UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark one)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2011
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 001-33506
SHORETEL, INC.
(Exact name of Registrant as specified in its charter)
| Delaware | 77-0443568 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 960 Stewart Drive, Sunnyvale, California | 94085-3913 | |
| (Address of principal executive offices) | (Zip Code) |
(408) 331-3300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer | ¨ | Accelerated filer | x |
| Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of January 25, 2012, 48,165,674 shares of the registrant’s common stock were outstanding.
SHORETEL, INC. AND SUBSIDIARIES
FORM 10-Q for the Quarter Ended December 31, 2011
INDEX
| Page | ||
| 3 | ||
| Item 1 | 3 | |
| 3 | ||
| 4 | ||
| 5 | ||
| 6 | ||
| Item 2 | 15 | |
| Item 3 | 27 | |
| Item 4 | 27 | |
| 27 | ||
| Item 1 | 27 | |
| Item 1A | 27 | |
| Item 2 | 29 | |
| Item 6 | 29 | |
| 30 | ||
| 31 | ||
PART I. FINANCIAL INFORMATION
SHORETEL, INC. AND SUBSIDIARIES
(In thousands, except per share amounts)
(Unaudited)
December 31, 2011 | June 30, 2011 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 94,491 | $ | 89,695 | ||||
| Short-term investments | 21,359 | 16,057 | ||||||
| Accounts receivable, net of allowances of $707 as of December 31, 2011 and $737 as of June 30, 2011 | 30,948 | 33,812 | ||||||
| Inventories | 22,602 | 19,062 | ||||||
| Prepaid expenses and other current assets | 4,598 | 3,540 | ||||||
| Total current assets | 173,998 | 162,166 | ||||||
| Property and equipment - net | 7,659 | 8,236 | ||||||
| Goodwill | 7,415 | 7,415 | ||||||
| Intangible assets | 7,828 | 8,570 | ||||||
| Other assets | 864 | 714 | ||||||
| Total assets | $ | 197,764 | $ | 187,101 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 7,882 | $ | 6,394 | ||||
| Accrued liabilities and other | 10,122 | 8,533 | ||||||
| Accrued employee compensation | 9,486 | 11,022 | ||||||
| Deferred revenue | 32,965 | 26,362 | ||||||
| Total current liabilities | 60,455 | 52,311 | ||||||
| Long-term deferred revenue | 12,241 | 11,321 | ||||||
| Other long-term liabilities | 2,298 | 2,045 | ||||||
| Total liabilities | 74,994 | 65,677 | ||||||
| Commitments and contingencies (Note 12) | — | — | ||||||
| Stockholders' equity: | ||||||||
| Preferred stock, par value $.001 per share, authorized 5,000 shares; none issued and outstanding | — | — | ||||||
| Common stock and additional paid-in capital, par value $.001 per share, authorized 500,000; shares issued and outstanding, 48,143 and 47,455 shares as of December 31, 2011 and June 30, 2011, respectively | 249,659 | 241,063 | ||||||
| Accumulated other comprehensive income (loss) | (30 | ) | 40 | |||||
| Accumulated deficit | (126,859 | ) | (119,679 | ) | ||||
| Total stockholders’ equity | 122,770 | 121,424 | ||||||
| Total liabilities and stockholders’ equity | $ | 197,764 | $ | 187,101 | ||||
See Notes to Condensed Consolidated Financial Statements
SHORETEL, INC. AND SUBSIDIARIES
(In thousands, except per share amounts)
(Unaudited)
| Three Months Ended | Six Months Ended | |||||||||||||||
| December 31, | December 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| Revenue: | ||||||||||||||||
| Product | $ | 46,277 | $ | 37,913 | $ | 88,461 | $ | 73,139 | ||||||||
| Support and services | 11,735 | 9,816 | 23,409 | 18,869 | ||||||||||||
| Total revenue | 58,012 | 47,729 | 111,870 | 92,008 | ||||||||||||
| Cost of revenue: | ||||||||||||||||
| Product (1) | 16,103 | 12,847 | 30,558 | 24,614 | ||||||||||||
| Support and services (1) | 3,969 | 3,125 | 7,884 | 6,101 | ||||||||||||
| Total cost of revenue | 20,072 | 15,972 | 38,442 | 30,715 | ||||||||||||
| Gross profit | 37,940 | 31,757 | 73,428 | 61,293 | ||||||||||||
| Operating expenses: | ||||||||||||||||
| Research and development (1) | 12,240 | 10,512 | 24,053 | 20,834 | ||||||||||||
| Sales and marketing (1) | 21,596 | 18,314 | 42,818 | 35,517 | ||||||||||||
| General and administrative (1) | 6,349 | 6,608 | 12,978 | 12,741 | ||||||||||||
| Total operating expenses | 40,185 | 35,434 | 79,849 | 69,092 | ||||||||||||
| Loss from operations | (2,245 | ) | (3,677 | ) | (6,421 | ) | (7,799 | ) | ||||||||
| Other income (expense): | ||||||||||||||||
| Interest income | 36 | 133 | 78 | 341 | ||||||||||||
| Other income (expense), net | (232 | ) | (106 | ) | (673 | ) | 273 | |||||||||
| Total other income (expense) | (196 | ) | 27 | (595 | ) | 614 | ||||||||||
| Loss before provision for tax | (2,441 | ) | (3,650 | ) | (7,016 | ) | (7,185 | ) | ||||||||
| Provision for income tax | 97 | 41 | 164 | 151 | ||||||||||||
| Net loss | $ | (2,538 | ) | $ | (3,691 | ) | $ | (7,180 | ) | $ | (7,336 | ) | ||||
| Net loss per share - basic and diluted | $ | (0.05 | ) | $ | (0.08 | ) | $ | (0.15 | ) | $ | (0.16 | ) | ||||
| Shares used in computing net loss per share - basic and diluted | 47,946 | 45,900 | 47,666 | 45,672 | ||||||||||||
| (1) Includes stock-based compensation expense as follows: | ||||||||||||||||
| Cost of product revenue | $ | 33 | $ | 27 | $ | 74 | $ | 62 | ||||||||
| Cost of support and services revenue | 209 | 161 | 408 | 361 | ||||||||||||
| Research and development | 911 | 778 | 1,923 | 1,602 | ||||||||||||
| Sales and marketing | 1,053 | 885 | 2,067 | 1,753 | ||||||||||||
| General and administrative | 1,066 | 777 | 2,050 | 1,674 | ||||||||||||
| Total stock-based compensation expense | $ | 3,272 | $ | 2,628 | $ | 6,522 | $ | 5,452 | ||||||||
See Notes to Condensed Consolidated Financial Statements
SHORETEL, INC. AND SUBSIDIARIES
(In thousands)
(Unaudited)
| Six Months Ended | ||||||||
| December 31, | ||||||||
| 2011 | 2010 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net loss | $ | (7,180 | ) | $ | (7,336 | ) | ||
| Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
| Depreciation and amortization | 3,262 | 1,932 | ||||||
| Stock-based compensation expense | 6,522 | 5,452 | ||||||
| Amortization of premium on investments | 136 | 354 | ||||||
| Loss on disposal of property and equipment | 27 | 82 | ||||||
| Provision (benefit) for doubtful accounts receivable | - | (98 | ) | |||||
| Changes in assets and liabilities: | ||||||||
| Accounts receivable | 2,864 | 126 | ||||||
| Inventories | (3,540 | ) | (2,745 | ) | ||||
| Prepaid expenses and other current assets | (1,058 | ) | 4,237 | |||||
| Other assets | (151 | ) | 273 | |||||
| Accounts payable | 1,476 | 459 | ||||||
| Accrued liabilities and other | 1,842 | (1,299 | ) | |||||
| Accrued employee compensation | (1,536 | ) | (195 | ) | ||||
| Deferred revenue | 7,523 | 2,972 | ||||||
| Net cash provided by operating activities | 10,187 | 4,214 | ||||||
| CASH FLOWS FROM INVESTING ACTIVITES: | ||||||||
| Purchases of property and equipment | (1,408 | ) | (4,033 | ) | ||||
| Purchases of investments | (24,916 | ) | (3,136 | ) | ||||
| Proceeds from sale/maturities of investments | 19,408 | - | ||||||
| Cost of acquisition of business | - | (11,375 | ) | |||||
| Purchases of patents and technology | (550 | ) | (770 | ) | ||||
| Net cash provided by (used in) investing activities | (7,466 | ) | (19,314 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Proceeds from issuance of common stock | 2,527 | 2,330 | ||||||
| Taxes paid on vested and released stock awards | (452 | ) | (352 | ) | ||||
| Net cash provided by (used in) financing activities | 2,075 | 1,978 | ||||||
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 4,796 | (13,122 | ) | |||||
| CASH AND CASH EQUIVALENTS - Beginning of period | 89,695 | 68,426 | ||||||
| CASH AND CASH EQUIVALENTS - End of period | $ | 94,491 | $ | 55,304 | ||||
| SUPPLEMENTAL CASH FLOW DISCLOSURE: | ||||||||
| Cash paid (refunds received) for taxes | $ | 183 | $ | (1,547 | ) | |||
| NONCASH INVESTING AND FINANCING ACTIVITIES: | ||||||||
| Unpaid portion of property and equipment purchases included in period-end accruals | $ | 203 | $ | 174 | ||||
See Notes to Condensed Consolidated Financial Statements
SHORETEL, INC. AND SUBSIDIARIES
(Unaudited)
1. Description of Business
ShoreTel, Inc. and its subsidiaries (referred herein as “the Company”) is a leading provider of Pure Internet Protocol, or IP, unified communications systems for enterprises. The Company’s systems are based on its distributed software architecture and switch-based hardware platform which enable multi-site enterprises to be served by a single telecommunications system. The Company’s systems enable a single point of management, easy installation and a high degree of scalability and reliability, and provide end users with a consistent, full suite of features across the enterprise, regardless of location. As a result, management believes that the Company’s systems enable enhanced end user productivity and provide lower total cost of ownership and higher customer satisfaction than alternative systems.
2. Basis of Presentation and Significant Accounting Policies
The accompanying condensed consolidated financial statements as of December 31, 2011 and for the three and six months ended December 31, 2011 and 2010 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2011.
In the opinion of the management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of financial position as of December 31, 2011, results of operations for the three and six months ended December 31, 2011 and 2010, and cash flows for the six months ended December 31, 2011 and 2010, as applicable, have been made. The results of operations for the three and six months ended December 31, 2011 are not necessarily indicative of the operating results to be expected for the full fiscal year or any future periods.
Computation of Net Loss per Share
Basic net loss per share is determined by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per share is determined by dividing net loss by the weighted average number of common shares used in the basic loss per share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive securities outstanding under the treasury stock method. Dilutive securities of 9.7 million and 9.8 million shares were not included in the computation of diluted net loss per share for the three and six months ended December 31, 2011 and 2010, respectively, because to do so would have been anti-dilutive.
Comprehensive Income (loss)
Other comprehensive income consists of net income (loss) for the period plus unrealized gains (losses) on short-term investments. Accordingly, comprehensive loss was $(2.5) million and $(3.6) million for the three months ended December 31, 2011 and 2010 and $(7.3) million and $(7.3) million for the six months ended December 31, 2011 and 2010, respectively.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of accounts receivable, cash and cash equivalents and short-term investments. Ongoing credit evaluations of customers' financial condition are performed and the amount of credit is limited when deemed necessary. Accounts receivable from one value-added distributor accounted for 29% of total accounts receivable at December 31, 2011. At June 30, 2011, there were no individual customers constituting 10% or more of accounts receivable. The Company invests its cash and cash equivalents and short-term investments with high credit quality financial institutions. However, balances held with these institutions may exceed the amount of insurance provided on such balances.
3. Business Combination
Proposed Acquisition
On January 31, 2012, the Company entered into a Definitive Agreement (“agreement”) with M5 Networks, Inc. (“M5”), a privately-held company headquartered in New York and a provider of hosted unified communications solutions. Under the terms of the agreement, the Company will acquire M5 for an aggregate purchase price of approximately $159.7 million, which includes $84.1million in cash and 9.5 million shares of ShoreTel common stock, and up to $13.7 million in additional contingent and deferred consideration upon the achievement of certain performance milestones within the twelve months ended December 31, 2012. The contingent payments are payable over the two years after closing and are based upon the achievement of certain performance milestones for the twelve months ended December 31, 2012. In connection with the agreement, the Company is in the process of establishing a financing arrangement with a bank. The acquisition of M5 enables ShoreTel to expand its product and service offerings by providing a cloud based solution and enter a growing market segment consisting of customers that are looking to deploy unified communications through a hosted model. The Company expects that the proposed acquisition will close in the third quarter of its fiscal 2012, subject to certain closing conditions.
Agito Networks, Inc. Acquisition
On October 19, 2010, the Company acquired Agito Networks, Inc. (“Agito”), a leader in platform-agnostic enterprise mobility, for total cash consideration of $11.4 million. The acquisition of Agito expands and enhances the Company’s product offering by adding Agito’s mobility solution to the Company’s existing range of products, software and services. In accordance with ASC 805, Business Combinations, the total consideration paid for Agito was first allocated to the net tangible assets acquired based on the estimated fair values of the assets at the acquisition date. The excess of the fair value of the consideration paid over the fair value of Agito’s net tangible and identifiable intangible assets acquired resulted in the recognition of goodwill of approximately $7.4 million, primarily related to expected synergies to be achieved in connection with the acquisition. The goodwill recognized is deductible for income tax purposes.
The table below shows the allocation of the purchase price to tangible and intangible assets and liabilities assumed (in thousands):
| Tangible assets | $ | 261 | ||
| Goodwill | 7,415 | |||
| Intangible assets | 4,220 | |||
| Liabilities assumed | (521 | ) | ||
| $ | 11,375 |
The unaudited pro forma financial information in the table below summarizes the combined results of operations for the Company and Agito as though the companies were combined as of the beginning of fiscal year 2010. The pro forma financial information for the period presented also includes the business combination accounting effects resulting from the acquisition, including amortization charges from acquired intangible assets, adjustments to interest expenses for certain borrowings and exclusion of acquisition- related expenses and the related tax effects as though the companies were combined as of the beginning of fiscal year 2010. The pro forma financial information as presented below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of fiscal year 2010.
| (Unaudited) | ||||||||
| Three Months Ended | Six Months Ended | |||||||
| (in thousands, except per share amounts) | December 31, 2010 | December 31, 2010 | ||||||
| Total revenue | $ | 47,832 | $ | 92,451 | ||||
| Net loss | (4,106 | ) | (9,721 | ) | ||||
| Basic and diluted earnings per share | (0.09 | ) | (0.21 | ) | ||||
4. Balance Sheet Details
Balance sheet components consist of the following:
December 31, 2011 | June 30, 2011 | |||||||
| (Amounts in thousands) | ||||||||
| Inventories: | ||||||||
| Raw materials | $ | 350 | $ | 283 | ||||
| Distributor inventory | 2,472 | 1,091 | ||||||
| Finished goods | 19,780 | 17,688 | ||||||
| Total inventories | $ | 22,602 | $ | 19,062 | ||||
| Property and equipment: | ||||||||
| Computer equipment and tooling | $ | 11,948 | $ | 10,868 | ||||
| Software | 2,375 | 2,311 | ||||||
| Furniture and fixtures | 2,043 | 1,925 | ||||||
| Leasehold improvements & others | 2,629 | 2,568 | ||||||
| Total property and equipment | 18,995 | 17,672 | ||||||
| Less accumulated depreciation and amortization | (11,336 | ) | (9,436 | ) | ||||
| Property and equipment – net | $ | 7,659 | $ | 8,236 | ||||
| Deferred revenue: | ||||||||
| Product | $ | 8,229 | $ | 3,195 | ||||
| Support and services | 36,977 | 34,488 | ||||||
| Total deferred revenue | $ | 45,206 | $ | 37,683 | ||||
Intangible Assets:
The following is a summary of the Company’s intangible assets as of the following dates (in thousands):
| December 31, 2011 | June 30, 2011 | |||||||||||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||||||
| Patents | $ | 3,485 | $ | (1,330 | ) | $ | 2,155 | $ | 2,935 | $ | (1,022 | ) | $ | 1,913 | ||||||||||
| Technology | 6,248 | (1,785 | ) | 4,463 | 6,127 | (861 | ) | 5,266 | ||||||||||||||||
| Customer relationships | 300 | (90 | ) | 210 | 300 | (30 | ) | 270 | ||||||||||||||||
| Intangible assets in process | 1,000 | - | 1,000 | 1,121 | - | 1,121 | ||||||||||||||||||
| Intangible assets | $ | 11,033 | $ | (3,205 | ) | $ | 7,828 | $ | 10,483 | $ | (1,913 | ) | $ | 8,570 | ||||||||||
The intangible assets are all amortizable and have original estimated useful lives of three to six years. Amortization of intangible assets for the three months ended December 31, 2011 and 2010 was $0.7 million and $0.4 million, respectively, and for the six months ended December 31, 2011 and 2010 was $1.3 million and $0.5 million, respectively.
The estimated amortization expenses for intangible assets for the next five years and thereafter are as follows (in thousands):
| Years Ending June 30, | ||||
| 2012 (remaining six months) | $ | 1,329 | ||
| 2013 | 2,657 | |||
| 2014 | 2,151 | |||
| 2015 | 526 | |||
| 2016 | 129 | |||
| Thereafter | 36 | |||
| Total | $ | 6,828 | ||
Short-Term Investments:
The following tables summarize the Company’s short-term investments (in thousands):
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
| As of December 31, 2011 | ||||||||||||||||
| Corporate notes and commercial paper | $ | 7,389 | $ | 1 | $ | (27 | ) | $ | 7,363 | |||||||
| U.S. Government agency securities | 14,000 | - | (4 | ) | 13,996 | |||||||||||
| Total short-term investments | $ | 21,389 | $ | 1 | $ | (31 | ) | $ | 21,359 | |||||||
| As of June 30, 2011 | ||||||||||||||||
| Corporate notes and commercial paper | $ | 6,105 | $ | 24 | $ | - | $ | 6,129 | ||||||||
| U.S. Government agency securities | 9,912 | 16 | - | 9,928 | ||||||||||||
| Total short-term investments | $ | 16,017 | $ | 40 | $ | - | $ | 16,057 | ||||||||
The following table summarizes the maturities of the Company’s fixed income securities (in thousands):
Amortized Cost | Fair Value | |||||||
| As of December 31, 2011 | ||||||||
| Less than 1 year | $ | 21,033 | $ | 21,003 | ||||
| Due in 1 to 3 years | 356 | 356 | ||||||
| Total | $ | 21,389 | $ | 21,359 | ||||
Amortized Cost | Fair Value | |||||||
| As of June 30, 2011 | ||||||||
| Less than 1 year | $ | 16,017 | $ | 16,057 | ||||
| Due in 1 to 3 years | - | - | ||||||
| Total | $ | 16,017 | $ | 16,057 | ||||
Actual maturities may differ from the contractual maturities because borrowers may have the right to call or prepay certain obligations.
5. Fair Value Disclosure
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal market (or most advantageous market, in the absence of a principal market) for the asset or liability in an orderly transaction between market participants at the measurement date. Further, entities are required to maximize the use of observable inputs and minimize the use of unobservable inputs in measuring fair value, and to utilize a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of inputs used to measure fair value are as follows:
| ● | Level 1 — Quoted prices in active markets for identical assets or liabilities. |
| ● | Level 2 — Observable inputs other than quoted prices included within Level 1, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs other than quoted prices that are observable or are derived principally from, or corroborated by, observable market data by correlation or other means. |
| ● | Level 3 — Unobservable inputs that are supported by little or no market activity, are significant to the fair value of the assets or liabilities, and reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. |
The tables below set forth the Company’s cash equivalents and short-term investments measured at fair value on a recurring basis (in thousands):
| December 31, 2011 | ||||||||||||||||
| Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
| Assets: | ||||||||||||||||
| Cash and cash equivalents: | ||||||||||||||||
| Money market funds | $ | 67,209 | $ | 67,209 | $ | - | $ | - | ||||||||
| Short-term investments: | ||||||||||||||||
| Corporate notes and commercial paper | 7,363 | - | 7,363 | - | ||||||||||||
| U.S. Government agency securities | 13,996 | - | 13,996 | - | ||||||||||||
| Total financial instruments measured and recorded at fair value | $ | 88,568 | $ | 67,209 | $ | 21,359 | $ | - | ||||||||
The above table excludes $27.3 million of cash balances on deposit at banks
| June 30, 2011 | ||||||||||||||||
| Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
| Assets: | ||||||||||||||||
| Cash and cash equivalents: | ||||||||||||||||
| Money market funds | $ | 72,445 | $ | 72,445 | $ | - | $ | - | ||||||||
| Short-term investments: | ||||||||||||||||
| Corporate notes and commercial paper | 6,129 | - | 6,129 | - | ||||||||||||
| U.S. Government agency securities | 9,928 | - | 9,928 | - | ||||||||||||
| Total financial instruments measured and recorded at fair value | $ | 88,502 | $ | 72,445 | $ | 16,057 | $ | - | ||||||||
The above table excludes $17.3 million of cash balances on deposit at banks.
Money market funds are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets. Short-term investments are classified within Level 2 of the fair value hierarchy because they are valued based on other observable inputs, including broker or dealer quotations, or alternative pricing sources. When quoted prices in active markets for identical assets or liabilities are not available, the Company relies on non-binding quotes from independent pricing services. Non-binding quotes are based on proprietary valuation models prepared by independent pricing services. These models use algorithms based on inputs such as observable market data, quoted market prices for similar instruments, historical pricing trends of a security as relative to its peers, internal assumptions of the independent pricing service and statistically supported models. The Company corroborates the reasonableness of non-binding quotes received from the independent pricing service by comparing them to the a) actual experience gained from the purchases and redemption of investment securities, b) quotes received on similar securities obtained when purchasing securities and c) monitoring changes in ratings of similar securities and the related impact on the fair value. The types of instruments valued based on other observable inputs include corporate notes and commercial paper and U.S. Government agency securities. The Company reviewed financial and non-financial assets and liabilities and concluded that there were no material impairment charges during the six months ended December 31, 2011 and 2010, respectively.
6. Income Taxes
The Company recorded an income tax expense of $97,000 and $41,000 for the three months ended December 31, 2011 and 2010, respectively and $0.2 million for both, the three and six months ended December 31, 2011 and 2010, respectively.
The income tax provision of $0.2 million for the six months ended December 31, 2011 represents the income tax provisions for profitable jurisdictions based upon income earned during this period and tax provisions for certain states that are determined on a basis other than income earned. No tax benefit was accrued for jurisdictions where we anticipate incurring a loss during the full fiscal year.
The Company maintains liabilities for uncertain tax positions. As of December 31, 2011 and June 30, 2011, the Company’s total amount of unrecognized tax benefits were $3.1 million. Of the total $3.1 million of unrecognized tax benefit as of December 31, 2011, only $0.1 million, if recognized would impact the effective tax rate.
While management believes that the Company has adequately provided for all tax positions, amounts asserted by tax authorities could be greater or less than the Company’s current position. Accordingly, the Company’s provisions on federal, state and foreign tax related matters to be recorded in the future may change as revised estimates are made or the underlying matters are settled or otherwise resolved. The Company does not expect its unrecognized tax benefits to change materially over the next 12 months.
The Company’s primary tax jurisdiction is in the United States. For federal and state tax purposes, the tax years 2000 through 2011 remain open and subject to tax examination by the appropriate federal or state taxing authorities.
7. Common Stock
Common Shares Reserved for Issuance
At December 31, 2011, the Company has reserved shares of common stock for issuance as follows (in thousands):
| Reserved under stock option plans | 13,284 | |||
| Reserved under employee stock purchase plan | 164 | |||
| Total | 13,448 |
8. Stock-Based Compensation
The Company estimated the grant date fair value of stock option awards and Employee Stock Purchase Plan (ESPP) rights using the Black-Scholes option valuation model with the following assumptions:
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| Expected life from grant date of option (in years) | 6.08 | 6.08 | 6.08 | 6.16 | ||||||||||||
| Expected life from grant date of ESPP (in years) | 0.50 | 0.50 | 0.50 | 0.50 | ||||||||||||
| Risk free interest rate for option | 0.95 | % | 1.44 | % | 1.14 | % | 1.49 | % | ||||||||
| Risk free interest rate for ESPP | 0.05 - 0.07 | % | 0.19-0.20 | % | 0.05 - 0.07 | % | 0.19-0.20 | % | ||||||||
| Expected volatility for option | 66 | % | 57 | % | 65 | % | 57 | % | ||||||||
| Expected volatility for ESPP | 52 -74 | % | 46-51 | % | 52 -74 | % | 46-51 | % | ||||||||
| Expected dividend yield | 0 | % | 0 | % | 0 | % | 0 | % | ||||||||
During the three months ended December 31, 2011 and 2010, the Company recorded non-cash stock-based compensation expense of $3.3 million and $2.6 million, respectively. During the six months ended December 31, 2011 and 2010, the Company recorded non-cash stock-based compensation expense of $6.5 million and $5.5 million, respectively.
Compensation expense is recognized only for the portion of stock options that are expected to vest, assuming an expected forfeiture rate in determining stock-based compensation expense, which could affect the stock-based compensation expense recorded if there is a significant difference between actual and estimated forfeiture rates. As of December 31, 2011, total unrecognized compensation cost related to stock-based awards granted to employees and non-employee directors was $17.5 million. This cost will be amortized on a ratable basis over a weighted-average vesting period of approximately 2.5 years.
9. Stock Option Plan
In January 1997, the Board of Directors and stockholders adopted the 1997 stock option plan (the “1997 Plan”) which, as amended, provided for granting incentive stock options (“ISOs”) and nonqualified stock options (“NSOs”) for shares of common stock to employees, directors, and consultants of the Company. This plan was terminated in January 2007 for new issuances.
In February 2007, the Company adopted the 2007 Equity Incentive Plan (the “2007 Plan”) which, as amended, provides for grants of ISOs, NSOs, restricted stock units (“RSUs”) and restricted stock awards (“RSAs”) to employees, directors and consultants of the Company. Options granted generally vest ratably over four years from the date of grant. The 2007 Plan provides that the options shall be exercisable over a period not to exceed ten years. Five million shares of common stock were initially reserved for future issuance in the form of stock options, restricted stock awards or units, stock appreciation rights and stock bonuses. In February of each fiscal year, pursuant to the automatic increase provisions of the 2007 Plan, the Company’s board of directors increased the number of shares authorized and reserved for issuance under the 2007 Plan by 2.4 million shares in January 2012 and 2.3 million shares in February 2011.
Transactions under the 1997 and 2007 option plans are summarized as follows (in thousands, except per share data and contractual term):
| Options Outstanding | ||||||||||||||||||||
Shares Available for Grant | Shares Subject to Options Outstanding | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Term (in years) | Weighted- Average Intrinsic Value | ||||||||||||||||
| Balance at July 1, 2011 | 4,475 | 7,931 | $ | 5.45 | ||||||||||||||||
| Options expired | (1 | ) | - | - | ||||||||||||||||
| Options granted (weighted average fair value $4.67 per share) | (774 | ) | 774 | 7.90 | ||||||||||||||||
| Options exercised | - | (163 | ) | 4.19 | ||||||||||||||||
| Options cancelled/forfeited | 234 | (234 | ) | 4.16 | ||||||||||||||||
| Restricted stock units granted (see Note 11) | (501 | ) | - | - | ||||||||||||||||
| Restricted stock units cancelled/forfeited | 135 | - | - | |||||||||||||||||
| Balance at December 31, 2011 | 3,568 | 8,308 | $ | 5.70 | 6.61 | $ | 11,138 | |||||||||||||
| Vested and expected to vest at December 31, 2011 | 7,840 | $ | 5.61 | 6.46 | $ | 10,907 | ||||||||||||||
| Options exercisable at December 31, 2011 | 4,362 | $ | 4.86 | 5.37 | $ | 8,255 | ||||||||||||||
The total pre-tax intrinsic value for options exercised in the three months ended December 31, 2011 and 2010 was $0.1 million and $0.7 million, respectively, and for the six months ended December 31, 2011 and 2010 was $0.4 million and $1.1 million, respectively, representing the difference between the fair values of the Company’s common stock underlying these options at the dates of exercise and the exercise prices paid.
10. Employee Stock Purchase Plan
On September 18, 2007, the Board of Directors approved the commencement of offering periods under a previously-approved employee stock purchase plan (the “ESPP”). The ESPP allows eligible employees to purchase shares of Company stock at a discount through payroll deductions. The ESPP consists of six-month offering periods commencing on May 1st and November 1st, each year. Under the ESPP, employees purchased shares of the Company's common stock at 90% of the market value at either the beginning of the offering period or the end of the offering period, whichever price is lower. The ESPP was amended in November 2010 to permit employees to purchase shares of the Company’s common stock at 85% of market value at either the beginning of the offering period or the end of the offering period, whichever price is lower, effective for the offering period commencing on and after May 1, 2011.
In January 2012 and February 2011, pursuant to the automatic increase provisions of the ESPP, the Company’s Board of Directors approved increases to the number of shares authorized and reserved for issuance under the ESPP by 481,433 and 469,980 shares, respectively.
As of December 31, 2011, 164,168 shares are reserved for future issuance.
11. Restricted Stock
Under the 2007 Plan, the Company issued restricted stock awards to non-employee directors electing to receive them in lieu of an annual cash retainer during the six months ended December 31, 2011 which vest immediately upon issuance.
In addition, restricted stock units can be issued under the 2007 Plan to eligible employees, and generally vest 25% at one year or 50% at two years from the date of grant and 25% annually thereafter.
Restricted stock award and restricted stock unit activity for the six months ended December 31, 2011 and 2010 is as follows (in thousands):
| Six Months Ended | ||||||||
| December 31, | ||||||||
| 2011 | 2010 | |||||||
| Beginning units outstanding | 1,196 | 809 | ||||||
| Awarded | 501 | 767 | ||||||
| Released | (221 | ) | (213 | ) | ||||
| Forfeited | (69 | ) | (177 | ) | ||||
| Ending units outstanding | 1,407 | 1,186 | ||||||
Information regarding restricted stock units outstanding at December 31, 2011 is summarized below:
Number of Shares (thousands) | Weighted Average Remaining Contractual Lives | Average Intrinsic Value (thousands) | |||||||
| Shares outstanding | 1,407 | 1.59 years | $ | 8,980 | |||||
| Shares vested and expected to vest | 1,170 | 1.55 years | 7,467 | ||||||
12. Litigation, Commitments and Contingencies
Litigation — At December 31, 2011, the Company is involved in litigations relating to claims arising out of the ordinary course of business or otherwise. Any litigation, regardless of outcome, is costly and time-consuming, can divert the attention of management and key personnel from business operations and deter distributors from selling the Company’s products and dissuade potential customers from purchasing the Company’s products. The Company defends itself vigorously against any such claims. Based on the information currently available, management believes that there are no claims or actions pending or threatened against us whose ultimate resolution will have a material adverse effect on our financial position, liquidity or results of operations, although the results of litigation are inherently uncertain. During the three months ended December 31, 2011, the Company settled one of the claims against it by entering into a patent license and a settlement agreement for $0.5 million. The settlement amount is included in general and administrative expenses during the quarter.
Leases — The Company leases its facilities under noncancelable operating leases which expire at various times through 2018. The leases provide for the lessee to pay all cost of utilities, insurance, and taxes. Future minimum lease payments under the noncancelable leases as of December 31, 2011, are as follows (in thousands):
| Years Ending June 30, | ||||
| 2012 (remaining six months) | $ | 1,060 | ||
| 2013 | 2,425 | |||
| 2014 | 2,334 | |||
| 2015 | 1,537 | |||
| 2016 | 1,293 | |||
| Therafter | 1,860 | |||
| Total | $ | 10,509 | ||
Lease obligations for the Company’s foreign offices are denominated in foreign currencies, which were converted in the above table to U.S. dollars at the interbank exchange rate on December 31, 2011.
Rent expense for the three months ended December 31, 2011 and 2010 was $0.5 million and $0.5 million, respectively and for the six months ended December 31, 2011 and 2010 was $1.0 million and $0.9 million, respectively.
Purchase commitments —The Company had purchase commitments with contract manufacturers for inventory and with technology firms for usage of software licenses totaling approximately $19.6 million as of December 31, 2011 and $19.9 million as of June 30, 2011.
Indemnification — Under the indemnification provisions of the Company’s customer agreements, the Company agrees to indemnify and defend its customers against infringement of any patent, trademark, or copyright of any country or the misappropriation of any trade secret, arising from the customers’ legal use of the Company’s services. The exposure to the Company under these indemnification provisions is generally limited to the total amount paid by the customers under pertinent agreements. However, certain indemnification provisions potentially expose the Company to losses in excess of the aggregate amount received from the customer. To date, there have been no claims against the Company or its customers pertaining to such indemnification provisions and no amounts have been recorded.
The Company also has entered into customary indemnification agreements with each of its officers and directors.
13. Segment Information
The Company is organized as, and operates in, one reportable segment: the development and sale of IP voice communication systems. The Company’s chief operating decision-maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of evaluating financial performance and allocating resources, accompanied by information about revenue by geographic regions. The Company’s assets are primarily located in the United States of America and not allocated to any specific region and it does not measure the performance of its geographic regions based upon asset-based metrics. Therefore, geographic information is presented only for revenue. Revenue by geographic region is based on the ship to address on the customer order.
The following presents total revenue by geographic region (in thousands):
| Three Months Ended | Six Months Ended | |||||||||||||||
| December 31, | December 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| United States of America | $ | 50,858 | $ | 42,113 | $ | 97,988 | $ | 81,620 | ||||||||
| International | 7,154 | 5,616 | 13,882 | 10,388 | ||||||||||||
| Total | $ | 58,012 | $ | 47,729 | $ | 111,870 | $ | 92,008 | ||||||||
Revenue from one value-added distributor accounted for approximately 25% and 20% of the total revenue during the three and six months ended December 31, 2011, respectively. No one reseller or end customer accounted for more than 10% of the total revenue during the three and six months ended December 31, 2010.
The following is a summary of long-lived assets, excluding financial instruments, deferred tax assets, other assets, goodwill and intangible assets (in thousands):
| December 31, | June 30, | |||||||
| 2011 | 2011 | |||||||
| United States of America | $ | 6,781 | $ | 7,725 | ||||
| International | 878 | 511 | ||||||
| Total | $ | 7,659 | $ | 8,236 | ||||
14. Derivative Instruments and Hedging Activities
In the normal course of business, the Company is exposed to fluctuations in interest rates and the exchange rates associated with foreign currencies. During the three months ended December 31, 2011, the Company used derivative instruments to reduce the volatility of earnings associated with changes in foreign currency exchange rates. The Company used foreign exchange forward contracts to mitigate the gains and losses generated from the re-measurement of certain foreign monetary assets and liabilities, primarily including cash balances, third party accounts receivable and intercompany transactions recorded on the balance sheet. These derivatives are not designated and do not qualify as hedge instruments. Accordingly, changes in the fair value of these instruments are recognized in earnings during the period of change. The change in the fair value recorded during the three and six months ended December 31, 2011 was not material. These derivatives have maturities of approximately one month.
The following table presents the gross notional value of all our foreign exchange forward contracts outstanding as of December 31, 2011 and June 30, 2011 (in thousands):
| December 31, 2011 | June 30, 2011 | |||||||||||||||
Local Currency Amount | Notional Contract Amount (USD) | Local Currency Amount | Notional Contract Amount (USD) | |||||||||||||
| Australian dollar | 1,900 | $ | 1,938 | - | $ | - | ||||||||||
| British pound | 2,600 | 4,031 | - | - | ||||||||||||
| Euro | 660 | 852 | - | - | ||||||||||||
| Total | $ | 6,821 | $ | - | ||||||||||||
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this document. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section entitled “Risk Factors.”
Overview
We are a leading provider of IP telecommunications solutions for enterprises. Our solution is comprised of our ShoreGear switches, ShorePhone IP phones and ShoreWare software applications. We were founded in September 1996 and shipped our first system in 1998. We have continued to develop and enhance our product line since that time. Our acquisition of Agito Networks, Inc. (“Agito”), a leader in platform-agnostic enterprise mobility, in the second quarter of fiscal 2011, expands our existing mobile solution with the vision of allowing users to communicate on any device, such as a desk phone, mobile phone, or computer, at any location using any cellular or Wi-Fi network simply and cost effectively.
We sell our products using single-tier or two-tier distribution channel to enterprises across all industries, including small, medium and large companies and public institutions. Our single-tier distribution channel consists of resellers that usually sell our products to end customers. Resellers usually do not stock our products and do not have rights of return. Our two-tier distribution channel consists of value-added distributors that stock and sell our products to other resellers or to end customers. The value-added distributors have limited rights of return. We refer to our resellers and value-added distributors collectively as “channel partners”.
We believe our channel strategy allows us to reach a larger number of prospective enterprise customers more effectively than if we were to sell directly. As of December 31, 2011, we worked with over 1,000 channel partners to sell our products. Our internal sales and marketing personnel support these channel partners in their selling efforts. In some circumstances, the enterprise customer will purchase products directly from us, but in these situations we typically compensate the channel partner for its sales efforts. At the request of the channel partner, we will ship our products directly to the enterprise customer.
Most channel partners generally perform installation and implementation services for the enterprises that use our systems. In most cases, our channel partners provide the post-contractual support to the enterprise customer by providing first-level support services and purchasing additional services from us under a post-contractual support contract. For channel partners without support capabilities or that do not desire to provide support, we offer full support contracts to provide all of the support to enterprise customers. Our channel partners may provide managed services offerings to the enterprise customer under which the channel partner may purchase our products and services and, in turn, charge the enterprise customer a monthly subscription fee to access those products and services. In addition, we have begun to engage some of our channel partners to purchase our products and services from us under a monthly managed services model.
We outsource the manufacturing of our products to contract manufacturers. Our outsourced manufacturing model allows us to scale our business without the significant capital investment and on-going expenses required to establish and maintain a manufacturing operation. Our phone and switch products are manufactured by contract manufacturers located in Austin, Texas and in China. Our contract manufacturers provide us with a range of operational and manufacturing services, including component procurement, final testing and assembly of our products. We work closely with our contract manufacturers to manage the cost of components, since our total manufacturing costs are directly tied to component costs. We regularly provide forecasts to our contract manufacturers, and we order products from our contract manufacturers based on our projected sales levels well in advance of receiving actual orders from our enterprise customers. We seek to maintain sufficient levels of finished goods inventory to meet our forecasted product sales with limited levels of inventory to compensate for unanticipated shifts in sales volume and product mix.
Although we have historically sold our systems primarily to small and medium sized enterprises, we have expanded our sales and marketing activities to increase our focus on larger enterprise customers. Accordingly, we have a major accounts program whereby our sales personnel assist our channel partners to sell to large enterprise accounts, and we coordinate with our channel partners to enable them to better serve large multi-site enterprises. To the extent we are successful in penetrating larger enterprise customers; we expect that the sales cycle for our products will increase, and that the demands on our sales and support infrastructure will also increase.
We are headquartered in Sunnyvale, California and have sales, customer support, general and administrative and engineering functions in Austin, Texas. The majority of our personnel work at these locations. Sales, engineering, and support personnel are located throughout the United States and, to a lesser extent, in the United Kingdom, Germany, Belgium, Spain, Hong Kong, Singapore, Mexico, Australia, Canada and India. Most of our enterprise customers are located in the United States. Revenue from international sales was 12% and 12% of our total revenue for the three months ended December 31, 2011 and 2010, respectively and was 12% and 11% of our total revenue for the six months ended December 31, 2011 and 2010, respectively. Although we intend to focus on increasing international sales and expect those revenues to grow faster than the overall company revenue, we expect that sales to enterprise customers in the United States will continue to comprise the significant majority of our sales.
Key Business Metrics
We monitor a number of key metrics to help forecast growth, establish budgets, measure the effectiveness of sales and marketing efforts and measure operational effectiveness.
Initial and repeat sales orders. Our goal is to attract a significant number of new enterprise customers and to encourage existing enterprise customers to purchase additional products and support. Many enterprise customers make an initial purchase and deploy additional sites at a later date, and also buy additional products and support as their businesses expand. As our installed enterprise customer base has grown we have experienced an increase in revenue attributable to existing enterprise customers, which currently represents a significant portion of our total revenue.
Deferred revenue. Deferred revenue relates to the timing of revenue recognition for specific transactions based on service, support, specific commitments, product and services delivered to our value-added distributors that have not sold through to resellers, and other factors. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from the Company’s transactions described above and are recognized as the revenue recognition criteria are met. Nearly all system sales include the purchase of post-contractual support contracts with terms of up to five years, and the rate of renewal on these contracts have been high historically. We recognize support revenue on a ratable basis over the term of the support contract. Since we receive payment for support in advance of our recognizing the related revenue, we carry a deferred revenue balance on our consolidated balance sheet. This deferred revenue helps provide predictability to our future support and services revenue. Accordingly, the level of purchases of post-contractual support with our product sales is an important metric for us along with the renewal rates for these services. Our deferred revenue balance at December 31, 2011 was $45.2 million, consisting of $8.2 million of deferred product revenue and $37.0 million of deferred support and services revenues, of which $33.0 million is expected to be recognized within one year.
Gross margin. Our gross margin for products is primarily affected by our ability to reduce hardware costs faster than the decline in average overall system prices and our channels sales mix as we expand our two-tier distribution channel in the domestic market. Since sales channeled through our distributors typically have a lower margin than sales made directly to our resellers, we have experienced a decline in our gross margins as the two-tier channel grows. We continue to work on introducing new lower cost hardware which will help improve our product gross margin. In general, product gross margin on our switches is greater than product gross margin on our IP phones. We consider our ability to monitor and manage these factors to be a key aspect of maintaining product gross margin and increasing our profitability.
Gross margin for support and services is impacted primarily by the growth in revenue, personnel costs and labor related expenses. The primary goal of our support and services function is to ensure maximum customer satisfaction and our investments in support personnel and infrastructure are made with this goal in mind. We expect that as our installed enterprise customer base grows, we will be able to maintain our gross margin for support and services. However, the timing of additional investments in our support and services infrastructure could materially affect our cost of support and services revenue, both in absolute dollars and as a percentage of support and services revenue and total revenue, in any particular period.
Operating expenses. Our operating expenses are comprised primarily of compensation and benefits for our employees and, therefore, the increase in operating expenses has been primarily related to increases in our headcount. We intend to expand our workforce to support our anticipated growth, and therefore our ability to forecast and increase revenue is critical to managing our operating expenses and profitability.
Basis of Presentation
Revenue. We derive our revenue from sales of our IP telecommunications systems and related support and services. Our typical system includes a combination of IP phones, switches and software applications. Prices to a given channel partner for hardware and software products depend on that channel partner’s volume and certain certifications, as well as our own strategic considerations.
Support and services revenue primarily consists of post-contractual support, and to a lesser extent revenue from training services, professional services and installations that we perform. Post-contractual support includes software updates which grant rights to unspecified software license upgrades and maintenance releases issued during the support period. Post-contractual support also includes both Internet-and phone-based technical support. Post-contractual support revenue is recognized ratably over the contractual service period.
Cost of revenue. Cost of product revenue consists primarily of hardware costs, royalties and license fees for third-party software included in our systems, salary and related overhead costs of operations personnel, freight, warranty costs and provision for excess inventory. The majority of these costs vary with the unit volumes of product sold. Cost of support and services revenue consists of salary and related costs of personnel engaged in support and services.
Research and development expenses. Research and development expenses primarily include personnel costs, outside engineering costs, professional services, prototype costs, test equipment, software usage fees and facilities expenses. Research and development expenses are recognized when incurred. We are devoting substantial resources to the development of additional functionality for existing products and the development of new products and related software applications.
Sales and marketing expenses. Sales and marketing expenses primarily include personnel costs, sales commissions, travel, marketing promotional and lead generation programs, our annual partner conference, advertising, trade shows, demonstration equipment, professional services fees and facilities expenses. We plan to continue to invest in development of our distribution channel by increasing the size of our field sales force to enable us to expand into new geographies and further increase our sales to large enterprise customers. We plan to continue investing in our domestic and international marketing activities to help build brand awareness and create sales leads for our channel partners. We expect that sales and marketing expenses will increase in absolute dollars and remain our largest operating expense category.
General and administrative expenses. General and administrative expenses relate to our executive, finance, human resources, legal and information technology organizations. Expenses primarily include personnel costs, professional fees for legal, accounting, tax, compliance and information systems, travel, allowance for doubtful accounts, recruiting expense, software amortization costs, depreciation expense and facilities expenses. As we expand our business, we expect to increase our general and administrative expenses.
Other income (expense). Other income (expense) primarily consists of interest earned on cash, cash equivalents and short-term investments, gains and losses on foreign currency translations and transactions, as well as other miscellaneous items affecting our operating results.
Provision for income tax. Provision for income tax includes federal, state and foreign tax on our taxable income. Since our inception, we accumulated substantial net operating loss and tax credit carryforwards. We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carry-forwards and other tax credits measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.
Critical Accounting Policies and Estimates
The preparation of our financial statements and related disclosures in conformity with generally accepted accounting principles in the United States of America, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical experience and various other factors that we believe are reasonable under the circumstances. We consider our accounting policies related to revenue recognition, stock-based compensation and accounting for income taxes to be critical accounting policies. A number of significant estimates, assumptions, and judgments are inherent in our determination of when to recognize revenue, how to estimate the best evidence of selling price for revenue recognition and the calculation of stock-based compensation expense. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates. Management believes there have been no significant changes during the six months ended December 31, 2011 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For a description of those accounting policies, please refer to our 2011 Annual Report on Form 10-K.
Results of Operations
The following table sets forth unaudited selected condensed consolidated statements of operations data for three and six months ended December 31, 2011 and 2010 (Amounts in thousands, except per share amounts).
| Three Months Ended | Six Months Ended | |||||||||||||||
| December 31, | December 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| Revenue: | ||||||||||||||||
| Product | $ | 46,277 | $ | 37,913 | $ | 88,461 | $ | 73,139 | ||||||||
| Support and services | 11,735 | 9,816 | 23,409 | 18,869 | ||||||||||||
| Total revenue | 58,012 | 47,729 | 111,870 | 92,008 | ||||||||||||
| Cost of revenue: | ||||||||||||||||
| Product (1) | 16,103 | 12,847 | 30,558 | 24,614 | ||||||||||||
| Support and services (1) | 3,969 | 3,125 | 7,884 | 6,101 | ||||||||||||
| Total cost of revenue | 20,072 | 15,972 | 38,442 | 30,715 | ||||||||||||
| Gross profit | 37,940 | 31,757 | 73,428 | 61,293 | ||||||||||||
| Gross profit % | 65.4 | % | 66.5 | % | 65.6 | % | 66.6 | % | ||||||||
| Operating expenses: | ||||||||||||||||
| Research and development (1) | 12,240 | 10,512 | 24,053 | 20,834 | ||||||||||||
| Sales and marketing (1) | 21,596 | 18,314 | 42,818 | 35,517 | ||||||||||||
| General and administrative (1) | 6,349 | 6,608 | 12,978 | 12,741 | ||||||||||||
| Total operating expenses | 40,185 | 35,434 | 79,849 | 69,092 | ||||||||||||
| Loss from operations | (2,245 | ) | (3,677 | ) | (6,421 | ) | (7,799 | ) | ||||||||
| Other income (expense), net | (196 | ) | 27 | (595 | ) | 614 | ||||||||||
| Loss before provision for tax | (2,441 | ) | (3,650 | ) | (7,016 | ) | (7,185 | ) | ||||||||
| Provision for income tax | 97 | 41 | 164 | 151 | ||||||||||||
| Net loss | $ | (2,538 | ) | $ | (3,691 | ) | $ | (7,180 | ) | $ | (7,336 | ) | ||||
| Net loss per share - basic and diluted (2) | $ | (0.05 | ) | $ | (0.08 | ) | $ | (0.15 | ) | $ | (0.16 | ) | ||||
| Shares used in computing net loss per share - basic and diluted (2) | 47,946 | 45,900 | 47,666 | 45,672 | ||||||||||||
| (1) Includes stock-based compensation expense as follows: | ||||||||||||||||
| Cost of product revenue | $ | 33 | $ | 27 | $ | 74 | $ | 62 | ||||||||
| Cost of support and services revenue | 209 | 161 | 408 | 361 | ||||||||||||
| Research and development | 911 | 778 | 1,923 | 1,602 | ||||||||||||
| Sales and marketing | 1,053 | 885 | 2,067 | 1,753 | ||||||||||||
| General and administrative | 1,066 | 777 | 2,050 | 1,674 | ||||||||||||
| Total stock-based compensation expense | $ | 3,272 | $ | 2,628 | $ | 6,522 | $ | 5,452 | ||||||||
(2) Potentially dilutive securities were not included in the compilation of diluited net loss per share for the periods which had a net loss because to do so would have been anti-dilutive.
The following table sets forth selected condensed consolidated statements of operations data as a percentage of total revenue for each of the periods indicated.
| Three Months Ended | Six Months Ended | |||||||||||||||
| December 31, | December 31, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| Revenue: | ||||||||||||||||
| Product | 80 | % | 79 | % | 79 | % | 79 | % | ||||||||
| Support and services | 20 | % | 21 | % | 21 | % | 21 | % | ||||||||
| Total revenue | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||
| Cost of revenue: | ||||||||||||||||
| Product | 28 | % | 27 | % | 27 | % | 27 | % | ||||||||
| Support and services | 7 | % | 6 | % | 7 | % | 6 | % | ||||||||
| Total cost of revenue | 35 | % | 33 | % | 34 | % | 33 | % | ||||||||
| Gross profit | 65 | % | 67 | % | 66 | % | 67 | % | ||||||||
| Operating expenses: | ||||||||||||||||
| Research and development | 21 | % | 22 | % | 22 | % | 23 | % | ||||||||
| Sales and marketing | 37 | % | 39 | % | 38 | % | 39 | % | ||||||||
| General and administrative | 11 | % | 14 | % | 12 | % | 14 | % | ||||||||
| Total operating expenses | 69 | % | 75 | % | 72 | % | 76 | % | ||||||||
| Loss from operations | (4 | %) | (8 | %) | (6 | %) | (9 | %) | ||||||||
| Other income (expense), net | - | - | - | 1 | % | |||||||||||
| Loss before provision for income tax | (4 | %) | (8 | %) | (6 | %) | (8 | %) | ||||||||
| Provision for income tax | - | - | - | - | ||||||||||||
| Net loss | (4 | %) | (8 | %) | (6 | %) | (8 | %) | ||||||||
Use of Non-GAAP Financial Measures
We believe that evaluating our ongoing operating results may limit the reader’s understanding if limited to reviewing only generally accepted accounting principles (GAAP) financial measures. Many investors and analysts have requested that, in addition to reporting financial information in accordance with GAAP we also disclose certain non-GAAP information because it is useful in understanding our performance as it excludes non-cash and other special charges or credits that many investors and management feel may obscure our true operating performance. Likewise, we use these non-GAAP financial measures to manage and assess the profitability of the business and determine a portion of our employee compensation. We do not consider stock-based compensation expenses, amortization of acquisition-related intangibles, litigation settlement, severance paid to former Chief Executive Officer and related tax adjustments in managing our core operations. These measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. Non-GAAP net loss excludes stock-based compensation expense, amortization of acquisition-related intangible assets, litigation settlement, severance paid to former Chief Executive Officer and their related tax effect. Non-GAAP net loss per share is calculated by dividing Non-GAAP net loss by the weighted average number of diluted shares outstanding for the period. These measures should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP, and because these amounts are not determined in accordance with GAAP, they should not be used exclusively in evaluating our business and operations. We have provided a reconciliation of non-GAAP financial measures in the table below.
RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES
(Amounts in thousands, except per share amounts)
(Unaudited)
| Three Months Ended | Six Months Ended | |||||||||||||||||||||||||
| December 31, 2011 | December 31, 2011 | |||||||||||||||||||||||||
| GAAP | Excludes | Non-GAAP | GAAP | Excludes | Non-GAAP | |||||||||||||||||||||
| Revenue: | ||||||||||||||||||||||||||
| Product | $ | 46,277 | $ | - | $ | 46,277 | $ | 88,461 | $ | - | $ | 88,461 | ||||||||||||||
| Support and services | 11,735 | - | 11,735 | 23,409 | - | 23,409 | ||||||||||||||||||||
| Total revenues | 58,012 | - | 58,012 | 111,870 | - | 111,870 | ||||||||||||||||||||
| Cost of revenue | ||||||||||||||||||||||||||
| Product | 16,103 | (218 | ) | (a),(b) | 15,885 | 30,558 | (444 | ) | (a),(b) | 30,114 | ||||||||||||||||
| Support and services | 3,969 | (209 | ) | (a) | 3,760 | 7,884 | (408 | ) | (a) | 7,476 | ||||||||||||||||
| Total cost of revenue | 20,072 | (427 | ) | 19,645 | 38,442 | (852 | ) | 37,590 | ||||||||||||||||||
| Gross profit | 37,940 | 427 | 38,367 | 73,428 | 852 | 74,280 | ||||||||||||||||||||
| Gross profit % | 65.4 | % | 66.1 | % | 65.6 | % | 66.4 | % | ||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||
| Research and development | 12,240 | (911 | ) | (a) | 11,329 | 24,053 | (1,923 | ) | (a) | 22,130 | ||||||||||||||||
| Sales and marketing | 21,596 | (1,083 | ) | (a),(b) | 20,513 | 42,818 | (2,127 | ) | (a),(b) | 40,691 | ||||||||||||||||
| General and administrative | 6,349 | (1,566 | ) | (a),(c) | 4,783 | 12,978 | (2,550 | ) | (a),(c) | 10,428 | ||||||||||||||||
| Total operating expenses | 40,185 | (3,560 | ) | 36,625 | 79,849 | (6,600 | ) | 73,249 | ||||||||||||||||||
| Income (Loss) from operations | (2,245 | ) | 3,987 | 1,742 | (6,421 | ) | 7,452 | 1,031 | ||||||||||||||||||
| Other income (expense), net | (196 | ) | - | (196 | ) | (595 | ) | - | (595 | ) | ||||||||||||||||
| Income (Loss) before provision for income tax | (2,441 | ) | 3,987 | 1,546 | (7,016 | ) | 7,452 | 436 | ||||||||||||||||||
| Provision for income tax | 97 | 12 | (d) | 109 | 164 | 12 | (d) | 176 | ||||||||||||||||||
| Net income (loss) | $ | (2,538 | ) | $ | 3,975 | $ | 1,437 | $ | (7,180 | ) | $ | 7,440 | $ | 260 | ||||||||||||
| Net income (loss) per share: | ||||||||||||||||||||||||||
| Basic | $ | (0.05 | ) | $ | 0.08 | $ | 0.03 | $ | (0.15 | ) | $ | 0.16 | $ | 0.01 | ||||||||||||
| Diluted | $ | (0.05 | ) | $ | 0.08 | $ | 0.03 | $ | (0.15 | ) | $ | 0.16 | $ | 0.01 | ||||||||||||
| Shares used in computing net loss per share: | ||||||||||||||||||||||||||
| Basic | 47,946 | 47,946 | 47,666 | 47,666 | ||||||||||||||||||||||
| Diluted | 47,946 | 49,228 | 47,666 | 49,202 | ||||||||||||||||||||||
| (a) Excludes stock-based compensation as follows: | ||||||||||||||||||||||||||
| Cost of product revenue | $ | 33 | $ | 74 | ||||||||||||||||||||||
| Cost of support and services revenue | 209 | 408 | ||||||||||||||||||||||||
| Research and development | 911 | 1,923 | ||||||||||||||||||||||||
| Sales and marketing | 1,053 | 2,067 | ||||||||||||||||||||||||
| General and administrative | 1,066 | 2,050 | ||||||||||||||||||||||||
| $ | 3,272 | $ | 6,522 | |||||||||||||||||||||||
| (b) Excludes amortization of acquisition-related intangibles: | ||||||||||||||||||||||||||
| Cost of product revenue | $ | 185 | $ | 370 | ||||||||||||||||||||||
| Sales and marketing | 30 | 60 | ||||||||||||||||||||||||
| $ | 215 | $ | 430 | |||||||||||||||||||||||
| (c) Excludes litigation settlement included in: | ||||||||||||||||||||||||||
| General and administrative | $ | 500 | $ | 500 | ||||||||||||||||||||||
| (d) | Excludes the tax impact of the items which are excluded in (a) to (c) above. |
RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES
(Amounts in thousands, except per share amounts)
(Unaudited)
| Three Months Ended | Six Months Ended | |||||||||||||||||||||||||
| December 31, 2010 | December 31, 2010 | |||||||||||||||||||||||||
| GAAP | Excludes | Non-GAAP | GAAP | Excludes | Non-GAAP | |||||||||||||||||||||
| Revenue: | ||||||||||||||||||||||||||
| Product | $ | 37,913 | $ | - | $ | 37,913 | $ | 73,139 | $ | - | $ | 73,139 | ||||||||||||||
| Support and services | 9,816 | - | 9,816 | 18,869 | - | 18,869 | ||||||||||||||||||||
| Total revenues | 47,729 | - | 47,729 | 92,008 | - | 92,008 | ||||||||||||||||||||
| Cost of revenue | ||||||||||||||||||||||||||
| Product | 12,847 | (168 | ) | (a), (c) | 12,679 | 24,614 | (203 | ) | (a), (c) | 24,411 | ||||||||||||||||
| Support and services | 3,125 | (161 | ) | (a) | 2,964 | 6,101 | (361 | ) | (a) | 5,740 | ||||||||||||||||
| Total cost of revenue | 15,972 | (329 | ) | 15,643 | 30,715 | (564 | ) | 30,151 | ||||||||||||||||||
| Gross profit | 31,757 | 329 | 32,086 | 61,293 | 564 | 61,857 | ||||||||||||||||||||
| Gross profit % | 66.5 | % | 67.2 | % | 66.6 | % | 67.2 | % | ||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||
| Research and development | 10,512 | (778 | ) | (a) | 9,734 | 20,834 | (1,602 | ) | (a) | 19,232 | ||||||||||||||||
| Sales and marketing | 18,314 | (894 | ) | (a), (c) | 17,420 | 35,517 | (1,762 | ) | (a), (c) | 33,755 | ||||||||||||||||
| General and administrative | 6,608 | (777 | ) | (a) | 5,831 | 12,741 | (2,199 | ) | (a), (b) | 10,542 | ||||||||||||||||
| Total operating expenses | 35,434 | (2,449 | ) | 32,985 | 69,092 | (5,563 | ) | 63,529 | ||||||||||||||||||
| Income (Loss) from operations | (3,677 | ) | 2,778 | (899 | ) | (7,799 | ) | 6,127 | (1,672 | ) | ||||||||||||||||
| Other income, net | 27 | - | 27 | 614 | - | 614 | ||||||||||||||||||||
| Income (Loss) before provision for income tax | (3,650 | ) | 2,778 | (872 | ) | (7,185 | ) | 6,127 | (1,058 | ) | ||||||||||||||||
| Provision for (benefit from) income tax | 41 | 99 | (d) | 140 | 151 | - | (d) | 151 | ||||||||||||||||||
| Net income (loss) | $ | (3,691 | ) | $ | 2,679 | $ | (1,012 | ) | $ | (7,336 | ) | $ | 6,127 | $ | (1,209 | ) | ||||||||||
| Net income (loss) per share: | ||||||||||||||||||||||||||
| Basic | $ | (0.08 | ) | $ | 0.06 | $ | (0.02 | ) | $ | (0.16 | ) | $ | 0.13 | $ | (0.03 | ) | ||||||||||
| Diluted (e) | $ | (0.08 | ) | $ | 0.06 | $ | (0.02 | ) | $ | (0.16 | ) | $ | 0.13 | $ | (0.03 | ) | ||||||||||
| Shares used in computing net loss per share: | ||||||||||||||||||||||||||
| Basic | 45,900 | 45,900 | 45,672 | 45,672 | ||||||||||||||||||||||
| Diluted (e) | 45,900 | 45,900 | 45,672 | 45,672 | ||||||||||||||||||||||
| (a) Excludes stock-based compensation as follows: | ||||||||||||||||||||||||||
| Cost of product revenue | $ | 27 | $ | 62 | ||||||||||||||||||||||
| Cost of support and services revenue | 161 | 361 | ||||||||||||||||||||||||
| Research and development | 778 | 1,602 | ||||||||||||||||||||||||
| Sales and marketing | 885 | 1,753 | ||||||||||||||||||||||||
| General and administrative | 777 | 1,674 | ||||||||||||||||||||||||
| $ | 2,628 | $ | 5,452 | |||||||||||||||||||||||
| (b) Excludes severance for former Chief Executive Officer: | ||||||||||||||||||||||||||
| General and administration | $ | - | $ | 525 | ||||||||||||||||||||||
| (c) Excludes amortization of acquisition-related intangibles: | ||||||||||||||||||||||||||
| Cost of product revenue | $ | 141 | $ | 141 | ||||||||||||||||||||||
| Sales and marketing | 9 | 9 | ||||||||||||||||||||||||
| $ | 150 | $ | 150 | |||||||||||||||||||||||
| (d) | Excludes the tax impact of the items which are excluded in (a) to (c) above. |
| (e) | Potentially dilutive securities were not included in the calculation of diluted net loss per share for the periods which had a net loss because to do so would have been anti-dilutive. |
Comparison of the three months ended December 31, 2011 and December 31, 2010
Revenue.
| Three Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Revenue | $ | 58,012 | $ | 47,729 | $ | 10,283 | 22 | % | ||||||||
Revenue. Revenue increased by $10.3 million or 22% in the three months ended December 31, 2011 as compared to the three months ended December 31, 2010. The increase from the prior period was due to increases in both product and support and services revenues during the period. Product revenues in the three months ended December 31, 2011 were $46.3 million, representing an increase of $8.4 million or 22%. The increase in product revenues was primarily attributable to our continued investments in both sales and marketing efforts as well as our expansion of two-tier distribution channel relationships for our domestic markets. These efforts have led to the realization of higher sales volumes, expansion of our customer base and increased market share and increased brand awareness which has driven our revenue growth. Revenues from service providers as well as from international markets have also increased as a result of these efforts. Support and services revenue in the three months ended December 31, 2011 was $11.7 million, an increase of $1.9 million or 20%. The increase in support and services revenue was primarily due to the increase in support contract renewals from a larger customer base.
Cost of revenue and gross profit.
| Three Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Cost of revenue | $ | 20,072 | $ | 15,972 | $ | 4,100 | 26 | % | ||||||||
| Gross profit | 37,940 | 31,757 | 6,183 | 19 | % | |||||||||||
| Gross margin | 65 | % | 67 | % | n/a | (2 | %) | |||||||||
Cost of revenue. Gross margins decreased to 65% in the three months ended December 31, 2011 as compared to 67% in the three months ended December 31, 2010. The decrease from the prior period was primarily attributable to decreases in both product and service margins during the period. Product margins were 65% and service margins were 66% of their respective revenues in the three months ended December 31, 2011 as compared to 66% and 68% of their respective revenues in three months ended December 31, 2010. The decrease in product margins was due to a change in our channel sales mix as a greater percentage of total sales were transacted through our domestic two-tier distribution partners , as such sales generally have a lower margin than the sales made directly to our resellers. The decrease in service margins was primarily due to an increase in personnel costs associated with headcount in our service department to meet the needs of our larger customer base.
Operating expenses.
| Three Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Research and development | $ | 12,240 | $ | 10,512 | $ | 1,728 | 16 | % | ||||||||
| Sales and marketing | 21,596 | 18,314 | 3,282 | 18 | % | |||||||||||
| General and administration | 6,349 | 6,608 | (259 | ) | (4 | %) | ||||||||||
Research and development. Research and development expenses increased by $1.7 million or 16% in the three months ended December 31, 2011 as compared to the three months ended December 31, 2010. The increase in research and development expenses from the prior period is primarily due to an increase in personnel costs of $1.4 million as a result of an increase in headcount of approximately 37 employees to support product development efforts as we continue to expand both our products and solutions offerings.
Sales and marketing. Sales and marketing expenses increased by $3.3 million or 18% in the three months ended December 31, 2011 as compared to the three months ended December 31, 2010. The increase in sales and marketing expenses from the prior period is primarily due to an increase in personnel related costs including, bonuses and commissions of $2.5 million, travel expenses of $0.2 million, advertising and promotional activities of $0.2 million and share-based compensation of $0.2 million. Such increases were a result of headcount increase of 45 employees attributable to our focused effort to expand our customer base.
General and administrative. General and administrative expenses decreased by $0.3 million or 4% in the three months ended December 31, 2011 as compared to the three months ended December 31, 2010. The decrease in general and administrative expenses from the prior period is primarily due to a decrease in legal expenses of approximately $0.2 million and a decrease in professional and outside consulting fees of $0.5 million that were incurred in connection with our acquisition of Agito in the prior year and a decrease of $0.2 million in equipment expenses and software licenses. These decreases were partially offset by a increase in stock-based compensation expense of $0.3 million and a legal settlement of $0.5 million.
Other income (expense), net.
| Three Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Other income (expense), net | $ | (196 | ) | $ | 27 | $ | (223 | ) | (826 | %) | ||||||
Other income (expense), net. Other income decreased by $0.2 million due to a decrease in interest income by $0.1 million as a result of lower interest rates and an increase in foreign exchange loss of $0.1 million due to the weakening of foreign currencies against the U.S. dollar.
Provision for income tax.
| Three Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Provision for income tax | $ | 97 | $ | 41 | $ | 56 | 137 | % | ||||||||
Provision for income tax. The provision for income taxes increased by $56,000 in three months ended December 31, 2011 as compared to three months ended December 31, 2010. The increase in income tax expense from the prior period is primarily due to higher state income tax expense for the three months ended December 31, 2011 as compared to the three months ended December 31, 2010.
Comparison of the six months ended December 31, 2011 and December 31, 2010
Revenue.
| Six Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Revenue | $ | 111,870 | $ | 92,008 | $ | 19,862 | 22 | % | ||||||||
Revenue. Revenue increased by $19.9 million or 22% in the six months ended December 31, 2011 as compared to the six months ended December 31, 2010. The increase in revenue from the prior period was primarily due to increases in both product and support and services revenues during the period. Product revenues in the six months ended December 31, 2011 were $88.5 million, representing an increase of $15.3 million or 21%. The increase in product revenue is primarily attributable to the higher sales volumes from our channel partners and expansion in the U.S. two-tier distribution channel which was primarily attributable to our continued investments in both sales and marketing efforts. These efforts have led to the realization of higher sales volumes, expansion of our customer base, increased brand awareness and increased market share which has driven our revenue growth from service providers and international and domestic markets. Support and services revenue in the six months ended December 31, 2011 were $23.4 million, an increase of $4.5 million or 24%. The increase in support and services revenue was primarily due to an increase in support renewals from our larger customer base.
Cost of revenue and gross profit.
| Six Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Cost of revenue | $ | 38,442 | $ | 30,715 | $ | 7,727 | 25 | % | ||||||||
| Gross profit | 73,428 | 61,293 | 12,135 | 20 | % | |||||||||||
| Gross margin | 66 | % | 67 | % | n/a | (1 | %) | |||||||||
Cost of revenue. Gross margins decreased to 66% in the six months ended December 31, 2011 as compared to 67% in the six months ended December 31, 2010. The decrease from the prior period was primarily attributable to decreases in both product and service margins during the period. Product margins decreased to 65% in the six months ended December 31, 2011 as compared to 66% in the six months ended December 31, 2010. The decrease in product margins was due to a change in our channel sales mix as a greater percentage of total sales were transacted through our domestic two-tier distribution partners, as such sales generally have a lower margin than the sales made directly to our resellers, as well as moderate increase in discounting and changes in overall product mix to lower margin items. The support and service margins were 66% in the six months ended December 31, 2011 as compared to 68% in the six months ended December 31, 2010. The decrease in service margins was primarily due to an increase in the number of service personnel during the first six months of the current fiscal year as compared to the first six months of the prior year to support the needs of our growing customer base.
Operating expenses.
| Six Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Research and development | $ | 24,053 | $ | 20,834 | $ | 3,219 | 15 | % | ||||||||
| Sales and marketing | 42,818 | 35,517 | 7,301 | 21 | % | |||||||||||
| General and administration | 12,978 | 12,741 | 237 | 2 | % | |||||||||||
Research and development. Research and development expenses increased by $3.2 million or 15% in the six months ended December 31, 2011 as compared to the six months ended December 31, 2010. The increase is primarily due to an increase in employee compensation and related fringe benefits of $2.8 million as result of increased headcount and share-based compensation of $0.3 million to existing and new employees.
Sales and marketing. Sales and marketing expenses increased by $7.3 million or 21% in the six months ended December 31, 2011 as compared to the six months ended December 31, 2010. The increase in sales and marketing expenses is primarily due to employee compensation, bonuses, commissions and related fringe benefits of $5.6 million, share-based compensation of $0.3 million, travel expenses of $0.7 million as a result of headcount increase and consulting and outsourced services of $0.4 million.
General and administrative. General and administrative expenses increased by $0.2 million or 2% in the six months ended December 31, 2011 as compared to the six months ended December 31, 2010. Though the headcount increased during the six months ended December 31, 2011 by approximately 13 employees, the increase in the employee compensation and related fringe benefits in this period was offset by the one-time severance expense of $0.5 million to the former Chief Executive Officer included in the six months ended December 31, 2010. The increase in legal settlement of $0.5 million and share-based compensation of $0.3 million was offset by decreases of $0.2 million in legal expenses and $0.4 million in consulting and outsourced services. The legal and outsourced service expenses were higher in six months ended December 31, 2010 due to the Agito acquisition in that period.
Other income (expense), net.
| Six Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Other income (expense), net | $ | (595 | ) | $ | 614 | $ | (1,209 | ) | (197 | %) | ||||||
Other income (expense), net. The change of $1.2 million in other income, net was primarily attributable to $0.9 million of foreign exchange loss due to the strengthening of the U.S. dollar relative to other foreign currencies and a decrease in interest income of $0.3 million due to lower interest rates.
Provision for income tax.
| Six Months Ended | ||||||||||||||||
| December 31, | ||||||||||||||||
| 2011 | 2010 | Change $ | Change % | |||||||||||||
| (in thousands, except percentages) | ||||||||||||||||
| Provision for income tax | $ | 164 | $ | 151 | $ | 13 | 9 | % | ||||||||
Provision for income tax. The provision for income taxes increased moderately by $13,000 in the six months ended December 31, 2011 as compared to the six months ended December 31, 2010. This increase is primarily due to higher state income tax expense for the six months ended December 31, 2011 as compared to the six months ended December 31, 2010, partially offset in part by a decrease in foreign income tax expense.
Liquidity and Capital Resources
Balance Sheet and Cash Flows
The following table summarizes our cash, cash equivalents and short-term investments (in thousands):
| December 31, | June 30, | Increase/ | ||||||||||
| 2011 | 2011 | (Decrease) | ||||||||||
| Cash and cash equivalents | $ | 94,491 | $ | 89,695 | $ | 4,796 | ||||||
| Short-term investments | 21,359 | 16,057 | 5,302 | |||||||||
| Total | $ | 115,850 | $ | 105,752 | $ | 10,098 | ||||||
As of December 31, 2011, our principal sources of liquidity consisted of cash and cash equivalents and short-term investments of $115.9 million and accounts receivable of $30.9 million.
Our principal uses of cash historically have consisted of the purchase of finished goods inventory from our contract manufacturers, payroll and other operating expenses related to the development of new products and purchases of property and equipment.
On January 31, 2012, the Company entered into a Definitive Agreement (“agreement”) with M5 Networks, Inc. (“M5”), a privately-held company headquartered in New York and a provider of hosted unified communications solutions. Under the terms of the agreement, the Company will acquire M5 for an aggregate purchase price of approximately $159.7 million, which includes $84.1million in cash and 9.5 million shares of ShoreTel common stock, and up to $13.7 million in additional contingent and deferred consideration upon the achievement of certain performance milestones within the twelve months ended December 31, 2012. The contingent payments are payable over the two years after closing and are based upon the achievement of certain performance milestones for the twelve months ended December 31, 2012. In connection with the agreement, we are in the process of establishing a financing arrangement with a bank. We believe that the cash balance after the acquisition along with cash generated from our operations will be sufficient to fund our operating requirements for at least the next twelve months.
Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the addition of new business initiatives, the timing and extent of our expansion into new territories, the timing of introductions of new products and enhancements to existing products, the continuing market acceptance of our products and acquisition and licensing activities. We may enter into agreements relating to potential investments in, or acquisitions of, complementary businesses or technologies in the future, which could also require us to seek additional equity or debt financing. If needed, additional funds may not be available on terms favorable to us or at all.
The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods (in thousands):
| Six Months Ended | ||||||||
| December 31, | ||||||||
| 2011 | 2010 | |||||||
| Cash provided by operating activities | $ | 10,187 | $ | 4,214 | ||||
| Cash provided by (used in) investing activities | (7,466 | ) | (19,314 | ) | ||||
| Cash provided by (used in) financing activities | 2,075 | 1,978 | ||||||
| Net increase (decrease) in cash and cash equivalents | $ | 4,796 | $ | (13,122 | ) | |||
Cash flows from operating activities
Our cash flows from operating activities are significantly influenced by our cash expenditures to support the growth of our business in operating expense areas such as research and development, sales and marketing and administration. Our operating cash flows are also influenced by our working capital needs to support growth and fluctuations in inventory, accounts receivable, vendor accounts payable and other current assets and liabilities. We procure finished goods inventory from our contract manufacturers and typically pay them in 30 days. We extend credit to our channel partners and value added distributors on collection terms of 30 to 60 days. In some cases we also prepay for license rights to third-party products in advance of sales.
Net loss during the six months ended December 31, 2011 and 2010 included non-cash charges of $6.5 million and $5.5 million in stock-based compensation expense, respectively, and depreciation and amortization of $3.3 million and $1.9 million, respectively.
Cash provided by operating activities during the six months ended December 31, 2011 also reflects net changes in operating assets and liabilities, which provided $7.4 million of cash consisting primarily of a decrease in accounts receivable of $2.9 million due to a decrease in the days sales outstanding, increase in deferred revenue of $7.5 million due to higher support contracts and increased volume through our two-tier value-added distributors, increase in accounts payable of $1.5 million and increase in accrued liabilities and other of $1.8 million. These cash inflows were offset by increases in inventory of $3.5 million, and prepaid expenses and other current assets of $1.0 million and decrease in accrued employee compensation of $1.5 million.
Cash provided by operating activities during the six months ended December 31, 2010 also reflect net changes in operating assets and liabilities, which provided $3.8 million consisting primarily of a significant decrease in prepaid expenses and other current assets of $4.2 million from the settlement of a legal liability, a decrease in other assets of $0.3 million, a decrease in accounts receivables of $0.1 million, an increase in deferred revenue of $2.9 million, an increase in accounts payable of $0.5 million offset by an increase in inventories of $2.7 million, a decrease of $1.3 million in accrued liabilities and a decrease in accrued employee compensation of $0.2 million.
Cash flows from investing activities
We have classified our investment portfolio as “available for sale,” and our investments are made with a policy of capital preservation and liquidity as the primary objectives. We may hold investments in corporate bonds to maturity; however, we may sell an investment at any time if the quality rating of the investment declines, the yield on the investment is no longer attractive or we are in need of cash.
Net cash used in investing activities was $7.5 million during the six months ended December 31, 2011 and $19.3 million during the six months ended December 31, 2010, respectively. Net cash used in investing activities in the six months ended December 31, 2011 mainly related to the purchase of short-term investments of $24.9 million, purchase of property, plant and equipment of $1.4 million and purchase of patents of $0.6 million. These cash outflows were offset by maturities of short-term investments of $19.4 million. Net cash used in investing activities in the six months ended December 31, 2010 related to purchase consideration of $11.4 million paid for the acquisition of Agito Networks, Inc. in October 2010, purchase of short-term investments of $3.1 million, purchase of property, plant and equipment of $4.0 million and purchase of a perpetual license and patent of $0.8 million.
Cash flows from financing activities
Net cash provided by financing activities was $2.1 million and $2.0 million for the six months ended December 31, 2011 and 2010, respectively. In the six months ended December 31, 2011 we received $2.5 million from the exercise of stock options and issuance of common stock under our employee stock purchase plan, and paid $0.4 million associated with employee tax obligations on the vesting of restricted stock units which had been exchanged for such obligations. In the six months ended December 31, 2010, the cash provided from financing activities was primarily from the exercise of common stock options and issuance of common stock under our employee stock purchase plan for $2.3 million offset by $0.3 million of employee tax obligations on vesting of restricted stock units.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements nor do we have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual obligations and commitments
The following table summarizes our contractual obligations as of December 31, 2011 and the effect that such obligations are expected to have on our liquidity and cash flows in future periods:
| Payments Due by Period | ||||||||||||||||||||
| Total | Less Than | 1-3 Years | 3-5 Years | Thereafter | ||||||||||||||||
| (In thousands) | 1 Year | |||||||||||||||||||
| Operating lease obligations | $ | 10,509 | $ | 2,321 | $ | 5,676 | $ | 2,285 | $ | 227 | ||||||||||
| Outstanding letters of credit | 103 | 103 | - | - | - | |||||||||||||||
| Software license commitments | 688 | 250 | 438 | - | - | |||||||||||||||
| Non-cancellable purchase commitments for inventory | 18,910 | 18,910 | - | - | - | |||||||||||||||
| Total | $ | 30,210 | $ | 21,584 | $ | 6,114 | $ | 2,285 | $ | 227 | ||||||||||
In the normal course of our business, we are exposed to foreign currency exchange rate risk inherent in conducting business globally in foreign currencies. We are primarily exposed to foreign currency fluctuations related to collections from accounts receivable balances and cash in banks that are denominated in Australian dollar, British pound and the Euro. We use relatively short-term foreign currency forward contracts to minimize the risk associated with the foreign exchange effects of the remeasurement losses and gains of the related foreign currency denominated exposures. We recognize the gains and losses on foreign currency forward contracts in the same period as the remeasurement losses and gains of the related foreign currency denominated exposures. We have performed a sensitivity analysis as of December 31, 2011, which indicated that a hypothetical 10% adverse movement in foreign currency exchange rates would not result in a material foreign exchange loss as of December 31, 2011.
We do not have any material changes in the market risk and the interest rate risk disclosure included in the “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of Part II of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2011.
ITEM 4. |
Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective.
Internal Control Over Financial Reporting. There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
| ITEM 1. |
See Note 12 to the Financial Statements.
| ITEM 1A. |
Except as noted below there are no material changes in our risk factors as described in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2011.
We have made acquisitions in the past and expect to acquire other companies or technologies, which could divert our management 's attention, result in additional dilution to our stockholders, increase expenses, and otherwise disrupt our operations and harm our operating results.
We acquired one company in 2011 and have recently announced that we entered into a definitive agreement to acquire M5 Networks, Inc. ("M5") in a cash and stock transaction valued at approximately up to $160 million. We may acquire or invest in other businesses, products or technologies that we believe could complement or expand our product line, enhance our technical capabilities or otherwise offer growth opportunities. The pending acquisition of M5 and other potential acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated. We cannot assure you that we will realize the anticipated benefits of these acquisitions.
There are inherent risks in integrating and managing corporate acquisitions, and we have limited experience with acquisitions. If we acquire M5 or any other additional businesses, we may not be able to integrate the acquired personnel, operations, product lines and technologies successfully, or effectively manage the combined business following the acquisition. We also may not achieve the anticipated benefits from the acquired business due to a number of factors, including:
| • | unanticipated costs or liabilities associated with the acquisition; |
| • | incurrence of acquisition-related direct and indirect costs; |
| • | diversion of management's attention from other business concerns; |
| • | risks related to entering into new markets; |
| • | harm to our existing business relationships with business partners and customers as a result of the acquisition; |
| • | the potential loss of key employees; |
| • | use of resources that are needed in other parts of our business; |
| • | use of substantial portions of our available cash to consummate the acquisition; and |
| • | risks and costs associated with the incurrence of debt financing sufficient to have available the cash needed to consummate the acquisition of M5. |
In addition, a significant portion of the purchase price of M5 and other companies we acquire may be allocated to goodwill and other indefinite lived intangible assets, which must be assessed for impairment at least annually. Also, contingent considerations related to the acquisitions will be remeasured to fair value at each reporting period, with any changes in the value recorded as income or expense. In the future, if our acquisitions do not yield expected returns, we may be required to take charges to our operating results based on this impairment assessment process, which could harm our results of operations.
Acquisitions could also result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our operating results, hi addition, if an acquired business fails to meet our expectations, our operating results, business and financial condition may suffer.
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Use of Proceeds from Public Offering of Common Stock
The effective date of the registration statement for our initial public offering was July 2, 2007. As of December 31, 2011, the proceeds from our initial public offering have been invested in cash, cash equivalents and short-term investments. None of the use of the proceeds was made, directly or indirectly, to our directors, officers, or persons owning 10% or more of our common stock.
See Index to Exhibits following the signature page to this Form 10-Q, which is incorporated by reference herein.
Pursuant to the requirements 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.
| Date: February 9, 2012 | ||
| ShoreTel, Inc. | ||
| By: | /s/ Michael E. Healy | |
| Michael E. Healy | ||
| Chief Financial Officer | ||
| Exhibit Number | Exhibit Title |
31.1(1) | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. |
31.2(1) | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. |
32.1(1) | Section 1350 Certification of Chief Executive Officer. |
32.2(1) | Section 1350 Certification of Chief Financial Officer. |
10.1+ | ShoreTel FY 2012 Executive Bonus Plan |
| Agreement and Plan of Reorganization among ShoreTel Inc., M5 Networks, Inc., Mets Acquisition Corp., Mets Acquisition II LLC, and Fortis Advisors LLC, dated January 31, 2012 |
| (1) | This certification accompanying this report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934 (whether made before or after the date of the Report), irrespective of any general incorporation language contained in such filing. |
| + | Management compensatory plan |
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