scalable with advanced CMOS processes as they emerge. |
| • | Mixed-Mode Signal Processing Architecture. We have designed a novel analog architecture that we call MMSP, which provides a different partitioning of signal processing between the analog and digital domains. MMSP reduces the complexity of data acquisition circuitry and, as a result, reduces the die size and power consumption of the overall AFE. MMSP also simplifies the digital signal processing logic that follows the ADC. |
| • | Multi-Core Signal Processor Architecture. We estimate that the total amount of processing required to counteract the effect of impairments on a Multi-Gig signal as it is transmitted over copper cabling is approximately 10 Tera-operations per second, which is approximately 200 times more than 1GbE. Processing such a large amount of data with a traditional architecture would be highly inefficient and costly. We use our proprietary transistor-level implementation and mapping techniques to create highly efficient multi-core processing engines, which we call MCSPs. Our MCSPs deliver high performance with low power consumption and a small footprint. |
| • | Extensive Development of Proprietary Advanced Signal Processing Algorithms. The process of detecting and decoding the desired data from a noisy environment requires sophisticated digital signal processing, or DSP, and algorithms that we have developed over the last 10 years with our team of DSP engineers. We believe these algorithms are critical to the performance and the stability of the end customer solution. |
| • | Advanced Power Management Techniques. Designing a multichannel Ethernet PHY interface that can handle data transfer speeds up to 10Gbps while minimizing leakage power across smaller process geometries presents a significant challenge. However, by combining innovative techniques, our engineers have been able to significantly reduce the impact of static and dynamic leakage power. |
| • | Fully Configurable Programmable Architecture. We design our semiconductor solutions to operate in a variety of environments and applications. By keeping our architecture programmable, we enable our customers to use the same device in different applications and enjoy the optimum benefits of our solutions. This programmable architecture also enables us to scale across multiple markets and improve our time to market. |
While the corporate data center market provides an opportunity for us to serve both server applications and switching applications, historically our core focus has been on, and a significant majority of our data center market revenue has been generated from, the server portion of that market, primarily supporting our relationship with Intel. We initially used these core innovations in the development of 10GBASE-T PHY devices, and subsequently in custom ASICs for Intel that integrate our PHY devices with various elements of Intel’s proprietary technologies. These custom ASICs are driving the transition to 10GbE networking from legacy 1GbE technology in corporate data center server applications. More recently, we employed our fundamental PHY expertise to develop AQrate, our technology designed to improve transmission speeds from 1GbE to 5GbE over existing copper cabling infrastructure in the enterprise infrastructure, access and automotive markets. We are currently developing solutions for Multi-Gig Ethernet over copper to serve the potential automotive market opportunity.
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Our Competitive Strengths
| • | Differentiated Technology Architecture. We believe our connectivity solutions, many of which are protected with patents and our fundamental trade secrets around analog and mixed signal design, provide us with a significant competitive advantage across our target end markets. Our semiconductor solutions have repeatedly established benchmarks in the industry in terms of performance, power consumption and density. We believe our design techniques and technical innovations, including our MMSP and MCSP technology, enable us to successfully compete with and win designs against larger, more established peers. We continue to invest in our core technology to stay ahead of the competition in the process node migration of our products. |
| • | Top Industry Talent. We believe the engineering and design talent of our employees is critical to our success. As of December 31, 2018, we employed 234 engineers with deep technical expertise in analog, digital signal processing and mixed-mode signal design, digital signal processing, communication theory and chip-level integration. Our highly talented team of engineers brings together expertise in varied products, including Ethernet PHYs, high-speed serializer/deserializer, Ethernet switching, cellular networking, memory, microprocessors, programmable logic arrays, PLDs, and experience from across industry leaders, including AMD, Beceem, Broadcom, Centillium, Intel, LSI Logic, Philips and Samsung. We intend to continue to aggressively recruit and seek to retain talented engineering and design personnel. |
| • | Consistent Long-Term Relationships with Leaders in Our Markets. We have built significant long-term relationships with, and have developed our solutions for, industry leaders, including Intel, the leader in server microprocessors, and Cisco, the leader in networking infrastructure. We have repeatedly demonstrated our ability to address and preempt the technological challenges facing each of these customers and, as a result, we are designed into several of their respective current systems and their emerging products and architectures. Our key customers rely on our technologically advanced solutions to enable their end products to provide their customers with the highest performance and reliability while maintaining a low total cost of ownership. As such, we have built significant long-term relationships with our key customers that enable them to trust our ability to successfully execute to their internal roadmaps and meet the needs of their end customers. |
| • | Market Insight and Vision. We are deeply involved with our customers in defining next-generation technologies by leveraging our market knowledge and product expertise in the data center, enterprise infrastructure, access and automotive markets. We are helping shape our customers’ roadmaps and product offerings to their end customers through our fundamental understanding of their technology cycles and product needs. We believe this has enabled us to anticipate market trends ahead of our competition, develop innovative technologies in existing markets and create new market opportunities. |
| • | Track Record of Execution. We believe we have demonstrated a track record of execution excellence by productizing existing technologies and bringing to market industry-defining technological developments. To date, we have shipped millions of data center-class ICs with our core communications technologies and have achieved design wins for ASIC and PHY products across a variety of end markets with a growing number of existing and new customers. Similarly, we demonstrated our ability to bring an entirely new product to market with the successful development and launch of AQrate in the enterprise infrastructure, access and automotive markets. AQrate has been established as the technology leader through its adoption by the IEEE as the baseline for the IEEE 802.3bz standard for 2.5GBASE-T and 5GBASE-T products. |
Our Strategy
Key elements of our strategy include:
| • | Expand Market Share with Leaders in Existing Markets. Customers with which we have existing supplier relationships are continuously developing new products in existing and new application areas. These customers tend to be large multinational enterprises with significant annual budgets for IC purchases. We intend to increase our market share through our existing customer base by applying our design capabilities to new design programs and by continuing to foster deep relationships with these customers. We believe our product roadmaps will enhance our ability to win new business due to the fact that these new roadmaps have been developed in close collaboration with our existing customers. Further, these customers also typically include our products to develop their future product roadmaps. |
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| • | Sell to New Customers in Existing Markets. We have successfully demonstrated a number of key benefits to our existing customers within certain applications and markets, such as the data center and enterprise infrastructure markets. We believe these customers’ products have become more competitive as a direct result of using our solutions. We intend to work with other leading original equipment manufacturers in our existing markets to help them realize similar benefits by deploying our IC solutions. |
| • | Broaden Product Portfolio to Target New Markets. We intend to continue to develop new products that we can leverage across our core data center and enterprise infrastructure markets, and use to penetrate the access and other new markets. In particular, we believe that our core expertise, IP and product portfolio can be leveraged to continue to expand into the access market and to address connectivity needs in the automotive market, where technology requirements for autonomous driving vehicles will push the bandwidth for wired high-speed connectivity well beyond the 100 Mbps and 1Gbps currently being deployed. |
| • | Continue to Enhance Key Technological Expertise. We maintain three intertwining areas of technical expertise: analog and mixed-mode signal design, signal processing and algorithms, and Ethernet networking. Our engineers have a deep knowledge of Ethernet and data networking that enables us to assist our customers in driving their product roadmaps. We intend to invest in research and development to continue to drive industry leadership. To maintain our position as a technology leader, we intend to continue to leverage our deep market insight and product roadmap knowledge of our customers and our customers’ customers to look ahead to new products and solutions. |
Products
Our products currently address the data center, enterprise infrastructure, access and automotive markets. We initially focused on the development of 10GBASE-T PHY devices and later, custom ASICs that integrate our PHY devices with customer IP for data center server applications, to lead the transition to 10GbE networking from legacy 1GbE technology. We leveraged our advanced connectivity technology to develop AQrate, a proprietary product designed to significantly improve transmission speeds from 1Gbps to 5Gbps over existing cabling infrastructure in the enterprise infrastructure market. Most recently, we introduced multiple lines of products to serve the access market composed of client connectivity for PCs and service provider access gateways, as well as multi-gig PHY and controller products for automotive.
Corporate Data Center Products
Our differentiated architecture, combining MMSP and MCSP, was first implemented in the 10GBASE-T line of products, shipping to corporate data center environments. Our architecture’s characteristic low-power, high-performance, and high-density enabled us to demonstrate the world’s first single-chip 10GBASE-T product in 90nm standard CMOS process. This 90nm generation was the first 10GBASE-T product to be deployed in a corporate data center-class Ethernet switch in 2010.
The follow-on 40nm process generation, unveiled in 2012, led to the world’s first fully integrated 10GBASE-T MAC and PHY products for corporate data center servers. This allowed our server customers to deploy the technology for the first time as a LOM solution as part of the Romley server platform cycle. These ICs were also designed on add-on Network Interface Controller cards. The 40nm process generation, in combination with our architecture, allowed us to deliver the highest density 10GBASE-T quad-port solution for 48-port top-of-rack, or ToR, switches. We have shipped the 40nm generation of products in millions of ports to our server and switching customers, contributing to making 10GBASE-T a mainstream technology in corporate data centers.
We have since transitioned to the 28nm process generation, continuing to lead the industry, and delivered the world’s first 28nm 10GBASE-T in 2013. While the majority of our revenue was generated by our 40nm products in 2015, our 28nm products are beginning to account for an increasingly significant portion of our revenue. For the years ended December 31, 2018 and 2017, 28nm products accounted for 79% and 65% of total revenue, respectively.
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Enterprise Infrastructure Products
The development of the AQrate product line, based on the novel 2.5GbE/5GbE protocol invented by Aquantia, started in 2012 and led to the sampling of our first product in November 2013. This innovative product line was quickly adopted by Cisco and other major switching and WLAN AP OEMs in the ensuing months. Our AQrate product line is composed of single-, dual- quad- and octal-port configurations. The single- and dual-port devices are designed for use in applications ranging from WLAN APs, compact switches, client PCs, storage devices and security cameras, and the quad- and octal-port versions are designed for use in enterprise and campus Ethernet switches. We are currently in full production for our entire line of AQrate products, all of which are manufactured in 28nm and support five Ethernet speeds, including 100M, 1000BASE-T, 2.5GBASE-T, 5GBASE-T and 10GBASE-T.
Access Products
- Client Connectivity. We anticipate that, over time, PC OEMs will adopt solutions that integrate the PHY and MAC controller. Our product road map for PC OEMs includes the AQC line (standard product), AQS line (SFP+ modules), and AQN line (NIC), which are all based on our GEN2 AQrate PHYs. These PHYs are low-power, high performance 5-speed 10GBASE-T/5GBASE-T/ 2.5GBASE-T/ 1000BASE-T/ 100BASE-TX transceivers. Our products deliver 2.5GbE and 5GbE network connectivity speeds through 100 meters of Cat 5e cabling. Using a 30-meter Cat 6a cable, 10GbE speeds are achievable. These products are compliant with IEEE 802.3an/802.3bz standards to perform all the physical layer functions required to implement 10GBASE-T/5GBASE-T/ 2.5GBASE-T/1000BASE-T/100BASE-TX transmission over twisted pair cabling.
- Carrier Access. Our PHY products are designed to also serve the carrier and service provider applications, with their implementation mainly on home gateways potentially replacing 1GbE WAN and LAN ports with multi-gig Ethernet.
Automotive Products
As we anticipate that the development of Level 4 and 5 of autonomous vehicle architectures would require bandwidth in excess of 1Gbps, we set out to develop and productize a new product family of multi-gig Ethernet PHYs and MAC controllers, called AQcelerate, specifically for the automotive industry. The AQcelerate line of products allows the transport of data at 2.5GbE, 5GbE and 10GbE over automotive-grade copper cabling.
Our Customers
We sell our products directly to IC suppliers, OEMs, original design manufacturers, or ODMs primarily through direct sales. We work closely with our OEM customers throughout their design cycles, and we are able to develop long-term relationships with them as our technology becomes embedded in their products. As a result, we believe we are well-positioned to be designed into their current systems and to continually develop next generation Ethernet solutions for their future products.
Across the corporate data center, enterprise infrastructure, access and automotive markets, our customers include Brocade (now part of Extreme Networks), Cisco, Dell, Hewlett-Packard Enterprise, Intel, Juniper and NEC, among others. Intel is the industry leader in server microprocessors, Cisco is the industry leader in networking infrastructure, and collectively, our customer base represents a significant majority of market share in these industries.
We currently rely, and expect to continue to rely, on a limited number of customers for a significant portion of our revenue. For the years ended December 31, 2018, 2017 and 2016, Intel accounted for approximately 49%, 60%, and 68% of our revenue and Cisco accounted for 27%, 28% and 21% of our revenue, respectively. Our 10 largest customers collectively accounted for 93%, 97% and 98% of our revenue for the years ended December 31, 2018, 2017 and 2016, respectively. No other single customer directly or indirectly accounted for more than 10% of our revenue in the years ended December 31, 2018, 2017 or 2016.
Sales to customers in Asia accounted for 98%, 99% and 99% of our revenue in the years ended December 31, 2018, 2017 and 2016, respectively. Because many of our customers or their ODMs are located in Asia, we anticipate that a significant portion of our products will continue to be sold to Asia.
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Sales and Marketing
Our design cycle from initial engagement to volume shipment typically ranges from 18 months to three years, depending on whether we are developing an ASSP or an ASIC, with product life cycles of four years or more. For many of our products, early engagement with our customers’ technical staff is critical for success. To ensure an adequate level of early engagement, our application and development engineers work closely with our customers to identify and propose solutions to their systems’ challenges.
We work closely with our customers, including technology leaders such as Intel and Cisco for the data center and enterprise infrastructure markets, to anticipate end customer market needs. We also participate actively in setting industry standards with organizations such as IEEE to ensure that we have a voice in the definition of future market trends.
We sell our products worldwide through multiple channels, including our direct sales force, a network of third-party sales representatives and distributors. For major accounts in the United States and some overseas markets, we rely on our direct sales team located in the United States and Taiwan, while for others, we collaborate with third-party sales representatives and distributors in the United States, Asia, Europe, the Middle East and Africa.
Manufacturing
We operate a fabless business model and use third-party foundries and assembly and test manufacturing contractors to manufacture, assemble and test our semiconductor products. This outsourced manufacturing approach allows us to focus our resources on the design, sale and marketing of our products. In addition, we believe that outsourcing many of our manufacturing and assembly activities provides us with the flexibility needed to respond to new market opportunities, simplifies our operations and significantly reduces our capital commitments.
We subject our third-party manufacturing contractors to qualification requirements to meet the high quality and reliability standards required of our products. We carefully qualify each of our partners and their processes before applying the technology to our products. Our engineers work closely with our foundries and other contractors to increase yield, lower manufacturing costs and improve product quality.
| • | Wafer Fabrication. We currently utilize a wide range of semiconductor process generations to develop and manufacture our products. For most of our products, we use Taiwan Semiconductor Manufacturing Company, or TSMC, and GLOBALFOUNDRIES for semiconductor wafer production. |
| • | Package, Assembly and Testing. Upon the completion of processing at the foundry, we use third-party contractors for packaging, assembly and testing, including Amkor, STATS ChipPAC and ASE in Taiwan and Korea. |
| • | Warehousing. JSI in Hong Kong warehouses our products, providing easy transport and accessibility from the assembly and test sites. |
Research and Development
We believe that our future success depends on our ability to introduce enhancements on our existing products and to develop new products for both existing and new markets. As such, a significant majority of our operating expenses has been allocated to this effort. Our research and development efforts are directed to the development of additional high-performance connectivity semiconductor solutions across a range of process technologies.
We have assembled a core team of experienced engineers and systems designers in five design centers located in the United States, Canada, India, the Netherlands and Russia. Our research and development expenses for the years ended December 31, 2018, 2017 and 2016 were $56.0 million, $44.8 million and $36.6 million, respectively.
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Competition
The global semiconductor market in general, and the data center and wireless communications infrastructure in particular, is highly competitive. We compete in different target markets on the basis of a number of competitive factors. We expect competition to increase and intensify as additional semiconductor companies enter our markets, and as internal silicon design resources of large OEMs grow. Increased competition could result in price pressure, reduced gross margins and loss of market share, any of which could harm our business, revenue and results of operations.
Our competitors range from large, international companies offering a wide range of semiconductor products to smaller companies specializing in narrow market verticals. In the enterprise and data center markets, our primary competitors are Broadcom and Marvell. We expect competition in our current markets to increase in the future as existing competitors improve or expand their product offerings and as new competitors enter these markets. In addition, our future growth will depend in part on our ability to successfully enter and compete in new markets. Some of these markets will likely be served by only a few large, multinational OEMs with substantial negotiating and buying power relative to us and, in some instances, with internally developed silicon solutions that can be competitive to our products.
Our ability to compete successfully depends on elements both within and outside of our control, including industry and general economic trends. During past periods of downturns in our industry, competition in the markets in which we operate intensified as our customers reduced their purchase orders. Many of our competitors are substantially larger, have greater financial, technical, marketing, distribution, customer support and other resources, are more established than we are and have significantly better brand recognition and broader product offerings which may enable them to better withstand similar adverse economic or market conditions in the future. Any such development may materially and adversely affect our current and future target markets and our ability to compete successfully in those markets.
We compete or plan to compete in different target markets to various degrees on the basis of a number of principal competitive factors, including:
| • | features and functionality; |
| • | reputation and reliability; |
| • | research and development; |
| • | high-level talent, including our management team and engineers; and |
We believe we compete favorably with respect to each of these factors. We maintain our competitive position through our ability to successfully design, develop and market complex Ethernet connectivity solutions for the customers we serve.
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Intellectual Property
We rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, and contractual protections, to protect our core technology and intellectual property. As of December 31, 2018, we had 99 issued patents, 87 of which are U.S. patents, and 28 pending and provisional U.S. patent applications. The 87 issued patents in the U.S. generally expire between 2024 and 2037. Our issued patents and pending patent applications relate to both our 10GBASE-T PHYs, our AQrate PHYs, controller and QuantumStream technologies.
We may not receive competitive advantages from any rights granted under our patents, and our patent applications may not result in the issuance of any patents. In addition, any future patents may be opposed, contested, circumvented, designed around by a third party or found to be unenforceable or invalidated. Others may develop technologies that are similar or superior to our proprietary technologies, duplicate our proprietary technologies or design around patents owned or licensed by us. Further, we may be required to license certain of our patents on reasonable and non-discriminatory terms to our competitors due to having promoted the adoption of certain IEEE standards.
We generally control access to and use of our confidential information through the use of internal and external controls, including contractual protections with employees, contractors and customers. We rely in part on the laws of the United States and international laws to protect our work. All employees and consultants are required to evaluate confidentiality agreements in connection with their employment and consulting relationships with us. We also require them to agree to disclose and assign to us all inventions conceived or made in connection with the employment or consulting relationship.
Despite our efforts to protect our intellectual property, unauthorized parties may still copy or otherwise obtain and use our software, technology or other information that we regard as proprietary intellectual property. In addition, we intend to expand our international operations, and effective patent, copyright, trademark and trade secret protection may not be available or may be limited to foreign countries.
The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which has resulted in protracted and expensive litigation for many companies. We have in the past received and, particularly as a public company, we expect that in the future we may receive, communications liability for damages that may invalidate our proprietary rights and harm our business and our ability to compete. Any litigation, regardless of success or merit, could cause us to incur substantial expenses, reduce our sales and divert the efforts of our technical and management personnel. In the event we receive an adverse result in any litigation, we could be required to pay substantial damages, seek licenses from third parties, which may not be available on reasonable terms or at all, cease sale of products, expend significant resources to develop alternative technology or discontinue the use of processes requiring the relevant technology.
Information about Segment and Geographic Revenue
Information about segment and geographic revenue is set forth in Note 11 to the “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements” under Part II, Item 8 of this Annual Report on Form 10-K.
Cybersecurity
We have implemented a security program consisting of policies, procedures, and technology meant to maintain the privacy, security and integrity of information, systems, and networks. Among other things, the program includes controls designed to limit and monitor access to authorized systems, networks, and data, prevent inappropriate access or modification, and monitor for threats or vulnerability.
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Employees
As of December 31, 2018, we employed 310 full-time equivalent employees located in the United States, Canada, India, the Netherlands, Russia and Taiwan, including 248 in research, product development, engineering and operations and logistics, 26 in general and administrative and 36 in sales and marketing. We consider relations with our employees to be good and have never experienced a work stoppage. None of our employees are either represented by a labor union or subject to a collective bargaining agreement.
Facilities
Our principal executive offices are located in a leased facility in San Jose, California, consisting of approximately 66,943 square feet of office space under a lease that started in April 2018 and expires in March 2024. The facility accommodates product development and our principal engineering, sales, marketing, operations and finance and administrative activities. We also lease offices in Canada, India, the Netherlands, Russia and Taiwan. We do not own any real property. We believe that our leased facilities are adequate to meet our current needs and that additional facilities will be available on commercially reasonable terms for lease to meet future needs.
Corporate Information
We were incorporated in Delaware on January 27, 2004. Our corporate website address is www.aquantia.com. Information contained on or accessible through our website is not a part of this report and the inclusion of our website address in this report is an inactive textual reference only.
Available Information
We electronically file our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Exchange Act, with the Securities and Exchange Commission, or the SEC. The SEC maintains an Internet site that contains reports and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov. You may obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports with the SEC on our website.
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Our operations and financial results are subject to various risks and uncertainties including those described below. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks or others not specified below materialize, our business, financial condition and results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline.
Risks Related to Our Business and Our Industry
We depend on a limited number of customers for a substantial majority of our revenue. If we fail to retain or expand our customer relationships or if our customers cancel or reduce their purchase commitments, our revenue could decline significantly.
We derive a substantial majority of our revenue from a limited number of customers. We believe that our operating results for the foreseeable future will continue to depend on sales to Intel Corporation, or Intel, and Cisco Systems, Inc., or Cisco, our two largest customers. For the years ended December 31, 2018, 2017 and 2016, sales to Intel accounted for approximately 49%, 60% and 68% of our revenue, respectively. For the years ended December 31, 2018, 2017 and 2016, sales to Cisco accounted for approximately 27%, 28% and 21% of our revenue, respectively. Substantially all of our sales to date, including sales to Intel and Cisco, have been made on a purchase order basis, which orders may be cancelled, changed or delayed with little or no notice or penalty. As a result of this customer concentration, our revenue could fluctuate materially and could be materially and disproportionately impacted by purchasing decisions of Intel, Cisco or any other significant customer. In the future, Intel, Cisco or any other significant customer may decide to purchase fewer units than they have in the past, may alter their purchasing patterns at any time with limited notice, or may decide not to continue to purchase our semiconductor solutions at all, any of which could cause our revenue to decline materially and materially harm our financial condition and results of operations. In addition, our relationships with existing customers may deter potential customers who compete with these customers from buying our semiconductor solutions. If we are unable to diversify our customer base, we will continue to be susceptible to risks associated with customer concentration.
Our revenue and operating results may fluctuate from period to period, which could cause our stock price to fluctuate.
Our revenue and operating results have fluctuated in the past and may fluctuate from period to period in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following factors:
| • | customer demand and product life cycles; |
| • | the receipt, reduction or cancellation of orders by customers; |
| • | fluctuations in the levels of component inventories held by our customers, which have in the past caused significant fluctuations in our revenue; |
| • | the gain or loss of significant customers; |
| • | market acceptance of our products and our customers’ products; |
| • | our ability to develop, introduce and market new products and technologies on a timely basis; |
| • | the timing and extent of product development costs; |
| • | new product announcements and introductions by us or our competitors; |
| • | our research and development costs and related new product expenditures; |
| • | seasonality and fluctuations in sales by product manufacturers that incorporate our semiconductor solutions into their products; |
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| • | end-market demand into which we have limited insight, including cyclicality, seasonality and the competitive landscape; |
| • | cyclical fluctuations in the semiconductor market; |
| • | fluctuations in our manufacturing yields; |
| • | significant warranty claims, including those not covered by our suppliers; and |
| • | changes in our pricing, product cost and product mix. |
As a result of these and other factors, you should not rely on the results of any prior quarterly or annual periods, or any historical trends reflected in such results, as indications of our future revenue or operating performance. Fluctuations in our revenue and operating results could cause our stock price to decline.
We have an accumulated deficit and have incurred net losses in the past, and we may continue to incur net losses in the future.
As of December 31, 2018, we had an accumulated deficit of $207.4 million. We generated net losses of $9.8 million, $5.4 million and $0.4 million for the years ended December 31, 2018, 2017 and 2016, respectively. We may continue to incur net losses in the future.
Our success and future revenue depend on our ability to achieve design wins and to convince our current and prospective customers to design our products into their product offerings. If we do not continue to win designs or our products are not designed into our customers’ product offerings, our results of operations and business will be harmed.
We sell our semiconductor solutions to customers who include our solutions in their hardware products. This selection process is typically lengthy and may require us to incur significant design and development expenditures and dedicate scarce engineering resources in pursuit of a single design win. If we fail to convince our current or prospective customers to include our products in their product offerings or fail to achieve a consistent number of design wins, our results of operations and business will be harmed.
Because of our extended sales cycle, our revenue in future years is highly dependent on design wins we are awarded today. It is typical that a design win today will not result in meaningful revenue until one year or later, if at all. For example, for the year ended December 31, 2018, substantially all of our revenue was derived from design wins for which revenue was first recognized more than 12 months beforehand. If we do not continue to win designs in the short term, our revenue in the following years will deteriorate.
Further, a significant portion of our revenue in any period may depend on a single product design win with a large customer. As a result, the loss of any key design win or any significant delay in the ramp of volume production of the customer’s products into which our product is designed could adversely affect our financial condition and results of operations. We may not be able to maintain sales to our key customers or continue to secure key design wins for a variety of reasons, and our customers can stop incorporating our products into their product offerings with limited notice to us and suffer little or no penalty.
The loss of a key customer or design win, a reduction in sales to any key customer, a significant delay or negative development in our customers’ product development plans, or our inability to attract new significant customers or secure new key design wins could seriously impact our revenue and materially and adversely affect our results of operations.
The success of our products is dependent on our customers’ ability to develop products that achieve market acceptance, and our customers’ failure to do so could negatively affect our business.
The success of our semiconductor solutions is heavily dependent on the timely introduction, quality and market acceptance of our customers’ products incorporating our solutions, which may be impacted by factors beyond our control. Our customers’ products are often very complex and subject to design complexities that may result in design
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flaws, as well as potential defects, errors and bugs. We have in the past been subject to delays and project cancellations as a result of design flaws in the products developed by our customers, changing market requirements, such as the customer adding a new feature, or because a customer’s product fails their end customer’s evaluation or field trial. In other cases, customer products are delayed due to incompatible deliverables from other vendors. We incur significant design and development costs in connection with designing our products for customers’ products that may not ultimately achieve market acceptance. If our customers discover design flaws, defects, errors or bugs in their products, or if they experience changing market requirements, failed evaluations or field trials, or incompatible deliverables from other vendors, they may delay, change or cancel a project, and we may have incurred significant additional development costs and may not be able to recoup our costs, which in turn would adversely affect our business and financial results.
Defects in our products could harm our relationships with our customers and damage our reputation.
Defects in our products may cause our customers to be reluctant to buy our products, which could harm our ability to retain existing customers and attract new customers and adversely impact our reputation and financial results. The process of identifying a defective or potentially defective product in systems that have been widely distributed may be lengthy and require significant resources. Further, if we are unable to determine the root cause of a problem or find an appropriate solution, we may delay shipment to customers. As a result, we may incur significant replacement costs and contract damage claims from our customers, and our reputation and financial results may be adversely affected.
Our target markets may not grow or develop as we currently expect, and if we fail to penetrate new markets and scale successfully within those markets, our revenue and financial condition would be harmed.
A substantial majority of our revenue is derived from the data center market. In 2014, we began introducing products for the enterprise infrastructure market and, in 2016, we began introducing products into the access market which serves the client connectivity and carrier access markets. We are currently developing solutions for Multi-Gig Ethernet over copper with major car manufacturers and Tier-1 suppliers in the automotive market. Any deterioration in these markets or reduction in capital spending to support these markets could lead to a reduction in demand for our products, which would adversely affect our revenue and results of operations. Further, if our target markets do not grow or develop in ways that we currently expect, demand for our technology may not materialize as expected, which would also negatively impact our business.
We may be unable to predict the timing or development of trends in these end markets with any accuracy and these trends may not be beneficial to us. If we fail to accurately predict market requirements or market demand for these solutions, our business will suffer. A market shift towards an industry standard that we may not support could significantly decrease the demand for our solutions. For example, we have invested significant resources in developing semiconductor solutions to address 2.5 Gigabit Ethernet, or GbE, 5GbE and 10GbE operation over today’s Cat5e and Cat6 cabling infrastructure. If these technologies are not adopted as an industry standard, our investment may not lead to future revenue.
Our future revenue growth, if any, will depend in part on our ability to expand within our existing markets, our ability to continue to penetrate newer markets, such as the access market which we entered in 2016, and our ability to enter into new markets, such as the automotive market. Each of these markets presents distinct and substantial challenges and risks and, in many cases, requires us to develop new customized solutions to address the particular requirements of that market. Meeting the technical requirements and securing design wins in any of these new markets will require a substantial investment of our time and resources. We cannot assure you that we will secure design wins from these or other new markets, or that we will achieve meaningful revenue from sales with these markets. If any of these markets do not develop as we currently anticipate or if we are unable to penetrate them and scale in them successfully, our projected revenue would decline.
If we are unable to manage our growth effectively, we may not be able to execute our business plan and our operating results and stock price could suffer.
In order to succeed in executing our business plan, we will need to manage our growth effectively as we make significant investments in research and development and sales and marketing, and expand our operations and
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infrastructure both domestically and internationally. In addition, in connection with operating as a public company, we will incur additional significant legal, accounting and other expenses that we did not incur as a private company. If our revenue does not increase to offset these increases in our expenses, we may not achieve or maintain profitability in future periods.
To manage our growth effectively, we must continue to expand our operations, engineering, financial accounting, internal management and other systems, procedures and controls. This may require substantial managerial and financial resources, and our efforts may not be successful. Any failure to successfully implement systems enhancements and improvements will likely have a negative impact on our ability to manage our expected growth, as well as our ability to ensure uninterrupted operation of key business systems and compliance with the rules and regulations applicable to public companies. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities or develop new semiconductor solutions, and we may fail to satisfy customer product or support requirements, maintain the quality of our solutions, execute our business plan or respond to competitive pressures, any of which could negatively affect our brand, results of operations and overall business.
The average selling prices of our products and of other products in our markets have decreased historically over time and may do so in the future, which could harm our revenue and gross margins.
The average selling prices of our products and of other semiconductor products in the markets we serve generally have decreased over time. Our revenue is derived from sales to large customers and, in some cases, we have agreed in advance to modest price reductions, generally over a period of time ranging from 18 months to five years, once the specified product begins to ship in volume. However, our customers may change their purchase orders and demand forecasts at any time with limited notice due in part to fluctuating end-market demand, which can sometimes lead to price renegotiations. Although these price renegotiations can sometimes result in the average selling prices fluctuating over the shorter term, we expect average selling prices generally to decline over the longer term as our products mature.
We seek to offset the anticipated reductions in our average selling prices by reducing the cost of our products through improvements in manufacturing yields and lower wafer, assembly and testing costs, developing new products, enhancing lower-cost products on a timely basis and increasing unit sales. However, if we are unable to offset these anticipated reductions in our average selling prices, our results of operations, cash flows and overall business could be negatively affected.
If we are not able to successfully introduce and ship in volume new products as our existing products near the end of their product lifecycle, our business and revenue will suffer.
We have developed products that we anticipate will have product life cycles of 10 years or more, as well as other products in more volatile high growth or rapidly changing areas, which may have shorter life cycles. Our future success depends, in part, on our ability to develop and introduce new technologies and products that generate new sources of revenue to replace, or build upon, existing revenue streams that may be dependent upon limited product life cycles. If we are unable to repeatedly introduce, in successive years, new products that ship in volume, or if our transition to these new products does not successfully occur prior to any decrease in revenue from our prior products, our revenue will likely decline significantly and rapidly.
Our gross margins may fluctuate due to a variety of factors, which could negatively impact our results of operations and our financial condition.
Our gross margins may fluctuate due to a number of factors, including customer and product mix, market acceptance of our new products, timing and seasonality of the end-market demand, yield, wafer pricing, competitive pricing dynamics and geographic and market pricing strategies.
Further, because we are so dependent on a few large customers, these customers have significant leverage with respect to negotiating pricing and other terms with us and may put downward pressure on our margins. To attract new customers or retain existing customers, we have in the past and will in the future offer certain customers favorable prices, which would decrease our average selling prices and likely impact gross margins. Further, we may also offer
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pricing incentives to our customers on earlier generations of products that inherently have a higher cost structure, which would negatively affect our gross margins.
Because we do not operate our own manufacturing, assembly or testing facilities, we may not be able to reduce our costs as rapidly as companies that operate their own facilities, and our costs may even increase, which could further reduce our gross margins. We rely primarily on obtaining yield improvements and volume-based cost reductions to drive cost reductions in the manufacture of existing products, introducing new products that incorporate advanced features and optimize die size, and other price and performance factors that enable us to increase revenue while maintaining gross margins. To the extent that such cost reductions or revenue increases do not occur in a timely manner, our financial condition and results of operations could be adversely affected.
In addition, we maintain inventory of our products at various stages of production and in finished good inventory. We hold these inventories in anticipation of customer orders. If those customer orders do not materialize, we may have excess or obsolete inventory which we would have to reserve or write off, and our gross margins would be adversely affected.
Our customers require our products and our third-party contractors to undergo a lengthy and expensive qualification process which does not assure product sales. If we are unsuccessful or delayed in qualifying any of our products with a customer, our business and operating results would suffer.
Prior to purchasing our semiconductor solutions, our customers require that both our solutions and our third-party contractors undergo extensive qualification processes, which involve testing of our products in the customers’ systems, as well as testing for reliability. This qualification process may continue for several months. However, qualification of a product by a customer does not assure any sales of the product to that customer. Even after successful qualification and sales of a product to a customer, a subsequent revision in our third-party contractors’ manufacturing process or our selection of a new supplier may require a new qualification process with our customers, which may result in delays and in our holding excess or obsolete inventory. After our products are qualified, it can take several months or more before the customer commences volume production of components or systems that incorporate our products. Despite these uncertainties, we devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualifying our products with customers in anticipation of sales. If we are unsuccessful or delayed in qualifying any of our products with a customer, sales of those products to the customer may be precluded or delayed, which would cause our business and operating results to suffer.
We may be subject to warranty or product liability claims, which could result in unexpected expenses and loss of market share.
From time to time, we may be subject to warranty or product liability claims that may require us to make significant expenditures to defend those claims, replace our solutions, refund payments or pay damage awards. We generally agree to indemnify our customers for defects in our products.
If a customer’s equipment fails in use, the customer may incur significant monetary damages, including an equipment recall or associated replacement expenses as well as lost revenue. The customer may claim that a defect in our product caused the equipment failure and assert a claim against us to recover monetary damages. In certain situations, circumstances might warrant that we consider incurring the costs or expense related to a recall of one of our products in order to avoid the potential claims that may be raised should a customer reasonably rely upon our product and suffer a failure due to a design or manufacturing process defect. In addition, the cost of defending these claims and satisfying any arbitration award or judgment with respect to these claims would result in unexpected expenses and could harm our business prospects. Although we carry product liability insurance, this insurance is subject to significant deductibles and may not adequately cover our costs arising from defects in our products or otherwise.
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If we fail to accurately anticipate and respond to rapid technological change in the industries in which we operate, our ability to attract and retain customers could be impaired and our competitive position could be harmed.
We operate in industries characterized by rapidly changing technologies as well as technological obsolescence. The introduction of new products by our competitors, the delay or cancellation of any of our customers’ product offerings for which our semiconductor solutions are designed, the market acceptance of products based on new or alternative technologies or the emergence of new industry standards could render our existing or future products uncompetitive, obsolete and otherwise unmarketable. Our failure to anticipate or timely develop new or enhanced products or technologies in response to changing market demand, whether due to technological shifts or otherwise, could result in the loss of customers and decreased revenue and have an adverse effect on our operating results.
If our products do not conform to, or are not compatible with, existing or emerging industry standards, demand for our existing solutions may decrease, which in turn would harm our business and operating results.
We design certain of our products to conform to current industry standards. Some industry standards may not be widely adopted or implemented uniformly, and competing standards may emerge that may be preferred by our customers or by our third-party suppliers. In addition, existing standards may be challenged as infringing upon the intellectual property rights of other companies or may be superseded by new innovations or standards.
Our ability to compete in the future will depend on our ability to identify and ensure compliance with evolving industry standards in our target markets, including in the data center and enterprise infrastructure markets. The emergence of new industry standards could render our products incompatible with products developed by third-party suppliers or make it difficult for our products to meet the requirements of certain original equipment manufacturers, or OEMs. If our customers or our third-party suppliers adopt new or competing industry standards with which our solutions are not compatible, or if industry groups fail to adopt standards with which our solutions are compatible, our products would become less desirable to our current or prospective customers. As a result, our sales would suffer, and we could be required to make significant expenditures to develop new solutions.
Although we believe our products are fully compliant with applicable industry standards, proprietary enhancements may not in the future result in full conformance with existing industry standards under all circumstances. Due to the interdependence of various components in the systems within which our products and the products of our competitors operate, once a design is adopted, customers are unlikely to switch to another design until the next generation of the applicable technology. For example, we have developed our AQrate technology, which is designed to address 2.5GbE and 5GbE operation over today’s Cat5e and Cat6 cabling infrastructure. If this semiconductor solution fails to meet the needs of our customers or penetrate new markets in a timely fashion, and does not gain acceptance, we may not maintain or may lose market share and our competitive position, and operating results will be adversely affected.
We may experience difficulties demonstrating the value to customers of newer solutions if they believe existing solutions are adequate to meet end customer expectations. If we are unable to sell new generations of our product, our business would be harmed.
As we develop and introduce new solutions, we face the risk that customers may not value or be willing to bear the cost of incorporating these newer solutions into their product offerings, particularly if they believe their customers are satisfied with those current offerings. Regardless of the improved features or superior performance of the newer solutions, customers may be unwilling to adopt our new solutions due to design or pricing constraints. Because of the extensive time and resources that we invest in developing new solutions, if we are unable to sell customers new generations of our solutions, our revenue could decline and our business, financial condition, results of operations and cash flows would be negatively affected.
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We depend on our executive officers and other key employees, and the loss of one or more of these employees or an inability to attract and retain highly skilled employees could adversely affect our business.
Our success depends largely upon the continued services of our executive officers and other key employees, including our design and technical personnel. From time to time, there may be changes in our executive management team or other key personnel, which could disrupt our business. We do not have employment agreements with our executive officers or other key personnel that require them to continue to work for us for any specified period and, therefore, they could terminate their employment with us at any time. The loss of one or more of our senior executive officers or other key employees could have an adverse effect on our business.
In addition, to execute our growth plan, we must attract and retain highly qualified personnel. Competition for these personnel in the San Francisco Bay Area, where our headquarters is located, and in other locations where we maintain offices, is intense, especially for engineers experienced in designing and developing semiconductor solutions. We have from time to time experienced, and we expect to continue to experience, difficulty in hiring and retaining employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than we have. If we hire employees from competitors or other companies, their former employers may attempt to assert that these employees or we have breached legal obligations, resulting in a diversion of our time and resources if we respond to them. In addition, job candidates and existing employees often consider the value of the equity awards they receive in connection with their employment. If the perceived value of our equity awards declines, it may adversely affect our ability to recruit and retain highly skilled employees. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be adversely affected.
We may be unable to make the substantial investments that are required to remain competitive in our business.
The semiconductor industry requires substantial and continuous investment in research and development in order to bring to market new and enhanced solutions. Our research and development expenses were $56.0 million, $44.8 million and $36.6 million for the years ended December 31, 2018, 2017 and 2016, respectively. We expect to increase our research and development expenditures compared to prior periods as part of our strategy to increase demand for our solutions in our current markets and to expand into additional markets. We are a smaller company with limited resources, and we may not have sufficient resources to maintain the level of investment in research and development required to remain competitive. In addition, we cannot assure you that the technologies, which are the focus of our research and development expenditures, will become commercially successful or generate any revenue.
If we fail to compete effectively, we may lose or fail to gain market share, which could negatively impact our operating results and our business.
The global semiconductor market in general, and the data center and enterprise communications markets in particular, is highly competitive. We compete in our target markets on the basis of a number of competitive factors. We expect competition to increase and intensify as additional semiconductor companies enter our target markets, and as internal silicon design resources of large OEMs grow. Increased competition could result in price pressure, reduced gross margins and loss of market share, any of which could harm our business, revenue and results of operations. Our competitors range from large, international companies offering a wide range of semiconductor products to smaller companies specializing in narrow market verticals. In the markets we serve, our primary competitors are Broadcom and Marvell. We expect competition in our current markets to increase in the future as existing competitors improve or expand their product offerings and as new competitors enter these markets. In addition, our future growth will depend in part on our ability to successfully enter and compete in new markets, such as the access market. Some of these markets will likely be served by only a few large, multinational OEMs with substantial negotiating and buying power relative to us and, in some instances, with internally developed silicon solutions that can be competitive to our products.
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Our ability to compete successfully depends, in part, on factors that are outside of our control, including industry and general economic trends. Many of our competitors are substantially larger, have greater financial, technical, marketing, distribution, customer support and other resources, are more established than we are and have significantly better brand recognition and broader product offerings, which may enable them to better withstand adverse economic or market conditions in the future and reduce their pricing so as to compete against us. Our ability to compete successfully will depend on a number of factors, including:
| • | our ability to define, design and regularly introduce new products that anticipate the functionality and integration needs of our customers’ next-generation products and applications; |
| • | our ability to build strong and long-lasting relationships with our customers and other industry participants; |
| • | our ability to capitalize on, and prevent losses due to, vertical integration by significant customers, including Intel and Cisco; |
| • | our solutions’ performance and cost-effectiveness relative to those of competing products; |
| • | the effectiveness and success of our customers’ products utilizing our solutions within their competitive end markets; |
| • | our research and development capabilities to provide innovative solutions and maintain our product roadmap; |
| • | the strength of our sales and marketing efforts, and our brand awareness and reputation; |
| • | our ability to deliver products in volume on a timely basis at competitive prices; |
| • | our ability to build and expand international operations in a cost-effective manner; |
| • | our ability to protect our intellectual property and obtain intellectual property rights from third parties that may be necessary to meet the evolving demands of the market; |
| • | our ability to promote and support our customers’ incorporation of our solutions into their products; |
| • | our ability to continue to develop products at each new technology node; and |
| • | our ability to retain high-level talent, including our management team and engineers. |
Our competitors may also establish cooperative relationships among themselves or with third parties or may acquire companies that provide similar products to ours. As a result, new competitors or alliances may emerge that could capture significant market share. Any of these factors, alone or in combination with others, could harm our business and result in a loss of market share and an increase in pricing pressure. In addition, a number of our competitors are able to sell their solutions through multiple channels, including through distributors and third-party sales organizations, while we rely primarily on direct sales, which may provide our competitors with a strategic advantage in sales of their solutions and could harm our prospects and business.
We rely on the use of certain materials from a single supplier or a limited number of suppliers in our supply chain. The lack of availability of these materials could delay the execution of our business strategy and adversely affect our revenues and operating results.
Our supply chain consists of wafers, substrates, package, assembly, test, magnetics and controllers. We rely on the use of certain materials in our supply chain for the manufacturing of our products. If any or some of these materials become unavailable, increase prices, or, if any of these suppliers cease operations and we cannot find an alternative source, our development efforts could be delayed and the product productions may cease which could adversely affect our revenues and our operating results.
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We depend on third parties for our wafer, assembly and testing operations, which exposes us to certain risks that may harm our business.
We operate an outsourced manufacturing business model. As a result, we rely on third parties for all of our manufacturing operations, including wafer fabrication, assembly and testing. Although we use multiple third-party supplier sources, we depend on these third parties to supply us with material of a requested quantity in a timely manner that meets our standards for yield, cost and manufacturing quality. We do not have any long-term supply agreements with any of our manufacturing suppliers. These third-party manufacturers often serve customers that are larger than us or require a greater portion of their services, which may decrease our relative importance and negotiating leverage with these third parties.
If market demand for wafers or production and assembly materials increases, or if a supplier of our wafers ceases or suspends operations, our supply of wafers and other materials could become limited. We currently rely on foundries such as Taiwan Semiconductor Manufacturing Company, or TSMC, and GLOBALFOUNDRIES for most of our semiconductor wafer production, and any disruption in their supply of wafers or any increases in their wafer or materials prices could adversely affect our gross margins and our ability to meet customer demands in a timely manner, or at all, and lead to reduced revenue. Moreover, wafers constitute a large portion of our product cost. If we are unable to purchase wafers at favorable prices, our gross margins would be adversely affected.
To ensure continued wafer supply, we may be required to establish alternative wafer supply sources, which could require significant expenditures and limit our negotiating leverage. We currently rely on TSMC and GLOBALFOUNDRIES as our primary foundries; and only a few foundry vendors have the capability to manufacture our most advanced solutions. If we engage alternative supply sources, we may encounter start-up difficulties and incur additional costs. In addition, shipments could be significantly delayed while these sources are qualified for volume production.
Certain of our manufacturing facilities are located outside of the United States, where we are subject to increased risk of political and economic instability, difficulties in managing operations, difficulties in enforcing contracts and our intellectual property, and employment and labor difficulties. Any of these factors could result in manufacturing and supply problems, and delays in our ability to provide our solutions to our customers on a timely basis, or at all. If we experience manufacturing problems at a particular location, we may be required to transfer manufacturing to a new location or supplier. Converting or transferring manufacturing from a primary location or supplier to a backup facility could be expensive and could take several quarters or more. During such a transition, we would be required to meet customer demand from our then-existing inventory, as well as any partially finished goods that could be modified to the required product specifications. We do not seek to maintain sufficient inventory to address a lengthy transition period because we believe it is uneconomical to keep more than minimal inventory on hand and because semiconductors are subject to a rapid obsolescence timeline. As a result, we may not be able to meet customer needs during such a transition, which could damage our customer relationships.
If one or more of these vendors terminates its relationship with us, or if we encounter any problems with our manufacturing supply chain, our ability to ship our solutions to our customers on time and in the quantity required would be adversely affected, which in turn could cause an unanticipated decline in our sales and loss of customers.
If the foundries that we employ do not achieve satisfactory yields or quality, our reputation and customer relationships could be harmed.
We depend on satisfactory foundry manufacturing capacity, wafer prices and production yields, as well as timely wafer delivery to meet customer demand and maintain gross margins. The fabrication of our products is a complex and technically demanding process. Minor deviations in the manufacturing process can cause substantial decreases in yields and, in some cases, cause production to be suspended. Our foundry vendors may experience manufacturing defects and reduced manufacturing yields from time to time. Further, any new foundry vendors we employ may present additional and unexpected manufacturing challenges that could require significant management time and focus. Changes in manufacturing processes or the inadvertent use of defective or contaminated materials by the foundries that we employ could result in lower than anticipated production yields or unacceptable performance of our devices. Many of these problems are difficult to detect at an early stage of the manufacturing process and may be time consuming and expensive to correct. Poor production yields from the foundries that we employ, or defects, integration issues or other performance problems in our solutions could significantly harm our customer relationships and financial results, and give rise to financial or other damages to our customers. Any product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend.
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We rely on our relationships with industry and technology leaders to enhance our product offerings and our inability to continue to develop or maintain such relationships in the future would harm our ability to remain competitive.
We develop many of our semiconductor products for applications in systems that are driven by industry and technology leaders in the communications and computing markets. We work with IC suppliers, OEMs, system manufacturers and standards bodies, such as the Institute of Electrical and Electronics, or IEEE, and the NBASE-T Alliance, to define industry conventions and standards within our target markets. For example, AQrate has been established as the technology leader through its adoption by the IEEE as the baseline for the IEEE 802.3bz standard for 2.5GBASE-T and 5GBASE-T products. We believe that these relationships enhance our ability to achieve market acceptance and widespread adoption of our products. If we are unable to continue to develop or maintain these relationships, our semiconductor solutions could become less desirable to our customers, our sales could suffer and our competitive position could be harmed.
We are subject to the cyclical nature of the semiconductor industry.
The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and demand. The industry experienced a significant downturn during the most recent global recession. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. With the recent changes to import regulations, significant tariffs may be assessed on products which may adversely impact product demand and contribute to a downturn to the industry. Any future downturns in the semiconductor industry could harm our business and operating results. Furthermore, any significant upturn in the semiconductor industry could result in increased competition for access to third-party foundry and assembly capacity. We are dependent on the availability of this capacity to manufacture and assemble our products and we can provide no assurance that adequate capacity will be available to us in the future.
Deterioration of the financial conditions of our customers could adversely affect our operating results.
The deterioration of the financial condition of our customers could adversely impact our collection of accounts receivable. We regularly review the collectability and creditworthiness of our customers to determine an appropriate allowance for doubtful accounts. Based on our review of our customers, substantially all of which are very large IC Suppliers, OEMs, we currently have no reserve for doubtful accounts. If our doubtful accounts, however, were to exceed our current or future allowance for doubtful accounts, our operating results would be adversely affected.
In preparing our consolidated financial statements, we make good faith estimates and judgments that may change or turn out to be erroneous, which could adversely affect our operating results for the periods in which we revise our estimates or judgments.
In preparing our consolidated financial statements in conformity with U.S. generally accepted accounting principles, or GAAP, we must make estimates and judgments in applying our most critical accounting policies. Those estimates and judgments have a significant impact on the results we report in our consolidated financial statements. The most difficult estimates and subjective judgments that we make relate to revenue recognition, inventories, stock-based compensation and income taxes. We base our estimates on historical experience, input from outside experts and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We also have other key accounting policies that are not as subjective, and therefore, their application would not require us to make estimates or judgments that are as difficult, but which nevertheless could significantly affect our financial reporting. Actual results may differ materially from these estimates. If these estimates, judgments or their related assumptions change, our operating results for the periods in which we revise our estimates, judgments or assumptions could be adversely and perhaps materially affected.
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Changes to financial accounting standards may affect our results of operations and could cause us to change our business practices.
We prepare our consolidated financial statements to conform to GAAP. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, the Securities and Exchange Commission, or the SEC, and various bodies formed to interpret and create accounting rules and regulations. In the past few years, new accounting standards have been issued which are expected substantially change the accounting for most companies including those related to revenue recognition and leasing. Changes in accounting rules can have a significant effect on our reported financial results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our financial results or the way we conduct our business.
Future loan agreements could contain certain restrictive covenants that may limit our operating flexibility.
We may enter into loan agreements that could contain certain restrictive covenants that either limit our ability to, or require a mandatory prepayment in the event that, we incur additional indebtedness or liens, merge with other companies or consummate certain changes of control, acquire other companies, make certain investments, pay dividends, transfer or dispose of assets, amend certain material agreements or enter into various specified transactions. Furthermore, any restrictive terms may limit our operating flexibility which may in turn adversely impact our operating results. In addition, in the event of any future liquidation, any future lenders would be repaid all outstanding principal and interest prior to distribution of assets to unsecured creditors, and the holders of our common stock would receive a portion of any liquidation proceeds only if all of our creditors were first repaid in full.
We may not be able to accurately predict our future capital needs, and we may not be able to obtain additional financing to fund our operations.
We may need to raise additional funds in the future. Any required additional financing may not be available on terms acceptable to us, or at all. If we raise additional funds by issuing equity securities or convertible debt, investors may experience significant dilution of their ownership interest, and the newly-issued securities may have rights senior to those of the holders of our common stock. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operational flexibility and would also require us to incur interest expense. If additional financing is not available when required or is not available on acceptable terms, we may have to scale back our operations or limit our production activities, and we may not be able to expand our business, develop or enhance our solutions, take advantage of business opportunities or respond to competitive pressures, which could negatively impact our revenue and the competitiveness of our products.
We may make acquisitions in the future that could disrupt our business, cause dilution to our stockholders, reduce our financial resources and harm our business.
In the future, we may acquire other businesses, products or technologies. Our ability to make acquisitions and successfully integrate personnel, technologies or operations of any acquired business is unproven. If we complete acquisitions, we may not achieve the combined revenue, cost synergies or other benefits from the acquisition that we anticipate, strengthen our competitive position or achieve our other goals in a timely manner, or at all, and these acquisitions may be viewed negatively by our customers, financial markets or investors. In addition, any acquisitions we make lead to difficulties in integrating personnel, technologies and operations from the acquired businesses and in retaining and motivating key personnel. Acquisitions may disrupt our ongoing operations, divert management from their primary responsibilities, subject us to additional liabilities, increase our expenses and adversely impact our business, results of operations, financial condition and cash flows. Acquisitions may also reduce our cash available for operations and other uses, and could result in an increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt, any of which could harm our business.
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A portion of our operations is located outside of the United States, which subjects us to additional risks, including increased complexity and costs of managing international operations and geopolitical instability.
We outsource the manufacturing of all of our products to third parties that are primarily located in Asia. In addition, we have research and development design centers in Canada, India, the Netherlands and Russia, and we expect to continue to conduct business with companies that are located outside the United States, particularly in Eastern Europe and Asia. As a result of our international focus, we face numerous challenges and risks, including:
| • | complexity and costs of managing international operations, including manufacture, assembly and testing of our products; |
| • | geopolitical and economic instability and military conflicts; |
| • | limited protection of our intellectual property and other assets; |
| • | compliance with local laws and regulations and unanticipated changes in local laws and regulations, including tax laws and regulations; |
| • | trade and foreign exchange restrictions and higher tariffs; |
| • | timing and availability of import and export licenses and other governmental approvals, permits and licenses, including export classification requirements; |
| • | foreign currency fluctuations and exchange losses relating to our international operating activities; |
| • | restrictions imposed by the U.S. government or foreign governments on our ability to do business with certain companies or in certain countries as a result of international political conflicts and the complexity of complying with those restrictions; |
| • | transportation delays and other consequences of limited local infrastructure, and disruptions, such as large scale outages or interruptions of service from utilities or telecommunications providers; |
| • | difficulties in staffing international operations; |
| • | local business and cultural factors that differ from our normal standards and practices; |
| • | differing employment practices and labor relations; |
| • | heightened risk of terrorist acts; |
| • | regional health issues, travel restrictions and natural disasters; and |
Fluctuations in exchange rates between and among the currencies of the countries in which we do business could adversely affect our results of operations.
Our sales have been historically denominated in U.S. dollars. An increase in the value of the U.S. dollar relative to the currencies of the countries in which our customers operate could impair the ability of our customers to cost-effectively purchase or integrate our solutions into their product offerings, which may materially affect the demand for our solutions and cause these customers to reduce their orders, which in turn would adversely affect our revenue and business. If we increase operations in other currencies in the future, we may experience foreign exchange gains or losses due to the volatility of other currencies compared to the U.S. dollar. Certain of our employees are located in Canada, India, the Netherlands, Russia and Taiwan. Accordingly, a portion of our payroll as well as certain other operating expenses are paid in currencies other than the U.S. dollar. Our results of operations are denominated in U.S. dollars, and the difference in exchange rates in one period compared to another may directly impact period-to-period comparisons of our results of operations. Furthermore, currency exchange rates have been especially volatile in the recent past, and these currency fluctuations may make it difficult for us to predict our results of operations.
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Failure to comply with the laws associated with our activities outside of the United States could subject us to penalties and other adverse consequences.
We face significant risks if we fail to comply with anti-corruption laws and anti-bribery laws, including, without limitation, the U.S. Foreign Corrupt Practices Act of 1977, as amended, or the FCPA, the U.S. Travel Act and the UK Bribery Act 2010, that prohibit improper payments or offers of payment to foreign governments and political parties by us for the purpose of obtaining or retaining business. In many foreign countries, particularly in countries with developing economies, it may be a local custom that businesses operating in such countries engage in business practices that are prohibited by the FCPA or other applicable laws and regulations. We are in the early stages of implementing our FCPA compliance programs and cannot assure you that all of our employees and agents, as well as those companies to which we outsource certain of our business operations, will not take actions in violation of our policies and applicable law, for which we may be ultimately held responsible. Any violation of these laws could result in severe criminal or civil sanctions and, in the case of the FCPA, suspension or debarment from U.S. government contracting, which could have an adverse effect on our reputation, business, financial condition and results of operations.
In addition, data privacy laws in various jurisdictions are changing significantly and creating a complex regulatory compliance environment. For example, the European Union adopted the General Data Protection Regulation, or the GDPR, which came into effect in May 2018 and requires companies to meet requirements regarding the use and handling of personal data in the European Union. Failure to meet GDPR requirements could result in penalties of the greater of €20 million or up to 4% of a company’s worldwide revenue, as well as other potential penalties and fines. It can be challenging to comply with these changing laws and our efforts to comply could cause us to incur substantial costs. Failure to comply also subjects us to significant potential penalties, reputational damage and loss of business.
We are subject to government regulation, including import, export and economic sanctions laws and regulations that may expose us to liability and increase our costs.
Our products and technology are subject to U.S. export controls, including the U.S. Department of Commerce’s Export Administration Regulations and economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Controls. These regulations may limit the export of our products and technology, and provision of our services outside of the United States, or may require export authorizations, including by license, a license exception or other appropriate government authorizations, including annual or semi-annual reporting and the filing of an encryption registration. Export control and economic sanctions laws may also include prohibitions on the sale or supply of certain of our products to embargoed or sanctioned countries, regions, governments, persons and entities. In addition, various countries regulate the importation of certain products, through import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products. The exportation, reexportation, and importation of our products and technology and the provision of services, including by our partners, must comply with these laws or else we may be adversely affected, through reputational harm, government investigations, penalties, and a denial or curtailment of our ability to export our products and technology or provide services. Complying with export control and sanctions laws may be time consuming and may result in the delay or loss of sales opportunities. Although we take precautions to prevent our products and technology from being provided in violation of such laws, our products and technology may have previously been, and could in the future be, provided inadvertently in violation of such laws, despite the precautions we take. If we are found to be in violation of U.S. sanctions or export control laws, it could result in substantial fines and penalties for us and for the individuals working for us. Changes in export or import laws or corresponding sanctions, may adversely impact our operations, delay the introduction and sale of our products in international markets, or, in some cases, prevent the export or import of our products and technology to certain countries, regions, governments, persons or entities altogether, which could adversely affect our business, financial condition and results of operations.
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New or future changes to U.S. and non-U.S. tax laws could materially adversely affect our company.
New or future changes in tax laws, regulations, and treaties, or the interpretation thereof, in addition to tax regulations enacted but not in effect, tax policy initiatives and reforms under consideration in the United States or related to the Organisation for Economic Co-operation and Development’s, or OECD, Base Erosion and Profit Shifting, or BEPS, Project, the European Commission’s state aid investigations, and other initiatives could have an adverse effect on the taxation of international businesses. Furthermore, countries where we are subject to taxes, including the United States, are independently evaluating their tax policy and we may see significant changes in legislation and regulations concerning taxation. Certain countries have already enacted legislation, including those related to BEPS Project, which could affect international businesses, and other countries have become more aggressive in their approach to audits and enforcement of their applicable tax laws. We are unable to predict what future tax reform may be proposed or enacted or what effect such changes would have on our business, but any such changes, to the extent they are brought into tax legislation, regulations, policies, or practices, could increase our effective tax rates in the countries where we have operations and have an adverse effect on our overall tax rate, along with increasing the complexity, burden and cost of tax compliance, all of which could impact our operating results, cash flows and financial condition.
The U.S. Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The Act among other changes, reduces the U.S. federal corporate tax rate from 35% to 21%, implements a modified territorial tax system that includes a one-time transition tax on deemed repatriation of previously untaxed accumulated earnings and profits of certain foreign subsidiaries, and creates new taxes on certain foreign-sourced earnings. Many of the provisions of the Act are highly complex and may be subject to further interpretive guidance from the Internal Revenue Service or others. The final impact of the Act may differ significantly from our estimates, due to, among other things, changes in interpretations and assumptions made by us as a result of additional information, additional guidance that may be issued by the U.S. Department of the Treasury. We continue to examine the impact of certain provisions of the Act related to base erosion anti-abuse tax and other provisions that could adversely affect our effective tax rate in the future.
We have recorded significant valuation allowances on our deferred tax assets, and the recording and release of such allowances may have a material impact on our results of operations and cause fluctuations in our stock price.
The need for a valuation allowance requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable; such assessment is required on a jurisdiction-by-jurisdiction basis. In making such assessment, significant weight is given to evidence that can be objectively verified. As such, we determined that full valuation allowance is required on our deferred tax assets.
In the future, we may release valuation allowance and recognize deferred tax assets depending on achieving profitability. We continue to monitor the likelihood that we will be able to recover our deferred tax asset. There can be no assurance that we will generate profits in future periods enabling it to fully realize its deferred tax. The timing of the reversal of such valuation allowance is subject to objective and subjective factors that cannot be readily predicted in advance. The reversal of a previously recorded valuation allowance may have a material impact on our financial results, which may lead to fluctuation in the value of our stock.
Tax regulatory authorities may disagree with our positions and conclusions regarding certain tax positions resulting in unanticipated costs or non-realization of expected benefits.
A tax authority may disagree with tax positions that we have taken. For example, the Internal Revenue Service or another tax authority could challenge our allocation of income by tax jurisdiction and the amounts paid between our affiliated companies pursuant to our intercompany arrangements and transfer pricing policies, including amounts paid with respect to our intellectual property in connection with our intercompany research and development cost sharing arrangement and legal structure. A tax authority may take the position that material income tax liabilities, interest and penalties are payable by us, in which case, we expect that we might contest such assessment. Contesting such an assessment may be lengthy and costly and if we were unsuccessful in disputing the assessment, the implications could materially and adversely affect our anticipated effective tax rate or operating income, where applicable.
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Catastrophic events may disrupt our business.
Our corporate headquarters and our foundry vendors are located in areas that are in active earthquake zones. In the event of a major earthquake, hurricane or other catastrophic event such as fire, power loss, telecommunications failure, cyber-attack, war, terrorist attack or disease outbreak, we may be unable to continue our operations and may endure system interruptions, reputational harm, delays in our product development, breaches of data security, or loss of critical data, any of which could have an adverse effect on our future results of operations.
A breach of our security systems may damage our reputation and adversely affect our business.
Our security systems are designed to protect our customers’, suppliers’ and employees’ confidential information, as well as maintain the physical security of our facilities. We also rely on a number of third-party cloud-based service providers of corporate infrastructure services relating to, among other things, human resources, electronic communication services and some finance functions, and we are, of necessity, dependent on the security systems of these providers. We and our third-party providers are vulnerable to outages, telecommunications failures and catastrophic events, as well as computer viruses, break-ins, phishing attacks, and other cyber-attacks. We have in the past and may in the future experience security breaches or unauthorized access to our systems. Any security breaches or other unauthorized access by third parties to the systems of our cloud-based service providers or the existence of computer viruses in their data or software could expose us to a risk of information loss and misappropriation of confidential information. Accidental or willful security breaches or other unauthorized access by third parties to our information systems or facilities, or the existence of computer viruses in our data or software, could expose us to a risk of information loss and misappropriation of proprietary and confidential information. Any theft or misuse of this information could result in, among other things, unfavorable publicity, damage to our reputation, difficulty in marketing our products, allegations by our customers that we have not performed our contractual obligations, litigation by affected parties and possible financial obligations for liabilities and damages related to the theft or misuse of this information, any of which could have an adverse effect on our business, financial condition, our reputation and our relationships with our customers and suppliers. Since the techniques used to obtain unauthorized access or to sabotage systems change frequently and are often not recognized until after they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures.
Risks Related to Our Intellectual Property and Potential Product Liability
Our failure to adequately protect our intellectual property rights could impair our ability to compete effectively or defend ourselves from litigation, which could harm our business, financial condition and results of operations.
Our success depends, in part, on our ability to protect our intellectual property. We rely primarily on patent, copyright, trademark and trade secret laws, as well as confidentiality and non-disclosure agreements and other contractual protections, to protect our technologies and proprietary know-how, all of which offer only limited protection. The steps we have taken to protect our intellectual property rights may not be adequate to prevent misappropriation of our proprietary information or infringement of our intellectual property rights, and our ability to prevent such misappropriation or infringement is uncertain, particularly in countries outside of the United States. As of December 31, 2018, we had 87 issued patents, expiring generally between 2024 and 2037, 28 pending and provisional patent applications in the United States and 12 issued international patents. Even if the pending patent applications are granted, the rights granted to us may not be meaningful or provide us with any commercial advantage. For example, these patents could be opposed, contested, circumvented, designed around by our competitors or be declared invalid or unenforceable in judicial or administrative proceedings. Further, we are a participant in the IEEE standard process and, as a result, have signed letters of assurance with the IEEE stipulating that we will agree to license to other members of the IEEE, under reasonable and non-discriminatory terms, patents containing essential claims that are necessary for the implementation of the IEEE standards for 10GBASE-T as well as 2.5GBASE-T and 5GBASE-T. Essential claims include any claim the practice of which was necessary to implement a portion of the IEEE standard when, at the time of IEEE’s approval, there was no commercially and technically feasible non-infringing alternative implementation method. To date, we do not license any of our patents to other members of the IEEE; however, we may decide, or otherwise be required pursuant to such letters of assurance, to enter into such licensing agreements with respect to a significant number of our patents relating to both our 10GBASE-T PHYs and our AQrate technology in the future. The failure of our patents to adequately protect our technology might make it easier for our competitors to offer similar products or technologies. Our foreign patent protection is generally not as comprehensive as our U.S. patent protection and may not protect our intellectual property in some countries where our
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products are sold or may be sold in the future. Many U.S.-based companies have encountered substantial intellectual property infringement in foreign countries, including countries where we sell products. Even if foreign patents are granted, effective enforcement in foreign countries may not be available. If such an impermissible use of our intellectual property or trade secrets were to occur, our ability to sell our solutions at competitive prices may be adversely affected and our business, financial condition, results of operations and cash flows could be adversely affected.
The legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and evolving. We cannot assure you that others will not develop or patent similar or superior technologies or solutions, or that our patents, trademarks and other intellectual property will not be challenged, invalidated or circumvented by others.
Unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for doing so, which could harm our business. Monitoring unauthorized use of our intellectual property is difficult and costly. It is possible that unauthorized use of our intellectual property may have occurred or may occur without our knowledge. We cannot assure you that the steps we have taken will prevent unauthorized use of our intellectual property. Our failure to effectively protect our intellectual property could reduce the value of our technology in licensing arrangements or in cross-licensing negotiations.
We may in the future need to initiate infringement claims or litigation in order to try to protect our intellectual property rights. Litigation, whether we are a plaintiff or a defendant, can be expensive, time-consuming and may divert the efforts of our technical staff and management, which could harm our business, whether or not such litigation results in a determination favorable to us. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, any enforcement of our patents or other intellectual property may provoke third parties to assert counterclaims against us. If we are unable to protect our proprietary rights or if third parties independently develop or gain access to our or similar technologies, our business, revenue, reputation and competitive position could be harmed.
We have granted the right to manufacture our custom products to our customers upon the occurrence of certain events. If our customers exercise such rights, our business and financial results would suffer.
We have granted certain of our customers, including Intel and Cisco, a worldwide, nonexclusive, nontransferable, perpetual, irrevocable right and license to manufacture or have manufactured our products that have been customized for them. These rights are exercisable only upon the occurrence of certain events, including for example, if we fail to consistently supply products in quantities ordered, we discontinue manufacture of such products or we experience an insolvency event. If these rights are triggered, and our customers choose to exercise these rights, our business and financial results would suffer.
Third parties’ assertions of infringement of their intellectual property rights could result in our having to incur significant costs and cause our operating results to suffer.
The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which has resulted in protracted and expensive litigation for many companies. We expect that in the future, particularly as a public company with an increased profile and visibility, we may receive communications from others alleging our infringement of patents, trade secrets or other intellectual property rights. Lawsuits resulting from such allegations could subject us to significant liability for damages and invalidate our proprietary rights. Any potential intellectual property litigation also could force us to do one or more of the following:
| • | stop selling solutions or using technology that contain the allegedly infringing intellectual property; |
| • | lose the opportunity to license our technology to others or to collect royalty payments based upon successful protection and assertion of our intellectual property against others; |
| • | incur significant legal expenses; |
| • | pay substantial damages to the party whose intellectual property rights we may be found to be infringing; |
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| • | redesign those products that contain the allegedly infringing intellectual property; or |
| • | attempt to obtain a license to the relevant intellectual property from third parties, which may not be available on reasonable terms or at all. |
Any significant impairment of our intellectual property rights from any litigation we face could harm our business and our ability to compete.
We may face claims of intellectual property infringement, which could be time-consuming and costly to defend or settle and which could result in the loss of significant rights and harm our relationships with our customers and distributors.
The semiconductor industry, the industry in which we operate, is characterized by companies that hold patents and other intellectual property rights and vigorously pursue, protect and enforce intellectual property rights. From time to time, third parties may assert against us and our customers and distributors their patent and other intellectual property rights to technologies that are important to our business.
Claims that our products, processes or technology infringe third-party intellectual property rights, regardless of their merit or resolution, could be costly to defend or settle and could divert the efforts and attention of our management and technical personnel.
Infringement claims also could harm our relationships with our customers or distributors and might deter future customers from doing business with us. We do not know whether we will prevail in these proceedings given the complex technical issues and inherent uncertainties in intellectual property litigation. If any future proceedings result in an adverse outcome, we could be required to:
| • | cease the manufacture, use or sale of the infringing products, processes or technology; |
| • | pay substantial damages for infringement by us or our customers; |
| • | expend significant resources to develop non-infringing products, processes or technology, which may not be successful; |
| • | license technology from the third-party claiming infringement, which license may not be available on commercially reasonable terms, or at all; |
| • | cross-license our technology to a competitor to resolve an infringement claim, which could weaken our ability to compete with that competitor; or |
| • | pay substantial damages to our customers or end users to discontinue their use of or to replace infringing technology sold to them with non-infringing technology, if available. |
Any of the foregoing results could adversely affect our business, financial condition and results of operations.
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Any potential dispute involving our patents or other intellectual property could affect our customers, which could trigger our indemnification obligations to them and result in substantial expense to us.
In any potential dispute involving our patents or other intellectual property, our customers could also become the target of litigation. Our agreements with customers and other third parties generally include indemnification or other provisions under which we agree to indemnify or otherwise be liable to them for losses suffered or incurred as a result of claims of intellectual property infringement, damages caused by us to property or persons, or other liabilities relating to or arising from our solutions included in their products. Large indemnity payments or damage claims from contractual breach could harm our business, operating results, and financial condition. From time to time, customers require us to indemnify or otherwise be liable to them for breach of confidentiality or failure to implement adequate security measures with respect to their intellectual property and trade secrets. Although we normally contractually limit our liability with respect to such obligations, we may still incur substantial liability related to them. Any litigation against our customers could trigger technical support and indemnification obligations under some of our agreements, which could result in substantial expense to us.
In addition, other customers or end customers with whom we do not have formal agreements requiring us to indemnify them may ask us to indemnify them if a claim is made as a condition to awarding future design wins to us. Because most of our customers are larger than we are and have greater resources than we do, they may be more likely to be the target of an infringement claim by third parties than we would be, which could increase our chances of becoming involved in a future lawsuit. If any such claims were to succeed, we might be forced to pay damages on behalf of our customers that could increase our expenses, disrupt our ability to sell our solutions and reduce our revenue. Any dispute with a customer with respect to such obligations could have adverse effects on our relationship with that customer and other current and prospective customers, reduce demand for our solutions, and harm our business and results of operations. In addition to the time and expense required for us to supply support or indemnification to our customers, any such litigation could severely disrupt or shut down the business of our customers, which in turn could hurt our relations with our customers and cause the sale of our products to decrease.
Risks Related to Our Common Stock
Our stock price has been and is likely to continue to be volatile, which could cause the value of our common stock to decline.
The trading price and volume of our common stock has been and is likely to continue to be volatile and could fluctuate significantly in response to numerous factors, many of which are beyond our control, including:
| • | actual or anticipated fluctuations in our results of operations due to, among other things, changes in customer demand, product life cycles, pricing, ordering patterns and unforeseen operating costs; |
| • | the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; |
| • | failure of securities analysts to initiate or maintain coverage of our company, changes in financial estimates or ratings by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; |
| • | announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments; |
| • | announcements by our significant customers of changes to their product offerings, business plans or strategies; |
| • | changes in operating performance and stock market valuations of other technology companies generally, or those in the semiconductor industry; |
| • | timing and seasonality of the end-market demand; |
| • | cyclical fluctuations in the semiconductor market; |
| • | price and volume fluctuations in the overall stock market from time to time, including as a result of trends in the economy as a whole; |
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| • | actual or anticipated developments in our business or our competitors’ businesses or the competitive landscape generally; |
| • | new laws or regulations or new interpretations of existing laws, or regulations applicable to our business; |
| • | any major change in our management; |
| • | lawsuits threatened or filed against us; and |
| • | other events or factors, including those resulting from war, incidents of terrorism or responses to these events. |
In addition, the market for technology stocks and the stock markets in general have experienced extreme price and volume fluctuations. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business and adversely affect our business, results of operations, financial condition and cash flows.
Substantial future sales of shares of our common stock could cause the market price of our common stock to decline.
The market price of our common stock could decline as a result of substantial sales of our common stock, particularly sales by our directors, executive officers and significant stockholders, a large number of shares of our common stock becoming available for sale or the perception in the market that holders of a large number of shares intend to sell their shares. The market price of our common stock could decline if the holders of those shares sell them or are perceived by the market as intending to sell them.
In addition, certain holders of our common stock have rights, subject to certain conditions, require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders. If we register the resale of these shares in the future, the holders could sell those shares freely in the public market, without regard to the limitations of Rule 144. We have also registered shares of common stock issuable upon the exercise of outstanding options or other equity awards, and any options or equity awards that we may issue in the future, under our employee equity incentive plans, which shares will be able to be sold freely in the public market upon issuance.
If securities analysts or industry analysts downgrade our common stock, publish negative research or reports or fail to publish reports about our business, our stock price and trading volume could decline.
The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us, our business and our market. If one or more analysts adversely changes their recommendation regarding our stock or changes their recommendation about our competitors’ stock, our stock price would likely decline. If one or more analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets which in turn could cause our stock price or trading volume to decline.
We may invest or spend the proceeds from our IPO in ways with which you may not agree or in ways which may not yield a return.
Our management will have considerable discretion in the application of the net proceeds, and our stockholders will not have the opportunity, as part of their investment decision, to assess whether the proceeds are being used appropriately. The net proceeds may be used for corporate purposes that do not increase the value of our business, which could cause our stock price to decline.
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We do not intend to pay dividends on our common stock so any returns will be limited to changes in the value of our common stock.
We have never declared or paid any cash dividends on our common stock. We currently anticipate that we will retain future earnings for the development, operation, and expansion of our business and do not anticipate declaring or paying any cash dividends for the foreseeable future. In addition, our ability to pay cash dividends on our common stock is prohibited by the terms of our current debt financing arrangements. Any return to stockholders will therefore be limited to the increase, if any, in our stock price, which may never occur.
We might not be able to utilize a significant portion of our net operating loss carryforwards and research and development tax credit carryforwards.
As of December 31, 2018, we had U.S. federal and state net operating loss, or NOL, carryforwards of approximately $175.7 million and U.S. federal and state research and development tax credit carryforwards of approximately $8.9 million. The U.S. federal NOL carryforwards begin to expire in 2025 and the state NOL carryforwards begin to expire in 2019. The U.S. federal research and development tax credit carryforwards begin to expire in 2026 and the state research and development tax credit carryforwards carry forward indefinitely. These net operating loss and U.S. federal tax credit carryforwards could expire unused and be unavailable to offset future income tax liabilities. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, and corresponding provisions of California state law, if a corporation undergoes an “ownership change,” which is generally defined as a greater than 50% change, by value, in its equity ownership over a three-year period, the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes to offset its post-change income may be limited. We completed Section 382 analysis and determined ownership changes occurred in July 2005, November 2009 and August 2017, which resulted in reductions to the U.S. federal and California net operating losses of $34.9 million and $24.1 million, respectively, and U.S. federal research and development credits by $1.8 million. In addition, we may experience ownership changes in the future as a result of subsequent shifts in our stock ownership, some of which may be outside of our control. If we determine that an ownership change has occurred and our ability to use our historical net operating loss and tax credit carryforwards is materially limited, it would harm our future operating results by effectively increasing our future tax obligations.
Our actual operating results may not meet our guidance and investor expectations, which would likely cause our stock price to decline.
From time to time, we may release guidance in our earnings releases, earnings conference calls or otherwise, regarding our future performance that represent our management’s estimates as of the date of release. If given, this guidance, which will include forward-looking statements, will be based on projections prepared by our management. Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. The principal reason that we expect to release guidance is to provide a basis for our management to discuss our business outlook with analysts and investors. With or without our guidance, analysts and other investors may publish expectations regarding our business, financial performance and results of operations. We do not accept any responsibility for any projections or reports published by any such third parties. Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions of the guidance furnished by us will not materialize or will vary significantly from actual results. If our actual performance does not meet or exceed our guidance or investor expectations, the trading price of our common stock is likely to decline.
We may not be able to effectively or efficiently manage or transition to a public company.
We completed our IPO in November 2017 and anticipate to incurring significant legal, accounting and other expenses that we did not incur before as a private company. Our management team and other personnel will need to devote a substantial amount of time to, and we may not effectively or efficiently manage, our transition into a public company. We intend to hire additional accounting and finance personnel with system implementation experience and expertise regarding compliance with the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. We may be unable to locate and hire qualified professionals with requisite technical and public company experience when and as needed. In addition, new employees will require time and training to learn our business and operating processes and procedures. If we are unable to recruit and retain additional finance personnel or if our finance and accounting team is
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unable for any reason to respond adequately to the increased demands that will result from being a public company, the quality and timeliness of our financial reporting may suffer, which could result in the identification of material weaknesses in our internal controls. Any consequences resulting from inaccuracies or delays in our reported financial statements could cause our stock price to decline and could harm our business, operating results and financial condition.
If we fail to strengthen our financial reporting systems, infrastructure and internal control over financial reporting to meet the demands that will be placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act, we may be unable to report our financial results timely and accurately and prevent fraud. We expect to incur significant expense and devote substantial management effort toward ensuring compliance with Section 404 of the Sarbanes-Oxley Act, or Section 404.
We implemented an enterprise resource planning, or ERP, system. This required significant investment of capital and human resources, the re-engineering of many processes of our business and the attention of many employees who would otherwise be focused on other aspects of our business. Any disruptions or deficiencies in the design and implementation of the improvements of our new ERP system could result in potentially much higher costs than we had anticipated and could adversely affect our ability to develop and launch solutions, fulfill contractual obligations, file reports with the SEC in a timely manner, otherwise operate our business or otherwise impact our controls environment. Any of these consequences could have an adverse effect on our results of operations and financial condition.
As a public company, we are subject to regulatory compliance requirements, such as Section 404, that have and may continue to increase our costs, and if we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud.
Rules and regulations such as the Sarbanes-Oxley Act have increased our legal and finance compliance costs and made some activities more time consuming and costly. For example, Section 404 requires that our management report on, and our independent auditors attest to, the effectiveness of our internal control structure and procedures for financial reporting. However, our auditors will not be required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 until we are no longer an “emerging growth company,” as defined in the JOBS Act. Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. Section 404 compliance may divert internal resources and will take a significant amount of time and effort to complete. We may not be able to successfully complete the procedures and certification and attestation requirements of Section 404 by the time we will be required to do so. Implementing these changes may take a significant amount of time and may require specific compliance training of our personnel. In the future, we may discover areas of our internal controls that need improvement. If our auditors or we discover a material weakness or significant deficiency, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our consolidated financial statements and harm our stock price. Any inability to provide reliable financial reports or prevent fraud would harm our business. We may not be able to effectively and timely implement necessary control changes and employee training to ensure continued compliance with the Sarbanes-Oxley Act and other regulatory and reporting requirements. If we fail to successfully complete the procedures and certification and attestation requirements of Section 404, or if in the future our Chief Executive Officer, Chief Financial Officer or independent registered public accounting firm determines that our internal controls over financial reporting are not effective as defined under Section 404, we could be subject to investigations or sanctions by the New York Stock Exchange, the SEC or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our shares of common stock. We cannot assure you that we will be able to fully comply with the requirements of the Sarbanes-Oxley Act or that management or, when applicable, our auditors will conclude that our internal controls are effective in future periods. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation.
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Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.
Provisions in our amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. Our amended and restated certificate of incorporation and bylaws include provisions that:
| • | authorize our board of directors to issue, without further action by the stockholders, shares of undesignated preferred stock with terms, rights, and preferences determined by our board of directors that may be senior to our common stock; |
| • | require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent; |
| • | specify that special meetings of our stockholders can be called only by our board of directors, the Chairman of our board of directors, or our Chief Executive Officer; |
| • | establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors; |
| • | establish that our board of directors is divided into three classes, with each class serving three-year staggered terms; |
| • | prohibit cumulative voting in the election of directors; |
| • | provide that our directors may be removed only for cause; |
| • | provide that vacancies on our board of directors may be filled by a majority of directors then in office, even if less than a quorum; and |
| • | require the approval of our board of directors or the holders of at least 66 2/3% of our outstanding shares of capital stock to amend our bylaws and certain provisions of our certificate of incorporation. |
These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder. Any delay or prevention of a change of control transaction or changes in our management could cause our stock price to decline.
Our charter documents designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain what they believe to be a favorable judicial forum for disputes with us or our directors, officers, or other employees.
Our amended and restated certificate of incorporation and bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (1) any derivative action or proceeding brought on our behalf, (2) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (3) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation or our bylaws or (4) any action asserting a claim against us governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and consented to the provisions of our certificate of incorporation described above. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers, and other employees. Alternatively, if a court were to find these provisions of our amended and restated certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or results of operations and result in a diversion of the time and resources of our management and board of directors.
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Item 1B. | Unresolved Staff Comments |
None.
We lease 66,943 square feet of office space in San Jose, California which currently serves as our headquarters, which will expire in March 2024. We also lease offices in Canada, India, the Netherlands, Russia and Taiwan. We do not own any real property. We believe that our leased facilities are adequate to meet our current needs and that additional facilities will be available on commercially reasonable terms for lease to meet future needs. For additional information regarding our obligations under property leases, see Note 6 in the notes to our consolidated financial statements included elsewhere in this report for additional information.
From time to time, we may become involved in legal proceedings arising in the ordinary course of our business. We are not currently a party to any legal proceedings the outcome of which, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our business, operating results, financial condition or cash flows.
Item 4. | MINE SAFETY DISCLOSURES |
Not applicable.
PART II
Item 5. | Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market for Registrant’s Common Equity
Our common stock trades on the New York Stock Exchange under the symbol “AQ”
As of February 28, 2019, we had approximately 313 holders of record of our common stock. This number does not include the number of persons whose shares are in nominee or in “street name” accounts through brokers.
We have never declared or paid any cash dividends on shares of our capital stock. We expect to retain all of our earnings to finance the expansion and development of our business and we do not currently intend to pay any cash dividends on our capital stock in the foreseeable future. Our board of directors will determine future dividends, if any.
Director and Executive Officers have currently and may from time to time in the future, establish pre-set trading plans in accordance with Rule 10b5-1 promulgated under the Securities Exchange Act of 1934, as amended, or the Exchange Act.
Securities Authorized for Issuance under Equity Compensation Plans
Information regarding the securities authorized for issuance under our equity compensation plans can be found under Part III, “Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.
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Share Performance Graph
The following information is not deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission or subject to Regulation 14A or 14C under the Exchange Act or to the liabilities of Section 18 of the Exchange Act, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent we specifically incorporate it by reference into such a filing.
Set forth below is a line graph showing the cumulative total stockholder return (change in stock price plus reinvested dividends) assuming the investment of $100 in each of our common stock, the S&P 500 Index and PHLX Semiconductor Index for the period commencing on November 3, 2017, the first trading day of our stock and ending on December 31, 2018. The comparisons in the table are required by the Securities and Exchange Commission and are not intended to forecast or be indicative of future performance of our common stock.
| | 11/2017 | | | 12/2017 | | | 3/2018 | | | 6/2018 | | | 9/2018 | | | 12/2018 | |
Aquantia Corp. | | | 100.00 | | | | 125.89 | | | | 174.44 | | | | 128.67 | | | | 142.11 | | | | 97.44 | |
S&P 500 | | | 100.00 | | | | 101.11 | | | | 100.34 | | | | 103.79 | | | | 111.79 | | | | 96.68 | |
PHLX Semiconductor | | | 100.00 | | | | 99.15 | | | | 106.92 | | | | 103.98 | | | | 108.52 | | | | 90.62 | |
Issuer Purchases of Equity Securities
In 2018, we repurchased 8,649 shares of common stock for approximately $32,000 from an employee pursuant to our option to repurchase unvested shares of common stock upon such employee’s termination.
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Use of Proceeds
On November 7, 2017, we completed our IPO of 7,840,700 shares of our common stock at an offering price of $9.00 per share, including 1,022,700 shares pursuant to the underwriters’ over-allotment option to purchase additional shares of our common stock. All shares issued and sold in our IPO were registered under the Securities Act pursuant to a Registration Statement on Form S-1 (File No. 333-220871), which was declared effective by the SEC on November 2, 2017.
Morgan Stanley & Co. LLC, Barclays Capital Inc. and Deutsche Bank Securities Inc. acted as joint book-running managers for our IPO. Needham & Company LLC and Raymond James & Associates, Inc. acted as co-managers. The offering commenced on October 23, 2017 and, following the sale of the shares upon the closing of the IPO on November 7, 2017, the offer terminated. Net proceeds to us were $63.3 million after deducting underwriters’ discounts and commissions of $4.9 million and deducting estimated offering expenses payable of approximately $2.3 million. No payments were made by us to directors, officers or persons owning 10% or more of our common stock or to their associates, or to our affiliates.
We have used the net proceeds to us from our IPO as follows: (i) to pay fees and expenses of approximately $2.5 million in connection with our IPO, (ii) to repay in full the outstanding indebtedness under our loan with Pinnacle Ventures L.L.C. of approximately $9.2 million, including accrued interest and fees; (iii) to pay and terminate the line of credit with Hercules of approximately $0.3 million and (iv) approximately $0.5 million for other corporate purposes, including insurance premiums for being a publicly traded company.
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Item 6. | Selected Consolidated Financial Data |
The following selected consolidated financial data should be read together with Part II, “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this report. The selected consolidated balance sheet data as of December 31, 2018 and 2017, and the selected consolidated statements of operations data for each of the years ended December 31, 2018, 2017 and 2016 have been derived from our audited consolidated financial statements included elsewhere in this report. The selected consolidated balance sheet data as of December 31, 2016, 2015 and 2014 and the selected consolidated statement of operations data for the years ended December 31, 2015 and 2014 have been derived from our audited consolidated financial statements not included in this report. Historical results are not necessarily indicative of the results to be expected in the future.
| | Year Ended | |
| | December 31, | |
| | 2018(1) | | | 2017 | | | 2016 | | | 2015 | | | 2014 | |
Consolidated Statements of Operations Data | | (in thousands, except for share and per share amounts) | |
Revenue | | $ | 120,784 | | | $ | 103,371 | | | $ | 86,675 | | | $ | 80,807 | | | $ | 24,500 | |
Cost of revenue(2) | | | 52,395 | | | | 44,348 | | | | 34,064 | | | | 41,511 | | | | 16,189 | |
Gross profit | | | 68,389 | | | | 59,023 | | | | 52,611 | | | | 39,296 | | | | 8,311 | |
Operating expenses:(3) | | | | | | | | | | | | | | | | | | | | |
Research and development | | | 56,023 | | | | 44,763 | | | | 36,553 | | | | 25,262 | | | | 27,343 | |
Sales and marketing | | | 10,117 | | | | 7,235 | | | | 5,347 | | | | 3,756 | | | | 2,142 | |
General and administrative | | | 12,754 | | | | 9,975 | | | | 7,124 | | | | 6,284 | | | | 4,403 | |
Collaboration and development charge | | | - | | | | - | | | | - | | | | 12,024 | | | | - | |
Total operating expenses | | | 78,894 | | | | 61,973 | | | | 49,024 | | | | 47,326 | | | | 33,888 | |
Income (loss) from operations | | | (10,505 | ) | | | (2,950 | ) | | | 3,587 | | | | (8,030 | ) | | | (25,577 | ) |
Other income (expense): | | | | | | | | | | | | | | | | | | | | |
Other income, net | | | 1,208 | | | | 141 | | | | 14 | | | | 5 | | | | 12 | |
Interest expense | | | - | | | | (1,735 | ) | | | (3,334 | ) | | | (3,321 | ) | | | (2,164 | ) |
Change in fair value of convertible preferred stock warrant liability | | | - | | | | (990 | ) | | | (544 | ) | | | 1,591 | | | | (15 | ) |
Total other income (expense) | | | 1,208 | | | | (2,584 | ) | | | (3,864 | ) | | | (1,725 | ) | | | (2,167 | ) |
Loss before income tax expense | | | (9,297 | ) | | | (5,534 | ) | | | (277 | ) | | | (9,755 | ) | | | (27,744 | ) |
Provision for (benefit from) income taxes | | | 475 | | | | (117 | ) | | | 168 | | | | 200 | | | | 56 | |
Net loss | | $ | (9,772 | ) | | $ | (5,417 | ) | | $ | (445 | ) | | $ | (9,955 | ) | | $ | (27,800 | ) |
Net loss per share, basic and diluted | | $ | (0.29 | ) | | $ | (0.59 | ) | | $ | (0.10 | ) | | $ | (6.64 | ) | | $ | (24.83 | ) |
Weighted-average shares used to compute net loss per share, basic and diluted (4) | | | 34,181,200 | | | | 9,204,384 | | | | 4,240,461 | | | | 1,498,233 | | | | 1,119,632 | |
(1) In 2018, we adopted Accounting Standards Update 2014-09, Revenue from Contracts with Customers, which amended the accounting standards for revenue recognition using the modified retrospective method which applied to the period beginning January 1, 2018. See Note 2 in the notes to our consolidated financial statements included elsewhere in this report for additional details.
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(2)(3) Cost of revenue and operating expenses include stock-based compensation expense as follows:
| | Year ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | | | 2015 | | | 2014 | |
| | (in thousands) | |
Cost of revenue | | $ | 156 | | | $ | 47 | | | $ | 31 | | | $ | 19 | | | $ | 10 | |
Research and development | | | 3,793 | | | | 973 | | | | 489 | | | | 373 | | | | 382 | |
Sales and marketing | | | 843 | | | | 197 | | | | 95 | | | | 71 | | | | 36 | |
General and administrative | | | 1,728 | | | | 456 | | | | 324 | | | | 329 | | | | 430 | |
Total | | $ | 6,520 | | | $ | 1,673 | | | $ | 939 | | | $ | 792 | | | $ | 858 | |
(4) See Note 9 in the notes to our consolidated financial statements included elsewhere in this report for the calculation of our basic and diluted net loss per common share and the weighted-average number of shares used in the computation of the per share amounts.
| | As of December 31, | |
| | 2018 | | | 2017 | | | 2016 | | | 2015 | | | 2014 | |
| | (in thousands) | |
Consolidated Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | |
Cash, cash equivalents and investments | | $ | 67,414 | | | $ | 56,402 | | | $ | 28,893 | | | $ | 34,290 | | | $ | 7,056 | |
Working capital | | | 81,431 | | | | 79,230 | | | | 26,268 | | | | 38,305 | | | | 9,397 | |
Total assets | | | 114,423 | | | | 110,366 | | | | 65,709 | | | | 66,565 | | | | 20,571 | |
Total debt | | | - | | | | - | | | | 18,229 | | | | 28,909 | | | | 23,308 | |
Convertible preferred stock warrant liability | | | - | | | | - | | | | 12,885 | | | | 12,346 | | | | 1,863 | |
Total liabilities | | | 21,201 | | | | 19,452 | | | | 46,082 | | | | 52,299 | | | | 35,483 | |
Convertible preferred stock | | | - | | | | - | | | | 199,434 | | | | 199,153 | | | | 162,183 | |
Total stockholders’ equity (deficit) | | | 93,222 | | | | 90,914 | | | | (179,807 | ) | | | (184,887 | ) | | | (177,095 | ) |
Non-GAAP Financial Measures
We use the financial measures set forth below, which are non-GAAP financial measures, to help us analyze our financial results, establish budgets and operational goals for managing our business and to evaluate our performance. We also believe that the presentation of these non-GAAP financial measures provides an additional tool for investors to use in comparing our core business and results of operations over multiple periods with other companies in our industry, many of which present similar non-GAAP financial measures to investors. However, the non-GAAP financial measures may not be comparable to similarly titled measures reported by other companies due to differences in the way that these measures are calculated. The non-GAAP financial measures should not be considered as the sole measure of our performance and should not be considered in isolation from, or as a substitute for, comparable financial measures calculated in accordance with GAAP.
Non-GAAP Net Income (Loss). We define non-GAAP net income (loss) as net loss reported on our consolidated statements of operations and comprehensive loss, excluding the impact of the following non-cash charges: stock-based compensation, amortization of acquired intangibles resulting from business combination, change in fair value of convertible preferred stock warrant liability and a collaboration and development charge. We have presented non-GAAP net income (loss) because we believe that the exclusion of these non-cash charges allows for a more relevant comparison of our results of operations to other companies in our industry.
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Reconciliation of Non-GAAP Financial Measures
The following tables reconcile the most directly comparable GAAP financial measure to each of these non-GAAP financial measures.
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | | | 2015 | | | 2014 | |
| | (in thousands) | |
Non-GAAP Net Income (Loss): | | | | | | | | | | | | | | | | | | | | |
Net loss | | $ | (9,772 | ) | | $ | (5,417 | ) | | $ | (445 | ) | | $ | (9,955 | ) | | $ | (27,800 | ) |
Stock-based compensation | | | 6,520 | | | | 1,673 | | | | 939 | | | | 792 | | | | 858 | |
Amortization of acquired intangibles resulting from business combination | | | 34 | | | | 34 | | | | 33 | | | | 33 | | | | 170 | |
Change in fair value of convertible preferred stock warrant liability | | | - | | | | 990 | | | | 544 | | | | (1,591 | ) | | | 15 | |
Collaboration and development charge | | | - | | | | - | | | | - | | | | 12,024 | | | | - | |
Non-GAAP net income (loss) | | $ | (3,218 | ) | | $ | (2,720 | ) | | $ | 1,071 | | | $ | 1,303 | | | $ | (26,757 | ) |
Quarterly Statements of Operations
The following tables set forth selected unaudited quarterly condensed consolidated statements of operations data for each of the eight quarters in the period ended December 31, 2018. The quarterly unaudited financial information for each of these quarters has been prepared on the same basis as the audited annual consolidated financial statements included elsewhere in this report and, in the opinion of management, includes all adjustments of a normal, recurring nature that are necessary for the fair presentation of the results of operations for these periods in accordance with generally accepted accounting principles in the United States. This data should be read in conjunction with our audited consolidated financial statements and related notes included elsewhere in this report. These quarterly operating results are not necessarily indicative of operating results to be expected for a full year or any future periods.
| | Three Months Ended | |
| | Mar. 31, | | | June 30, | | | Sep. 30, | | | Dec. 31, | | | Mar. 31, | | | June 30, | | | Sep. 30, | | | Dec. 31, | |
| | 2017 | | | 2017 | | | 2017 | | | 2017 | | | 2018 | | | 2018 | | | 2018 | | | 2018 | |
| | (dollars in thousands) | |
Quarterly results of operations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Revenue | | $ | 23,643 | | | $ | 25,164 | | | $ | 26,718 | | | $ | 27,846 | | | $ | 28,358 | | | $ | 30,432 | | | $ | 32,902 | | | $ | 29,092 | |
Cost of revenue | | | 10,047 | | | | 10,912 | | | | 11,616 | | | | 11,773 | | | | 12,241 | | | | 12,914 | | | | 13,866 | | | | 13,374 | |
Gross profit | | | 13,596 | | | | 14,252 | | | | 15,102 | | | | 16,073 | | | | 16,117 | | | | 17,518 | | | | 19,036 | | | | 15,718 | |
Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Research and development | | | 10,407 | | | | 10,537 | | | | 11,512 | | | | 12,307 | | | | 12,574 | | | | 12,772 | | | | 15,701 | | | | 14,976 | |
Sales and marketing | | | 1,634 | | | | 1,822 | | | | 1,927 | | | | 1,852 | | | | 2,287 | | | | 2,614 | | | | 2,354 | | | | 2,862 | |
General and administrative | | | 2,227 | | | | 2,248 | | | | 2,572 | | | | 2,928 | | | | 2,997 | | | | 3,324 | | | | 3,214 | | | | 3,219 | |
Total operating expenses | | | 14,268 | | | | 14,607 | | | | 16,011 | | | | 17,087 | | | | 17,858 | | | | 18,710 | | | | 21,269 | | | | 21,057 | |
Loss from operations | | | (672 | ) | | | (355 | ) | | | (909 | ) | | | (1,014 | ) | | | (1,741 | ) | | | (1,192 | ) | | | (2,233 | ) | | | (5,339 | ) |
Other income (expense): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other income, net | | | 17 | | | | 11 | | | | (4 | ) | | | 117 | | | | 248 | | | | 291 | | | | 311 | | | | 358 | |
Interest expense | | | (559 | ) | | | (457 | ) | | | (382 | ) | | | (337 | ) | | | - | | | | - | | | | - | | | | - | |
Change in fair value of convertible preferred stock warrant liability | | | (660 | ) | | | (1,040 | ) | | | 317 | | | | 393 | | | | - | | | | - | | | | - | | | | - | |
Total other income (expense) | | | (1,202 | ) | | | (1,486 | ) | | | (69 | ) | | | 173 | | | | 248 | | | | 291 | | | | 311 | | | | 358 | |
Loss before income tax expense | | | (1,874 | ) | | | (1,841 | ) | | | (978 | ) | | | (841 | ) | | | (1,493 | ) | | | (901 | ) | | | (1,922 | ) | | | (4,981 | ) |
Provision for (benefit from) income taxes | | | 151 | | | | (509 | ) | | | 27 | | | | 214 | | | | (125 | ) | | | (68 | ) | | | 143 | | | | 525 | |
Net loss | | $ | (2,025 | ) | | $ | (1,332 | ) | | $ | (1,005 | ) | | $ | (1,055 | ) | | $ | (1,368 | ) | | $ | (833 | ) | | $ | (2,065 | ) | | $ | (5,506 | ) |
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The following table summarizes our quarterly results of operations as a percentage of revenue for each of the periods indicated:
| | Three Months Ended | | |
| | Mar. 31, | | | June 30, | | | Sep. 30, | | | Dec. 31, | | | Mar. 31, | | | June 30, | | | Sep. 30, | | | Dec. 31, | | |
| | 2017 | | | 2017 | | | 2017 | | | 2017 | | | 2018 | | | 2018 | | | 2018 | | | 2018 | | |
Quarterly results of operations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Revenue | | | 100 | | % | | 100 | | % | | 100 | | % | | 100 | | % | | 100 | | % | | 100 | | % | | 100 | | % | | 100 | | % |
Cost of revenue | | | 42 | | | | 43 | | | | 43 | | | | 42 | | | | 43 | | | | 42 | | | | 42 | | | | 46 | | |
Gross profit | | | 58 | | | | 57 | | | | 57 | | | | 58 | | | | 57 | | | | 58 | | | | 58 | | | | 54 | | |
Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Research and development | | | 44 | | | | 42 | | | | 43 | | | | 44 | | | | 44 | | | | 42 | | | | 48 | | | | 51 | | |
Sales and marketing | | | 7 | | | | 7 | | | | 7 | | | | 7 | | | | 8 | | | | 9 | | | | 7 | | | | 10 | | |
General and administrative | | | 10 | | | | 9 | | | | 10 | | | | 11 | | | | 12 | | | | 11 | | | | 10 | | | | 11 | | |
Total operating expenses | | | 61 | | | | 58 | | | | 60 | | | | 62 | | | | 64 | | | | 62 | | | | 65 | | | | 72 | | |
Loss from operations | | | (3 | ) | | | (1 | ) | | | (3 | ) | | | (4 | ) | | | (7 | ) | | | (4 | ) | | | (7 | ) | | | (18 | ) | |
Other income (expense): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other income, net | | | - | | | | - | | | | - | | | | 1 | | | | 1 | | | | 1 | | | | 1 | | | | 2 | | |
Interest expense | | | (2 | ) | | | (2 | ) | | | (2 | ) | | | (1 | ) | | | - | | | | - | | | | - | | | | - | | |
Change in fair value of convertible preferred stock warrant liability | | | (3 | ) | | | (4 | ) | | | 1 | | | | 1 | | | | - | | | | - | | | | - | | | | - | | |
Total other income (expense) | | | (5 | ) | | | (6 | ) | | | (1 | ) | | | 1 | | | | 1 | | | | 1 | | | | 1 | | | | 2 | | |
Loss before income tax expense | | | (8 | ) | | | (7 | ) | | | (4 | ) | | | (3 | ) | | | (6 | ) | | | (3 | ) | | | (6 | ) | | | (16 | ) | |
Provision for (benefit from) income taxes | | | 1 | | | | (2 | ) | | | - | | | | 1 | | | | - | | | | - | | | | - | | | | 2 | | |
Net loss | | | (9 | ) | % | | (5 | ) | % | | (4 | ) | % | | (4 | ) | % | | (6 | ) | % | | (3 | ) | % | | (6 | ) | % | | (18 | ) | % |
Reconciliation of Non-GAAP Financial Measures
The following tables reconcile the most directly comparable GAAP financial measure to each of these non-GAAP financial measures:
| | Three Months Ended | |
| | Mar. 31, | | | June 30, | | | Sep. 30, | | | Dec. 31, | | | Mar. 31, | | | June 30, | | | Sep. 30, | | | Dec. 31, | |
| | 2017 | | | 2017 | | | 2017 | | | 2017 | | | 2018 | | | 2018 | | | 2018 | | | 2018 | |
Quarterly Non-GAAP reconciliation | | (dollars in thousands) | |
Net loss | | $ | (2,025 | ) | | $ | (1,332 | ) | | $ | (1,005 | ) | | $ | (1,055 | ) | | $ | (1,368 | ) | | $ | (833 | ) | | $ | (2,065 | ) | | $ | (5,506 | ) |
Stock-based compensation | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Cost of revenue | | | 7 | | | | 7 | | | | 12 | | | | 21 | | | | 25 | | | | 21 | | | | 44 | | | | 66 | |
Research and development | | | 132 | | | | 161 | | | | 251 | | | | 429 | | | | 573 | | | | 521 | | | | 1,326 | | | | 1,373 | |
Sales and marketing | | | 27 | | | | 37 | | | | 46 | | | | 87 | | | | 111 | | | | 162 | | | | 239 | | | | 331 | |
General and administrative | | | 76 | | | | 102 | | | | 99 | | | | 179 | | | | 269 | | | | 458 | | | | 514 | | | | 487 | |
Total stock-based compensation | | | 242 | | | | 307 | | | | 408 | | | | 716 | | | | 978 | | | | 1,162 | | | | 2,123 | | | | 2,257 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Amortization of acquired intangibles resulting from business combination | | | 8 | | | | 8 | | | | 9 | | | | 9 | | | | 8 | | | | 9 | | | | 8 | | | | 9 | |
Change in fair value of convertible preferred stock warrant liability | | | 660 | | | | 1,040 | | | | (317 | ) | | | (393 | ) | | | - | | | | - | | | | - | | | | - | |
Non-GAAP net income (loss) | | $ | (1,115 | ) | | $ | 23 | | | $ | (905 | ) | | $ | (723 | ) | | $ | (382 | ) | | $ | 338 | | | $ | 66 | | | $ | (3,240 | ) |
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Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
You should read the following discussion and analysis of our financial condition and results of operations together with the section titled “Item 6. Selected Consolidated Financial Data” and our consolidated financial statements and related notes that are included elsewhere in this report. This discussion contains forward-looking statements based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and in other parts of this report. See also the section titled “Special Note Regarding Forward-Looking Statements” in this Annual Report.
Overview
We are a leader in the design, development and marketing of advanced high-speed communications integrated circuits, or ICs, for Ethernet connectivity in the data center, enterprise infrastructure, access and automotive markets. Our Ethernet solutions provide a critical interface between the high-speed analog signals transported over wired infrastructure and the digital information used in computing and networking equipment. Our products are designed to cost-effectively deliver leading-edge data speeds for use in the latest generation of communications infrastructure to alleviate network bandwidth bottlenecks caused by the exponential growth of global Internet Protocol, or IP, traffic. Many of our semiconductor solutions have established benchmarks in the industry in terms of performance, power consumption and density. Our innovative solutions enable our customers to differentiate their product offerings, position themselves to gain market share and drive the ongoing equipment infrastructure upgrade cycles in the data center, enterprise infrastructure, access and automotive markets.
We are a fabless semiconductor company. We have shipped tens of millions of ports to customers across multiple advanced semiconductor process generations. Our end customers include Brocade (now part of Extreme Networks), Cisco, Dell, Hewlett-Packard Enterprise, Intel, Juniper, and NEC. For the years ended December 31, 2018, 2017 and 2016, our revenue was $120.8 million, $103.4 million and $86.7 million, respectively, our net loss was $9.8 million, $5.4 million and $0.4 million, respectively, and our non-GAAP net income (loss) was $(3.2) million, $(2.7) million and $1.1 million, respectively. See “Item 6. Selected Consolidated Financial Data—Non-GAAP Financial Measures” for additional information regarding non-GAAP financial measures and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures.
We derive revenue from our products, which include our 10GBASE-T physical layer devices, or PHYs, custom ASICs for Intel and our recently developed AQrate product line. We currently generate revenue from the sale of our products directly to IC suppliers, original equipment manufacturers, or OEMs, and original design manufacturers, or ODMs. We market and sell our products through our direct sales force.
We shipped our first products in 2009. Historically, a substantial majority of our revenue has been generated from our largest customer, Intel, including sales to contract manufacturers or ODMs at the direction of this customer in the data center server market, in particular the server portion of that market in support of our relationship with Intel. For the years ended December 31, 2018, 2017 and 2016, Intel accounted for 49%, 60% and 68% and Cisco accounted for 27%, 28% and 21% of our revenue, respectively. Our 10 largest customers collectively accounted for 93%, 97% and 98% of our revenue in the years ended December 31, 2018, 2017 and 2016, respectively. To continue to grow our revenue, it is important that we acquire new customers and sell additional products to our existing customers. While we intend to expand our customer base over time, the markets we serve tend to be highly concentrated, and we expect that a large portion of our revenue will continue to be derived from a relatively small number of customers for the foreseeable future. As the markets expand, the market share of our largest customers may not increase proportionally or may decrease as competition enters into the market. This has in the past materially impacted our revenues and our market share, and it may continue to do so in the future until the diversification of our customer base lessens the impact of this significant customer concentration.
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Key Factors Affecting Our Performance
Pricing and Product Cost. Our pricing and margins depend on the volumes and the features of the ICs we provide to our customers. We believe the primary driver of gross margin is the average selling prices, or ASPs, negotiated between us and our customers relative to volume, material costs and manufacturing yield. Typically, our selling prices are contractually set for multiple quarters and our prototype selling prices are higher than our selling prices at volume production. In certain cases, we have agreed in advance to modest price reductions, generally over a period of time ranging from 18 months to five years, once the specified product begins to ship in volume. However, our customers may change their purchase orders and demand forecasts at any time with limited notice, which can sometimes lead to price renegotiations. Although these price renegotiations can sometimes result in ASPs of our products fluctuating over the shorter term, we expect ASPs generally to decline over the longer term as our products mature. These declines often coincide with improvements in manufacturing yields and lower wafer, assembly and testing costs, which offset some or all of the margin reduction that results from lower ASPs. Since we rely on third-party wafer foundries and assembly and test contractors to manufacture, assemble and test our ICs, we maintain a close relationship with our suppliers to improve quality, increase yields and lower manufacturing costs. In addition, our customers may seek to renegotiate product pricing under the contracts or purchase orders we have with them based on volume or other factors, which could drive fluctuations in ASPs.
Design Wins with New and Existing Customers. Our existing and prospective customers tend to be multinational enterprises with large annual purchases of ICs that are continuously developing new products for existing and new application areas. Our solutions enable our customers to differentiate their product offerings and position themselves to gain market share and drive the next upgrade cycles in data center and enterprise infrastructure. We have programs in place to help our existing customers use our solutions throughout their product portfolio, and we work closely with our existing and prospective customers to understand their product roadmaps and strategies. Because of our extended sales cycle, our revenue in future years is highly dependent on design wins we are awarded today. Further, because we expect our revenue relating to our mature products to decline in the future, we consider design wins critical to our future success and anticipate being increasingly dependent on revenue from newer design wins for our newer products.
Customer Demand and Product Life Cycles. Once customers design our ICs into their products, we closely monitor all phases of the product life cycle, including the initial design phase, prototype production, volume production and inventories. For example, during the periods presented, we had several products progressing through their product life cycles. In the data center market, the majority of our revenue for the periods presented was derived from our 10GBASE-T custom ASIC product, which we refer to as Twinville. In late 2015, we introduced and began to record revenue from our Sageville and Coppervale products. We anticipate that our Twinville product will transition to these two newer ASIC products over time, although the timing and rate of such transition will depend on our customers’ adoption of these products and the demand for our customers’ products. In the enterprise infrastructure market, during the periods presented, we developed our 5GBASE-T and 2.5GBASE-T AQrate product. We first shipped our AQrate products into the enterprise infrastructure market in the fourth quarter of 2014. We began shipping AQrate products in volume in 2015 and 2016. We also started to ship our multiple lines of products into the access market in the fourth quarter of 2016. We expect the revenue from our AQrate products, and therefore the percentage of our total revenue attributable to the enterprise infrastructure and access markets, to increase from the current levels. We are also shipping products into the automotive market but do not expect significant volume production to occur before 2020.
We also carefully monitor changes in customer demand and end-market demand, including seasonality, cyclicality and the competitive landscape. Our customers share their development schedules with us, including the projected launch dates of their product offerings. Once our customers are in production, they generally will provide nine to 12-month forecasts of expected demand, which gives us an indication of future demand. However, our customers may change their purchase orders and demand forecasts at any time with limited notice. In light of our significant customer concentration, our revenue is likely to be materially and disproportionally, due in part to fluctuating end-market demand, impacted by the purchasing decisions of our largest customers.
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Seasonality
Our revenue is subject to some seasonal variation as we begin to serve many markets and end-markets which historically experience lower sales in the first quarter of the year which may result in slower growth and lower sales as compared to other quarters.
Components of Results of Operations
Revenue
The revenue recognition accounting policy described below relates to revenue transactions from January 1, 2018 and onward, which are accounted for in accordance with ASC Topic 606. See Note 1 of our consolidated financial statements contained in our previously-filed Annual Report on Form 10-K for the year ended December 31, 2017 for our revenue recognition accounting policy as it relates to revenue transactions prior to January 1, 2018.
We generate revenue from the sale of our products. Product revenues consist of sales to customers which are mainly comprised of end customers, their manufacturing subcontractors, and distributors. Revenue is recognized after we (a) identify the contract with a customer, (b) identify the performance obligations in the contract, (c) determine the transaction price, (d) allocate the transaction price to the performance obligations in the contract, and (e) satisfy the performance obligation when the control of products is transferred to the customer. We offer a limited number of customer rebates and accrue an estimate of such rebates at the time revenue is recognized. Such rebates were not material in any of the periods presented, and the differences between the actual amount of such rebates and our estimates also were not material. Sales to most of our distributors are made under contracts that allow for pricing credits upon shipment to the end customer and rights of return for on hand inventory at the distributor. Under the accounting guidance, revenue is recognized at the point of transfer of control to the distributor, which typically occurs at the point of shipment. We adjust the transaction price for any unprocessed claims and for future estimated pricing credits which is recorded in accrued liabilities on the consolidated balance sheets based on historical trends and distributor provided reports.
Our success and future revenue depend on our ability to achieve design wins and to convince our current and prospective customers to design our products into their product offerings. In addition, our revenue may fluctuate as a result of a variety of factors including customer demand and product life cycles, product cost and product mix sold during the period.
In the fourth quarter of 2014, we first began to ship into the enterprise infrastructure market and began shipping in volume in 2015. Due to the introduction of our AQrate products, we anticipate that revenue from the enterprise infrastructure market will grow at a greater rate than revenue from the data center market over the next two years. In the fourth quarter of 2016, we started to sample our first access market products. We believe that the access market will represent a significant portion of our revenue in the near future. We are also shipping products into the automotive market but do not expect significant volume production to occur before 2020.
We anticipate that our revenue will fluctuate based on a variety of factors including the amount and timing of customer and end-market demand, product life cycles, average selling price which declines as our product reaches maturity, production schedule, and product mix sold during the period. For example, revenue in the data center market is expected to decrease significantly in 2019 based on customer forecast. In addition, we may introduce new products at lower average selling price than our existing products with the intent of increasing the market demand for our products, which may cause a fluctuation in our revenues during the period in which these new products are introduced.
Cost of Revenue
Cost of revenue consists of costs of materials, primarily wafers processed by third-party foundries, costs associated with packaging, assembly and testing paid to our third-party contract manufacturers, and personnel and other costs associated with our manufacturing operations. Our cost of revenue also includes allocation of overhead and facility costs, depreciation of production equipment, inventory write-downs and amortization of production mask costs. As we introduce new products, the cost of revenue will fluctuate depending on yield, volume and production cost of these products.
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Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been, and will continue to be, affected by a variety of factors, including product mix, ASPs, material costs, production costs that are themselves dependent upon improvements to yield, production efficiencies, elimination or addition to production processes as required by our end customers and timing of such improvements, and increasing manufacturing overhead to support the greater number of products and markets we serve.
We expect our gross margin to fluctuate on a quarterly basis as a result of changes in ASPs due to new product introductions, existing product transitions to high-volume manufacturing, product maturation and fluctuations in manufacturing costs.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing and general and administrative expenses, and a collaboration and development charge. Personnel costs are the most significant component of our operating expenses and consist of salaries, benefits, bonuses, stock-based compensation and commissions. Our operating expenses also include allocated costs of facilities, information technology, depreciation and amortization. Although our operating expenses may fluctuate, we expect our overall operating expenses to increase in absolute dollars over time.
| • | Research and Development. Our research and development expenses consist primarily of personnel costs, pre-production engineering mask costs, software license and intellectual property expenses, design tools and prototype-related expenses, facility costs, supplies and depreciation expense. We expense research and development costs as incurred. In addition, we enter into development agreements with some of our customers that provide fees that partially offset development costs. Such fees are recognized upon completion of the contract deliverables or milestones, and acceptance by the customer if required. We believe that continued investment in our products and services is important for our future growth and acquisition of new customers and, as a result, we expect our research and development expenses to continue to increase on an absolute basis. |
| • | Sales and Marketing. Sales and marketing expenses consist of personnel costs, field application engineering support, travel costs, professional and consulting fees and allocated overhead costs. We expect sales and marketing expense to increase in absolute dollars as we increase our sales and marketing personnel and grow our international operations. |
| • | General and Administrative. General and administrative expenses consist of personnel costs, professional and consulting fees, legal and allocated overhead costs. We expect general and administrative expense to increase in absolute dollars as we grow our operations and incur additional expenses associated with operating as a public company. |
| • | Collaboration and Development Charge. Collaboration and development charge in the first quarter of 2015 represents the fair value of a fully vested pre-IPO convertible preferred stock warrant exercisable for 975,616 shares of Series H convertible preferred stock, which was exercised in full on May 5, 2017. This warrant was issued to GLOBALFOUNDRIES U.S. Inc., or GLOBALFOUNDRIES, at an exercise price of $0.10 per share in connection with a letter agreement to collaborate on the development of products that we plan to have manufactured by GLOBALFOUNDRIES upon qualification. As a result of the exercise of this warrant, we will not incur further such charges associated with this agreement. |
Other Income (Expense)
Other income (expense) consists primarily of interest income from marketable securities and investments, finance cost related to our capital lease, interest expense on our previously outstanding debt, change in fair value of convertible preferred stock warrant liability and foreign exchange gains and losses. See Note 1 to our audited consolidated financial statements included elsewhere in this report for more information about our debt and the repayment of such debt from the proceeds from our IPO.
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Prior to the completion of our IPO, convertible preferred stock warrants were classified as liabilities on our consolidated balance sheets and remeasured to fair value at each balance sheet date with the corresponding change recorded as other income (expense). Upon the exercise of the warrants, the liability was reclassified to convertible preferred stock at their then fair value. In November 2017, upon the completion of the IPO, the warrants were converted into warrants to purchase shares of common stock and the liability was reclassified to stockholders’ equity (deficit) at their then fair value, and will no longer be subject to fair value accounting. See Notes 1 and 5 in the notes to our consolidated financial statements for more information.
Income Tax Expense
Income tax expense consists primarily of state income taxes and income taxes in certain foreign jurisdictions in which we conduct business. We have a full valuation allowance for deferred tax assets as the realization of the full amount of our deferred tax assets is uncertain, including net operating loss, or NOL, carryforwards, and tax credits related primarily to research and development. We expect to maintain this full valuation allowance until realization of the deferred tax assets becomes more likely than not.
As of December 31, 2018, we had NOL carryforwards of approximately $175.7 million and $92.0 million for U.S. federal and state income tax purposes, respectively, and had research and development tax credit carryforwards of approximately $8.9 million and $9.6 million for U.S. federal and state income tax purposes, respectively. The NOL carryforwards begin to expire in 2025 for U.S. federal income tax purposes and begin to expire in 2019 for state income tax purposes. The U.S. federal tax credit carryforwards begin to expire in 2026 and the state tax credits carry forward indefinitely.
Internal Revenue Code Section 382 and similar California rules place a limitation on the amount of taxable income that can be offset by NOL carryforwards after a change in control (generally greater than 50% in ownership). Generally, after a control change, a corporation cannot deduct NOL carryforwards in excess of the Section 382 limitations. Due to these provisions, utilization of NOL and tax credit carryforwards may be subject to annual limitations regarding their utilization against taxable income in future periods. We completed Section 382 analysis and determined ownership changes occurred in July 2005, November 2009 and August 2017, which resulted in reductions to our U.S. federal and California net operating losses of $34.9 million and $24.1 million, respectively, and U.S. federal research and development credits by $1.8 million.
On December 22, 2017, the Tax Cuts and Jobs Act, or the Act, was signed into legislation, making the most significant changes to the U.S. tax system since 1986. The Act, among other changes, reduces the U.S. federal corporate tax rate from 35% to 21%, implements a modified territorial tax system that includes a one-time transition tax on deemed repatriation of previously untaxed accumulated earnings and profits of certain foreign subsidiaries, and creates new taxes on certain foreign-sourced earnings. As of December 31, 2017, our foreign subsidiaries are in a cumulative deficit. Therefore, the one-time transition tax on deemed repatriation of previously untaxed accumulated earnings and profits of foreign subsidiaries has minimal impact on us. Due to the Act, we have remeasured our U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. We recorded a provisional decrease related to our deferred tax assets and liabilities of $15.7 million with a corresponding adjustment to our valuation allowance for the year ended December 31, 2017. We have completed the analysis of the Act including (a) provisions for Global Intangible Low-Taxed Income, or GILTI, wherein taxes on foreign income are imposed in excess of a deemed return on tangible assets of foreign corporations (including related accounting policy elections) and (b) state tax implications of the Act. There were no adjustments made to the provision amounts recorded. We will continue to monitor changes in tax regulations and guidance as additional clarifications under the Act become available which may result in additional adjustments to our financial statements. As our deferred tax asset is offset by a full valuation allowance, this change in rates had no impact on our financial position or results of operations.
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Results of Operations
The following table summarizes our results of operations for the periods presented. The period-to-period comparison of results is not necessarily indicative of results to be expected for future periods.
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Consolidated Statements of Operations Data: | | | | | | | | | | | | |
Revenue | | $ | 120,784 | | | $ | 103,371 | | | $ | 86,675 | |
Cost of revenue | | | 52,395 | | | | 44,348 | | | | 34,064 | |
Gross profit | | | 68,389 | | | | 59,023 | | | | 52,611 | |
Operating expenses: | | | | | | | | | | | | |
Research and development | | | 56,023 | | | | 44,763 | | | | 36,553 | |
Sales and marketing | | | 10,117 | | | | 7,235 | | | | 5,347 | |
General and administrative | | | 12,754 | | | | 9,975 | | | | 7,124 | |
Total operating expenses | | | 78,894 | | | | 61,973 | | | | 49,024 | |
Income (loss) from operations | | | (10,505 | ) | | | (2,950 | ) | | | 3,587 | |
Other income (expense): | | | | | | | | | | | | |
Other income, net | | | 1,208 | | | | 141 | | | | 14 | |
Interest expense | | | - | | | | (1,735 | ) | | | (3,334 | ) |
Change in fair value of convertible preferred stock warrant liability | | | - | | | | (990 | ) | | | (544 | ) |
Total other income (expense) | | | 1,208 | | | | (2,584 | ) | | | (3,864 | ) |
Loss before income tax expense | | | (9,297 | ) | | | (5,534 | ) | | | (277 | ) |
Provision for (benefit from) income taxes | | | 475 | | | | (117 | ) | | | 168 | |
Net loss | | $ | (9,772 | ) | | $ | (5,417 | ) | | $ | (445 | ) |
The following table summarizes our results of operations as a percentage of revenue for each of the periods indicated:
| | Year Ended |
| | December 31, | | |
| | 2018 | | | 2017 | | | 2016 | | |
Consolidated Statements of Operations Data: | | | | | | | | | | | | | |
Revenue | | | 100 | | % | | 100 | | % | | 100 | | % |
Cost of revenue | | | 43 | | | | 43 | | | | 39 | | |
Gross profit | | | 57 | | | | 57 | | | | 61 | | |
Operating expenses: | | | | | | | | | | | | | |
Research and development | | | 45 | | | | 42 | | | | 43 | | |
Sales and marketing | | | 8 | | | | 7 | | | | 6 | | |
General and administrative | | | 11 | | | | 10 | | | | 8 | | |
Total operating expenses | | | 64 | | | | 59 | | | | 57 | | |
Income (loss) from operations | | | (7 | ) | | | (2 | ) | | | 4 | | |
Other income (expense): | | | | | | | | | | | | | |
Other income, net | | | 1 | | | | - | | | | - | | |
Interest expense | | | - | | | | (2 | ) | | | (4 | ) | |
Change in fair value of convertible preferred stock warrant liability | | | - | | | | (1 | ) | | | (1 | ) | |
Total other income (expense) | | | 1 | | | | (3 | ) | | | (5 | ) | |
Loss before income tax expense | | | (6 | ) | | | (5 | ) | | | (1 | ) | |
Provision for (benefit from) income taxes | | | - | | | | - | | | | - | | |
Net loss | | | (6 | ) | % | | (5 | ) | % | | (1 | ) | % |
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Comparison of the Years Ended December 31, 2018 and 2017
Revenue
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2018 | | | 2017 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Revenue by market | | | | | | | | | | | | | | | | | |
Data center | | $ | 63,549 | | | $ | 64,781 | | | $ | (1,232 | ) | | | (2 | ) | % |
Enterprise infrastructure | | | 42,482 | | | | 35,208 | | | | 7,274 | | | | 21 | | |
Access | | | 14,094 | | | | 3,132 | | | | 10,962 | | | | 350 | | |
Automotive | | | 659 | | | | 250 | | | | 409 | | | | 164 | | |
Total Revenue | | $ | 120,784 | | | $ | 103,371 | | | $ | 17,413 | | | | 17 | | |
Revenue increased by $17.4 million, or 17%, for the year ended December 31, 2018 compared to the year ended December 31, 2017, primarily attributable to higher product sales to the access market of $11.0 million, to the enterprise infrastructure market of $7.3 million and to the automotive market of $0.4 million, offset by $1.2 million decrease in the data center market mainly due to the lower ASP as customers are transitioning to newer products.
Cost of Revenue, Gross Profit and Gross Margin
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2018 | | | 2017 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Cost of revenue | | $ | 52,395 | | | $ | 44,348 | | | | 8,047 | | | | 18 | | % |
Gross profit | | $ | 68,389 | | | $ | 59,023 | | | | 9,366 | | | | 16 | | % |
Gross margin | | | 57 | | % | | 57 | | % | | | | | | - | | pts |
Cost of revenue increased by $8.0 million, or 18%, for the year ended December 31, 2018 compared to the year ended December 31, 2017. The increase was primarily due to $7.6 million of product costs on the $17.4 million increase in revenue.
Gross profit increased by $9.4 million, or 16%, for the year ended December 31, 2018 compared to the year ended December 31, 2017. Gross margin for the year ended December 31, 2018, compared to the year ended December 31, 2017 was unchanged.
Operating Expenses
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2018 | | | 2017 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Operating expenses: | | | | | | | | | | | | | | | | | |
Research and development | | $ | 56,023 | | | $ | 44,763 | | | | 11,260 | | | | 25 | | % |
Sales and marketing | | | 10,117 | | | | 7,235 | | | | 2,882 | | | | 40 | | |
General and administrative | | | 12,754 | | | | 9,975 | | | | 2,779 | | | | 28 | | |
Total operating expenses | | $ | 78,894 | | | $ | 61,973 | | | | 16,921 | | | | 27 | | |
Research and development expenses increased $11.3 million, or 25%, for the year ended December 31, 2018 compared to the year ended December 31, 2017, primarily due to an increase of $3.1 million in personnel-related costs and $2.8 million in stock-based compensation as we continued to expand our research and development headcount, $2.9 million in design tools and prototype-related expenses, $0.7 million in higher professional fees and $0.4 million in depreciation and amortization related to lab equipment.
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Sales and marketing expenses increased $2.9 million, or 40%, for the year ended December 31, 2018 compared to the year ended December 31, 2017, primarily due to an increase of $1.4 million in personnel-related costs and $0.6 million in stock-based compensation due to higher headcount and higher professional fees including commissions of $0.4 million.
General and administrative expenses increased $2.8 million, or 28%, for the year ended December 31, 2018 compared to the year ended December 31, 2017, primarily due to increase of $1.3 million in stock-based compensation, $1.1 million in facilities related expenses as we moved into our new headquarters and $0.3 million in personal-related costs.
Other Income (Expense)
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2018 | | | 2017 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Other income (expense): | | | | | | | | | | | | | | | | | |
Other income, net | | | 1,208 | | | 141 | | | | 1,067 | | | * | | |
Interest expense | | $ | - | | | $ | (1,735 | ) | | $ | 1,735 | | | | 100 | | % |
Change in fair value of convertible preferred stock warrant liability | | | - | | | | (990 | ) | | | 990 | | | | 100 | | |
Total other income (expense) | | $ | 1,208 | | | $ | (2,584 | ) | | $ | 3,792 | | | | (147 | ) | |
* | Percentage change not meaningful |
Other expense for the year ended December 31, 2018 decreased by $3.8 million compared to the year ended December 31, 2017, primarily due to income from our investments of $1.2 million, no interest expense as the principal on our debt was repaid in December 2017 and no further remeasurement of convertible preferred stock warrant liability at the completion of the IPO in 2017.
Income Tax Expense (Benefit)
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2018 | | | 2017 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Provision for (benefit from) income taxes | | $ | 475 | | | $ | (117 | ) | | $ | 592 | | | | 506 | | % |
Income tax expense increased by $0.6 million for the year ended December 31, 2018 compared to the year ended December 31, 2017, primarily due to higher income tax related to our foreign subsidiaries.
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Comparison of the Years Ended December 31, 2017 and 2016
Revenue
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2017 | | | 2016 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Revenue by market | | | | | | | | | | | | | | | | | |
Data center | | $ | 64,781 | | | $ | 64,024 | | | $ | 757 | | | | 1 | | % |
Enterprise infrastructure | | | 35,208 | | | | 22,476 | | | | 12,732 | | | | 57 | | |
Access | | | 3,132 | | | | 175 | | | | 2,957 | | | * | | |
Automotive | | | 250 | | | | - | | | | 250 | | | * | | |
Total Revenue | | $ | 103,371 | | | $ | 86,675 | | | $ | 16,696 | | | | 19 | | |
* | Percentage change not meaningful |
Revenue increased by $16.7 million, or 19%, for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily attributable to $12.7 million increase in product sold to the enterprise infrastructure market and $3.0 million increase in product sales sold to the access market, a new market we entered into since the fourth quarter of 2016, and a $2.4 million increase in data center product sales as customers transitioned from 40nm products to 28nm products net of lower average selling price, offset by a $1.6 million impact on non-recurring deferred revenue recognized in data center market for the year ended December 31, 2016.
Cost of Revenue, Gross Profit and Gross Margin
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2017 | | | 2016 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Cost of revenue | | $ | 44,348 | | | $ | 34,064 | | | | 10,284 | | | | 30 | | % |
Gross profit | | $ | 59,023 | | | $ | 52,611 | | | | 6,412 | | | | 12 | | % |
Gross margin | | | 57 | | % | | 61 | | % | | | | | | (4 | ) | pts |
Cost of revenue increased by $10.3 million, or 30%, for the year ended December 31, 2017 compared to the year ended December 31, 2016. The increase was primarily due to $7.7 million of product costs on higher revenue and $2.5 million increase related to product mix, offset by the sales of products previously reserved.
Gross profit increased by $6.4 million, or 12%, for the year ended December 31, 2017 compared to the year ended December 31, 2016. For the year ended December 31, 2017, our gross margin decreased by 4%. The gross margin decrease was primarily due to higher product cost related to product mix, which approximated 2.6% and the impact of $1.6 million of the aforementioned deferred revenue recognized for the year ended December 31, 2016, which approximated 1.8% of total revenue for the year ended December 31, 2016.
Operating Expenses
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2017 | | | 2016 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Operating expenses: | | | | | | | | | | | | | | | | | |
Research and development | | $ | 44,763 | | | $ | 36,553 | | | | 8,210 | | | | 22 | | % |
Sales and marketing | | | 7,235 | | | | 5,347 | | | | 1,888 | | | | 35 | | |
General and administrative | | | 9,975 | | | | 7,124 | | | | 2,851 | | | | 40 | | |
Total operating expenses | | $ | 61,973 | | | $ | 49,024 | | | | 12,949 | | | | 26 | | |
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Research and development expenses increased $8.2 million, or 22%, for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to an increase of $3.7 million in personnel-related costs as we continued to expand our research and development headcount, $2.2 million in design tools and prototype-related expenses, $1.3 million in depreciation and amortization related to lab equipment and licenses and $0.5 million in stock-based compensation.
Sales and marketing expenses increased $1.9 million, or 35%, for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to an increase in personnel-related costs of $1.4 million due to higher headcount and marketing tradeshow costs of $0.3 million.
General and administrative expenses increased $2.9 million, or 40%, for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to increases of $1.1 million for legal, consulting and audit fees, $0.8 million for personnel-related costs and $0.4 million in depreciation expense.
Other Income (Expense)
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2017 | | | 2016 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Other income (expense): | | | | | | | | | | | | | | | | | |
Other income, net | | 141 | | | 14 | | | | (127 | ) | | * | | |
Interest expense | | $ | (1,735 | ) | | $ | (3,334 | ) | | $ | (1,599 | ) | | | 48 | | % |
Change in fair value of convertible preferred stock warrant liability | | | (990 | ) | | | (544 | ) | | | 446 | | | | (82 | ) | |
Total other income (expense) | | $ | (2,584 | ) | | $ | (3,864 | ) | | $ | (1,280 | ) | | | 33 | | |
* | Percentage change not meaningful |
Other expense for the year ended December 31, 2017 decreased by $1.3 million compared to the year ended December 31, 2016, primarily due to lower interest expense of $1.6 million as the principal of debt was repaid in November 2017, offset by an increase in the fair value of the convertible preferred stock warrant liability, a non-cash expense.
Income Tax Expense (Benefit)
| | Year Ended | | | | | |
| | December 31, | | | Change | | |
| | 2017 | | | 2016 | | | $ | | | % | | |
| | (dollars in thousands) | | |
Provision for (benefit from) income taxes | | $ | (117 | ) | | $ | 168 | | | $ | (285 | ) | | | (170 | ) | % |
Income tax expense decreased by $0.3 million for the year ended December 31, 2017 compared to the year ended December 31, 2016, primarily due to a research credit benefit from a foreign tax jurisdiction, offset by higher income tax related to our foreign subsidiaries and a credit not anticipated to be benefitted.
Liquidity and Capital Resources
Since our inception, we have financed our operations primarily through cash generated from product sales, proceeds from our convertible preferred stock and debt financings and our IPO in November 2017. As of December 31, 2018, we had cash, cash equivalents and investments of $67.4 million. Our principal use of cash is to fund our operations to support our growth.
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We believe that our existing cash and cash equivalents, our expected cash flows from product sales, and funds available for borrowing under our credit facilities will be sufficient to meet our cash needs for at least the next 12 months. Over the longer term, our future capital requirements will depend on many factors, including our growth rate, the timing and extent of our sales and marketing and research and development expenditures, and the continuing market acceptance of our solutions. In the event that we need to borrow funds or issue additional equity, we cannot assure you that any such additional financing will be available on terms acceptable to us, if at all. In addition, any future borrowings may result in additional restrictions on our business and any issuance of additional equity would result in dilution to investors. If we are unable to raise additional capital when we need it, it would harm our business, results of operations and financial condition.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Net cash provided by (used in) operating activities | | $ | 10,055 | | | $ | (11,509 | ) | | $ | 12,138 | |
Net cash used in investing activities | | | (16,680 | ) | | | (54,043 | ) | | | (8,431 | ) |
Net cash provided by (used in) financing activities | | | 5,269 | | | | 44,699 | | | | (9,104 | ) |
Net increase (decrease) in cash and cash equivalents | | $ | (1,356 | ) | | $ | (20,853 | ) | | $ | (5,397 | ) |
Operating Activities
We have historically used cash in operating activities primarily due to our net losses, adjusted for changes in our operating assets and liabilities, particularly from accounts receivable, inventories, prepaid expenses and other assets, accounts payable and accrued expenses, and deferred revenue. In addition, cash in operating activities are adjusted for non-cash expense items such as depreciation and amortization, stock-based compensation expense, issuance of convertible preferred stock warrants, the change in fair value of our convertible preferred stock warrant liability and amortization of our debt discount.
For the year ended December 31, 2018, cash provided by operating activities was approximately $10.1 million. The cash provided by operating activities was primarily due to lower inventory on hand level of $4.0 million, higher accrued and other liabilities of $3.6 million, lower prepaid expenses and other assets of $3.3 million, and non-cash expenses of $12.3 million, offset by net loss of $9.8 million.
For the year ended December 31, 2017, cash used in operating activities was approximately $11.5 million. The cash used in operating activities was primarily due to $14.1 million in net decrease from changes in operating assets and liabilities, of which $11.5 million were used to increase inventories for the anticipation of product demands in multiple markets, and net loss of $5.4 million, offset by non-cash expenses of $8.0 million.
For the year ended December 31, 2016, cash provided by operating activities was approximately $12.1 million. The cash provided by operating activities was primarily the result of decreased inventories of $9.6 million as product revenue increased, non-cash items totaling $5.4 million, offset by other changes in operating assets and liabilities of $0.4 million, net loss of $0.4 million, and decrease in deferred revenue of $2.1 million primarily from the recognition of previously recorded deferred revenue related to a significant agreement with Intel.
Investing Activities
Our investing activities consist of available-for-sale investment activities, capital expenditures for property and equipment purchases and IP licenses. Our capital expenditures for property and equipment have primarily been for general business purposes, including machinery and equipment, leasehold improvements, software and computer equipment used internally, and production masks to manufacture our products.
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For the year ended December 31, 2018, we used approximately $16.7 million in investing activities primarily for purchases of short-term investments, net of sales and maturities, of $12.1 million and purchases of lab equipment, software, and product equipment of $4.6 million.
For the year ended December 31, 2017, we used approximately $54.0 million in investing activities, of which $48.5 million was invested in available-for-sale investments and $5.6 million for the purchases of property and equipment for general business purposes.
For the year ended December 31, 2016 we used approximately $8.4 million in investing activities for the purchase of production masks, IP licenses and other property and equipment for general business purposes.
Financing Activities
Cash generated by financing activities includes proceeds from our issuance of common stock following employee stock option exercises and sales through our employee stock purchase plan.
For the year ended December 31, 2018, cash provided by financing activities of $5.3 million consisting primarily of proceeds from the exercise of employee stock options and from our employee stock purchase plan.
For the year ended December 31, 2017, we generated $44.7 million of cash from financing activities, consisting of proceeds of $65.6 million proceeds from our IPO, $1.4 million in proceeds from the exercise of employee stock options and preferred stock warrants, offset by net repayment of our borrowings of $19.2 million and payments of $2.9 million of costs related to the IPO.
For the year ended December 31, 2016, we used $9.1 million of cash in financing activities, consisting of $11.6 million used in repayments of our line of credit and borrowings and payments of $2.4 million on costs related to our IPO completed in November 2017, partially offset by $4.9 million proceeds from the exercise of employee stock options and preferred stock warrants.
Contractual Obligations and Commitments
As of December 31, 2018, our operating lease obligations are for our U.S. headquarters and our international research facilities that expire at various dates through March 2024. Purchase obligations consist of non-cancelable agreements and purchase orders for goods and services. See Note 6 in the notes to our consolidated financial statements included elsewhere in this report for additional information and future minimum payments and obligations.
Off-Balance Sheet Arrangements
During the periods presented, 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
Our audited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.
The critical accounting policies requiring estimates, assumptions and judgments that we believe have the most significant impact on our audited consolidated financial statements are described below.
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Revenue Recognition
Our product revenues consist of sales to customers which are mainly comprised of end customers, their manufacturing subcontractors, and distributors. Revenue is recognized after we (a) identify the contract with a customer, (b) identify the performance obligations in the contract, (c) determine the transaction price, (d) allocate the transaction price to the performance obligations in the contract, and (e) satisfy the performance obligation when the control of products is transferred to the customer.
We consider the purchase orders, which in some cases are governed by master sales agreements, to be the contract with its customers. In evaluating the existence of the contract, we consider various factors relative to the contract including the customer’s ability to pay amounts due under the contract. We are obligated to deliver a fixed number of products to its customers, each of which is distinct, and have been separately identified to be the performance obligations. We generally provide an assurance warranty that its products will substantially conform to the published specifications for twelve months from the date of shipment. We have not provided services in addition to the standard warranty. As such, we do not consider activities related to such warranty, if any, to be a separate performance obligation.
In determining the transaction price, we consider the variability of the amount due under the contract including amounts subject to refund or adjustment when determining the net consideration to which we expect to be entitled within the contract. As our standard payment terms are less than one year, we have elected the practical expedient under the accounting guidance and do not assess whether the contract has a significant financing component. We allocate revenue to each product based on their relative standalone selling price. Frequently, we receive orders for products to be delivered over multiple dates that may extend across several reporting periods. We invoice for each delivery upon shipment and recognize revenues for each distinct product delivered, assuming transfer of control has occurred. As scheduled delivery dates are within one year, under the optional exemption revenues allocated to future shipments of partially completed contracts are not disclosed. We have also elected the practical expedient to expense commissions when incurred as the amortization period of the commission asset the Company would have otherwise recognized is less than one year.
Sales to certain of end customers include limited rebates. We estimate these rebates, using historical volumes of such rebates, at the time revenue is recognized. Such rebates were not significant in any of the periods presented, and the differences between the actual amount of such rebates and our estimates also were not significant.
Sales to most of our distributors are made under contracts that allow for pricing credits upon shipment to the end customer and rights of return for on hand inventory at the distributor. Under the accounting guidance, revenue is recognized at the point of transfer of control to the distributor, which typically occurs at the point of shipment. We adjust the transaction price for any unprocessed claims and for future estimated pricing credits which is recorded in accrued liabilities on our consolidated balance sheets. The adjustments for these estimates are recorded as a reduction to revenue in the same period when the related revenue is recorded and is calculated based on an analysis of the historical actual claims received, both in aggregate and at a distributor level to the extent that it is probable that a significant future reversal of revenue will not occur. Historically, adjustments for actual pricing credits and product returns have not been significantly differed from the amounts estimated by the Company. As of December 31, 2018, we recorded an accrued liability of $0.3 million related to the above adjustments to transaction price.
We use estimates and judgment based on historical experience and other facts and adjust for such estimates and assumption when facts and circumstance changes. If actual results are not consistent with the assumptions and estimates used such as financial condition of the customer deteriorated, rebate and distributor return increased, we may be required to record additional expense that could materially negatively impact our operating results.
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Inventories
Inventories consist of processed wafers, work-in-process and finished goods and are stated at the lower of standard cost or net realizable value. Standard costs approximate actual costs and are based on a first-in, first-out basis. We perform detailed reviews of the net realizable value of inventories, both on hand as well as for inventories that we are committed to purchase and write down the inventory value for estimated deterioration, excess and obsolete and other factors based on management’s assessment of future demand and market conditions. Once written down, inventory write-downs are not reversed until the inventory is sold or scrapped. If market conditions are less favorable, we may be required to take additional inventory write-downs, which could adversely impact our gross margin and operating results.
Convertible Preferred Stock Warrant Liability
We accounted for our convertible preferred stock warrants outstanding prior to our IPO as derivative liabilities as the terms of the warrants are not fixed due to potential adjustments in the exercise price and the number of shares upon an equity financing at a lower price. The convertible preferred stock warrants were initially recorded at fair value when issued, with gains and losses arising from changes in fair value recognized in other income (expense) in the consolidated statements of operations and comprehensive loss at each period end while such instruments were outstanding and classified as liabilities. Upon the exercise of the warrants, the liability was reclassified to convertible preferred stock at their then fair value. Upon the completion of the IPO, the warrants were converted into warrants to purchase shares of common stock and the liability was reclassified to stockholders’ equity (deficit) at their then fair value, and were no longer subject to fair value accounting.
The assumptions used to determine the fair value of convertible preferred stock warrants relate to the weighted-average assumptions from January 1, 2017 through November 3, 2017 when our convertible preferred stock warrants were converted into common stock warrants, and for the year ended December 31, 2016 were as follows:
| | Period from January 1, 2017 through November 3, 2017 | | | Year ended December 31, 2016 | |
Valuation method | | Black-Scholes Pricing Model | | | Black-Scholes Pricing Model | |
Risk-free interest rate | | 0.89%-2.24% | | | 0.39%-2.25% | |
Expected term | | 0.4 - 7.9 yrs | | | 0.3 - 9.0 yrs | |
Expected dividends | | 0% | | | 0% | |
Volatility | | 25% - 35% | | | 25% - 50% | |
Fair value of preferred stock: | | | | | | | | |
Convertible preferred Series A | | $ | 9.00 | | | $ | 4.40 | |
Convertible preferred Series B | | | 9.00 | | | | 7.30 | |
Convertible preferred Series C-1 | | | 9.00 | | | | 7.30 | |
Convertible preferred Series D | | | 9.00 | | | | 7.80 | |
Convertible preferred Series E | | | 9.00 | | | | 7.70 | |
Convertible preferred Series F | | | 9.00 | | | | 9.10 | |
Convertible preferred Series G | | | 9.00 | | | | 14.00 | |
Convertible preferred Series H | | | 9.00 | | | | 14.30 | |
Stock-Based Compensation
Compensation expense related to stock-based transactions is measured and recognized in the financial statements at fair value. Stock-based compensation expense is measured at the grant date based on the fair value of the equity award and is recognized as expense over the requisite service period, which is generally the vesting period, on the straight-line method. We estimate the fair value of each stock option award on the date of grant using the Black-Scholes option-pricing model. Determining the fair value of stock option awards at the grant date requires judgment, including estimating the expected volatility, expected term, risk-free interest rate, and expected dividends.
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We account for equity instruments issued to non-employees based on the fair value of the awards determined using the Black-Scholes option pricing model. The fair value of such instruments is recognized as an expense over the period in which the related services are received.
We estimated the fair value of stock option awards granted using the following valuation assumptions:
| | 2018 | | | 2017 | | | 2016 | |
Risk-free interest rate | | 2.87% | | | 1.89%-2.40% | | | 1.46%-2.43% | |
Expected term | | 6.1 yrs | | | 6.1 - 10 yrs | | | 6.1 - 10 yrs | |
Expected dividends | | 0% | | | 0% | | | 0% | |
Volatility | | 35% | | | 26% - 30% | | | 30% - 34% | |
The following table summarizes the effects of stock-based compensation on our consolidated statements of operations and comprehensive loss for the years ended December 31, 2018, 2017 and 2016.
| | Year ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Cost of revenue | | $ | 156 | | | $ | 47 | | | $ | 31 | |
Research and development | | | 3,793 | | | | 973 | | | | 489 | |
Sales and marketing | | | 843 | | | | 197 | | | | 95 | |
General and administrative | | | 1,728 | | | | 456 | | | | 324 | |
Total | | $ | 6,520 | | | $ | 1,673 | | | $ | 939 | |
As of December 31, 2018, we had approximately $2.0 million of unrecognized stock-based compensation expense which we expect to recognize over a weighted-average period of approximately 2.8 years.
The intrinsic value of all outstanding options as of December 31, 2018 was $9.9 million based on the closing stock price of $8.77 as reported on the New York Stock Exchange.
Common Stock Valuations
Prior to the IPO in November 2017, our board of directors determined the fair value of the common stock underlying our stock options. The board of directors granted options to be exercisable at a price per share not less than the per share fair value of our common stock underlying those options on each grant date.
The common stock valuations were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. The assumptions we use in the valuation model are based on future expectations combined with management judgment. Our board of directors is comprised of a majority of non-employee directors who we believe have the relevant experience and expertise to determine a fair value of our common stock on each respective grant date. In the absence of a public trading market for our common stock, our board of directors, with input from management, exercised significant judgment and considered numerous objective and subjective factors to determine the common stock’s fair value as of the date of each option grant, including the following factors:
| • | valuations performed by an unrelated third-party specialist; |
| • | the prices, rights, preferences and privileges of our preferred stock relative to the common stock; |
| • | our operating and financial performance; |
| • | current business conditions and projections; |
| • | the market performance of comparable publicly traded companies; |
| • | our history and the introduction of new products and services; |
| • | our stage of development; |
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| • | the hiring of key personnel; |
| • | the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options, such as an initial public offering or sale of the company, given prevailing market conditions at the time; |
| • | any adjustment necessary to recognize a lack of marketability for our common stock; and |
| • | U.S. and global capital market conditions. |
At each grant date, our board of directors reviewed any recent events and their potential impact on the estimated fair value per share of the common stock. For grants of stock awards made on dates for which there was no valuation performed by an independent valuation specialist, our board of directors determined the fair value of our common stock on the date of grant based upon the immediately preceding valuation and other pertinent information available to it at the time of grant.
Our common stock valuation models have historically utilized a market approach, which bases the valuation of our common stock on multiples of revenue, operating income, net income and similar metrics of publicly traded companies we believe are similar to us in terms of size, product market, liquidity, financial leverage, revenue, profitability, growth and other factors. We also examine transactions in the same or similar assets at the measurement date. These transactions can include venture investments in private firms, or stock market trading prices of similar publicly traded companies.
We also allocate value to each class of stock using an Option Pricing Model, or OPM, and Probability Weighted Expected Return Method, or PWERM. The OPM treats common stock and convertible preferred stock as call options on an enterprise value, with exercise prices based on the liquidation preference of our convertible preferred stock. The common stock is modeled as a call option with a claim on the enterprise at an exercise price equal to the remaining value immediately after our convertible preferred stock is liquidated. The OPM is appropriate to use when the range of possible future outcomes is difficult to predict and thus creates highly speculative forecasts. PWERM involves a forward-looking analysis of the possible future outcomes of the enterprise. This method is particularly useful when discrete future outcomes can be predicted at a relatively high confidence level with a probability distribution. Discrete future outcomes considered under the PWERM include an initial public offering, or IPO, as well as non-IPO market based outcomes. Determining the fair value of the enterprise using the PWERM requires us to develop assumptions and estimates for both the probability of an IPO liquidity event and non-IPO outcomes, as well as the values we expect those outcomes could yield. We apply significant judgment in developing these assumptions and estimates, primarily based upon the enterprise value we determined using the market approach, our knowledge of the business and our reasonable expectations of discrete outcomes occurring.
In determining the estimated fair value of our common stock, our board of directors also considered the fact that our stockholders could not freely trade our common stock in the public markets. Accordingly, we applied discounts to reflect the lack of marketability of our common stock based on the expected time to liquidity. The estimated fair value of our common stock at each grant date reflected a non-marketability discount partially based on the anticipated likelihood and timing of a future liquidity event.
The key subjective factors and assumptions used in our valuations primarily consisted of: (1) the selection of the appropriate market comparable transactions, (2) the selection of the appropriate comparable publicly traded companies, (3) the financial forecasts utilized to determine future cash balances and necessary capital requirements, (4) the probability and timing of the various possible liquidity events, (5) the estimated weighted-average cost of capital and (6) the discount for lack of marketability of our common stock.
Following the IPO, the fair value of our common stock is determined based on the closing price of our common stock on the NYSE on the grant date.
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Income Taxes
Deferred tax liabilities and assets are recognized for the expected future tax consequences of temporary differences between the financial statements carrying amounts and the tax basis of assets and liabilities and net operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Tax provision related to Global Intangible Low-Taxed Income (GILTI) are recorded using the period expense method.
A tax position can be recognized only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date and then only in an amount more likely than not to be sustained upon review by the tax authorities. We consider many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.
Recent Accounting Pronouncements
Recent accounting pronouncements is set forth in Note 1 to the “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements” under Part II, Item 8 of this Annual Report on Form 10K.
JOBS Act Transition Period
The Jumpstart Our Business Startups Act of 2012, or the JOBS Act, was enacted in April 2012. Section 107(b) of the JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Concentration of Credit Risk
We are exposed to the credit risk of our customers. We had two end customers who each accounted for more than 10% of our revenue for the each of the years ended December 31, 2018, 2017 and 2016. Our concentration of accounts receivable as of December 31, 2018 and 2017 and revenue for the years ended December 31, 2018, 2017 and 2016 was as follows:
| | As of | |
| | December 31, | |
| | 2018 | | | 2017 | |
Accounts Receivable: | | | | | | | | |
Customer A | | | 42 | % | | | 49 | % |
Customer B | | | 19 | | | | 34 | |
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Revenue: | | | | | | | | | | | | |
Customer A | | | 49 | % | | | 60 | % | | | 68 | % |
Customer B | | 27 | | | 28 | | | 21 | |
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We market and sell our products worldwide and attribute revenue to the geography where product is shipped. The geographical distribution of our revenue, as a percentage of revenue was as follows:
| | Year Ended | | |
| | December 31, | | |
| | 2018 | | | 2017 | | | 2016 | | |
Malaysia | | | 58 | | % | | 61 | | % | | 69 | | % |
China | | | 26 | | | | 30 | | | | 26 | | |
United States | | | 2 | | | | 1 | | | | 1 | | |
Other | | | 14 | | | | 8 | | | | 4 | | |
Total | | | 100 | | % | | 100 | | % | | 100 | | % |
Foreign Currency Risk
Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. All of our revenue is denominated in U.S. dollars. Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the United States and to a lesser extent in India, the Netherlands, Russia and Taiwan. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. The effect of a hypothetical 10% change in foreign currency exchanges rates applicable to our business would not have a material impact on our consolidated financial statements.
Interest Rate and Investment Risk
We established an investment policy to preserve principal, maintain liquidity and capture a market rate of return. The policy requires minimum credit ratings of marketable securities, diversification of credit risk and lowers long-term interest rate risk by limiting the maturity duration of marketable securities. Our interest rate risk relates primarily to interest income from investments as we repaid our outstanding debt in full as of December 31, 2018. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. We have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates. The effect of a hypothetical 10% change in interest rates relating to our marketable securities would not have a material impact on our consolidated financial statements.
Our marketable securities consisting primarily of commercial paper, U.S. government securities, corporate bonds and money market funds are classified as available-for-sale securities and are recorded on our balance sheet at fair value with their related unrealized gains or losses reflected as a component of accumulated other comprehensive loss in the consolidated statement of stockholders’ equity. We are exposed to market risk as it relates to changes in the market value of our investments in addition to the liquidity and credit worthiness of the underlying issuers of our investments. We currently expect that our ability to access or liquidate these investments as needed to support our business activities will continue but we cannot ensure that this will not change. Our investments are subject to fluctuations in fair value due to the volatility of the credit markets and prevailing interest rates for such securities. As of December 31, 2018 and 2017, our cash, cash equivalent and short-term investment balance was $67.4 million and $56.4 million, respectively, and our unrealized loss was $123,000 and $96,000, respectively.
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Item 8. | Financial Statements and Supplementary Data |
Index to Consolidated Financial Statements
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Aquantia Corp. and subsidiaries
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Aquantia Corp. and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of operations, and comprehensive loss, convertible preferred stock and stockholders' equity (deficit), and cash flows, for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
March 6, 2019
We have served as the Company's auditor since 2006.
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AQUANTIA CORP.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
| | December 31, | |
| | 2018 | | | 2017 | |
Assets | | | | | | | | |
Current assets: | | | | | | | | |
Cash and cash equivalents | | $ | 6,684 | | | $ | 8,040 | |
Short-term investments | | | 60,730 | | | | 48,362 | |
Accounts receivable | | | 16,927 | | | | 15,012 | |
Inventories | | | 14,474 | | | | 18,469 | |
Prepaid expenses and other current assets | | | 2,018 | | | | 5,623 | |
Total current assets | | | 100,833 | | | | 95,506 | |
Property and equipment, net | | | 9,225 | | | | 9,973 | |
Intangible assets, net | | | 3,748 | | | | 4,556 | |
Other assets | | | 617 | | | | 331 | |
Total assets | | $ | 114,423 | | | $ | 110,366 | |
Liabilities and Stockholders’ Equity | | | | | | | | |
Current liabilities: | | | | | | | | |
Accounts payable | | $ | 5,495 | | | $ | 7,059 | |
Accrued liabilities | | | 13,907 | | | | 9,217 | |
Total current liabilities | | | 19,402 | | | | 16,276 | |
Other long-term liabilities | | | 1,799 | | | | 3,176 | |
Total liabilities | | | 21,201 | | | | 19,452 | |
Commitments and contingencies (Note 6) | | | | | | | | |
Stockholders’ equity: | | | | | | | | |
Preferred stock, $0.00001 par value, 5,000,000 and 10,000,000 shares authorized as of December 31, 2018 and 2017, respectively; zero share outstanding at December 31, 2018 and 2017, respectively | | | - | | | | - | |
Common stock, $0.00001 par value, 95,000,000 and 400,000,000 shares authorized as of December 31, 2018 and 2017, respectively; 35,050,425 and 33,523,683 shares outstanding at December 31, 2018 and 2017, respectively | | | - | | | | - | |
Additional paid-in capital | | | 300,791 | | | | 288,719 | |
Accumulated other comprehensive loss | | | (123 | ) | | | (96 | ) |
Accumulated deficit | | | (207,446 | ) | | | (197,709 | ) |
Total stockholders’ equity | | | 93,222 | | | | 90,914 | |
Total liabilities and stockholders’ equity | | $ | 114,423 | | | $ | 110,366 | |
See notes to consolidated financial statements.
69
AQUANTIA CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Amounts in thousands except share and per share data)
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Consolidated Statements of Operations Data: | | | | | | | | | | | | |
Revenue | | $ | 120,784 | | | $ | 103,371 | | | $ | 86,675 | |
Cost of revenue | | | 52,395 | | | | 44,348 | | | | 34,064 | |
Gross profit | | | 68,389 | | | | 59,023 | | | | 52,611 | |
Operating expenses: | | | | | | | | | | | | |
Research and development | | | 56,023 | | | | 44,763 | | | | 36,553 | |
Sales and marketing | | | 10,117 | | | | 7,235 | | | | 5,347 | |
General and administrative | | | 12,754 | | | | 9,975 | | | | 7,124 | |
Total operating expenses | | | 78,894 | | | | 61,973 | | | | 49,024 | |
Income (loss) from operations | | | (10,505 | ) | | | (2,950 | ) | | | 3,587 | |
Other income (expense): | | | | | | | | | | | | |
Other income, net | | | 1,208 | | | | 141 | | | | 14 | |
Interest expense | | | - | | | | (1,735 | ) | | | (3,334 | ) |
Change in fair value of convertible preferred stock warrant liability | | | - | | | | (990 | ) | | | (544 | ) |
Total other income (expense) | | | 1,208 | | | | (2,584 | ) | | | (3,864 | ) |
Loss before income tax expense | | | (9,297 | ) | | | (5,534 | ) | | | (277 | ) |
Provision for (benefit from) income taxes | | | 475 | | | | (117 | ) | | | 168 | |
Net loss | | $ | (9,772 | ) | | $ | (5,417 | ) | | $ | (445 | ) |
Net loss per share, basic and diluted | | $ | (0.29 | ) | | $ | (0.59 | ) | | $ | (0.10 | ) |
Weighted-average shares used to compute net loss per share, basic and diluted | | | 34,181,200 | | | | 9,204,384 | | | | 4,240,461 | |
Comprehensive income (loss): | | | | | | | | | | | | |
Net loss | | $ | (9,772 | ) | | $ | (5,417 | ) | | $ | (445 | ) |
Other comprehensive income (loss), net of tax: | | | | | | | | | | | | |
Unrealized gains and losses - short-term investments | | | (27 | ) | | | (96 | ) | | | - | |
Comprehensive loss | | $ | (9,799 | ) | | $ | (5,513 | ) | | $ | (445 | ) |
See notes to consolidated financial statements.
70
AQUANTIA CORP.
CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS’ EQUITY (DEFICIT)
(Amounts in thousands, except share amounts)
| | | | | | | | | | | | | | | | | | �� | | | | | Accumulated | | | | | | | | | |
| | Convertible | | | | | | | | | | | | Additional | | | Other | | | | | | | Total | |
| | Preferred Stock | | | | Common Stock | | | Paid-In | | | Comprehensive | | | Accumulated | | | Stockholders' | |
| | Shares | | | Amount | | | | Shares | | | Amount | | | Capital | | | loss | | | Deficit | | | Equity (Deficit) | |
BALANCE—December 31, 2015 | | | 19,791,207 | | | $ | 199,153 | | | | | 1,984,518 | | | $ | - | | | $ | 6,894 | | | $ | - | | | $ | (191,781 | ) | | $ | (184,887 | ) |
Exercise of stock options | | | - | | | | - | | | | | 2,459,180 | | | | - | | | | 4,586 | | | | - | | | | - | | | | 4,586 | |
Issuance of Series A convertible preferred stock upon exercise of warrants | | | 33,493 | | | | 281 | | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Stock-based compensation expense | | | - | | | | - | | | | | - | | | | - | | | | 939 | | | | - | | | | - | | | | 939 | |
Net loss | | | - | | | | - | | | | | - | | | | - | | | | - | | | | - | | | | (445 | ) | | | (445 | ) |
BALANCE—December 31, 2016 | | | 19,824,700 | | | | 199,434 | | | | | 4,443,698 | | | | - | | | | 12,419 | | | | - | | | | (192,226 | ) | | | (179,807 | ) |
Cumulative effect upon adoption of ASU 2016-09 (Note 2) | | | - | | | | - | | | | | - | | | | - | | | | 66 | | | | - | | | | (66 | ) | | | - | |
Other comprehensive loss - unrealized loss on short-term investments | | | - | | | | - | | | | | - | | | | - | | | | - | | | | (96 | ) | | | - | | | | (96 | ) |
Exercise of stock options | | | - | | | | - | | | | | 388,621 | | | | - | | | | 1,272 | | | | - | | | | - | | | | 1,272 | |
Issuance of restricted stock units | | | | | | | | | | | | 35,029 | | | | - | | | | - | | | | | | | | | | | | | |
Repurchase of unvested stock | | | - | | | | - | | | | | (1,119 | ) | | | - | | | | (3 | ) | | | - | | | | - | | | | (3 | ) |
Issuance of Series H convertible preferred stock upon exercise of warrants | | | 975,616 | | | | 10,835 | | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Proceeds from initial public offering, net of issuance costs | | | | | | | | | | | | 7,840,700 | | | | - | | | | 59,886 | | | | - | | | | - | | | | 59,886 | |
Conversion of preferred stock to common stock pursuant to IPO | | | (20,800,316 | ) | | | (210,269 | ) | | | | 20,816,754 | | | | - | | | | 210,269 | | | | - | | | | - | | | | 210,269 | |
Conversion of preferred stock warrants to common stock warrants | | | | | | | | | | | | | | | | - | | | | 3,137 | | | | - | | | | - | | | | 3,137 | |
Stock-based compensation expense | | | - | | | | - | | | | | - | | | | - | | | | 1,673 | | | | - | | | | - | | | | 1,673 | |
Net loss | | | - | | | | - | | | | | - | | | | - | | | | - | | | | - | | | | (5,417 | ) | | | (5,417 | ) |
BALANCE—December 31, 2017 | | | - | | | | - | | | | | 33,523,683 | | | | - | | | | 288,719 | | | | (96 | ) | | | (197,709 | ) | | | 90,914 | |
Cumulative effect upon adoption of ASC 606 | | | - | | | | - | | | �� | | - | | | | - | | | | - | | | | - | | | | 35 | | | | 35 | |
Other comprehensive loss - unrealized loss on short-term investments | | | - | | | | - | | | | | - | | | | - | | | | - | | | | (27 | ) | | | - | | | | (27 | ) |
Exercise of stock options | | | - | | | | - | | | | | 825,150 | | | | - | | | | 2,793 | | | | - | | | | - | | | | 2,793 | |
ESPP Purchase | | | | | | | | | | | | 366,369 | | | | | | | | 2,972 | | | | | | | | | | | | 2,972 | |
Issuance of restricted stock units | | | | | | | | | | | | 24,929 | | | | - | | | | - | | | | | | | | | | | | - | |
Repurchase of stock options | | | - | | | | - | | | | | (8,649 | ) | | | - | | | | (32 | ) | | | - | | | | - | | | | (32 | ) |
Issuance of common stock, net upon exercise of warrants | | | - | | | | - | | | | | 318,943 | | | | - | | | | - | | | | - | | | | - | | | | - | |
IPO Costs | | | | | | | | | | | | - | | | | | | | | (181 | ) | | | | | | | | | | | (181 | ) |
Stock-based compensation expense | | | - | | | | - | | | | | - | | | | - | | | | 6,520 | | | | - | | | | - | | | | 6,520 | |
Net loss | | | - | | | | - | | | | | - | | | | - | | | | - | | | | - | | | | (9,772 | ) | | | (9,772 | ) |
BALANCE—December 31, 2018 | | | - | | | $ | - | | | | | 35,050,425 | | | $ | - | | | $ | 300,791 | | | $ | (123 | ) | | $ | (207,446 | ) | | $ | 93,222 | |
See notes to consolidated financial statements.
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AQUANTIA CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Cash flows from operating activities | | | | | | | | | | | | |
Net loss | | $ | (9,772 | ) | | $ | (5,417 | ) | | $ | (445 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | | | | | | | | | | | | |
Depreciation and amortization | | | 5,822 | | | | 4,720 | | | | 2,740 | |
Stock-based compensation expense | | | 6,520 | | | | 1,673 | | | | 939 | |
Accretion of investment premium, net of amortization of discount | | | (244 | ) | | | - | | | | - | |
(Gain) loss on disposal of property and equipment | | | (70 | ) | | | - | | | | 33 | |
Change in fair value of convertible preferred stock warrant liability | | | - | | | | 990 | | | | 544 | |
Amortization of debt discount and extinguishment cost | | | - | | | | 477 | | | | 636 | |
Non-cash interest expense related to debt costs | | | - | | | | 175 | | | | 552 | |
Changes in operating assets and liabilities: | | | | | | | | | | | | |
Accounts receivable | | | (1,915 | ) | | | (3,517 | ) | | | (4,443 | ) |
Inventories | | | 3,995 | | | | (11,452 | ) | | | 9,570 | |
Prepaid expenses and other assets | | | 3,319 | | | | (4,110 | ) | | | 1,617 | |
Accounts payable | | | (1,231 | ) | | | 2,139 | | | | 2,198 | |
Accrued and other liabilities | | | 3,631 | | | | 2,813 | | | | 256 | |
Deferred revenue | | | - | | | | - | | | | (2,059 | ) |
Net cash provided by (used in) operating activities | | | 10,055 | | | | (11,509 | ) | | | 12,138 | |
Cash flows from investing activities | | | | | | | | | | | | |
Purchases of property and equipment | | | (4,599 | ) | | | (5,585 | ) | | | (6,308 | ) |
Purchases of IP licenses | | | - | | | | - | | | | (2,129 | ) |
Proceeds from sale of PP&E | | | 70 | | | | - | | | | 6 | |
Proceeds from sales of short-term investments | | | 2,000 | | | | | | | | | |
Proceeds from maturities of short-term investments | | | 43,573 | | | | 1,850 | | | | - | |
Purchases of short-term investments | | | (57,724 | ) | | | (50,308 | ) | | | - | |
Net cash used in investing activities | | | (16,680 | ) | | | (54,043 | ) | | | (8,431 | ) |
| | | | | | | | | | | | |
Cash flows from financing activities | | | | | | | | | | | | |
Repayments on short and long-term borrowings | | | - | | | | (19,161 | ) | | | (6,560 | ) |
Repayments on line of credit | | | - | | | | (10,000 | ) | | | (5,001 | ) |
Proceeds from line of credit | | | - | | | | 10,000 | | | | - | |
Proceeds from exercise of stock options and preferred stock warrants | | | 2,761 | | | | 1,368 | | | | 4,861 | |
Proceeds from employee stock purchase plan | | | 2,972 | | | | - | | | | - | |
Purchases of IP licenses | | | (26 | ) | | | (260 | ) | | | - | |
Proceeds from initial public offering | | | - | | | | 65,627 | | | | - | |
Payment of costs related to initial public offering | | | (438 | ) | | | (2,875 | ) | | | (2,404 | ) |
Net cash provided by (used in) financing activities | | | 5,269 | | | | 44,699 | | | | (9,104 | ) |
Net decrease in cash and cash equivalents | | | (1,356 | ) | | | (20,853 | ) | | | (5,397 | ) |
Cash and cash equivalents at beginning of period | | | 8,040 | | | | 28,893 | | | | 34,290 | |
Cash and cash equivalents at end of period | | $ | 6,684 | | | $ | 8,040 | | | $ | 28,893 | |
Supplemental disclosures of cash flow information | | | | | | | | | | | | |
Cash paid for interest | | $ | 25 | | | $ | 1,153 | | | $ | 1,972 | |
Cash paid for income taxes | | $ | 285 | | | $ | 232 | | | $ | 333 | |
Non-cash financing and investing transactions | | | | | | | | | | | | |
Reclassification of fair value of warrants to equity from liabilities upon warrant exercise and IPO | | $ | - | | | $ | 13,875 | | | $ | - | |
Unpaid costs related to initial public offering | | $ | - | | | $ | 254 | | | $ | 340 | |
Property and equipment received and accrued | | $ | 86 | | | $ | 419 | | | $ | 240 | |
IP licenses accrued | | $ | - | | | $ | - | | | $ | 3,286 | |
Transfer of deferred IPO cost to equity upon IPO | | $ | - | | | $ | 5,740 | | | $ | - | |
See notes to consolidated financial statements.
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AQUANTIA CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization, Description of Business and Basis for Presentation
Organization —Aquantia Corp. (together with its subsidiaries, the “Company”) was incorporated in Delaware on January 27, 2004. The Company is a leader in the design, development and marketing of advanced high-speed communications integrated circuits, or ICs, for Ethernet connectivity in the data center, enterprise infrastructure, access and automotive markets.
Initial Public Offering—On November 7, 2017, the Company completed its initial public offering, or IPO, of 7,840,700 shares of its common stock at the offering price of $9.00 per share, including 1,022,700 shares pursuant to the underwriters’ option to purchase additional shares of the Company’s common stock, resulting in net proceeds to the Company of $65.6 million after deducting underwriters' discounts and commissions of $4.9 million, but before deducting total offering expenses of $5.7 million which were reclassified to additional paid-in capital upon completion of the IPO. Immediately prior to the closing of the IPO, all outstanding shares of the Company’s convertible preferred stock automatically converted into shares of its common stock and the Company’s convertible preferred stock warrants automatically converted into warrants to purchase common stock. The Company used $9.2 million and $0.3 million of the IPO proceeds, respectively, to repay the outstanding indebtedness under the Company’s loan from Pinnacle Ventures, L.L.C. and the termination fee for the line of credit from Hercules.
Reverse Stock Split — In September 2017, the Company’s board of directors and stockholders approved a 1-for-10 reverse split of the Company’s common stock (the “Reverse Stock Split”), which was effected on October 5, 2017. The board of directors and stockholders also approved proportionate adjustments to the conversion prices of each series of convertible preferred stock and convertible preferred stock warrants. All share and per share information included in the accompanying consolidated financial statements and notes thereto have been adjusted to reflect the Reverse Stock Split.
Basis of Presentation and Principles of Consolidation— The consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and include the consolidated accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Liquidity and Capital Resources — As shown in the consolidated financial statements, the Company has incurred net losses from inception through December 31, 2018, resulting in an accumulated deficit of approximately $207.4 million. The Company has financed its operations primarily from cash received from product sales, IPO, sales of convertible preferred stock, and debt financing before the IPO. Based on expected cash flows, the Company believes that its existing cash will be sufficient to satisfy its anticipated cash requirements for the next 12 months.
2. Summary of Significant Accounting Policies
Use of Estimates —The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of expenses during the reporting period. Significant estimates used in the preparation of the consolidated financial statements include revenue recognition, the valuation of deferred tax assets, uncertain tax positions, and useful lives of long-lived assets. These estimates and the underlying assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors and adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates.
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Financial Instruments —Financial instruments held by the Company consist primarily of corporate bonds, U.S. government securities, commercial paper and money market funds. The Company considers all highly liquid financial instruments purchased with an original maturity or remaining maturities of three months or less at the date of purchase to be cash equivalents. All remaining financial instruments are classified as short-term investments. The Company’s financial instruments are classified as available-for-sale. Unrealized gains and losses on securities, net of tax, are recorded in accumulated other comprehensive loss and reported as a separate component of stockholders’ equity. Interest and dividend income and realized gains or losses are included in other income, net on the consolidated statements of operations and comprehensive loss.
The Company evaluates the investments periodically for possible other-than-temporary impairment and reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, the Company’s intent to hold and whether the Company will not be required to sell the security before its anticipated recovery, on a more-likely-than-not basis. If the declines in the fair value of the investments are determined to be other-than-temporary, the Company reports the credit loss portion of such decline in other income, net and the remaining noncredit loss portion in accumulated other comprehensive loss. The cost of securities sold is based on the specific identification method.
Accounts Receivable —The Company’s receivables are recorded when due and payable. The carrying value of the accounts receivable represents their estimated net realizable value which is reduced by an allowance for doubtful accounts that reflects management’s best estimate of amounts that will not be collected. Based on historical loss experience has been negligible, no allowance for doubtful account has been charged against accounts receivable in the periods presented.
Inventories —Inventories consist of processed wafers, work-in-process and finished goods and are stated at the lower of standard cost or net realizable value. Standard costs approximate actual costs and are based on a first-in, first-out basis. The Company performs detailed reviews of the net realizable value of inventories, both on hand as well as for inventories that it is committed to purchase and writes down the inventory value for estimated deterioration, excess and obsolete and other factors based on management’s assessment of future demand and market conditions. Once written down, inventory write downs are not reversed until the inventory is sold or scrapped. For each of the year ended December 31, 2018 and 2017, inventory write-downs were negligible.
Deferred Initial Public Offering Costs —Deferred initial public offering costs, consisting of direct and incremental legal, accounting and other fees and costs attributable to the Company’s IPO and the preparation of the related registration statement, are capitalized. The total deferred offering costs of $5.7 million were offset against the proceeds received upon the closing of the IPO.
Property and Equipment —Property and equipment is initially recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the estimated useful life or the original lease term, whichever is shorter.
Intangible Assets —Intangible assets consist of patents and IP license and are amortized over their useful lives of 7-12 years using a straight-line amortization method.
Impairment of Long-Lived Assets —Long-lived assets, such as property and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the undiscounted future cash flows. The Company has not recorded any impairment charges in any of the periods presented.
Product Warranty —The Company’s products are generally sold with a limited standard warranty for a period of one to three years, warranting that the product conforms to specifications and is free from material defects in design, materials and workmanship. To date, the Company has had negligible returns of any defective production parts.
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Convertible Preferred Stock Warrant Liability —The Company accounted for its convertible preferred stock warrants outstanding prior to the IPO as derivative liabilities as the terms of the warrants were not fixed due to potential adjustments in the exercise price and the number of shares upon an equity financing at a lower price. The convertible preferred stock warrants were initially recorded at fair value when issued, with gains and losses arising from changes in fair value recognized in other income (expense) in the consolidated statements of operations and comprehensive loss at each period end while such instruments were outstanding and classified as liabilities. The fair values of the convertible preferred stock warrants issued in connection with debt agreements were recorded as debt discounts and were amortized as non-cash interest expense in the consolidated statement of operations over the expected term of the debt agreements. Upon the exercise of the warrants, the liability was reclassified to convertible preferred stock at its then fair value. Upon the completion of the IPO in November 2017, the warrants were converted into warrants to purchase shares of common stock and the liability was reclassified to stockholders’ equity at their then fair value, and was no longer subject to fair value accounting.
Convertible Preferred Stock —Prior to the IPO, the Company recorded convertible preferred stock at fair value on the dates of issuance, net of issuance costs. The convertible preferred stock is recorded outside of stockholders’ equity because the shares contain liquidation features that were not solely within the Company’s control. The Company has elected not to adjust the carrying values of the convertible preferred stock to the liquidation preferences of such shares because it was uncertain whether or when an event would occur that would obligate the Company to pay the liquidation preferences to holders of shares of convertible preferred stock. Subsequent adjustments to the carrying values to the liquidation preferences were made only when it becomes probable that such a liquidation event will occur. In November 2017, all outstanding convertible preferred stock was converted to common stock and the balance of convertible preferred stock was reclassified to additional paid in capital upon the closing of the IPO.
Revenue Recognition — Product revenues consist of sales to customers which are mainly comprised of end customers, their manufacturing subcontractors, and distributors. Revenue is recognized after the Company (a) identifies the contract with a customer, (b) identifies the performance obligations in the contract, (c) determines the transaction price, (d) allocates the transaction price to the performance obligations in the contract, and (e) satisfies the performance obligation when the control of products is transferred to the customer.
The Company considers the purchase orders, which in some cases are governed by master sales agreements, to be the contract with its customers. In evaluating the existence of the contract, the Company considers various factors relative to the contract including the customer’s ability to pay amounts due under the contract. The Company is obligated to deliver a fixed number of products to its customers, each of which is distinct, and have been separately identified to be the performance obligations. The Company generally provides an assurance warranty that its products will substantially conform to the published specifications for twelve months from the date of shipment. The Company has not provided services in addition to the standard warranty. As such, the Company does not consider activities related to such warranty, if any, to be a separate performance obligation.
In determining the transaction price, the Company considers the variability of the amount due under the contract including amounts subject to refund or adjustment when determining the net consideration to which the Company expects to be entitled within the contract. As the Company’s standard payment terms are less than one year, the Company has elected the practical expedient under the accounting guidance and does not assess whether the contract has a significant financing component. The Company allocates revenue to each product based on their relative standalone selling price. Frequently, the Company receives orders for products to be delivered over multiple dates that may extend across several reporting periods. The Company invoices for each delivery upon shipment and recognizes revenues for each distinct product delivered, assuming transfer of control has occurred. As scheduled delivery dates are within one year, under the optional exemption revenues allocated to future shipments of partially completed contracts are not disclosed. The Company has also elected the practical expedient under ASC 340-40-25-4, “Other Assets and Deferred Costs”, to expense commissions when incurred as the amortization period of the commission asset the Company would have otherwise recognized is less than one year.
Sales to certain of end customers include limited rebates. The Company estimates these rebates, using historical volumes of such rebates, at the time revenue is recognized. Such rebates were not significant in any of the periods presented, and the differences between the actual amount of such rebates and our estimates also were not significant.
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Sales to most of our distributors are made under contracts that allow for pricing credits upon shipment to the end customer and rights of return for on hand inventory at the distributor. Under the accounting guidance, revenue is recognized at the point of transfer of control to the distributor, which typically occurs at the point of shipment. The Company adjusts the transaction price for any unprocessed claims and for future estimated pricing credits which is recorded in accrued liabilities on the consolidated balance sheets. The adjustments for these estimates are recorded as a reduction to revenue in the same period when the related revenue is recorded and is calculated based on an analysis of the historical actual claims received, both in aggregate and at a distributor level to the extent that it is probable that a significant future reversal of revenue will not occur. Historically, adjustments for actual pricing credits and product returns have not been significantly differed from the amounts estimated by the Company. As of December 31, 2018, the Company has recorded an accrued liability of $0.3 million related to the above adjustments to transaction price.
Cost of Revenue —Cost of revenue consists of wafers, processed by third-party foundries, costs associated with packaging, assembly, and test paid to third-party contract manufacturers, and personnel and other costs associated with the Company’s manufacturing operations. Cost of revenue also includes allocation of overhead and facility costs, depreciation of production equipment, inventory write-downs and amortization of production mask costs.
Research and Development —Research and development expenses are charged to operations as incurred. These costs include personnel costs, pre-production engineering mask costs, software license and intellectual property expenses, design tools and prototype-related expenses, facility costs, supplies and depreciation expense.
The Company enters into development agreements with some of its customers that provide fees that partially offset development costs. Such fees are recognized upon completion of the contract deliverables or milestones, and acceptance by the customer, if required.
Income Taxes —Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statements’ carrying amounts of existing assets and liabilities and their respective tax basis and net operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
A tax position is recognized only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date and then only in an amount more likely than not to be sustained upon review by the tax authorities. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately represent actual outcomes.
Stock-Based Compensation —Compensation expense related to stock-based transactions is measured and recognized in the financial statements at fair value. Stock-based compensation expense is measured at the grant date based on the fair value of the equity award and is recognized as expense, less actual forfeitures (see Note 7), over the requisite service period, which is generally the vesting period on the straight-line method. The Company estimates the fair value of each stock option award on the date of grant using the Black-Scholes option-pricing model. Determining the fair value of stock option awards at the grant date requires judgment, including estimating the common stock fair value, expected term, expected volatility, risk-free interest rate, and expected dividends.
The Company accounts for equity instruments issued to nonemployees based on the fair value of the awards determined using the Black-Scholes option pricing model. The fair value of such instruments is recognized as an expense over the vesting period.
Other Comprehensive Loss —As of December 31, 2018 and 2017, the Company purchased financial instruments which were classified as available-for-sale securities for which an accumulated other comprehensive loss of $123,000 and $96,000 were recorded, respectively.
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Net Loss per Share of Common Stock —Basic net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common shares and potentially dilutive securities outstanding for the period determined using the treasury-stock and if-converted methods. For purposes of the diluted net loss per share calculation, stock warrants, restricted stock units and stock options are considered to be potentially dilutive securities. Because the Company has reported a net loss for all periods presented, diluted net loss per common share is the same as basic net loss per common share for those periods.
Recent Accounting Pronouncements — In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. It clarifies the accounting for implementation costs in cloud computing arrangements. The new guidance requires companies to recognize the implementation costs as expense over the noncancelable term of the cloud computing arrangement plus any optional renewal periods (1) that are reasonably certain to be exercised by the customer or (2) for which exercise of the renewal option is controlled by the cloud service provider. The guidance is effective for fiscal year beginning after December 15, 2019. Early adoption is permitted. Management is currently evaluating early adopting this guidance in 2019 and does not anticipate the impact of this new standard on our consolidated financial statements will be significant.
In February 2018, the FASB released ASU 2018-2, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This standard update addresses a specific consequence of the Tax Cuts and Jobs Act (“U.S tax reform”) and allows a reclassification from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from U.S. tax reform. Consequently, the update eliminates the stranded tax effects that were created as a result of the historical U.S. federal corporate income tax rate to the newly enacted U.S. federal corporate income tax rate. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018. Early adoption is permitted. Management is currently evaluating the adoption date and the impact of this new standard on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new guidance requires entities to recognize assets and liabilities for leases with terms of more than 12 months and additional disclosures to better understand the amount, timing and uncertainty of cash flows arising from leases. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018. Early adoption is permitted. Management has concluded that it will not early adopt this standard and is currently evaluating the impact of this new standard on the Company’s consolidated financial statements. The Company expects that most of operating lease commitments will be subject to the new standard and recognized as lease liabilities and right-of-use assets upon adoption, which will increase total assets in the range of $5.5 million and $6.5 million and total liabilities in the range of $6.5 million and $7.5 million. The Company will elect the package of practical expedients permitted under the transition guidance, which allows the Company to carryforward its historical lease classification, its assessment on whether a contract is or contains a lease, and its indirect costs for any leases that exist prior to adoption of the new standard. The Company will also elect to combine lease and non-lease components. For leases with a term of 12 months or less, the Company plans to elect the short-term lease exemption, which allows the Company to not recognize right-of-use assets or lease liabilities for qualifying leases existing at transition and new leases the Company may enter into in the future.
Adopted
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) related to the recognition and reporting of revenue that establishes a comprehensive new revenue recognition model designed to depict the transfer of goods or services to a customer in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. The guidance allows for the use of either the full or modified retrospective transition method. This new standard was effective on January 1, 2018. The Company used the modified retrospective method. Under the new standards, there was no significant impact for revenue to the Company’s end customers and their manufacturing subcontractors; however, the timing for distributor transactions was changed. Under the new standard, the Company recognizes revenues on sales to distributors upon shipment and transfer of control (known as “sell-in” revenue recognition), rather than deferring recognition until distributor report that they
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have sold the product to their customers (known as “sell-through” revenue recognition). This change in methodology causes a shift in the timing of when revenue is recognized for this class of customers. Deferred revenue of $0.1 million was recorded to retained earnings upon adoption of this new standard on the Company’s consolidated financial statements.
In May 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. It provides clarity and reduces both (i) diversity in practice and (ii) cost and complexity when applying the guidance in Topic 718, Compensation-Stock Compensation, to a change to the terms or conditions of a share-based payment award. The amendments provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The guidance was effective for fiscal years beginning after December 15, 2017, and interim periods within those years and early adoption was permitted. The adoption of this guidance did not result in a significant impact to the Company’s consolidated financial statements.
3. Balance Sheet Components
Inventories consisted of the following (in thousands):
| | December 31, | |
| | 2018 | | | 2017 | |
Processed wafers | | $ | 1,233 | | | $ | 3,523 | |
Work in process | | | 5,990 | | | | 10,118 | |
Finished goods | | | 7,251 | | | | 4,828 | |
Total inventories | | $ | 14,474 | | | $ | 18,469 | |
Prepaid expenses and other current assets consisted of the following (in thousands):
| | December 31, | |
| | 2018 | | | 2017 | |
Processed wafer prepayments | | $ | 67 | | | $ | 3,443 | |
Electronic design automation tools | | | 444 | | | | 519 | |
Other prepaid and other current assets | | | 1,507 | | | | 1,661 | |
Total other prepaid and other current assets | | $ | 2,018 | | | $ | 5,623 | |
Property and equipment, net consisted of the following (in thousands):
| | | | December 31, | |
| | Estimated Useful Lives | | 2018 | | | 2017 | |
Machinery and equipment | | 2-3 years | | $ | 15,237 | | | $ | 13,268 | |
Production masks | | 4 years | | | 5,401 | | | | 5,401 | |
Software and computer equipment | | 3 years | | | 4,492 | | | | 3,820 | |
Leasehold improvements | | Shorter of estimated life of asset or remaining lease term | | | 1,414 | | | | 539 | |
Office furniture and fixtures | | 3 years | | | 117 | | | | 114 | |
Total property and equipment | | | | | 26,661 | | | | 23,142 | |
Less: accumulated depreciation and amortization | | | | | (17,436 | ) | | | (13,169 | ) |
Property and equipment, net | | | | $ | 9,225 | | | $ | 9,973 | |
Depreciation and amortization of property and equipment totaled $5.0 million, $3.9 million and $2.7 million for the years ended December 31, 2018, 2017 and 2016, respectively.
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Intangible assets, net are carried at cost, less accumulated amortization. Intangible assets were as follows (in thousands):
| | | | December 31, | |
| | Estimated Useful Lives | | 2018 | | | 2017 | |
IP license | | 7 years | | $ | 5,416 | | | $ | 5,416 | |
Patents | | 10-12 years | | | 348 | | | | 348 | |
Total intangible assets | | | | | 5,764 | | | | 5,764 | |
Less: accumulated amortization | | | | | (2,016 | ) | | | (1,208 | ) |
Intangible assets, net | | | | $ | 3,748 | | | $ | 4,556 | |
Amortization of intangible assets totaled $0.8 million, $0.8 million and $0.3 million for the years ended December 31, 2018, 2017 and 2016, respectively. Amortization expense related to amortizable intangibles in future periods as of December 31, 2018 is expected to be as follows (in thousands):
2019 | | | 808 | |
2020 | | | 808 | |
2021 | | | 808 | |
2022 | | | 800 | |
2023 and thereafter | | | 524 | |
Total | | $ | 3,748 | |
Accrued liabilities consisted of the following (in thousands):
| | December 31, | |
| | 2018 | | | 2017 | |
Accrued compensation and related benefits | | $ | 5,301 | | | $ | 5,242 | |
Customer deposit | | | 40 | | | | 1,154 | |
Accrued IP license fees | | | 4,829 | | | | 343 | |
Accrued technical consulting and professional services | | | 412 | | | | 259 | |
Accrued royalty, rebates, and commission | | | 443 | | | | 287 | |
Other accrued liabilities | | | 2,882 | | | | 1,932 | |
Total accrued liabilities | | $ | 13,907 | | | $ | 9,217 | |
4. Financial Instruments
The following is a summary of financial instruments (in thousands):
| | As of December 31, 2018 | |
| | | | | | Gross | | | Gross | | | | | |
| | | | | | Unrealized | | | Unrealized | | | Estimated Fair | |
| | Cost | | | Gains | | | Losses | | | Values | |
Available-for sale securities | | | | | | | | | | | | | | | | |
Commercial paper | | $ | 10,173 | | | $ | - | | | $ | (9 | ) | | $ | 10,164 | |
Money market funds | | | 403 | | | | - | | | | - | | | | 403 | |
Corporate bonds | | | 52,448 | | | | - | | | | (114 | ) | | | 52,334 | |
U.S. government securities | | | 1,972 | | | | - | | | | - | | | | 1,972 | |
Total available-for-sale securities | | $ | 64,996 | | | $ | - | | | $ | (123 | ) | | $ | 64,873 | |
Reported in: | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | | | | | | | | | | | | | $ | 4,143 | |
Short-term investments | | | | | | | | | | | | | | | 60,730 | |
Total available-for-sale securities | | | | | | | | | | | | | | $ | 64,873 | |
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| | As of December 31, 2017 | |
| | | | | | Gross | | | Gross | | | | | |
| | | | | | Unrealized | | | Unrealized | | | Estimated Fair | |
| | Cost | | | Gains | | | Losses | | | Values | |
Available-for sale securities | | | | | | | | | | | | | | | | |
Commercial paper | | $ | 13,927 | | | $ | - | | | $ | (11 | ) | | $ | 13,916 | |
Money market funds | | | 1,269 | | | | - | | | | - | | | | 1,269 | |
Corporate bonds | | | 36,534 | | | | - | | | | (81 | ) | | | 36,453 | |
U.S. government securities | | | 2,489 | | | | - | | | | (4 | ) | | | 2,485 | |
Total available-for-sale securities | | $ | 54,219 | | | $ | - | | | $ | (96 | ) | | $ | 54,123 | |
Reported in: | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | | | | | | | | | | | | | $ | 5,761 | |
Short-term investments | | | | | | | | | | | | | | | 48,362 | |
Total available-for-sale securities | | | | | | | | | | | | | | $ | 54,123 | |
The contractual maturities of available-for-sale securities are presented in the following table (in thousands):
| | December 31, 2018 | |
| | Amortized Cost Basis | | | Estimated Fair Value | |
Due in one year or less | | $ | 60,434 | | | $ | 60,313 | |
Due between one and five years | | | 4,562 | | | | 4,560 | |
| | $ | 64,996 | | | $ | 64,873 | |
Gross realized gains and gross realized losses on sales of available-for-sale securities for the years ended December 31, 2018 and 2017 were not significant. As of December 31, 2018, there were $19.2 million of securities that had been in a continuous loss position for 12 months or longer.
5. Fair Value Measurements
The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which to transact and the market-based risk. The Company applies fair value accounting for all financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company categorizes assets and liabilities recorded at fair value based upon the level of judgment associated with inputs used to measure their fair value. The categories are as follows:
Level 1 —Observable inputs, such as quoted prices in active markets for identical, unrestricted assets, or liabilities.
Level 2 —Quoted prices for similar assets or liabilities, or inputs other than quoted prices in active markets that are observable either directly or indirectly.
Level 3 —Unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions about the assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option-pricing models, discounted cash flows models, and similar techniques.
The hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The following tables represent the Company’s financial assets measured at fair value on a recurring basis categorized by the fair value hierarchy as of December 31, 2018 and 2017 (in thousands):
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| | As of December 31, 2018 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
Financial asset— available-for-sales securities | | | | | | | | | | | | | | | | |
Money market funds | | $ | 403 | | | $ | - | | | $ | - | | | $ | 403 | |
Commercial paper | | | - | | | | 10,164 | | | | - | | | | 10,164 | |
Corporate bonds | | | - | | | | 52,334 | | | | - | | | | 52,334 | |
U.S. government securities | | | - | | | | 1,972 | | | | - | | | | 1,972 | |
Total financial asset—available-for-sales securities | | $ | 403 | | | $ | 64,470 | | | $ | - | | | $ | 64,873 | |
| | As of December 31, 2017 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
Financial asset— available-for-sales securities | | | | | | | | | | | | | | | | |
Money market funds | | $ | 1,269 | | | $ | - | | | $ | - | | | $ | 1,269 | |
Commercial paper | | | - | | | | 13,916 | | | | - | | | | 13,916 | |
Corporate bonds | | | - | | | | 36,453 | | | | - | | | | 36,453 | |
U.S. government securities | | | - | | | | 2,485 | | | | - | | | | 2,485 | |
Total financial asset—available-for-sales securities | | $ | 1,269 | | | $ | 52,854 | | | $ | - | | | $ | 54,123 | |
Prior to the repayment of debt and conversion of convertible preferred warrants to common stock warrants in 2017, the summary of changes in the fair value of the Company’s Level 3 financial liabilities was as follows (in thousands):
Balance as of December 31, 2016 | | $ | 12,885 | |
Change in fair value of convertible preferred stock warrant liability | | | 990 | |
Exercise of Series H convertible preferred stock warrants | | | (10,738 | ) |
Conversion of convertible preferred stock warrants to common stock warrants upon IPO | | | (3,137 | ) |
Balance as of December 31, 2017 | | $ | - | |
Common Stock Warrants —As of December 31, 2018, the Company has the following outstanding common stock warrants, which were converted from convertible preferred stock warrants upon the closing of the IPO in November 2017 (in thousands except per share data):
| | | | | | | | As of December 31, 2018 | |
| | Exercise Price | | | | | Common Shares | |
Converted from | | Per Share | | | Expiration Date | | Underlying Warrants | |
Series G | | $ | 14.314298 | | | 12/16/2024 | | | 64,012 | |
Series G/H | | $ | 14.314298 | | | 1/30/2025 | | | 19,683 | |
Total Common Stock Warrants | | | | | | | | | 83,695 | |
Below is the description of the previously outstanding convertible preferred stock warrants:
Series A Convertible Preferred Stock Warrants Issued to Pinnacle Ventures —As consideration for a 2006 Loan and Security Agreement, the Company issued fully vested warrants to Pinnacle Ventures to purchase 33,499 shares of Series A convertible preferred stock at an exercise price of $8.209000 per share which were fully exercised as of December 31, 2016.
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Series B Convertible Preferred Stock Warrants Issued to Pinnacle Ventures —As consideration for a 2008 Amended and Restated Loan and Security Agreement with Pinnacle Ventures, the Company issued fully vested warrants to purchase 15,753 shares of Series B convertible preferred stock at an exercise price of $21.502753 per share. These Series B warrants have a term of 10 years. In connection with the issuance of the Series D convertible preferred stock in November 2009, warrants to purchase 12,556 shares of Series B convertible preferred stock automatically converted into warrants to purchase 40,516 shares of Series D convertible preferred stock at $6.663973 per share. This warrant expired in 2018.
Series C-1 Convertible Preferred Stock Warrants Issued to Intel Corporation —In connection with entering into an agreement with a customer, the Company issued warrants to purchase up to 400,608 shares of Series C-1 convertible preferred stock at an exercise price of $0.10 per share. The warrants are valued as they vest and become exercisable upon the achievement of certain milestones, primarily related to product development. As of December 31, 2017, warrants to purchase 53,400 shares of Series C-1 convertible preferred stock are subject to potential vesting under the Intel Agreement. The fair value at vesting will be allocated to the Intel Agreement. During the year ended December 31, 2009, warrants to purchase 347,208 shares vested with an initial value of $1,927,505. Prior to 2014, 100,000 of the shares underlying the vested warrants were issued upon exercise of such warrants. The remaining warrants were exercised in 2018.
Series D Convertible Preferred Stock Warrants Issued to Pinnacle Ventures —As consideration for a 2009 Amendment to the 2008 Amended and Restated Loan and Security Agreement with Pinnacle Ventures, the Company issued to Pinnacle Ventures fully vested warrants to purchase 21,008 shares of Series D convertible preferred stock. The Company also issued fully vested warrants to purchase an additional 21,008 shares of Series D convertible preferred stock when the Company borrowed an additional $3.5 million in December 2010. In addition, in connection with the issuance of the Series D convertible preferred stock in November 2009, warrants to purchase 12,556 shares of Series B convertible preferred stock automatically converted into fully vested warrants to purchase 40,516 shares of Series D convertible preferred stock. The Series D warrants have an exercise price of $6.663973 per share and a term of ten years and were exercised in 2018.
Series F Convertible Preferred Stock Warrants Issued to Pinnacle Ventures —On April 5, 2013, in connection with the 2013 Agreement, the Company issued to Pinnacle Ventures fully vested warrants to purchase 64,655 Series F convertible preferred stock at an exercise price of $9.280000 price per share. These warrants will expire in April 2023 and were exercised in 2018.
Series G Convertible Preferred Stock Warrants Issued to Pinnacle Ventures —On December 16, 2014, in connection with the 2013 Amended Agreement, the Company issued to Pinnacle Ventures fully vested warrants to purchase 64,012 shares of Series G convertible preferred stock at an exercise price of $14.314298 per share. At issuance, the estimated fair value was determined using the Monte Carlo Simulation with an aggregate fair value of $173,091 that was determined using the following assumptions: risk-free rate of 2.13%, contractual term of 9.71 years, and volatility of 50%. The warrants will expire in December 2024.
Series G or Series H Convertible Preferred Stock Warrants Issued to Hercules Technology Growth Capital —On January 30, 2015, the Company entered into a Loan and Security Agreement with Hercules Technology Growth Capital for an $11.5 million, revolving line of credit. In connection with this agreement, the Company issued fully vested warrants to purchase 19,683 shares at an exercise price of $14.314298 per share. At the election of the holder, these warrants may be exercised for Series G or Series H convertible preferred stock. At issuance, the estimated fair value was determined using the Monte Carlo Simulation with an aggregate fair value of $50,000 that was determined using the following assumptions: risk-free rate of 2.06%, contractual term of 9.83 years, and volatility of 50%. The warrants will expire in January 2025.
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Series H Convertible Preferred Stock Warrants Issued to GLOBALFOUNDRIES —In connection with the collaboration and development agreement with GLOBALFOUNDRIES on March 25, 2015, the Company issued to GLOBALFOUNDRIES fully vested warrants to purchase 975,616 shares of Series H convertible preferred stock at an exercise price of $0.10 per share. At issuance, the estimated fair value was determined using the Monte Carlo Simulation with an aggregate estimated fair value of $12.0 million that was determined using the following assumptions: risk-free interest rate of 1.03%, expected term of one year, no expected dividends, and volatility of 35%. The fair value of these warrants was recorded as an operating expense in the consolidated statement of operations at the date of issuance. These warrants would have expired at the earlier of March 2025, the Company’s IPO, or a deemed liquidation event. These warrants were exercised in May 2017.
The Company recorded a loss of $1.0 million and $0.5 million to “Change in fair value of convertible preferred stock warrant liability” in the consolidated statements of operations and comprehensive loss for the years ended December 31, 2017 and 2016, respectively, for the change in fair value of the convertible preferred stock warrants.
Determining Fair Value of Convertible Preferred Stock Warrants
The assumptions used to determine the fair value of convertible preferred stock warrants relate to the weighted average assumptions from January 1, 2017 through November 3, 2017, when the convertible preferred stock warrants were converted into common stock warrants and for the year ended December 31, 2016 were as follows:
| | Period from January 1, 2017 through November 3, 2017 | | | Year ended December 31, 2016 | |
Valuation method | | Black-Scholes Pricing Model | | | Black-Scholes Pricing Model | |
Risk-free interest rate | | 0.89%-2.24% | | | 0.39%-2.25% | |
Expected term | | 0.4 - 7.9 yrs | | | 0.3 - 9.0 yrs | |
Expected dividends | | 0% | | | 0% | |
Volatility | | 25% - 35% | | | 25% - 50% | |
Fair value of preferred stock: | | | | | | | | |
Convertible preferred Series A | | $ | 9.00 | | | $ | 4.40 | |
Convertible preferred Series B | | | 9.00 | | | | 7.30 | |
Convertible preferred Series C-1 | | | 9.00 | | | | 7.30 | |
Convertible preferred Series D | | | 9.00 | | | | 7.80 | |
Convertible preferred Series E | | | 9.00 | | | | 7.70 | |
Convertible preferred Series F | | | 9.00 | | | | 9.10 | |
Convertible preferred Series G | | | 9.00 | | | | 14.00 | |
Convertible preferred Series H | | | 9.00 | | | | 14.30 | |
There were no transfers within the hierarchy during the years ended December 31, 2018 and 2017. As of December 31, 2017, the Company’s only Level 3 financial instruments were convertible preferred stock warrants which ceased to be a financial liability upon their conversion to common stock warrants in November 2017 upon completion of the IPO.
6. Commitments and Contingencies
Lease and purchase obligations
The Company leases office and research facilities under operating leases for its U.S. headquarters and international locations that expires at various dates through March 2024. Under the lease agreements that contain escalating rent provisions, lease expense is recorded on a straight-line basis over the lease term. Rent expense for the years ended December 31, 2018, 2017 and 2016 was $1.9 million, $1.2 million and $0.9 million, respectively. In addition, the Company has purchase obligations which included agreements and issued purchase orders containing non-cancelable payment terms to purchase goods and services.
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As of December 31, 2018, future minimum operating lease payments and purchase obligations are as follows (in thousands):
| | | | | | | | | | | | Total | |
| | | | Operating | | | Purchase | | | Lease and Purchase | |
| | | | Leases | | | Obligations | | | Obligations | |
2019 | | | | $ | 1,482 | | | $ | 15,674 | | | $ | 17,156 | |
2020 | | | | | 1,516 | | | | 4,247 | | | | 5,763 | |
2021 | | | | | 1,993 | | | | 1,008 | | | | 3,001 | |
2022 | | | | | 2,033 | | | | - | | | | 2,033 | |
2023 and thereafter | | | | | 2,217 | | | | - | | | | 2,217 | |
Total | | | | $ | 9,241 | | | $ | 20,929 | | | $ | 30,170 | |
Litigation— The Company accrues for contingencies when it believes that a loss is probable and that it can reasonably estimate the amount of any such loss and the Company has made an assessment of the probability of incurring any such losses and whether or not those losses are estimable.
Although the Company is not currently subject to any litigation, and no litigation is currently threatened against the Company, the Company may be subject to legal proceedings, claims and litigation, including intellectual property litigation, arising in the ordinary course of business. Such matters are subject to many uncertainties and outcomes and are not predictable with assurance. The Company accrues amounts that it believes are adequate to address any liabilities related to legal proceedings and other loss contingencies that it believes will result in a probable loss that is reasonably estimable.
To the extent there is a reasonable possibility that a loss exceeding amounts already recognized may be incurred and the amount of such additional loss would be material, the company will either disclose the estimated additional loss or state that such an estimate cannot be made. The Company does not currently believe that it is reasonably possible that losses in connection with litigation arising in the ordinary course of business would be material.
Indemnification— Under the indemnification provisions of the Company’s standard sales related contracts, the Company agrees to defend its customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks, or trade secrets and to pay judgments entered on such claims. Certain agreements include indemnification provisions that could potentially expose the Company to losses in excess of the amount received under the agreement. In addition, the Company indemnifies its directors and certain of its officers while they are serving in good faith in such capacities. To date, the Company has not incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As of December 31, 2018 and 2017, no liability associated with such indemnifications had been recorded.
7. Common Stock and Share-based Compensation
The Company’s certificate of incorporation, as of December 31, 2018 and 2017, authorized the Company to issue up to 95,000,000 and 400,000,000 shares of common stock, respectively, and 5,000,000 and 10,000,000 shares of preferred stock, each at $0.00001 par value per share, respectively.
As of December 31, 2018, no preferred stock was outstanding. Each share of common stock is entitled to one vote. The holders of common stock are also entitled to receive dividends out of funds legally available. No dividends have been declared to date.
Immediately prior to the closing of the Company’s IPO, all outstanding shares of its convertible preferred stock automatically converted into 20,816,754 shares of common stock. As such, no shares of convertible preferred stock were outstanding as of December 31, 2018 and 2017.
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2015 Equity Incentive Plan and 2004 Equity Incentive Plan
Under the Company’s 2015 Equity Incentive Plan and 2004 Equity Incentive Plan, shares of common stock were reserved for the issuance of incentive stock options (“ISO”); nonstatutory stock options (“NSO”); or the sales of restricted common stock to employees, officers, directors, and consultants of the Company. The exercise price of an option is determined by the board of directors when the option is granted and may not be less than 85% of the fair market value of the shares on the date of grant, provided that the exercise price of an ISO is not less than 100% of the fair market value of the shares on the date of grant and the exercise price of any option granted to a 10% stockholder is not less than 110% of the fair market value of the shares on the date of grant. ISOs granted under the Plan generally vest 25% after the completion of 12 months of service and the balance in equal monthly installments over the next 36 months of service and expire 10 years from the grant date. NSOs vest as per the specific agreement and expire 10 years from the date of grant. The Plan allows for early exercise of options prior to full vesting as determined by the board of directors and set forth in the stock option agreements governing such options. Exercises of unvested options are subject to repurchase by the Company at not less than the original exercise price upon termination of employment.
2017 Equity Incentive Plan
In November 2017, the Company adopted the 2017 Equity Incentive Plan, or 2017 Plan, and all shares reserved for grant under the 2015 Equity Incentive Plan and 2004 Equity Incentive Plan were cancelled. The 2017 Plan had 3,294,919 common shares reserved, plus any shares subject to outstanding stock options or other stock awards that were granted under the 2015 Equity Incentive Plan and 2004 Equity Incentive Plan that were forfeited, terminate, expire or are otherwise not issued. In addition, the shares reserved under the 2017 Plan will automatically increase on the first day of each calendar year until January 1, 2027, by an amount equal to 5% of the total number of shares of the Company’s capital stock outstanding on the last day of the calendar month before the date of the automatic increase, or a lesser number of shares determined by the board of directors prior to the date of such automatic increase. The 2017 Plan provides for the grant of common stock awards, including incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock and restricted stock units, performance units and performance shares to employees, directors, and consultants of the Company. All granted shares that are canceled, forfeited or expired are returned to the 2017 Plan and are available for grant in conjunction with the issuance of new equity awards. Stock options may be granted at an exercise price per share not less than 100% of the fair market value at the date of grant. If a stock option is granted to a 10% stockholder, then the exercise price per share must not be less than 110% of the fair market value per share of common stock on the grant date. Options granted are exercisable over a maximum term of 10 years from the date of grant and generally vest over a period of four years. As of December 31, 2018, 2,367,378 shares are available for grant.
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Stock options
Activity of stock options granted under the Company’s equity incentive plans is set forth below:
| | | | | | | | | | Weighted- | | | | | |
| | | | | | Weighted | | | Average | | | | | |
| | | | | | Average | | | Remaining | | | Aggregate | |
| | Number of | | | Exercise | | | Contractual | | | Intrinsic Value | |
| | Shares | | | Price | | | Term (Years) | | | (in thousands) | |
Balance—January 1, 2016 | | | 4,827,785 | | | $ | 2.38 | | | | 7.2 | | | $ | 9,759 | |
Granted | | | 570,939 | | | $ | 4.32 | | | | | | | | | |
Exercised | | | (2,459,180 | ) | | $ | 1.85 | | | | | | | | | |
Canceled | | | (32,948 | ) | | $ | 3.11 | | | | | | | | | |
Balance—December 31, 2016 | | | 2,906,596 | | | $ | 3.20 | | | | 8.1 | | | $ | 4,941 | |
Granted | | | 1,320,382 | | | $ | 7.08 | | | | | | | | | |
Exercised | | | (388,621 | ) | | $ | 3.28 | | | | | | | | | |
Canceled | | | (104,813 | ) | | $ | 4.53 | | | | | | | | | |
Balance—December 31, 2017 | | | 3,733,544 | | | $ | 4.53 | | | | 7.9 | | | $ | 25,386 | |
Granted | | | 1,000 | | | $ | 13.89 | | | | | | | | | |
Exercised | | | (825,150 | ) | | $ | 3.38 | | | | | | | | | |
Canceled | | | (611,991 | ) | | $ | 6.23 | | | | | | | | | |
Balance—December 31, 2018 | | | 2,297,403 | | | $ | 4.49 | | | | 6.9 | | | $ | 9,858 | |
Vested and exercisable—December 31, 2018 | | | 1,547,754 | | | $ | 3.74 | | | | 6.5 | | | $ | 7,803 | |
Vested and exercisable—December 31, 2017 | | | 1,648,917 | | | $ | 2.89 | | | | 6.7 | | | $ | 13,924 | |
Outstanding options and exercisable options information by range of exercise prices as of December 31, 2018 was as follows:
| | | | | | | | | | Outstanding Options | | | Exercisable Options | |
| | | | | | | | | | | | | | Weighted | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Average | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Remaining | | | Weighted | | | | | | | Weighted | |
Range of | | | Number of | | | Contractual Term | | | Average | | | Number of | | | Average | |
Exercise Prices | | | Shares | | | (in Years) | | | Exercise Price | | | Shares | | | Exercise Price | |
$ | 1.10 | | | to | | $ | 1.90 | | | | 52,200 | | | | 1.8 | | | $ | 1.50 | | | | 52,200 | | | $ | 1.50 | |
$ | 2.00 | | | to | | $ | 3.90 | | | | 961,800 | | | | 6.0 | | | $ | 2.78 | | | | 961,800 | | | $ | 2.78 | |
$ | 4.30 | | | to | | $ | 7.10 | | | | 1,234,953 | | | | 7.8 | | | $ | 5.76 | | | | 1,167,626 | | | $ | 5.84 | |
$ | 8.61 | | | to | | $ | 9.90 | | | | 47,450 | | | | 8.7 | | | $ | 9.33 | | | | 33,012 | | | $ | 9.65 | |
$ | 9.91 | | | to | | $ | 13.89 | | | | 1,000 | | | | 9.3 | | | $ | 13.89 | | | | 1,000 | | | $ | 13.89 | |
Total | | | | | | | | | | 2,297,403 | | | | 6.9 | | | $ | 4.49 | | | | 2,215,638 | | | $ | 4.47 | |
As of December 31, 2018, approximately $2.0 million of unrecognized stock compensation costs related to awards were expected to be recognized over a weighted-average period of 2.8 years. As of December 31, 2017, approximately $4.8 million of unrecognized stock compensation costs related to awards were expected to be recognized over a weighted-average period of 3.1 years.
The aggregate intrinsic value of options exercised for the year ended December 31, 2018 was $7.1 million. The aggregate intrinsic value of options exercised during the year ended December 31, 2017 was $1.6 million.
The weighted-average grant-date fair value of options granted for the year ended December 31, 2018, was $5.46 per share. The weighted-average grant-date fair value of options granted during the year ended December 31, 2017 was $2.94 per share.
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The calculated fair value of option grants was estimated using the Black-Scholes model with the following assumptions for which options were granted:
| | Year ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Risk-free interest rate | | | 2.87 | % | | 1.89%-2.40% | | | 1.46%-2.43% | |
Expected term | | 6.1 yrs | | | 6.1 - 10 yrs | | | 6.1 - 10 yrs | |
Expected dividends | | | 0 | % | | | 0 | % | | | 0 | % |
Volatility | | | 35 | % | | 26% - 30% | | | 30% - 34% | |
Employee Stock Purchase Plan
Concurrent with the completion of the IPO in November 2017, the Company adopted the 2017 Employee Stock Purchase Plan, or ESPP. The ESPP authorizes the issuance of 1,317,967 shares of common stock outstanding under purchase rights granted to its employees. In addition, the shares reserved under the ESPP Plan will automatically increase on the first day of each calendar year until January 1, 2027, by the lesser of (i) an amount equal to 2% of the total number of shares of the Company’s capital stock outstanding on the last day of the calendar month before the date of the automatic increase, (ii) 1,000,000 shares of common stock, and (iii) a lesser number of shares determined by the board of directors prior to the date of such automatic increase. The ESPP allows eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions of up to 15% of their eligible compensation, subject to any plan limitations. The ESPP generally provides for offering periods and purchase periods every six months, and at the end of each purchase period, employees are able to purchase shares at 85% of the lower of the fair market value of the Company’s common stock on the first trading day of the purchase period or on the last trading day of the offering period. 366,369 shares were issued as of December 31, 2018 under the ESPP. Shares expected to be issued under the ESPP were 203,986 for the offering period as of December 31, 2018. The calculated fair value of the shares under the ESPP was estimated using the Black-Scholes model with the following assumptions: risk-free interest rate in the range of 1.31% and 2.36%, expected term of 0.5 year, expected dividends of 0% and volatility of 22%. For the year ended December 31, 2018 and 2017, unamortized compensation expense related to the ESPP was approximately $0.5 million and $0.5 million, respectively, to be recognized over approximately five months at each year end.
Restricted Stock Unit Awards
The Company grants restricted stock units (RSU) to employees under the 2017 Plan. RSUs granted typically vest ratably over a four-year period, and are converted into shares of the Company’s common stock upon vesting on a one-for-one basis subject to the employee’s continued service to the Company over that period. The fair value of RSUs is determined using the fair value of the Company’s common stock on the date of the grant, reduced by the discounted present value of dividends expected to be declared before the awards vest. Compensation expense is recognized on a straight-line basis over the requisite service period of each grant. Each RSU award granted from the 2017 Plan will reduce the number of shares available for issuance under the 2017 Plan by one share. As of December 31, 2018, and 2017, unamortized compensation expense related to RSU was approximately $15.8 million and $0.4 million, to be recognized over 3.0 years and 1.8 years, respectively.
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Activity of RSU granted under the Company’s equity incentive plans is set forth below:
| | | | | | Weighted | |
| | | | | | Average | |
| | | | | | Market | |
| | Number of Units | | | Value | |
Balance—January 1, 2017 | | | - | | | $ | - | |
Granted | | | 35,029 | | | $ | 10.56 | |
Released | | | - | | | $ | - | |
Canceled | | | - | | | $ | - | |
Balance—December 31, 2017 | | | 35,029 | | | $ | 10.56 | |
Granted | | | 1,657,237 | | | $ | 12.76 | |
Released | | | (24,929 | ) | | $ | 11.53 | |
Canceled | | | (113,248 | ) | | $ | 13.01 | |
Balance—December 31, 2018 | | | 1,554,089 | | | $ | 12.73 | |
The Company uses the straight-line vesting attribution method to record stock-based compensation expense. Stock-based compensation expense recognized in the consolidated statements of operations and comprehensive loss was as follows (in thousands):
| | Year ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Cost of revenue | | $ | 156 | | | $ | 47 | | | $ | 31 | |
Research and development | | | 3,793 | | | | 973 | | | | 489 | |
Sales and marketing | | | 843 | | | | 197 | | | | 95 | |
General and administrative | | | 1,728 | | | | 456 | | | | 324 | |
Total | | $ | 6,520 | | | $ | 1,673 | | | $ | 939 | |
No income tax benefit associated with stock-based compensation expense was recognized in the consolidated statements of operations and comprehensive income (loss) for the years ended December 31, 2018, 2017 and 2016.
8. Income Taxes
The following table represents domestic and foreign components of income (loss) before income taxes for the periods presented (in thousands):
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Domestic | | $ | (5,475 | ) | | $ | 4,195 | | | $ | (992 | ) |
Foreign | | | (3,822 | ) | | | (9,729 | ) | | | 715 | |
Total | | $ | (9,297 | ) | | $ | (5,534 | ) | | $ | (277 | ) |
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The Company’s provision for (benefit from) income taxes was as follows (in thousands):
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Current: | | | | | | | | | | | | |
Federal | | $ | - | | | $ | - | | | $ | (63 | ) |
State | | | 1 | | | | 1 | | | | 1 | |
Foreign | | | 474 | | | | (118 | ) | | | 230 | |
Total current: | | | 475 | | | | (117 | ) | | | 168 | |
Deferred: | | | | | | | | | | | | |
Federal | | | - | | | | - | | | | - | |
State | | | - | | | | - | | | | - | |
Foreign | | | - | | | | - | | | | - | |
Total deferred benefit: | | | - | | | | - | | | | - | |
Total provision for (benefit from) income taxes | | $ | 475 | | | $ | (117 | ) | | $ | 168 | |
Reconciliation of the statutory federal income tax rate to the Company’s effective income tax rate is as follows:
| | Year Ended | | |
| | December 31, | | |
| | 2018 | | | 2017 | | | 2016 | | |
Federal tax at statutory rate | | | 21 | | % | | 34 | | % | | 34 | | % |
Foreign taxes | | | (14 | ) | | | (58 | ) | | | 5 | | |
State taxes | | | 7 | | | | (2 | ) | | | 316 | | |
Change in warrant valuation | | | - | | | | (6 | ) | | | (66 | ) | |
Stock-based compensation | | | 1 | | | | (5 | ) | | | (80 | ) | |
Research and development credit | | | 22 | | | | 14 | | | | 343 | | |
Changes in reserves for uncertain tax positions | | | (18 | ) | | | 3 | | | | (731 | ) | |
Change in valuation allowance | | | (17 | ) | | | 283 | | | | 114 | | |
2017 Tax Cut and Jobs Act impact | | | - | | | | (283 | ) | | | - | | |
Tax effect upon adoption of ASU 2016-09 | | | - | | | | 19 | | | | - | | |
GILTI inclusion | | | (3 | ) | | | - | | | | - | | |
Other | | | (4 | ) | | | 3 | | | | 4 | | |
Total | | | (5 | ) | % | | 2 | | % | | (61 | ) | % |
Significant components of the Company’s net deferred tax assets were as follows (in thousands):
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | |
Deferred tax assets: | | | | | | | | |
Net operating loss carryforwards | | $ | 29,311 | | | $ | 31,286 | |
Tax credit carryforwards | | | 12,376 | | | | 9,439 | |
Accruals recognized in different periods | | | 1,041 | | | | 1,115 | |
Fixed assets depreciation | | | 381 | | | | 137 | |
Stock-based compensation | | | 734 | | | | 113 | |
Other | | | 96 | | | | 22 | |
Gross deferred tax assets: | | | 43,939 | | | | 42,112 | |
Deferred tax liabilities: | | | | | | | | |
Other | | | (135 | ) | | | (81 | ) |
Subtotal | | | 43,804 | | | | 42,031 | |
Valuation allowance | | | (43,804 | ) | | | (42,031 | ) |
Total net deferred tax assets | | $ | - | | | $ | - | |
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Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income (or loss) in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income tax expense (benefit) in the period that includes the enactment date. Valuation allowances are established when it is more likely than not that some portion of the deferred tax assets will not be realized.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Act”). The Act made broad and complex changes to the U.S. tax code including, but not limited to: (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) requiring current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations; (5) eliminating the corporate alternative minimum tax, or AMT, and changing how existing AMT credits can be realized; (6) creating the base erosion anti-abuse tax, or BEAT, a new minimum tax; (7) creating a new limitation on deductible interest expense; and (8) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.
Under the new corporate income tax rate of 21%, U.S. federal and state deferred tax assets decreased by approximately $15.7 million and the valuation allowance decreased by approximately the same amount as of December 31, 2017 when the Act was enacted. Due to the valuation allowance on the deferred tax assets, the provisional amount recorded related to the remeasurement was zero.
As of December 31, 2017, the Company's foreign subsidiaries are in a cumulative deficit. Therefore, the one-time transition tax on deemed repatriation of previously untaxed accumulated earnings and profits of foreign subsidiaries had minimal impact on the Company. Undistributed earnings of foreign subsidiaries are determined to be reinvested indefinitely. Therefore, there was no accounting impact resulted from this provision of the Act.
The SEC staff issued Staff Accountant Bulletin No. 118, or SAB 118, which provides guidance on accounting for the tax effects of the Act. SAB 118 provides a measurement period that should not extend beyond one year from the Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Act. At December 31, 2018, the Company completed its analysis on the Act including (a) provisions for Global Intangible Low-Taxed Income, or GILTI, wherein taxes on foreign income are imposed in excess of a deemed return on tangible assets of foreign corporations and elected the accounting policy to record the tax provision related to GILTI using the period expense method and (b) state tax implications of the Act resulting in no adjustment to the consolidated financial statements. The Company will continue to monitor changes in tax regulations and guidance as it relates to the Act, which may cause us to record further adjustments to the consolidated financial statements.
Based on the available objective evidence, both positive and negative, management believes that it is more likely than not that the net deferred tax assets will not be realized. Accordingly, the Company has provided a full valuation allowance against net deferred tax assets as of December 31, 2018, 2017 and 2016. The valuation allowance for deferred tax assets was $43.8 million, $42.0 million and $58.5 million as of December 31, 2018, 2017 and 2016, respectively. The change in the valuation allowance for the years ended December 31, 2018, 2017 and 2016 was $1.8 million, $(16.5) million and $(3.2) million, respectively.
As of December 31, 2018, the Company had net operating loss, or NOL, carryforwards of approximately $175.7 million and $92.0 million for federal and state income tax purposes, respectively. The NOL carryforwards begin to expire in 2025 and 2019 for federal and state purposes, respectively.
As of December 31, 2018, the Company had research and development tax credit carryforwards of approximately $8.9 million and $9.6 million for federal and state income tax purposes, respectively. The federal tax credit carryforwards begin to expire in 2026 and the state tax credits carry forward indefinitely.
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Internal Revenue Code Section 382 and similar California rules place a limitation on the amount of taxable income that can be offset by NOL carryforwards after a change in control (generally greater than 50% change in ownership). Generally, after a control change, a corporation cannot deduct NOL carryforwards in excess of the Section 382 limitations. Due to these provisions, utilization of NOL and tax credit carryforwards may be subject to annual limitations regarding their utilization against taxable income in future periods. The Company completed Section 382 analysis in 2016 and determined ownership changes occurred in July 2005, November 2009 and August 2017, which resulted in reductions to the U.S. federal and California net operating losses of $34.9 million and $24.1 million, respectively, and U.S. federal research and development credits by $1.8 million.
Reconciliation of the beginning and ending balances of the gross unrecognized tax benefits during the years ended December 31, 2018, 2017 and 2016 were as follows (in thousands):
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Unrecognized benefits - beginning of period | | $ | 7,047 | | | $ | 4,323 | | | $ | 4,100 | |
Increases in balances related to tax positions taken during a prior period | | | 1,783 | | | | 2,567 | | | | - | |
Increases in balances related to tax positions taken during the current period | | | - | | | | 1,276 | | | | 224 | |
Decreases in balances related to tax positions taken during a prior period | | | (58 | ) | | | (1,119 | ) | | | (1 | ) |
Unrecognized benefits - end of period | | $ | 8,772 | | | $ | 7,047 | | | $ | 4,323 | |
The Company’s policies are to record the tax provision related to GILTI using the period expense method and to classify interest and penalties associated with unrecognized tax benefits as income tax expense. The Company had no interest or penalty accruals associated with uncertain tax benefits in its balance sheets and statements of operations and comprehensive loss for the years ended December 31, 2018, 2017 and 2016.
Although the Company files U.S. federal and various state tax returns, the Company’s only major tax jurisdictions are the United States and California. As a result of NOL carryforwards, all of the Company’s tax years are open to federal and state examination in the United States. All tax years are open to examination in various foreign countries.
9. Net Loss Per Share
The following table summarizes the computation of basic and diluted net loss per share (in thousands, except share and per share data):
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Net loss | | $ | (9,772 | ) | | $ | (5,417 | ) | | $ | (445 | ) |
Weighted-average common shares outstanding | | | 34,181,200 | | | | 9,204,384 | | | | 4,240,461 | |
Less: Shares subject to repurchase | | | - | | | | - | | | | - | |
Weighted-average shares outstanding | | | 34,181,200 | | | | 9,204,384 | | | | 4,240,461 | |
Net loss per share, basic and diluted | | $ | (0.29 | ) | | $ | (0.59 | ) | | $ | (0.10 | ) |
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Basic net loss per share is computed by dividing the net loss by the weighted-average number of common shares outstanding for the period. Basic and diluted net loss per share is presented in conformity with the two-class method required for participating securities. Prior to the IPO, the holders of the Company’s convertible preferred stock were entitled to receive non-cumulative dividends, payable prior and in preference to any dividends on shares of the common stock. Any additional dividends would be distributed among the holders of convertible preferred stock and common stock pro rata, assuming the conversion of all convertible preferred stock into common stock. After to the IPO, all convertible preferred stocks were converted to common stock and the Company has one class of stock issued and outstanding.
Because the Company has reported a net loss for the years ended December 31, 2018, 2017 and 2016, diluted net loss per common share is the same as basic net loss per common share for those periods.
The following potentially dilutive securities outstanding have been excluded from the computation of diluted weighted-average shares outstanding because such securities have an antidilutive impact due to losses reported (in common stock equivalent shares):
| | As of | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Stock options to purchase common stock | | | 2,297,403 | | | | 3,733,544 | | | | 2,831,850 | |
Unvested restricted stock units | | | 1,554,089 | | | | 35,029 | | | | - | |
Convertible preferred stock | | | - | | | | - | | | | 19,833,843 | |
Common stock warrants | | | 83,695 | | | | 584,148 | | | | 1,559,764 | |
Total | | | 3,935,187 | | | | 4,352,721 | | | | 24,225,457 | |
10. Segment Reporting
The Company operates in one reportable segment related to the design, development and sale of network communication integrated circuits. The Company’s chief operating decision-maker (“CODM”) is its Chief Executive Officer, who reviews operating results on an aggregate basis and manages the Company’s operations as a whole for the purpose of evaluating financial performance and allocating resources. Substantially all of the Company’s long-lived assets were attributable to operations in the United States as of December 31, 2018, 2017 and 2016.
The following table summarizes revenue by market (in thousands):
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Revenue by market: | | | | | | | | | | | | |
Data Center | | $ | 63,549 | | | $ | 64,781 | | | $ | 64,024 | |
Enterprise Infrastructure | | | 42,482 | | | | 35,208 | | | | 22,476 | |
Access | | | 14,094 | | | | 3,132 | | | | 175 | |
Automotive | | | 659 | | | | 250 | | | | - | |
Total revenue | | $ | 120,784 | | | $ | 103,371 | | | $ | 86,675 | |
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The Company sells its products worldwide and attributes revenue to the geography where the product is shipped. The geographical distribution of revenue as a percentage of total revenue for the periods indicated was as follows:
| | Year Ended | | |
| | December 31, | | |
| | 2018 | | | 2017 | | | 2016 | | |
Malaysia | | | 58 | | % | | 61 | | % | | 69 | | % |
China | | | 26 | | | | 30 | | | | 26 | | |
United States | | | 2 | | | | 1 | | | | 1 | | |
Other | | | 14 | | | | 8 | | | | 4 | | |
Total | | | 100 | | % | | 100 | | % | | 100 | | % |
11. Concentrations
Credit —Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company’s cash equivalents consist of checking and money market accounts with a financial institution that management believes to be of high-credit quality; however, at times, balances exceed federally insured limits. Amounts held on deposit at financial institutions in excess of Federal Deposit Insurance Corporation-insured amounts were $1.1 million, $0.9 million and $28.0 million at December 31, 2018, 2017 and 2016, respectively.
Significant Customers —Credit risk with respect to accounts receivable is concentrated with two large customers that contribute a majority of the Company’s business and is mitigated by a relatively short collection period. Collateral is not required for accounts receivable. The fair value of accounts receivable approximates their carrying value. Revenue and accounts receivables concentrated with significant customers and their manufacturing subcontractors, as a percentage of total revenue and accounts receivable was as follows:
| | As of | |
| | December 31, | |
| | 2018 | | | 2017 | |
Accounts Receivable: | | | | | | | | |
Customer A | | | 42 | % | | | 49 | % |
Customer B | | | 19 | | | | 34 | |
| | Year Ended | |
| | December 31, | |
| | 2018 | | | 2017 | | | 2016 | |
Revenue: | | | | | | | | | | | | |
Customer A | | | 49 | % | | | 60 | % | | | 68 | % |
Customer B | | 27 | | | 28 | | | 21 | |
Significant Suppliers — The Company depends on a limited number of subcontractors and suppliers for its wafer and substrate supply and to fabricate, assemble, and test its semiconductor devices. The Company generally sources its production through standard purchase orders and has wafer supply and assembly and test agreements with certain outside contractors. While the Company seeks to maintain a sufficient level of supply and endeavors to maintain ongoing communications with suppliers to guard against interruptions or cessation of supply, business and results of operations could be adversely affected by a stoppage or delay of supply, substitution of more expensive or less reliable products or services, receipt of defective semiconductor devices, an increase in the price of products, or an inability to obtain reduced pricing from suppliers in response to competitive pressures.
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12. Employee Benefit Plan
The Company has established a 401(k) plan, which permits participants to make contributions by salary deduction pursuant to Section 401(k) of the Internal Revenue Code. The Company may, at its discretion, make matching contributions to the 401(k) Plan. The Company has made no contributions to the 401(k) Plan since its inception.
13. Related Party Transaction
In 2016, the Company entered into an agreement with a significant stockholder to license certain technology intended to be incorporated into the Company’s products under development. Under this agreement, the Company agreed to pay an initial $2.0 million licensing fee and additional licensing fees at a later point of the development program upon the achievement of certain development milestones. In addition, royalties may be due on products sold utilizing the licensed technology. From time to time, the Company also purchases tooling, mask sets, wafers and services from this stockholder in its ordinary course of business. As of December 31, 2017, the total balance due this stockholder was $3.4 million, which was included in accrued, accounts payable and other long-term liabilities.
In May 2018, this stockholder ceased to be a beneficial owner of more than 5% of the outstanding common stock.
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Item 9 — Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A — Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15 (e) and 15d – 15(e) under the Securities Exchange Act 1934, as amended, or the Exchange Act (as amended), that are designed to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), as appropriate, to allow for timely decisions regarding required disclosure.
Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Management’s Annual Report on Internal Control over Financial Reporting; Attestation Report of the Registered Public Accounting Firm.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in the Exchange Act Rule 13a-15(f). Our internal control over financial reporting is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. A control system, no matter how well designed and operated, can only provide reasonable, not absolute, assurance that the objectives of the control system are met. Because of these inherent limitations, management does not expect that our internal controls over financial reporting will prevent all error and all fraud. Management conducted an evaluation of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (the “2013 Framework”). Based on our evaluation under the 2013 Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2018.
This Annual Report on Form 10-K does not include an attestation report of the company’s registered public accounting firm due to a transition period established by rules and regulations of the SEC for newly public companies.
Further, our independent registered public accounting firm did not and will not be required to formally attest to the effectiveness of our internal controls over financials reporting as long as we are an “emerging growth company” pursuant to the provisions of the JOBS Act.
Changes in Internal Control over Financial Reporting
No changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended December 31, 2018 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our principal executive and chief executive officer, does not expect that our disclosure controls and procedures or our internal controls, will prevent all error and all fraud. A control system, no
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matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Aquantia have been detected.
Item 9B — Other Information
None.
PART III
Item 10 — Directors, Executive Officers and Corporate Governance
The information required by this item will be contained in our definitive proxy statement to be filed with the Securities and Exchange Commission, or SEC, in connection with our 2019 annual meeting of stockholders, or the 2018 Proxy Statement, which is expected to be filed not later than 120 days after the end of our fiscal year ended December 31, 2018, and is incorporated in this report by reference.
Item 11 — Executive Compensation
The information required by this item will be set forth in the 2019 Proxy Statement to be filed with the SEC within 120 days of the year ended December 31, 2018, and is incorporated herein by reference.
Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item will be set forth in the 2019 Proxy Statement to be filed with the SEC within 120 days of the year ended December 31, 2018, and is incorporated herein by reference.
Equity Compensation Plan Information
The following table summarizes the number of outstanding options granted to our employees, consultants and directors, as well as the number of shares of common stock remaining available for future issuance under our equity compensation plans as of December 31, 2018.
| | (a) Number of Securities to be Issued upon Exercise of Outstanding Options and Rights | | | (b) Weighted Average Exercise Price of Outstanding Options and Rights (1) | | | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column(a)) | |
Equity compensation plans approved by security holders (2)(3)(4)(5) | | | 3,851,492 | | | $ | 4.49 | | | | 2,367,378 | |
(1) | The calculation of the weighted average exercise price includes only stock options and does not include the outstanding restricted stock units which do not have an exercise price. |
(2) | Consists of four plans: 2017 Equity Incentive Plan, 2017 Employee Stock Purchase Plan or 2017 ESPP, 2015 Equity Incentive Plan and 2004 Equity Incentive Plan. |
(3) | The number of shares reserved for issuance under our 2017 Equity Incentive Plan will automatically increase on January 1st each year, beginning on January 1, 2018 and continuing through January 1, 2027, by the lesser of |
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| (a) five percent (5%) of the total number of shares of the Registrant’s capital stock outstanding on December 31st of the immediately preceding calendar year and (b) a number determined by the Registrant’s board of directors. |
(4) | The number of shares reserved for issuance under our 2017 ESPP will automatically increase on January 1st each year, beginning on January 1, 2018 and continuing through January 1, 2027, by the least of (a) two percent (2%) of the total number of shares of the Registrant’s capital stock outstanding on December 31st of the immediately preceding calendar year, (b) 1,000,000 shares of Common Stock and (c) a number determined by the Registrant’s board of directors. |
(5) | Includes 2,297,403 shares subject to outstanding stock options and 1,554,089 shares subject to outstanding restricted stock units. |
Item 13 — Certain Relationships and Related Transactions, and Director Independence
The information required by this item will be set forth in the 2019 Proxy Statement to be filed with the SEC within 120 days of the year ended December 31, 2018, and is incorporated herein by reference.
Item 14 — Principal Accountant Fees and Services
The information required by this item will be set forth in the 2019 Proxy Statement to be filed with the SEC within 120 days of the year ended December 31, 2018, and is incorporated herein by reference.
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PART IV
Item 15 — Exhibits and Financial Statement Schedules
(a)Documents filed as part of this report:
(1) Financial Statements
Reference is made to the “Index to Consolidated Financial Statements” under Part II, “Item 8, Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
(2) Financial Statement Schedules
All schedules are omitted because they are not applicable or not required or because the required information is shown in the consolidated financial statements and related notes.
(3) Exhibits
See Item 15(b) below. Each management contract or compensatory plan or arrangement required to be filed has been identified.
(b)Exhibits
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EXHIBIT INDEX
Exhibit Number | | Description | | Form | | SEC File No. | | Exhibit | | Filing Date |
3.1 | | Amended and Restated Certificate of Incorporation | | 8-K | | 001-38270 | | 3.1 | | Jul. 3, 2018 |
3.2 | | Amended and Restated Bylaws | | S-1 | | 333-220871 | | 3.3 | | Oct. 6, 2017 |
4.1 | | Form of Common Stock Certificate of the Registrant. | | S-1 | | 333-220871 | | 4.1 | | Oct. 6, 2017 |
4.2 | | Amended and Restated Investors’ Rights Agreement, by and among the Registrant and certain of its stockholders, dated March 25, 2015, as amended. | | S-1 | | 333-220871 | | 4.2 | | Oct. 6, 2017 |
10.1+ | | Form of Indemnification Agreement by and between the Registrant and its directors and officers. | | S-1 | | 333-220871 | | 10.1 | | Oct. 6, 2017 |
10.2+ | | 2004 Equity Incentive Plan, as amended, and Forms of Stock Option Agreement and Notice of Exercise thereunder. | | S-1 | | 333-220871 | | 10.2 | | Oct. 6, 2017 |
10.3+ | | 2015 Equity Incentive Plan and Forms of Stock Option Agreement and Notice of Exercise. | | S-1 | | 333-220871 | | 10.3 | | Oct. 6, 2017 |
10.4 | | Office and R&D Lease with Paul Erickson, Trustee of the H.C. and R.C. Merritt Trust and Century Urban Tasman, LLC dated December 7, 2017 | | 10-K | | 333-220871 | | 10.4 | | Mar. 7, 2018 |
10.5+* | | 2018 Executive Bonus Plan of Registrant. | | | | | | | | |
10.6+ | | Amended and Restated Employment Agreement, dated April 21, 2016, between Faraj Aalaei and the Registrant. | | S-1 | | 333-220871 | | 10.6 | | Oct. 6, 2017 |
10.7+ | | Offer of Employment, dated December 10, 2015, between Mark Voll and the Registrant. | | S-1 | | 333-220871 | | 10.7 | | Oct. 6, 2017 |
10.8+ | | Employment Offer Letter for Pirooz Parvarandeh and the Registrant. | | 8-K | | 001-38270 | | 99.1 | | Jan. 12, 2018 |
10.9+* | | Amended and Restated Employment Offer Letter for David Quarles and the Registrant. | | | | | | | | |
10.10# | | Master Purchase Agreement for 10 Gigabit Ethernet Physical Layer Devices, dated January 15, 2009, between the Registrant and Intel Corporation, as amended, and related Addendums. | | S-1 | | 333-220871 | | 10.12 | | Oct. 6, 2017 |
10.11# | | Letter Agreement, dated July 29, 2014, between the Registrant and GLOBALFOUNDRIES U.S. Inc. | | S-1 | | 333-220871 | | 10.13 | | Oct. 6, 2017 |
10.12+ | | 2017 Equity Incentive Plan, and Forms of Stock Option Agreement, Notice of Exercise and Stock Option Grant Notice thereunder. | | S-1/A | | 333-220871 | | 10.14 | | Oct. 23, 2017 |
10.13+ | | 2017 Employee Stock Purchase Plan. | | S-1/A | | 333-220871 | | 10.15 | | Oct. 23, 2017 |
21.1* | | Subsidiaries of the Registrant | | | | | | | | |
23.1* | | Consent of Deloitte & Touche LLP, an Independent Registered Public Accounting Firm. | | | | | | | | |
24.1* | | Power of Attorney. Reference is made to the signature page hereto. | | | | | | | | |
31.1** | | Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | | | | | | | |
31.2** | | Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | | | | | | | |
32.1** | | Certification of the Principal Executive Officer and Principal Financial Officer pursuant to the 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | | | | | | | | |
| | | | | | | | | | |
101.INS*** | | XBRL Instance Document | | | | | | | | |
101.SCH*** | | XBRL Taxonomy Extension Schema Document | | | | | | | | |
101.CAL*** | | XBRL Taxonomy Extension Calculation Linkbase Document | | | | | | | | |
101.DEF*** | | XBRL Taxonomy Extension Definition Linkbase Document | | | | | | | | |
101.LAB*** | | XBRL Taxonomy Extension Label Linkbase Document | | | | | | | | |
101.PRE*** | | XBRL Taxonomy Extension Presentation Linkbase Document | | | | | | | | |
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+ | Indicates a management contract or compensatory plan or arrangement. |
# | "Confidential treatment has been granted for portions omitted from this exhibit (indicated by asterisks) and those portions have been separately filed with the Securities and Exchange Commission." |
** | This certification is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Registrant under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Annual Report on Form 10-K, irrespective of any general incorporation language contained in such filing. |
Submitted electronically with this Annual Report.
***Submitted electronically with this Annual Report.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| AQUANTIA CORP. |
| |
| By: | /s/ Faraj Aalaei |
| | Faraj Aalaei |
| | Chairman, President and Chief Executive Officer |
| | (Principal Executive Officer) |
Date: March 6, 2019 | | |
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POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Faraj Aalaei and Mark Voll, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name | | Title | | Date |
| | |
/s/Faraj Aalaei | | Chairman, President and Chief Executive Officer | | March 6, 2019 |
Faraj Aalaei | | (Principal Executive Officer) | | |
| | |
/s/ Mark Voll | | Chief Financial Officer | | March 6, 2019 |
Mark Voll | | (Principal Financial and Accounting Officer) | | |
| | |
/s/ Dmitry Akhanov | | Director | | March 6, 2019 |
Dmitry Akhanov | | | | |
| | |
/s/ Bami Bastani | | Director | | March 6, 2019 |
Bami Bastani | | | | |
| | |
/s/ Geoffrey G. Ribar | | Director | | March 6, 2019 |
Geoffrey G. Ribar | | | | |
| | |
/s/ Ken Pelowski | | Director | | March 6, 2019 |
Ken Pelowski | | | | |
| | |
/s/ Sam Srinivasan | | Director | | March 6, 2019 |
Sam Srinivasan | | | | |
| | |
/s/ Anders Swahn | | Director | | March 6, 2019 |
Anders Swahn | | | | |
| | |
/s/ Lip-Bu Tan | | Lead Director | | March 6, 2019 |
Lip-Bu Tan | | | | |
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