UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ýQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2015
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: 001-35904
Cyan, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 20-5862569 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number) |
1383 N. McDowell Blvd., Suite 300
Petaluma, California 94954
(Address of Principal Executive Offices including Zip Code)
(707) 735-2300
(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 ý 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 ý 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 | ¨ | |||
Non-accelerated filer | ý | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
The number of shares of the registrant’s common stock, par value $0.0001, outstanding as of May 12, 2015 was: 48,445,483.
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Table of Contents
Page | ||
Part I. Financial Information | ||
Item 1. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Part II. Other Information | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
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FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) in Item 2, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained on this Form 10-Q include, but are not limited to, statements about:
• | our future financial performance, including our expectations regarding our revenue, cost of revenue, gross profit or gross margin, operating expenses, ability to generate cash flow, and ability to achieve, and maintain, future profitability; |
• | our dependence upon a concentrated base of customers and our efforts to diversify the customer base; |
• | our liquidity and working capital requirements, including our efforts to secure additional funding; |
• | the impact of seasonality on our business; |
• | anticipated trends and challenges in our business and in the markets in which we operate; |
• | market acceptance of our Blue Planet solution and its effect on our product mix and financials; |
• | our ability to anticipate market needs and develop new and enhanced products and services to meet those needs, and our ability to successfully monetize them; |
• | the evolution of technology affecting our products, services and markets; |
• | our ability to sell our products and expand internationally; |
• | maintaining and expanding our customer base and our relationships with our channel partners; |
• | our reliance on our third-party manufacturers and component suppliers; |
• | our ability to adequately protect our intellectual property; |
• | our ability to hire necessary qualified employees to expand our operations; |
• | the future trading prices of our common stock and the impact of securities analysts’ reports on these prices; |
• | the estimates and estimate methodologies used in preparing our consolidated financial statements and determining option exercise prices; |
• | our ability to stay abreast of new or modified laws and regulations that currently apply or become applicable to our business both in the United States and internationally; and |
• | our ability to sell our products and expand internationally. |
In addition, On May 3, 2015, the Company announced that it had entered into an Agreement and Plan of Merger with Ciena Corporation (“Ciena”). The potential merger with Ciena presents additional risks and uncertainties that could cause the actual results to differ from those expressed or implied by forward looking statements including the risk that the pending merger with Ciena may not be consummated due to a failure to obtain stockholder or regulatory approval or for any other reason; the risk that the closing of the merger will be delayed; uncertainties concerning the effect of the transaction on relationships with customers, employees and suppliers of either or both of the companies; the risk that the two companies will not be integrated successfully and in a timely manner even if the closing occurs as anticipated; and the risk that the transaction may involve unexpected costs or unexpected liabilities.
We caution you that the foregoing list may not contain all of the forward-looking statements made on this Form 10-Q. You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained on this Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, operating results and growth prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in the section titled “Risk Factors” and elsewhere on this Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained on this Form 10-Q. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.
The forward-looking statements made on this Form 10-Q reflect our outlook as of the date of this Form 10-Q. We undertake no obligation to update any forward-looking statements made on this Form 10-Q to reflect events or circumstances after the date hereof or to reflect new information or the occurrence of unanticipated events, except as required by law. We may
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not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.
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Item 1. Financial Statements
Cyan, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share amounts)
(Unaudited)
March 31, 2015 | December 31, 2014 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 53,870 | $ | 47,740 | |||
Restricted cash | 4,165 | 4,165 | |||||
Accounts receivable (net of allowance for doubtful accounts of $76 and $227 at March 31, 2015 and December 31, 2014) | 17,794 | 23,511 | |||||
Inventories | 9,267 | 12,362 | |||||
Deferred costs | 1,305 | 1,317 | |||||
Prepaid expenses and other | 2,546 | 3,079 | |||||
Total current assets | 88,947 | 92,174 | |||||
Long-term restricted cash | 7,868 | 7,868 | |||||
Property and equipment, net | 12,129 | 11,896 | |||||
Other assets | 3,186 | 3,737 | |||||
Total assets | $ | 112,130 | $ | 115,675 | |||
Liabilities and stockholders’ equity (deficit) | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 12,756 | $ | 12,058 | |||
Accrued liabilities | 7,638 | 6,775 | |||||
Accrued compensation | 5,317 | 4,146 | |||||
Deferred revenue | 5,503 | 5,646 | |||||
Deferred rent | 35 | 181 | |||||
Other liabilities | 842 | — | |||||
Total current liabilities | 32,091 | 28,806 | |||||
Convertible debt, net of discount | 18,917 | 18,498 | |||||
Derivative and warrant liabilities | 77,565 | 36,280 | |||||
Deferred revenue | 1,589 | 1,845 | |||||
Deferred rent | 342 | 302 | |||||
Total liabilities | 130,504 | 85,731 | |||||
Commitments and contingencies (Note 6) | |||||||
Stockholders’ equity (deficit): | |||||||
Preferred stock, $0.0001 par value, 20,000,000 shares authorized and no shares issued or outstanding as of March 31, 2015 and December 31, 2014. | — | — | |||||
Common stock, $0.0001 par value: 1,000,000,000 shares authorized as of March 31, 2015 and December 31, 2014; 48,296,114 and 47,305,129 shares issued and outstanding as of March 31, 2015 and December 31, 2014. | 5 | 5 | |||||
Additional paid in-capital | 221,305 | 216,607 | |||||
Accumulated other comprehensive loss | (287 | ) | (162 | ) | |||
Accumulated deficit | (239,397 | ) | (186,506 | ) | |||
Total stockholders’ equity (deficit) | (18,374 | ) | 29,944 | ||||
Total liabilities and stockholders’ equity (deficit) | $ | 112,130 | $ | 115,675 |
See accompanying Notes to Condensed Consolidated Financial Statements.
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Cyan, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended March 31, | |||||||
2015 | 2014 | ||||||
Revenue | $ | 36,005 | $ | 19,038 | |||
Cost of revenue | 20,974 | 11,615 | |||||
Gross profit | 15,031 | 7,423 | |||||
Operating expenses: | |||||||
Research and development | 8,941 | 9,472 | |||||
Sales and marketing | 11,436 | 11,029 | |||||
General and administrative | 5,082 | 4,563 | |||||
Total operating expenses | 25,459 | 25,064 | |||||
Loss from operations | (10,428 | ) | (17,641 | ) | |||
Other income (expense), net: | |||||||
Change in fair value of derivative and warrant liabilities | (41,285 | ) | — | ||||
Interest expense | (1,546 | ) | (47 | ) | |||
Other income (expense), net | 419 | (62 | ) | ||||
Total other income (expense), net | (42,412 | ) | (109 | ) | |||
Loss before provision for income taxes | (52,840 | ) | (17,750 | ) | |||
Provision for income taxes | 51 | 50 | |||||
Net loss | $ | (52,891 | ) | $ | (17,800 | ) | |
Basic and diluted net loss per share | $ | (1.11 | ) | $ | (0.38 | ) | |
Weighted-average number of shares used in computing basic and diluted net loss per share | 47,818 | 46,636 |
See accompanying Notes to Condensed Consolidated Financial Statements.
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Cyan, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(In thousands)
(Unaudited)
Three Months Ended March 31, | |||||||
2015 | 2014 | ||||||
Net loss | $ | (52,891 | ) | $ | (17,800 | ) | |
Other comprehensive income (loss): | |||||||
Foreign currency translation adjustments | (125 | ) | 127 | ||||
Unrealized gains on available for sale securities, net of tax | — | 9 | |||||
Total other comprehensive income (loss) | (125 | ) | 136 | ||||
Comprehensive loss | $ | (53,016 | ) | $ | (17,664 | ) |
See accompanying Notes to Condensed Consolidated Financial Statements.
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Cyan, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Three Months Ended March 31, | ||||||||
2015 | 2014 | |||||||
Operating activities | ||||||||
Net loss | $ | (52,891 | ) | $ | (17,800 | ) | ||
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | ||||||||
Depreciation and amortization | 1,177 | 889 | ||||||
Stock-based compensation | 4,403 | 2,515 | ||||||
Change in fair value of derivative and warrant liabilities | 41,285 | — | ||||||
Accretion of debt discount | 419 | — | ||||||
Loss on disposal of assets | 114 | — | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | 5,717 | 293 | ||||||
Lease receivable | — | 604 | ||||||
Inventories | 2,812 | 1,395 | ||||||
Deferred costs | 12 | 2,679 | ||||||
Prepaid expenses and other assets | 123 | 83 | ||||||
Accounts payable | 454 | (1,577 | ) | |||||
Accrued and other liabilities | 1,704 | (448 | ) | |||||
Accrued compensation | 1,171 | (694 | ) | |||||
Deferred revenue | (399 | ) | (2,789 | ) | ||||
Deferred rent | (106 | ) | (27 | ) | ||||
Net cash provided by (used in) operating activities | 5,995 | (14,877 | ) | |||||
Investing activities | ||||||||
Purchases of property and equipment | (843 | ) | (2,284 | ) | ||||
Purchase of available for sale securities | — | (11,498 | ) | |||||
Maturity of available for sale securities | — | 1,000 | ||||||
Sale of available for sale securities | — | 11,750 | ||||||
Sale of other investment | 807 | — | ||||||
Net cash used in investing activities | (36 | ) | (1,032 | ) | ||||
Financing activities | ||||||||
Proceeds from stock-based compensation programs | 1,358 | 236 | ||||||
Taxes paid related to net-share settlements of restricted stock units | (1,060 | ) | (92 | ) | ||||
Repayments of borrowings under term loan | — | (396 | ) | |||||
Payments on capital leases | — | (39 | ) | |||||
Net cash provided by (used in) financing activities | 298 | (291 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents | (127 | ) | 137 | |||||
Net increase (decrease) in cash and cash equivalents | 6,130 | (16,063 | ) | |||||
Cash and cash equivalents at beginning of period | 47,740 | 32,509 | ||||||
Cash and cash equivalents at end of period | $ | 53,870 | $ | 16,446 | ||||
Supplemental disclosures of cash flow information | ||||||||
Cash paid for interest | $ | — | $ | 47 | ||||
Non-cash Investing and financing activities | ||||||||
Property and equipment included in accounts payable | $ | 244 | $ | 215 |
See accompanying Notes to Condensed Consolidated Financial Statements.
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Significant Accounting Policies
Description of the Business — Cyan, Inc. (Cyan or the Company) was incorporated on October 25, 2006, in the state of Delaware and its principal executive offices are located in Petaluma, California. The Company has pioneered innovative, carrier-grade networking solutions that transform disparate and inefficient legacy networks into open, high-performance networks. The Company’s solutions include high-capacity, multi-layer switching and transport platforms as well as a carrier-grade software-defined networking platform and applications. The Company’s solutions enable its customers to virtualize their networks, accelerate service delivery and increase scalability and performance while reducing costs. The Company designed its solutions to provide a variety of existing and emerging premium applications including business Ethernet, wireless backhaul, broadband backhaul and cloud connectivity. The Company’s customers range from service providers to high-performance data center and large, private network operators.
Unaudited Interim Condensed Consolidated Financial Statements — The Company has prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with Generally Accepted Accounting Principles (GAAP), and with Securities and Exchange Commission (SEC) rules and regulations, which allow for certain information and footnote disclosures that are normally included in annual financial statements prepared in accordance with GAAP to be condensed or omitted. In the Company's opinion, these unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the fiscal year ended December 31, 2014 and include all adjustments necessary for fair presentation, consisting only of normal recurring adjustments. The Condensed Consolidated Balance Sheet at December 31, 2014 has been derived from the audited financial statements at that date.
The accompanying unaudited interim condensed consolidated financial statements should be read in conjunction with the Company's consolidated financial statements for the fiscal year ended December 31, 2014 which are included in the Company's Annual Report on Form 10-K filed with the SEC.
Events in 2015 required the Company to make additions to the Company's accounting policies for stock based compensation and customer credits, as more fully set forth below. There have been no other changes in the significant accounting policies as described in the audited consolidated financial statements for 2014 included in the Annual Report.
The results for the three months ended March 31, 2015 are not necessarily indicative of the results to be expected for any subsequent quarterly or annual financial period, including the fiscal year ending December 31, 2015.
Principles of Consolidation — The Company's consolidated financial statements include its accounts and the accounts of its wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated.
Fiscal Periods — The Company operates on fiscal periods ending on the last day of the respective calendar quarter.
Use of Estimates — The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses for the reporting period. For the Company, these estimates include, but are not limited to, allowances for doubtful accounts, inventory valuation, excess and obsolete inventory, allowances for obligations to its contract manufacturer, useful lives assigned to long-lived assets, sales returns reserve, the fair value of stock awards, the fair value of a contingent conversion feature, make-whole conversion adjustment, and certain interest features related to the Company's 8.0% convertible senior notes issued in December 2014 and due December 15, 2019 (the “Notes”) which are accounted for as a single compound embedded derivative (the “Compound Embedded Derivative”) and warrants associated with the Notes, warranty costs, contingencies, accounting for income taxes, including the determination of the timing of the establishment or release of the Company's valuation allowance related to the Company's deferred tax asset balances and reserves for uncertain tax positions, and the fair value of stock awards and the probability that specified goals underlying performance based awards will be achieved. Actual results could differ from those estimates, and such differences could be material to the Company’s consolidated financial position and results of operations.
Stock-based Compensation — The Company granted restricted stock units (RSUs) to its employees and performance based restricted stock units (PBRSUs) to members of the executive team in the three months ended March 31, 2015. The stock-based compensation expense related to RSUs is recognized on a ratable basis over the requisite service period of the grant. The stock-based compensation expense related to PBRSUs is recognized based on the attainment of specified goals over a graded vesting period of two years. The fair value of RSUs and PBRSUs is determined using the fair value of the Company’s common stock on the date of grant.
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Customer credits — In limited instances, the Company issues credits to its customers that can be applied against future purchases. The Company has recorded its customer credits obligations within Other liabilities. The Company estimates these credits, which increase as the level of business with the customer increases, based on the customer's historic and projected revenue for the year.
Liquidity — The accompanying financial statements as of and for the three months ended March 31, 2015 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business for the foreseeable future. Since inception, the Company has incurred net losses in each quarterly and annual period. In the three months ended March 31, 2015 the Company incurred net losses of $52.9 million. As of March 31, 2015, the Company had an accumulated deficit of $239.4 million.
The Company requires a significant amount of cash resources to operate its business. The Company provided approximately $6.1 million of cash in the three months ended March 31, 2015, including $6.0 million provided by operating activities. This was the first quarter during which the Company generated positive cash flow from operations. The Company ended the quarter with cash and cash equivalents, of $53.9 million, excluding $12.0 million in restricted cash. The Company's liquidity is affected by many factors including, among others, fluctuations in revenue, gross margin and operating expenses, as well as changes in operating assets and liabilities. At forecasted levels of revenue, expenses and capital expenditures, the Company believes that its existing cash and cash equivalents, together with its cash collections will be sufficient to meet its projected operating and capital expenditure requirements through the first quarter of 2016. However, as early as January 15, 2016 the Notes (see footnote 5) may be converted. Unless and until the Company obtains stockholder approval to issue additional shares, it will be required (i) to settle Notes purchased by the Company's officers, directors and their affiliated entities and any other Notes settled on the same date solely in cash and (ii) to settle all conversions of Notes (other than those purchased by the Company's officers, directors and their affiliated entities and only if settled on a date different from the date of settlement of the Notes purchased by the Company's officers, directors and their affiliated entities) by paying cash in an amount equal to at least the principal amount of Notes converted together with any combination of cash or shares of common stock, as selected by the Company, for the conversion value in excess of the principal amount, if any, subject to a share cap on the overall number of shares issued. The Company intends to seek stockholder approval at its 2015 annual stockholders meeting to permit the Company to settle the Notes including the notes purchased by the Company's officers, directors, and their affiliated entities, using shares of common stock, cash or a combination of both, at the Company's election and without a cap on the number of shares issued. The Company's 2015 annual meeting of stockholders has been postponed to accommodate additional agenda items associated with the proposed business combination with Ciena. There is no guarantee that such stockholder approval will be obtained. Were a material amount of the Notes to be converted prior to receiving the stockholder approval to include shares of the Company's common stock in the settlement, the Company's liquidity could be materially adversely affected and, if enough Notes were converted, the Company would not have sufficient capital resources to settle them entirely in cash.
The accompanying financial statements do not include any adjustments relating to the recoverability of the carrying amounts of recorded assets or the amount of liabilities that might result from the outcome of uncertainties.
New Accounting Pronouncements — In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers", (Topic 606) (ASU 2014-09), which provides guidance for revenue recognition. ASU 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. Additionally, it supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40, Other Assets and Deferred Costs-Contracts with Customers. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the previous guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 requires retrospective application by either a “full retrospective” adoption in which the standard is applied to all of the periods presented or a “modified retrospective” adoption for fiscal years beginning after December 15, 2016. The standard will be effective for the Company in the first quarter of fiscal 2017. Early adoption is not permitted. The Company has not selected a transition method and is currently assessing the potential impact on its financial statements from adopting this new guidance. The FASB has indicated that there may be certain future changes to the revenue guidance and on April 29, 2015, the FASB issued an exposure draft proposing the deferral of the effective date by one year.
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest", (Subtopic 835-30), to simplify the presentation of debt issuance costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The standard will be effective for the Company in the first quarter of fiscal 2016. Early adoption is permitted. The Company is currently assessing the potential impact on its financial statements from adopting this new guidance. The Company does not believe the adoption of this guidance will have a material impact on its Consolidated Financial Statements as the impact is classification only.
2. Net Loss Per Share
The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):
Three Months Ended March 31, | |||||||
2015 | 2014 | ||||||
Net loss | $ | (52,891 | ) | $ | (17,800 | ) | |
Weighted-average shares used to compute basic and diluted net loss per share | 47,818 | 46,636 | |||||
Basic and diluted net loss per share | $ | (1.11 | ) | $ | (0.38 | ) |
As the Company experienced losses for all periods presented, basic net loss per share is the same as diluted net loss per share for all the periods. The following potential common stock equivalents that could potentially dilute net loss per share in the future were excluded from the computation of diluted net loss per share because including them would have been anti-dilutive for the periods presented (in thousands):
Three Months Ended March 31, | |||||
2015 | 2014 | ||||
Employee stock options | 11,283 | 12,973 | |||
Restricted stock units | 3,620 | 2,788 | |||
Shares underlying the Notes | 20,470 | — | |||
Common stock warrants | 11,250 | — | |||
46,623 | 15,761 |
3. Fair Value Disclosure
Assets and liabilities recorded at fair value in the consolidated financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The Company categorizes its financial instruments into a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Hierarchical levels that are directly related to the amount of subjectivity associated with the inputs to the valuation of these assets or liabilities are as follows:
Level 1: Inputs are unadjusted quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2: Inputs (other than quoted market prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Level 3: Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
Fair Value Hierarchy
The following tables set forth by level within the fair value hierarchy the Company’s assets and liabilities at fair value as of March 31, 2015 (in thousands):
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Liabilities: | ||||||||||||||||
Derivative and warrant liabilities | $ | — | $ | — | $ | 77,565 | $ | 77,565 |
The following tables set forth by level within the fair value hierarchy the Company’s assets and liabilities at fair value as of December 31, 2014 (in thousands):
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets: | ||||||||||||||||
Cash equivalents: | ||||||||||||||||
Money market funds | $ | 4,110 | $ | — | $ | — | $ | 4,110 | ||||||||
Liabilities: | ||||||||||||||||
Derivative and warrant liabilities | $ | — | $ | — | $ | 36,280 | $ | 36,280 |
There were no transfers of assets or liabilities measured at fair value between levels within the fair value hierarchy during any of the periods presented.
The Notes include a conversion option, including contingent conversion, a make-whole conversion adjustment, and certain interest features which are accounted for as a single compound embedded derivative (the “Compound Embedded Derivative”). The fair value of the Compound Embedded Derivative was determined based on a binomial lattice model. The liability is classified within Level 3 as the volatility assumption was based on the weighting of observable and implied volatilities and the estimated weighting and implied volatility are unobservable inputs used to value the Compound Embedded Derivative. During the three months ended March 31, 2015, there were no changes to the valuation methodology used to estimate the fair value of the Compound Embedded Derivative. At March 31, 2015, the weighting of the observable and implied volatilities were updated to apply no weighting associated with the implied volatility and 50% to each of the observable volatilities, due to limited transactions associated with the implied volatility for the three months ended March 31, 2015.
In December 2014, the Company issued detachable warrants, in conjunction with issuing the Notes. The fair value of each warrant is estimated by utilizing a Black-Scholes option-pricing model. The liability is classified within Level 3 as the volatility assumption was based on the weighting of observable and implied volatilities and the estimated weighting and implied volatility are unobservable inputs used to value the Compound Embedded Derivative. During the three months ended March 31, 2015, there were no changes to the valuation methodology used to estimate the fair value of the Compound Embedded Derivative. At March 31, 2015, the weighting of the observable and implied volatilities were updated to apply no weighting associated with the implied volatility and 50% to each of the observable volatilities, due to limited transactions which would provide implied volatility during the three months ended March 31, 2015.
The following table summarizes the changes in the liabilities classified in Level 3 for the three months ended March 31, 2015 (in thousands):
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended March 31, 2015 | ||||
Beginning balance | $ | 36,280 | ||
Change in fair value of derivative and warrant liabilities | 41,285 | |||
Ending balance | $ | 77,565 |
Losses reported in this table include changes in fair value that are attributable primarily to the change in value of the Company's stock price for the three months ended which is an observable input. During the quarter, the Company's stock price increased from $2.50 per share to $3.99 per share.
The Company held no marketable securities at March 31, 2015 or at December 31, 2014.
4. Balance Sheet Components
Cash and Cash Equivalents
Cash and cash equivalents consisted of the following (in thousands):
March 31, 2015 | December 31, 2014 | ||||||
Cash | $ | 53,870 | $ | 43,630 | |||
Money market funds | — | 4,110 | |||||
Total cash and cash equivalents | $ | 53,870 | $ | 47,740 |
Inventory
Inventories consisted primarily of finished goods purchased from the contract manufacturer and are stated at the lower of cost or market value (on a first-in, first-out basis). Inventory consisted of the following (in thousands):
March 31, 2015 | December 31, 2014 | ||||||
Raw materials | $ | 928 | $ | 1,202 | |||
Finished goods | 8,339 | 11,160 | |||||
Total Inventory | $ | 9,267 | $ | 12,362 |
Property and Equipment, Net
Property and equipment, net consisted of the following (in thousands):
March 31, 2015 | December 31, 2014 | ||||||
Lab equipment and tooling | $ | 18,965 | $ | 18,303 | |||
Software | 849 | 628 | |||||
Leasehold improvements | 1,735 | 1,569 | |||||
Furniture and fixtures | 1,112 | 987 | |||||
Computer equipment | 730 | 720 | |||||
23,391 | 22,207 | ||||||
Less accumulated depreciation and amortization | (11,262 | ) | (10,311 | ) | |||
Property and equipment, net | $ | 12,129 | $ | 11,896 |
For the three months ended March 31, 2015 and 2014 depreciation and amortization expense on property and equipment was $1.0 million and $0.9 million.
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
March 31, 2015 | December 31, 2014 | ||||||
Inventory-in-transit | $ | 99 | $ | 1,516 | |||
Warranty reserve (1) | 2,641 | 2,564 | |||||
Sales returns reserve | 1,248 | 370 | |||||
Professional fees | 1,525 | 1,137 | |||||
Sales and use taxes | 224 | 201 | |||||
Accrued interest | 1,187 | 18 | |||||
Other | 714 | 969 | |||||
Total accrued liabilities | $ | 7,638 | $ | 6,775 |
(1) Activity related to warranties is as follows (in thousands):
Three Months Ended March 31, | |||||||
2015 | 2014 | ||||||
Beginning balance | $ | 2,564 | $ | 1,374 | |||
Charge to cost of sales | 361 | 473 | |||||
Costs incurred | (284 | ) | (170 | ) | |||
Closing balance | $ | 2,641 | $ | 1,677 |
5. Convertible Debt
On December 12, 2014, the Company issued $50.0 million aggregate principal amount of 8.0% Convertible Senior Secured Notes due December 15, 2019 (the “Notes”) and related warrants to purchase up to an aggregate 11.25 million shares of the Company’s common stock, par value $0.0001 per share (the “Warrants”), in a private placement to qualified institutional buyers and accredited investors.
Aggregate offering expenses in connection with the transaction, including the placement agent's fee of $2.3 million, were $3.5 million, resulting in net proceeds of $46.5 million. $12.0 million of the offering proceeds were deposited into an escrow account which the Company will use to pay the first six scheduled semi-annual interest payments on the Notes.
The Company issued the Notes under an Indenture, dated December 12, 2014 (the “Indenture”), between the Company and U.S. Bank National Association, as Trustee and Collateral Agent. The Notes provide 8.0% interest per annum, payable semi-annually in arrears on June 15 and December 15 of each year, with interest beginning to accrue from December 12, 2014. The Notes will mature on December 15, 2019, unless earlier converted, redeemed or repurchased by the Company. The Notes are convertible into the Company’s common stock as described below.
The Notes are secured by a first-priority lien, subject only to certain permitted liens and certain excluded assets, on substantially all of the Company’s and the subsidiary guarantors’ assets, whether now owned or hereafter acquired, including license agreements, general intangibles, accounts instruments, investment property, intellectual property and any proceeds of the foregoing. The guarantees of each subsidiary guarantor will be a senior secured obligation of such subsidiary guarantor and will have the same ranking with respect to indebtedness of such subsidiary guarantor as the Notes will have with respect to the Company’s indebtedness. At March 31, 2015 and December 31, 2014, there are no subsidiary guarantors.
The Notes are the Company’s senior secured obligation and will rank senior in right of payment to any of the Company’s indebtedness that is expressly subordinated in right of payment to the Notes; will rank effectively senior to any of the Company’s unsecured indebtedness to the extent of the value of the collateral securing the Notes; will rank equal in right of payment to the
14
Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Company’s existing and future liabilities that is not so subordinated to the Notes; and will rank structurally junior to all indebtedness and other liabilities (including trade payable) of the Company’s existing and future subsidiaries that do not guarantee the Notes.
The initial conversion rate for the Notes is 409.3998 shares of common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately $2.44 per share. Except in the case of certain specified corporate events, the Notes will not be convertible prior to January 15, 2016. Thereafter, until the close of business on June 15, 2019, the Notes will only be convertible under certain circumstances. On and after June 15, 2019, the Notes may be converted at any time prior to maturity. Unless and until the Company obtains stockholder approval to issue additional shares, it will be required (i) to settle Notes purchased by officers, directors and their affiliated entities and any other Notes settled on the same date solely in cash and (ii) to settle all conversions of Notes (other than those purchased by the Company's officers, directors and their affiliated entities and only if settled on a date different from the date of settlement of the Notes purchased by the Company's officers, directors and their affiliated entities) by paying cash in an amount equal to at least the principal amount of Notes converted together with any combination of cash or shares of common stock, as selected by the Company, for the conversion value in excess of the principal amount, if any, subject to a share cap on the overall number of shares issued. The Company intends to seek stockholder approval at its 2015 annual stockholders meeting to permit the Company to settle the Notes including the notes purchased by the Company's officers, directors, and their affiliated entities, using shares of common stock, cash or a combination of both, at the Company's election and without a cap on the number of shares issued. Upon conversion, in certain circumstances, the Company will also make an interest make-whole payment.
The Company may not redeem the Notes prior to December 20, 2017. On or after December 20, 2017, the Company may redeem the Notes at a redemption price equal to the principal amount of the Notes to be redeemed, plus accrued and unpaid interest, to, but excluding, the redemption date if the last reported sale price of its common stock for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending within three trading days prior to the date notice of redemption is delivered is at least 140% of the conversion price of the Notes on each applicable trading day.
In the event that the Company undergoes a fundamental change, the holders may require the Company to purchase for cash all or any portion of the Notes at a purchase price equal to the principal amount of the Notes to be purchased plus accrued and unpaid interest to, but excluding, the fundamental change purchase date. The Company will also increase the conversion rate, in certain circumstances, if a holder elects to convert Notes in connection with a fundamental change or a redemption of the Notes. It is anticipated that the proposed business combination with Ciena will constitute a fundamental change.
In addition to the Notes, the Company also issued warrants to purchase 225 shares of the Company's common stock for each $1,000 principal amount of Notes issued, resulting in issuing warrants exercisable for an aggregate of 11.25 million shares of common stock. The exercise price per share of common stock purchasable upon exercise of the Warrants is $3.62 per share of common stock. The exercise price is subject to appropriate anti-dilution adjustment in the event of certain stock dividends and distributions, stock splits, stock combinations, reclassifications or similar events affecting the Company’s common stock and also upon any distributions of assets, including cash, stock or other property to the Company’s stockholders.
The warrants are exercisable at any time on and after January 15, 2016 and expire on December 15, 2017. The warrants will be exercisable, at the option of each holder, in whole or in part by delivering to the Company a duly executed exercise notice and either by payment in full in immediately available funds for the number of shares of common stock purchased upon such exercise or through a cashless exercise, in which case the holder would receive upon such exercise the net number of shares of common stock determined according to the formula set forth in the warrant. If the proposed business combination with Ciena is completed, all of the warrants will be deemed automatically exercised on a cashless basis immediately prior to completion. No fractional shares of common stock will be issued in connection with the exercise of a warrant. In lieu of fractional shares, the Company will pay the holder an amount in cash equal to the fractional amount multiplied by the exercise price. Notwithstanding the foregoing, unless and until the Company has obtained the requisite stockholder approvals, the Company will be required to cash settle any exercises of the warrants according to the net value formula set forth in the warrants.
The conversion option and certain interest rate features, including contingent conversion and the make-whole interest, are embedded derivatives. These features are accounted for as a single compound embedded derivative (the “Compound Embedded Derivative”). The conversion option and warrants are not subject to the equity scope exception since explicit net cash settlement is required prior to receipt of approval of the stockholders to settle in shares. As such the Compound Embedded Derivative and warrants are accounted for at fair value with changes in fair value recorded in the Company’s consolidated statement of operations.
The fair value of the Compound Embedded Derivative was computed using a Binomial Lattice approach of a similar note with and without the Compound Embedded Derivative. The Warrants were valued using the Black-Scholes Option-pricing model.
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At March 31, 2015, the break out of the Compound Embedded Derivative and Warrants within Derivative and warrant liabilities was $61.4 million and $16.2 million, respectively. At December 31, 2014, the break out of the Compound Embedded Derivative and Warrants within Derivative and warrant liabilities was $30.6 million and $5.7 million, respectively.
The initial discounted value of the Notes of $18.4 million (after allocation of proceeds to the warrants and bifurcation of the Compound Embedded Derivative) is accreted to its $50.0 million principal amount over the term of the Notes under the effective interest rate method. The aggregate amount of issuance costs is deferred and amortized to interest expense under the effective interest method over the term of the Notes. The effective interest rate is 48.9%.
The following summarizes the activity of the Notes from issuance to March 31, 2015 (in thousands):
Gross Proceeds | $ | 50,000 | |
Initial value of Compound Embedded Derivative reported as debt discount | (26,965 | ) | |
Initial value of common stock warrants reported as debt discount | (4,605 | ) | |
Accretion of debt discount | 68 | ||
December 31, 2014 | 18,498 | ||
Accretion of debt discount | 419 | ||
March 31, 2015 | $ | 18,917 |
The following summarizes the amount of interest expense recognized relating to the contractual interest, amortization of the debt discount and amortization of debt issuance costs of the Notes (in thousands):
March 31, 2015 | March 31, 2014 | ||||||
Contractual interest | $ | 973 | $ | — | |||
Amortization of debt discount | 419 | — | |||||
Amortization of debt issuance costs | $ | 154 | $ | — | |||
Total interest expense | $ | 1,546 | $ | — |
6. Commitments and Contingencies
Facility Lease
In April 2007 the Company entered into a lease for the Company's headquarters facility in Petaluma, California. As amended to date, the 2007 lease provides for the lease of 18,895 square feet and expires in 2025. As of March 31, 2015, the Company's total remaining obligations under the 2007 lease were $5.9 million. In July 2013, the Company entered into a lease for an additional 20,005 square feet of space in Petaluma, California, increasing by a further 18,773 square feet in 2016. The 2013 lease expires concurrently with the 2007 lease in 2025. As of March 31, 2015, the Company's total remaining obligations under the 2013 lease are $11.4 million. The Company has an option to extend the term of both leases for an additional five-year period.
In relation to these lease agreements, an executive officer, who is also a member of the Company’s Board of Directors, owns approximately 40% of the limited liability company from which the Company is leasing the office premises. As of March 31, 2015 and December 31, 2014 no amounts were included in accounts payable or accrued expenses under these agreements.
As of March 31, 2015 and December 31, 2014 total deferred rent was $0.4 million and $0.5 million. For the three months ended March 31, 2015 and 2014 rent expense was $0.3 million and $0.2 million.
Future minimum annual obligations under non-cancellable lease agreements as of March 31, 2015 are approximately as follows (in thousands):
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Year ending December 31: | |||
2015 (remainder of year) | $ | 985 | |
2016 | 1,449 | ||
2017 | 1,768 | ||
2018 | 1,804 | ||
2019 | 1,799 | ||
Thereafter | 9,950 | ||
Total | $ | 17,755 |
Contingencies
From time to time, the Company may be involved in various legal proceedings arising from the normal course of business. On April 1, 2014 a purported stockholder class action lawsuit was filed in the Superior Court of California, County of San Francisco, against the Company, the members of the Company's Board of Directors, the Company's former Chief Financial Officer and the underwriters of the Company's IPO. On April 30, 2014 a substantially similar lawsuit was filed in the same court against the same defendants. The two cases have been consolidated under the caption Beaver County Employees Retirement Fund, et al. v. Cyan, Inc. et al., Case No. CGC-14-539008. The consolidated complaint alleges violations of federal securities laws on behalf of a purported class consisting of purchasers of the Company's common stock pursuant or traceable to the registration statement and prospectus for the Company's IPO, and seek unspecified compensatory damages and other relief. In July 2014, the defendants filed a demurrer to (motion to dismiss) the consolidated complaint. On October 22, 2014, the court overruled the demurrer and allowed the case to proceed. The Company intends to defend the litigation vigorously. Based on information currently available, the Company has determined that the amount of any possible loss or range of possible loss is not reasonably estimable.
Guarantees
The Company from time to time enters into certain types of contracts that contingently require it to indemnify various parties against claims from third parties. These contracts primarily relate to (i) certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities, and other claims arising from the Company’s use of the applicable premises; (ii) certain agreements with the Company’s officers, directors, and employees, under which the Company may be required to indemnify such persons for liabilities arising out of their relationship with the Company; (iii) contracts under which the Company may be required to indemnify customers against third-party claims that a Company product infringes a patent, copyright, or other intellectual property right; and (iv) procurement or license agreements, under which the Company may be required to indemnify licensors or vendors for certain claims that may be brought against them arising from the Company’s acts or omissions with respect to the supplied products or technology.
Generally, a maximum obligation under these contracts is not explicitly stated. Because the obligated amounts associated with these types of agreements are not explicitly stated, the overall maximum amount of the obligation cannot be reasonably estimated. Historically, the Company has not been required to make payments under these obligations, and no liabilities have been recorded for these obligations in the Company’s consolidated balance sheet.
Contract Manufacturer
As of March 31, 2015 and December 31, 2014 the Company has commitments to its contract manufacturer of $19.1 million and $9.7 million. These commitments include raw materials, work in progress and scheduled future orders, which are relatively short term. Should the Company be required to make payments under these commitments, the Company has the right to obtain and liquidate the related inventory to recover amounts paid under these commitments.
7. Stockholders' Equity and Stock-based Compensation
Stock-based Compensation
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Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table summarizes the allocation of stock-based compensation in the accompanying consolidated statements of operations (in thousands):
Three Months Ended March 31, | ||||||||
2015 | 2014 | |||||||
Cost of revenue | $ | 224 | $ | 60 | ||||
Research and development | 1,530 | 915 | ||||||
Sales and marketing | 1,485 | 798 | ||||||
General and administrative | 1,164 | 742 | ||||||
Total stock-based compensation | $ | 4,403 | $ | 2,515 |
Equity Plans
In January 2015 an additional 2,128,731 shares of common stock were reserved for future issuance under the 2013 Equity Incentive Plan in accordance with the annual increase provision of the plan.
Stock Options
A summary of the activity and changes during the three months ended March 31, 2015 and a summary of information related to options exercisable and vested and expected to vest are presented below:
Number of Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (Years) | Aggregate Intrinsic Value (in thousands) | ||||||||||
Balance at December 31, 2014 | 12,141,629 | $ | 3.99 | 6.57 | $ | 3,499 | |||||||
Options granted | 62,000 | 3.72 | |||||||||||
Options exercised | (583,528 | ) | 2.23 | ||||||||||
Options forfeited | (336,747 | ) | 6.62 | ||||||||||
Balance at March 31, 2015 | 11,283,354 | $ | 4.00 | 6.79 | $ | 13,084 | |||||||
Options vested and expected to vest - March 31, 2015 | 10,631,822 | $ | 3.92 | 6.72 | $ | 12,761 | |||||||
Options exercisable - March 31, 2015 | 7,663,734 | $ | 3.36 | 6.26 | $ | 11,293 |
The Company determined the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model using the following factors:
Three Months Ended March 31, | ||||||
2015 | 2014 | |||||
Expected term (years) | 6.08 | 6.08 | ||||
Volatility | 50 | % | 44 | % | ||
Risk-free interest rate | 1.32 | % | 1.49 - 1.73% | |||
Dividend yield | — | — |
Restricted Stock Units
In the three months ended March 31, 2015 the Compensation Committee of the Company's board of directors (the "Board") awarded RSUs to employees. The stock-based compensation expense related to RSUs is recognized on a ratable basis over the requisite service period of the grant. The fair value of RSUs is determined using the fair value of the Company’s common stock on the date of grant. In addition, the Compensation Committee of the Board of Directors awarded PBRSUs to members of the executive team. These are subject to performance based requirements as well as additional time based vesting requirements. They will become eligible to vest 50% if the performance objectives are satisfied and then the remaining 50%
18
Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
will vest only if the additional time-based vesting requirements are satisfied. The fair value of PBRSUs is determined using the fair value of the Company’s common stock on the date of grant.
The following table shows a summary of RSU activity, which includes PBRSUs, for the three months ended March 31, 2015 (unaudited):
Shares | Weighted-Average Grant Date Fair Value | |||||
Unvested as of December 31, 2014 | 3,067,728 | $ | 3.13 | |||
Granted | 3,094,243 | 3.59 | ||||
Vested | (672,568 | ) | 2.95 | |||
Forfeited | (15,888 | ) | 3.69 | |||
Unvested as of March 31, 2015 | 5,473,515 | $ | 3.41 |
8. Income Taxes
The Company’s provision for income taxes is based on the estimated annual effective tax rate, adjusted for discrete tax items recorded in the period. The effective tax rate for the three months ended March 31, 2015 and 2014 was less than one percent primarily as a result of the estimated tax losses for those fiscal periods for which no benefit is recorded due to the full valuation allowance recorded against the Company’s net deferred tax assets. The Company’s tax expense relates to state minimum taxes and foreign income taxes associated with the Company’s non-US operations.
As of March 31, 2015, based on the available objective evidence, management believes it is not more likely than not that the tax benefits of the US losses incurred during the three months ended March 31, 2015 will be realized. Accordingly, the Company did not record a tax benefit from the US losses incurred during the three months ended March 31, 2015.
The primary difference between the effective tax rate and the federal statutory tax rate relates to the valuation allowance on the Company’s net deferred tax assets, foreign tax rate differences and permanent differences for non-deductible stock-based compensation expense.
19
Cyan, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. Concentration
Customers comprising revenue for the three months ended and/or a receivable balance as of each reporting period of 10% or greater are as follows:
Percentage of Revenue | Percentage of Receivables | |||||||||||
Three Months Ended March 31, | March 31, | December 31, | ||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||
Customer A | 47 | % | * | 33 | % | 59 | % | |||||
Customer B | * | 17 | % | * | * | |||||||
Customer C | * | 14 | % | * | * | |||||||
Customer D | * | 10 | % | * | * | |||||||
Customer E | * | 10 | % | * | * | |||||||
Customer F | 14 | % | * | 22 | % | * |
*Represents less than 10%
10. Segment Information
The Company considers operating segments to be components of the Company in which separate financial information is available and is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and in assessing performance. The chief operating decision maker ("CODM") for the Company is the Chief Executive Officer.
The Company operates as a single operating segment. This reflects the fact that the Company's CODM evaluates the Company’s financial information and resources, and assesses performance on a consolidated basis. Since the Company operates as one operating segment, all required financial segment information is included in the consolidated financial statements.
11. Related Parties
Certain parties affiliated with the Company purchased $17.0 million in aggregate principal amount of Notes and related Warrants. Mark Floyd, chief executive officer of the Company and chairman of the Board purchased $2.0 million in aggregate principal amount of Notes and related Warrants, Michael Hatfield, president of the Company and a member of the Board purchased $4.0 million in aggregate principal amount of Notes and related Warrants, and affiliated funds of Norwest Venture Partners, with whom Promod Haque, a member of the Board, is affiliated, purchased $11.0 million in aggregate principal amount of Notes and related Warrants.
In addition, an executive officer, who is also a member of the Board, owns approximately 40% of the limited liability company from which the Company is leasing the office premises (see footnote 6).
12. Subsequent Events
On May 3, 2015, the Company entered into a definitive agreement to be acquired by Ciena Corporation ("Ciena") for an aggregate purchase price of approximately $400 million. Upon the closing of the transaction, Cyan stockholders will receive consideration equal to the value of 0.224 shares of Ciena common stock per share of Cyan common stock (89% of which will be delivered in Ciena common stock and 11% will be delivered in cash based on the value of Ciena common stock at closing). Based on the structure of the transaction, Cyan’s outstanding warrants will be deemed to have been automatically exercised upon closing and the notes will become convertible. In addition, Ciena will also assume Cyan’s outstanding equity awards.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains forward-looking statements, including, without limitation, our expectations and statements regarding our outlook and future revenues, expenses, results of operations, liquidity, plans, strategies and objectives of management and any assumptions underlying any of the foregoing. Our actual results may differ significantly from those projected in the forward-looking statements. Our forward-looking statements and factors that might cause future actual results to differ materially from our recent results or those projected in the forward-looking statements include, but are not limited to, those discussed in the section titled "Forward Looking Information" and “Risk Factors” of this Form 10-Q. Except as required by law, we assume no obligation to update the forward-looking statements or our risk factors for any reason.
In addition, On May 3, 2015, the Company announced that it had entered into an Agreement and Plan of Merger with Ciena. The potential merger with Ciena presents additional risks and uncertainties that could cause the actual results to differ from those expressed or implied by forward looking statements including the risk that the pending merger with Ciena may not be consummated due to a failure to obtain stockholder or regulatory approval or for any other reason; the risk that the closing of the merger will be delayed; uncertainties concerning the effect of the transaction on relationships with customers, employees and suppliers of either or both of the companies; the risk that the two companies will not be integrated successfully and in a timely manner even if the closing occurs as anticipated; and the risk that the transaction may involve unexpected costs or unexpected liabilities.
Overview
We have pioneered innovative, carrier-grade networking solutions that transform disparate and inefficient legacy networks into open, high-performance networks. Our solutions include high-capacity, multi-layer switching and transport platforms as well as a carrier-grade software-defined networking platform for network virtualization and control. Our solutions enable network operators to virtualize their networks, accelerate service delivery and increase scalability and performance, while reducing costs. We have designed our solutions to enable a variety of existing and emerging applications, including business Ethernet, wireless backhaul, broadband backhaul, cloud connectivity, bandwidth on demand and network functions virtualization (NFV).
Our Z-Series is a high-capacity, multi-layer switching and transport platform designed to support the multiple concurrent technologies used in regional and metro networks, including both Ethernet-based services as well as optical services. The Z-Series platform is architected to transport traffic over the most efficient network layer, utilizing both electrical and optical domains, to enable network operators to maximize network capacity at the lowest cost per bit. Our solutions are designed to support a variety of use cases from traffic aggregation at the network edge to multi-terabit switching optimized for handoff at the network core.
Our Blue Planet platform is a carrier-grade software-defined network (SDN) and NFV orchestration software platform built to address network operator requirements for network virtualization, management and control. Blue Planet is multi-function in that it is designed to simplify the management, deployment and orchestration of hardware and software elements from us or third-party vendors based on our customers’ requirements. To date, sales of our Z-Series platforms have accounted for substantially all of our revenue. Standalone sales of Blue Planet have accounted for an immaterial amount of our revenue and are expected to increase only modestly as a portion of our revenue in the near term. However, we expect that the portion of our revenue derived from standalone sales of Blue Planet will increase over the longer term.
Our customers range from service providers to high-performance data center and large, private network operators. Our solutions have been deployed primarily across North America, as well as in Asia and Europe.
Since inception, our revenue has been derived primarily from customers located in the United States. For the years ended December 31, 2014 and 2013 our largest customer was Windstream, which accounted for approximately 29% and 39% of our revenue. Additionally, Colt represented approximately 11% of our revenue for the year ended December 31, 2014 . No other customers represented more than 10% of our revenue for the years ended December 31, 2014 and 2013. In the first quarter of 2015, Windstream represented 47% of total revenue and one other customer represented 14% of total revenue.
In addition, a significant portion of our revenue in the US is from customers that identified to us that they were using government-supported loan programs or grants to fund their purchase from us including 13% during both the years ended December 31, 2014 and 2013 and 15% in the first quarter of 2015. Changes to or elimination of similar government programs have occurred in the past and are likely to occur in the future. To the extent that any of our customers have received grants or
21
loans under government stimulus programs, but no longer have access to such assistance, they may substantially reduce or curtail future purchases of our solutions.
Revenue from customers located outside of the United States was approximately 10% and 22% of our revenue for the three months ended March 31, 2015 and 2014. We expect the percentage of our revenue derived from international sales to fluctuate from period-to-period in the near term but to increase in the longer term.
Our customers have historically purchased our solutions using a pay-as-you-grow approach that begins with a targeted product purchase to address specific services or portions of their networks and expands over time to additional product purchases as they experience the benefits of our solutions. The sales cycle for a new customer deployment, from the time of prospect qualification to the completion of the first sale, may span multiple quarters if not years. Typically, after we have completed an initial customer deployment, we experience much shorter sales cycles.
We have historically employed a direct sales model. During 2012, we began to transition to a mixed sales channel approach, complementing our direct sales force with a channel distribution strategy in international markets. We expect to generate an increasing portion of our international sales through this network of channel partners in future periods.
We intend to continue to invest in our sales force, field operations and support capacity, and deepen our engagement with channel partners and establish relationships with new channel partners to target our existing core markets. We plan to target emerging customer verticals with use cases well suited to the benefits of our solutions, including cloud and content providers, educational institutions, large data center networks, governments, cable MSOs as well as enterprises that build and operate large, private networks.
We outsource the manufacturing of our Z-Series platforms. Our outsourced manufacturing model allows us to scale our business without the significant capital investment and ongoing expenses required to establish and maintain manufacturing operations. Our Z-Series platforms leverage industry standard components, and we work closely with our contract manufacturer and key suppliers to manage the procurement, quality and cost of these components. We seek to maintain an optimal level of finished goods inventory to meet our forecasted sales and accommodate unanticipated shifts in sales volume and mix while at the same time minimizing cash outflow.
We believe that our technological advantages will continue to support our growth and demand for our solutions. However, our business may be affected by future challenging economic conditions, decreased availability of capital for network infrastructure projects, or failure of the market for Blue Planet to develop. In addition, capital spending in our industry is cyclical and sporadic, can change on short notice and can fluctuate in response to outside factors such as the availability of government stimulus assistance. As a result, changes in spending behavior in any given quarter or during any economic downturn can reduce our revenue. Spending on network construction, maintenance, expansion and upgrades is also affected by seasonality, delays in the purchasing cycles and reductions in budgets of network operators. Finally, we may face direct and indirect risks as a result of our international operations, including expenses of doing business in multiple jurisdictions, differing regulatory environments, foreign currency fluctuations and varying collection practices.
We entered into a definitive agreement to be acquired by Ciena Corporation for an aggregate purchase price of approximately $400 million (or approximately $335 million net of cash). Upon the closing of the transaction, Cyan stockholders will receive consideration equal to the value of 0.224 shares of Ciena common stock per share of Cyan common stock (89% of which will be delivered in Ciena common stock and 11% of which will be delivered in cash based on the value of Ciena common stock at closing). Based on the structure of the transaction, our outstanding warrants will be deemed to have been automatically exercised upon closing and out outstanding notes will become convertible. In addition, Ciena Corporation will also assume our outstanding equity awards.
Components of Operating Results
Revenue
We generate revenue primarily from selling our Z-Series platforms and licensing our Blue Planet software-defined networking solutions and providing various professional service fees.
Cyan Z-Series
22
Our Z-Series hardware is a family of high-capacity, multi-layer switching and transport platforms. Each Z-Series platform is comprised of a chassis that supports a variety of interchangeable Z-Series line cards to provide a wide range of network applications. Our customers make an initial purchase of chassis and line cards to address their particular network deployment needs, then typically make subsequent purchases of line cards and/or larger chassis as the capacity and service needs of their networks evolve. The majority of our revenue is generated from sales of our Z-Series platforms. We generally recognize product revenue at the time of shipment provided that all other revenue recognition criteria have been met.
Cyan Blue Planet
In December 2012, we launched Blue Planet, our carrier-grade SDN and NFV platform that is designed to allow network operators of all types to manage their multi-vendor network and simplify the development, deployment and orchestration of scalable services over high-performance networks. In 2014 we introduced the ability to orchestrate virtual resources and functions and chain those to the physical network to streamline service creation and deployment. Blue Planet is available to customers regardless of whether they have deployed our Z-Series platforms in their networks. Customers may purchase Blue Planet using standard configurations to address common network needs or may customize their implementations by pairing the Blue Planet orchestration layer with their own selection of applications and element adapters. We offer Blue Planet on a variety of models. Where we sell Blue Planet on a term license basis or on a software-as-a-service (SaaS) basis deployed from the cloud, we invoice customers for the entire contract amount at the start of the contract term, which will lead to the majority of these invoiced amounts being treated as deferred revenue that will be recognized ratably over the term of the contract. While term-based licenses currently make up the majority of related revenues, we occasionally license software to customers on a perpetual basis with on-going support and maintenance services. Revenue from software that functions together with the tangible hardware elements to deliver the tangible products’ essential functionality is generally recognized upon shipment assuming all other revenue recognition criteria are met. Revenue from application software and related software elements which are not considered essential to the functionality of hardware is accounted for in accordance with software industry guidance, and therefore is recognized ratably over the longest service period for post-contract customer support (PCS) and professional services as we have not established VSOE for software or the related software elements.
CyNOC Professional Services
Our CyNOC offering is a network operations center service through which we monitor, and, in some cases, manage our customers’ multi-vendor networks. Additionally, a number of our customers which maintain their own internal NOC leverage our services as a backup NOC. These services are typically sold to our customers for a one-year term at the time of the initial product sale and renewed on an annual basis thereafter.
Maintenance, Support, Training and Other Professional Services
We offer a range services, including hardware installation and software and hardware maintenance and support, to provide a variety of customer service products and support through our technical support engineers as well as through our growing network of authorized and certified channel partners. These services are sold to our customers at the time of the initial product sale, typically for one-year terms that customers may choose to renew for successive annual or multi-year periods. These services are invoiced separately at the time of the initial product sale.
We also provide training and other professional services to our end-customers, including services related to the implementation, use, functionality and ongoing maintenance of our products. These services are invoiced separately when the services are delivered.
Deferred Revenue
Our deferred revenue consists of amounts that have been invoiced but that have not yet been recognized as revenue as of the period end, pending completion of the revenue recognition process. Our deferred revenue was $7.1 million and $7.5 million as of March 31, 2015 and December 31, 2014. At March 31, 2015 and December 31, 2014, the majority of our deferred revenue is related to term license, support and maintenance revenue that is recognized ratably over the contractual service period. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods. Over the longer term, we expect that the proportion of our deferred revenue relating to Blue Planet will increase relative to Z-Series related deferred revenue. In most cases, we expect to invoice our customers at the start of the Blue Planet license term, which will lead to the majority of these invoiced amounts being treated as deferred revenue and recognized ratably over the term of the contract or the associated maintenance period.
As a result, over the longer term, we expect that the proportion of our deferred revenue relating to Blue Planet will increase relative to Z-Series related deferred revenue.
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Costs of Revenue
Cost of revenue primarily consists of manufacturing costs of our products payable to our contract manufacturer. Our cost of revenue also includes third-party manufacturing and supply chain logistics costs, provisions for excess and obsolete inventory, warranty costs, hosting costs, certain allocated costs for facilities, depreciation and other expenses associated with logistics and quality control. Additionally, it includes salaries, benefits and stock-based compensation for personnel directly involved with manufacturing, installation, and certain and support services.
Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors. In the near term, we generally expect gross margin to remain relatively flat as our continued efforts and those of our contract manufacturer to manage our supply chain and raw materials pricing and scale efficiencies in our production model are offset against general marketplace price pressure. In the longer term, we expect that the market adoption of Blue Planet, and the resulting increase in Blue Planet revenue as a percentage of our revenue, will contribute to increases in gross margin. From time to time, however, we may experience lower gross margin in any particular period as a result of large initial deployments. These deployments typically include a significant proportion of lower-margin Z-Series chassis. As our customers expand their networks after large initial deployments, they typically purchase additional higher-margin line cards.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel-related costs, including stock-based compensation, commission and bonus, are the most significant component of each of these expense categories. The timing and number of additional hires has and could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue, in any particular period.
Research and Development
Research and development expense consists primarily of personnel and consultant costs. Research and development expense also includes costs for prototypes, lab supplies, product certification, travel, depreciation, recruiting and allocated costs for certain facilities costs.
Sales and Marketing
Sales and marketing expense consists primarily of personnel costs including commission costs. We expense commission costs as incurred. Sales and marketing expense also includes the costs of consultants, trade shows, marketing programs, promotional materials, demonstration equipment, travel, depreciation, recruiting and allocated costs for certain facilities costs.
General and Administrative
General and administrative expense consists of personnel costs, professional services costs as well as allocated costs for certain facilities costs. General and administrative personnel include our executive, finance, human resources, IT and legal organizations. Professional services consist primarily of legal, auditing, accounting, and other consulting costs.
Stock-Based Compensation
Stock-based compensation expense was $4.4 million and $2.5 million for the three months ended March 31, 2015 and 2014. We expect to continue to incur significant stock-based compensation expense because we expect stock-based compensation to continue to play an important part in the overall compensation structure for our employees.
Stock-based compensation included in the statements of operations data above was as follows (in thousands):
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Three Months Ended March 31, | ||||||||
2015 | 2014 | |||||||
Cost of revenue | $ | 224 | $ | 60 | ||||
Research and development | 1,530 | 915 | ||||||
Sales and marketing | 1,485 | 798 | ||||||
General and administrative | 1,164 | 742 | ||||||
Total stock-based compensation | $ | 4,403 | $ | 2,515 |
Other Income (Expense), Net
Change in fair value of derivative and warrant liabilities
In December 2014, we issued $50.0 million aggregate principal amount of 8.0% convertible senior notes due December 15, 2019 (the Notes). The Notes include a conversion option, including contingent conversion, a make-whole conversion adjustment, and certain interest features which are accounted for as a single compound embedded derivative (the Compound Embedded Derivative). In connection with the issuance of the notes we also issued certain warrants. We have classified the Compound Embedded Derivative Liability and warrants as derivative liabilities. They are recorded at fair value and are subject to re-measurement at each balance sheet date. We will recognize any change in fair value in our condensed consolidated statements of operations.
Interest Expense
Interest expense consists of interest on our notes payable and convertible debt as well as amortization of loan fees. In December 2012, we established a loan facility consisting of a revolving loan facility and a term loan facility governed by a Loan and Security Agreement with Silicon Valley Bank (SVB). In December 2014, we paid the then outstanding balance of approximately $3.4 million under the SVB loan facility and terminated the facility.
Interest expense on the Notes represents the coupon interest together with the non-cash interest expense resulting from the accretion of the debt discount.
Other Income (Expense), Net
Other income (expense), net consists of foreign currency gains and losses, interest income and other income and expense items. In February 2015, we realized a gain of $0.3 million from the sale of a non-operating investment in an unrelated company that was recognized as a component of other income (expense), net in the condensed consolidated statements of operations.
Provision for Income Taxes
Provision for income taxes consists primarily of state franchise and minimum taxes in the United States and income taxes in foreign jurisdictions in which we conduct business. Due to the uncertainty as to the realization of the benefits of our domestic deferred tax assets (including net operating loss carryforwards and research and development and other tax credits), we have a full valuation allowance reserved against such assets. We expect to maintain this full valuation allowance in the near term. We also expect our provision for income taxes to increase in future years.
Our corporate structure includes legal entities located in jurisdictions with income tax rates lower than the U.S. statutory tax rate. Our intercompany arrangements allocate income to such entities in accordance with arm’s-length principles and commensurate with functions performed, risks assumed and ownership of corporate assets. This includes the manner in which we develop and use our intellectual property as well as the transfer pricing of intercompany transactions.
As of December 31, 2014 we had $108.1 million of federal and $84.1 million of state net operating loss carryforwards available to reduce future taxable income. These net operating loss carryforwards begin to expire in 2026 for U.S. federal income tax and 2015 for state income tax purposes. Our ability to use our net operating loss carryforwards to offset any future taxable income may currently, or in the future be subject to limitations in the event that we experience a change of ownership as defined by Section 382 of the Internal Revenue Code of 1986, as amended, (Internal Revenue Code). We established a full
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valuation allowance to offset net deferred tax assets as of March 31, 2015 and December 31, 2014 due to the uncertainty of generating sufficient future taxable income.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, our condensed consolidated financial statements could be adversely affected.
The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: allowances for doubtful accounts, inventory valuation, excess and obsolete inventory, allowances for obligations to its contract manufacturer, useful lives assigned to long-lived assets, sales returns reserve, the fair value of stock awards, the fair value of a contingent conversion feature, make-whole conversion adjustment, and certain interest features related to our 8.0% convertible senior notes issued in December 2014 and due December 15, 2019 (the “Notes”) which are accounted for as a single compound embedded derivative (the “Compound Embedded Derivative”) and warrants associated with the Notes, warranty costs, contingencies, accounting for income taxes, including the determination of the timing of the establishment or release of the our valuation allowance related our deferred tax asset balances and reserves for uncertain tax positions, and the fair value of stock awards and the probability that specified goals underlying performance based awards will be achieved. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Form 10-K for a more complete discussion of our critical accounting policies and estimates. Our critical accounting policies have been discussed with the Audit Committee of the Board of Directors.
Events in 2015 required us to make additions to our accounting policies for stock based compensation and customer credits and to expand our consideration of possible conversion scenarios associated with the Notes as disclosed in the notes to condensed consolidated financial statements. There have been no other changes in the significant accounting policies as described in the audited consolidated financial statements for 2014 included in our Annual Report.
Results of Operations
Revenue
Three months ended March 31, | |||||||
2015 | 2014 | ||||||
(dollars in thousands) | |||||||
Revenue | $ | 36,005 | $ | 19,038 |
Revenue increased by $17.0 million or 89% for the three months ended March 31, 2015 from the three months ended March 31, 2014. The increase was primarily due to a substantial increase in revenue from Windstream. Revenue from Windstream represented 47% and 6% of revenue for the three months ended March 31, 2015 and 2014, respectively. Excluding Windstream from both periods, revenue increased by $1.1 million or 6% for the three months ended March 31, 2015 from the three months ended March 31, 2014.
Approximately 10% and 22% of our revenue for the three months ended March 31, 2015 and 2014 was attributable to customers located outside the United States. The decrease in international revenue as a percentage of total revenue was primarily due to the significant increase in Windstream revenue (Windstream is based in the United States). In addition, international revenue for the three months ended March 31, 2015 compared to March 31, 2014 was somewhat impacted by the continued strengthening of the US dollar which makes our products less price competitive internationally. We continue to introduce our products in new markets and expect international revenue to increase in dollar amount over time.
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Cost of Revenue, Gross Profit and Gross Margin
Three months ended March 31, | ||||||||
2015 | 2014 | |||||||
(dollars in thousands) | ||||||||
Cost of revenue | $ | 20,974 | $ | 11,615 | ||||
Gross profit | $ | 15,031 | $ | 7,423 | ||||
Gross margin | 41.7 | % | 39.0 | % |
Cost of revenue increased by $9.4 million, or 81%, for the three months ended March 31, 2015 from the three months ended March 31, 2014 corresponding to our 89% increase in revenue. Gross profit increased by $7.6 million, or 102%, for the three months ended March 31, 2015 from the three months ended March 31, 2014.
Gross margin increased by 2.7%, from 39.0% to 41.7%, for the three months ended March 31, 2015 compared to the prior year period. The increase in gross margin is due primarily to a similar level of fixed manufacturing expenses being spread over a much larger revenue base when comparing the first quarter 2015 to the first quarter 2014.
We anticipate our gross margins will fluctuate from period to period depending on the product mix sold, large initial deployments as well as other factors including provisions for warranty, inventory excess and obsolescence charges and the level of revenue experienced in any particular period.
Research and Development
Three months ended March 31, | ||||||||
2015 | 2014 | |||||||
(dollars in thousands) | ||||||||
Research and development | $ | 8,941 | $ | 9,472 | ||||
Percent of total revenue | 24.8 | % | 49.8 | % |
Research and development expense decreased by $0.5 million, or 6%, in the three months ended March 31, 2015 when compared to the three months ended March 31, 2014. The decrease was primarily related to reduced payroll expenses in the 2015 period as a result of the restructuring undertaken in the fourth quarter of 2014, partially offset by a higher level of stock based compensation.
In the near term, we expect our research and development expenses to remain relatively flat in dollar amount.
Sales and Marketing
Three months ended March 31, | ||||||||
2015 | 2014 | |||||||
(dollars in thousands) | ||||||||
Sales and marketing | $ | 11,436 | $ | 11,029 | ||||
Percent of total revenue | 31.8 | % | 57.9 | % |
Sales and marketing expense increased by $0.4 million, or 4%, from the three months ended March 31, 2015 to the three months ended March 31, 2014. The increase was primarily due to higher commissions associated with the significant increase in revenue and an increase in stock based compensation offset by lower spending on travel and entertainment and professional fees.
In the near term, we expect our sales and marketing expenses to be somewhat lower in dollar amount.
General and Administrative
Three months ended March 31, | ||||||||
2015 | 2014 | |||||||
(dollars in thousands) | ||||||||
General and administrative | $ | 5,082 | $ | 4,563 | ||||
Percent of total revenue | 14.1 | % | 24.0 | % |
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General and administrative expense increased by $0.5 million, or 11%, from the three months ended March 31, 2015 to the three months ended March 31, 2014. The increase was primarily related to increased accounting , legal, and outside service expenses, as well as increased stock based compensation expense, offset somewhat by lower payroll related expenses.
In the near term, we expect our general and administrative expenses to be modestly lower in dollar amount.
Other Income (Expense), Net
Three months ended March 31, | ||||||||
2015 | 2014 | |||||||
(dollars in thousands) | ||||||||
Change in fair value of derivative and warrant liabilities | $ | (41,285 | ) | $ | — | |||
Interest expense | (1,546 | ) | (47 | ) | ||||
Other income (expense), net | 419 | (62 | ) | |||||
Other Income (expense), net | $ | (42,412 | ) | $ | (109 | ) |
Other income (expense), net was $42.4 million during the quarter ended March 31, 2015, compared to income of $0.1 million in the same quarter in 2014. The difference between the two periods was primarily due to the change in fair value of the Notes. The Notes are recorded at fair value and are subject to re-measurement at each balance sheet date. Re-measurement at March 31, 2015 resulted in a $41.3 million change primarily as a result of a 60% increase in the price of our common stock over the period. Interest expense for the three months ended March 31, 2015 relates to our Notes. The effective interest rate applicable to the debt balance of the Notes is 48.9%. The difference between this interest rate and the Notes 8.0% coupon rate will be accreted to the debt balance over the 5-year term of the Notes.
Interest expense for the three months March 31, 2014 relates to obligations under our term loan that was paid off in the fourth quarter of 2014. These amounts were offset by a $0.3 million gain from the sale of a non-operating investment in an unrelated company.
Liquidity and Capital Resources
Historically, we required a significant amount of cash resources to operate our business. For example, in 2014, we used approximately $42 million in operating activities. In the first quarter of 2015, we had positive cash flow of $6.1 million including cash flow from operations of $6.0 million. At March 31, 2015, we had cash (including restricted cash of approximately $12 million) and cash equivalents totaling $65.9 million
At forecasted levels of revenue, expenses and capital expenditures, we believe that our existing cash, cash equivalents, together with cash collections will be sufficient to meet our projected operating and capital expenditure requirements through the first quarter of 2016. However, as early as January 15, 2016 the Notes may be converted. Unless and until we obtain stockholder approval to issue shares to settle the conversion of Notes, we will be required (i) to settle Notes purchased by our officers, directors and their affiliated entities and any other Notes settled on the same date solely in cash and (ii) to settle all conversions of Notes (other than those purchased by the our officers, directors and their affiliated entities and only if settled on a date different from the date of settlement of the Notes purchased by the our officers, directors and their affiliated entities) by paying cash in an amount equal to at least the principal amount of Notes converted together with any combination of cash or shares of common stock, as selected by us, for the conversion value in excess of the principal amount, if any, subject to a share cap on the overall number of shares issued. We intend to seek stockholder approval at its 2015 annual stockholders meeting to permit us to settle the Notes including the notes purchased by our officers, directors, and their affiliated entities, using shares of common stock, cash or a combination of both, at our election and without a cap on the number of shares issued. We intend to seek stockholder approval at our 2015 annual stockholders meeting to permit us to settle the Notes, including the notes purchased by our officers, directors and their affiliated entities, using shares of our common stock, cash or combination of both, at our election. Our 2015 annual meeting of stockholders has been postponed to accommodate additional agenda items associated with the proposed business combination with Ciena. There is no guarantee that such stockholder approval will be obtained. Were a material amount of the Notes to be converted prior to receiving the stockholder approval to include shares of our common stock in the settlement, our liquidity could be materially adversely affected and, if enough Notes converted, we would not have sufficient capital resources to settle them entirely in cash.
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The following table summarizes our cash flows (in thousands):
Three months ended March 31, 2015 | Three Months ended March 31, 2014 | |||||||
Net cash provided by (used in) operating activities | $ | 5,995 | $ | (14,877 | ) | |||
Net cash provided used in investing activities | (36 | ) | (1,032 | ) | ||||
Net cash provided by (used in) financing activities | 298 | (291 | ) | |||||
Effect of exchange rates on cash | (127 | ) | 137 | |||||
Net increase (decrease) in cash and cash equivalents | $ | 6,130 | $ | (16,063 | ) |
Operating Activities
In the three months ended March 31, 2015, cash provided by operating activities was $6.0 million. In arriving at cash from operations, net loss of $52.9 million, was offset by $47.4 million in non-cash items relating to stock-based compensation, depreciation and amortization, interest expense and most significantly the change in fair value of derivative and warrants. Our cash flow also benefited from a decrease in accounts receivable of $5.7 million due to increased collections, a decrease in our inventory balance of $2.8 million as we were successful in our efforts to better utilize our inventory to fulfill our sales volume in the first quarter of 2015, an increase in accrued and other liabilities of $1.7 million due to the timing of purchases of additional inventory, and an increase in accrued compensation of $1.2 million due to increased commissions from higher sales in the first quarter 2015.
In the three months ended March 31, 2014, cash used in operating activities was $14.9, primarily as a result of a net loss of $17.8 million, which was only partially offset by $3.4 million in non-cash depreciation and amortization and stock-based compensation. During the three months ended March 31, 2014 accounts receivable decreased $0.3 million or $1.7 million less than the decrease experienced in the three months ended March 31, 2013, due to the lack of sales linearity in the current quarter. Accounts payable decreased $1.6 million due to the timing of vendor payments. Further, in the three months ended March 31, 2014 the Company received $0.6 million when its lease receivables were paid off by the customer. These were partially offset by a net increase in other working capital amounts of $0.2 million.
Investing Activities
In the three months ended March 31, 2015, cash used in investing activities was insignificant and related primarily to capital expenditures, such as purchases of lab equipment, tooling and computer hardware to support our business of $0.8 million, offset by $0.8 million received from the sale of a non-operating investment in an unrelated company.
In the three months ended March 31, 2014, cash used in investing activities was $1.0 million and primarily related to capital expenditures, such as lab equipment, tooling and computer hardware to support our business of $2.3 million, partially offset by $1.3 million sales of marketable securities.
Financing Activities
In the three months ended March 21, 2015, cash provided by financing activities was $0.3 million. This included $1.4 million in proceeds from the exercise of stock options. These were partially offset by $1.1 million of taxes paid related to net-share settlement of restricted stock units.
In the three months ended March 31, 2014, cash used in financing activities was $0.3 million. This included $0.4 million repayments of borrowings under our term loan, partially offset by $0.2 million proceeds from the exercise of stock options.
Guaranties, Warranties and Indemnifications
We generally offer hardware warranties on our products for one to eight years based on a tiered structure as determined by the type of customer. In accordance with the Financial Accounting Standards Board’s, or FASB’s, Accounting Standards Codification, or ASC 450-20, Loss Contingencies, we record an accrual for expected warranty based on historical
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experience. We record a provision for estimated future warranty work in cost of goods sold upon recognition of revenue and we review the resulting accrual regularly and periodically adjust it to reflect changes in warranty estimates.
From time to time, we enter into certain types of contracts that contingently require us to indemnify various parties against claims from third parties. These contracts primarily relate to (i) certain real estate leases, under which we may be required to indemnify property owners for environmental and other liabilities, and other claims arising from our use of the applicable premises; (ii) certain agreements with our officers, directors, and employees, under which we be required to indemnify such persons for liabilities arising out of their relationship with us; (iii) contracts under which we may be required to indemnify customers against third-party claims that our product infringes a patent, copyright, or other intellectual property right; and (iv) procurement or license agreements, under which we may be required to indemnify licensors or vendors for certain claims that may be brought against us arising from our acts or omissions with respect to the supplied products or technology.
Generally, a maximum obligation under these contracts is not explicitly stated. Because the obligated amounts associated with these types of agreements are not explicitly stated, the overall maximum amount of the obligation cannot be reasonably estimated. Historically, we have not been required to make any payments under these obligations, and no liabilities have been recorded for these obligations in our consolidated balance sheets.
Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet arrangements as defined in Item 303 of SEC Regulation S-K and we do not have any holdings in variable interest entities.
Contractual Obligations and Commitments
We lease our headquarters in Petaluma, California and other locations worldwide under non-cancelable operating leases that expire at various dates through 2025. In addition, we subcontract with other companies to manufacture and supply components for our products. During the normal course of business, our contract manufacturer procures components from suppliers based on our forecasts. If we cancel all or part of the orders, we will be liable to our contract manufacturer for the cost of the components purchased by the subcontractors to manufacture our products. We periodically review this potential liability and, as of December 31, 2014, we had no significant related accruals recorded. Our financial position and results of operations could be negatively impacted if we are required to compensate our contract manufacturer for any unrecorded liabilities incurred.
In April 2007 we entered into a lease for our headquarters facility in Petaluma, California. As amended to date, the 2007 lease provides for the lease of 18,895 square feet and expires in 2025. In July 2013, we entered into a lease for an additional 20,005 square feet of space in Petaluma, California, increasing by a further 18,773 square feet in 2016. The 2013 lease expires concurrently with the 2007 lease in 2025.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks in the ordinary course of our business, primarily related to interest rate, inflation and foreign currency risks. We also are exposed to risks relating to changes in the general economic conditions that affect our business. To reduce certain of these risks, we monitor the financial condition of our customers and manage our contract manufacturer and suppliers. In addition, our investment strategy has been to invest in cash, cash equivalents and marketable securities. To date, we have not used derivative instruments to mitigate any market risk exposures. We have not used, nor do we intend to use, derivatives for trading or speculative purposes. We do not believe that these risks have been material to date.
We had cash and cash equivalents of $53.9 million at March 31, 2015. Cash and cash equivalents consist of cash and money market funds. The primary objectives of our investment activities are the preservation of capital, the fulfillment of liquidity needs and the fiduciary control of cash and cash equivalents. We do not enter into marketable securities for trading or speculative purposes.
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. However, if our costs, in particular salaries and manufacturing costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, operating results and financial condition.
Historically, as our operations and sales, including all of our manufacturing, have been primarily in the United States, we have not faced any significant foreign currency risk. As our international operations grow, our risks associated with fluctuation in currency rates will become greater, and we will continue to reassess our approach to managing this risk. In
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addition, currency fluctuations or a weakening U.S. dollar can increase the costs of our international expansion efforts. Conversely, a strengthening U.S. dollar could make it more difficult for us to compete in markets outside of the United States.
Changes in our stock price can have a material impact on the costs associated with our convertible notes and related warrants. Prior to obtaining-or if we do not obtain-stockholder approval to fully settle the conversion of our convertible notes and exercise of the related warrants, we would be required to settle these obligations in cash. Because the cash settlement amount of the notes and warrants increases if our stock price increases, increases in our stock price would result in an increase in the amount we would have to pay upon conversion of the notes and exercise of the warrants. For example, prior to obtaining stockholder approval-or if we don’t obtain stockholder approval if the price of our common stock used for purposes of measuring the settlement amount of the notes and warrants were $4.00 per share, we would be obligated to issue approximately 5.3 million shares of our common stock and pay cash of approximately $65.1 million to settle full conversion of the notes and exercise of the warrants. If the price of our common stock used for these calculations were $5.00 per share, the amounts would be approximately 6.9 million shares and $83.3 million in cash. In addition, changes in the price of our common stock result in changes in the fair value of the derivative liabilities associated with the convertible notes and warrants and could cause our charges for these liabilities to change significantly from period to period. For example, the fair market value of our common stock at March 31, 2015, which resulted in a charge of $41.3 million, was $3.99. If the fair market value on that date had been $4.99, the charge in the fourth quarter would have been $69.8 million.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of March 31, 2015. Based on their evaluation as of March 31, 2015 our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level to ensure that the information required to be disclosed by us on this Form 10-Q was (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of 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) that occurred during our most recently completed fiscal quarter. Based on that evaluation, our principal executive officer and principal financial officer concluded that there has not been any material change in our internal control over financial reporting during the quarter covered by this report that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
On April 1, 2014 a purported stockholder class action lawsuit was filed in the Superior Court of California, County of San Francisco, against the Company, the members of our Board of Directors, our former Chief Financial Officer and the underwriters of our IPO. On April 30, 2014 a substantially similar lawsuit was filed in the same court against the same defendants. The two cases have been consolidated under the caption Beaver County Employees Retirement Fund, et al. v. Cyan, Inc. et al., Case No. CGC-14-539008. The consolidated complaint alleges violations of federal securities laws on behalf of a purported class consisting of purchasers of our common stock pursuant or traceable to the registration statement and prospectus for our IPO, and seek unspecified compensatory damages and other relief. In July 2014, the defendants filed a demurrer (motion to dismiss) to the consolidated complaint. On October 22, 2014, the court overruled the demurrer and allowed the case to proceed. We intend to defend the litigation vigorously. Based on information currently available, we have determined that the amount of any possible loss or range of possible loss is not reasonably estimable.
From time to time, we may be involved in various legal proceedings arising from the normal course of our business activities.
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Item 1A. Risk Factors
The risks and uncertainties described below are not the only ones facing us. Other events that we do not currently anticipate or that we currently deem immaterial also may affect our results of operations, cash flows and financial condition.
Risks Related to Our Business
We currently generate the majority of our revenue from a concentrated base of customers, including Windstream Corporation. Unless we can substantially expand our sales to other existing or new customers, our period-to-period revenue may be highly volatile and we will not be able to grow our revenue.
For the years ended December 31, 2014, 2013 and 2012, revenue from Windstream represented approximately 29%, 39% and 45% of our total revenue. In recent periods, sales to Windstream have been highly volatile from quarter to quarter. For example, sales to Windstream declined from $19.0 million, or 50% of total revenue, in the third quarter of 2013 to $2.3 million, or 11% of total revenue, in the fourth quarter of 2013 and to $1.1 million, or 6% of total revenue, in the first quarter of 2014. The unanticipated 88% decline in revenue from Windstream from the third to the fourth quarters of 2013 resulted in our overall revenue in the fourth quarter of 2013 being substantially lower than we or the market anticipated. In the third quarter of 2014, sales to Windstream decreased to $5.6 million or 21% of total revenue from $6.7 million, or 28% of total revenue in the second quarter of 2014, but increased to $15.8 million or 52% in the fourth quarter of 2014 and $16.9 million or 47% in the first quarter of 2015.
While our sales to Windstream have been volatile, and can be potentially highly volatile, from quarter to quarter, we nonetheless anticipate that a significant portion of our revenue in 2015 and beyond will continue to depend on sales to Windstream especially as we have been selected by Windstream for additional upgrades to its regional and metro networks across major markets to 100G capacity. If our sales to Windstream decrease materially in any period, our revenue and results of operations would be adversely affected.
During 2015, two customers accounted for greater than 10% of our revenue: Windstream, which accounted for approximately 47%, and another customer, which accounted for approximately 14% of our revenue. During 2014 two customers accounted for greater than 10% of our revenue: Windstream, which accounted for approximately 29%, and Colt, which accounted for approximately 11% of our 2014 revenue. During 2013 two customers accounted for greater than 10% of revenue: Windstream, which accounted for approximately 39%, and Telephone and Data Systems, Inc., which accounted for approximately 11% of our 2013 revenue. Given the episodic nature of capital expenditures associated with network deployments, we may continue to derive a substantial amount of our revenue from a limited number of customers in any future period. Unless and until we substantially diversify our customer base, we may continue to experience significant volatility in our quarterly results, and may not be able to maintain or grow our revenues.
Sales of our solutions to our customers, including Windstream, are made pursuant to purchase orders, and not pursuant to long-term, committed-volume purchase contracts. As a result, we cannot assure you that we will be able to sustain or increase sales to any current or future customer from period to period, or that we will be able to offset the discontinuation of concentrated purchases by these customers with purchases by new or other existing customers. As a consequence of our customer concentration and the frequently concentrated nature of our customers’ purchases, our quarterly revenue and operating results may fluctuate substantially from quarter to quarter and are difficult to predict. The loss of, or a significant delay or reduction in purchases by, any of our significant customers has in the past and could in the future adversely affect our business and operating results.
We have a history of losses, and we may not be able to generate sufficient revenue to achieve or maintain profitability.
Since our inception, we have incurred net losses in each quarterly and annual period. For the year ended December 31, 2014 and the three months ended March 31, 2015, we incurred net losses of $59.2 million and $52.9 million, repectively. As of March 31, 2015, we had an accumulated deficit of $239.4 million. Although our revenue grew in each of the years from our inception through the year ended December 31, 2013, our revenue for 2014 fell below the level attained in 2013. Our revenue may not grow, or may decline, in future periods as a result of a number of factors, including uncertain demand for our solutions, increasing competition or our failure to capitalize on potential growth opportunities. In addition, we anticipate that we will continue to incur losses until at least the end of 2015 as we continue to expend substantial resources on sales and marketing, including domestic and international expansion efforts, product and feature development, technology infrastructure and general
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administration. If we are unable to grow our revenue, improve our gross margin or manage our expenses, we may continue to incur significant losses beyond 2015 and may not be able to achieve or maintain profitability.
Our revenue, gross margin and other operating results may fluctuate significantly and be unpredictable, which makes our future operating results difficult to predict and could cause the trading price of our common stock to decline.
Our revenue and operating results may fluctuate from period to period due to a variety of factors, many of which are outside of our control, which makes it difficult for us to predict our future operating results. The timing and size of orders for our Z-Series and Blue Planet platforms and other solutions have been highly variable and difficult to predict, and we expect similar unpredictability for our N-Series platform, leading to uncertainty and limiting our ability to accurately forecast revenue and resulting in significant fluctuations in revenue from period to period. This variability has been compounded by our customer concentration and the frequently concentrated nature of our customers’ purchases, which are made pursuant to purchase orders and not pursuant to long-term committed-volume purchase contracts.
In addition to, or as elaborated in, other risks listed in this Risk Factors section, factors that may affect our operating results include:
• | the timing of orders from our customers and channel partners, including by our largest customer, Windstream; |
• | fluctuations in demand for our solutions; |
• | the capital spending patterns of network operators and any decrease or delay in capital spending by network operators due to economic, regulatory or other reasons; |
• | the inherent complexity, seasonality, length and associated unpredictability of our sales cycles for our solutions; |
• | the availability to our customers, particularly domestic customers, of government stimulus funding for network expansion activities, including for purchases of network systems such as our Z-Series, N-Series and Blue Planet platforms; |
• | changing market conditions, including network operator consolidation; |
• | changes in the competitive dynamics of our markets, new market entrants and any related discounting, bundling or financing of products or services; |
• | our ability to generate incremental business from our expanded international sales and marketing operations; |
• | our ability to control costs such as the costs of the components for our Z-Series and N-Series platforms; |
• | the ability of our contract manufacturer and component suppliers to timely meet our manufacturing and supply needs at acceptable prices, or at all; |
• | the timing and execution of product transitions, new product introductions or product upgrades by us or our competitors; |
• | the risk that new product announcements may cause existing or prospective customers to delay purchases of existing products pending availability of announced new products prior to such newer products being available for commercial shipment; |
• | our ability to timely and effectively develop, introduce and gain market acceptance for new solutions, products, technologies and services, such as Blue Planet, and anticipate future market demands that meet our customers’ requirements; |
• | our ability to successfully expand the Z-Series, N-Series, Blue Planet and professional service solutions we sell to existing customers; |
• | the interoperability of our solutions with service providers’ networks and the ability of our Blue Planet solutions to manage the broad range of equipment in such networks; |
• | technical challenges in network operators’ overall networks, unrelated to our solutions, which could delay adoption and installation of our solutions; |
• | decisions by potential customers to purchase alternative products and services from other providers and their willingness to deploy our solutions; |
• | any decision by us to increase or decrease operating expenses in response to changes in the marketplace or perceived marketplace opportunities; |
• | our ability to derive benefits from our investments in sales, marketing, engineering or other activities; |
• | our ability to build and manage our channel partner and distribution networks, and the effectiveness of any changes we make to our distribution model; and |
• | general economic conditions, both domestically and in international markets. |
Any one of the factors above or the cumulative effect of the factors above may result in significant fluctuations in our operating results from period to period.
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This variability and unpredictability could result in our failure to meet our internal operating plan or the expectations of securities analysts or investors for any period. For example, in the fourth quarter of 2013 we provided guidance for the fourth quarter that did not meet analyst expectations and in the first quarter of 2014 we announced results for the fourth quarter that fell below our guidance and below analyst expectations, both of which events resulted in sharp declines in our stock price and resultant securities class action litigation. If we fail to meet such expectations in the future, the market price of our common stock could again fall substantially and we could face costly lawsuits, including securities class action litigation.
Our business depends on the capital spending patterns and financial capabilities of our service provider customers, and any decrease or delay in their capital spending may adversely affect our business and operating results.
Our revenue to date has been derived primarily from our service provider customers. Demand for our solutions depends on the amount and timing of capital spending by these customers as they construct, expand and upgrade their networks. In response to any future challenging economic conditions and decreased availability of capital, spending for network infrastructure projects could be delayed or cancelled by our customers. In addition, capital spending is cyclical in our industry and sporadic among individual service providers, and can change on short notice. As a result, we may not have visibility into changes in spending behavior until near the end of a given quarter. Further, infrastructure improvements may be further delayed or prevented by a variety of factors, including cost, regulatory obstacles, consolidation in the industry, lack of consumer demand and alternative technologies for service delivery. Specifically, we and many competitors experienced weakness in demand in North America in the third quarter of 2014 as service providers took a cautious approach towards capital spending. While we saw increased service provider revenue in the fourth quarter of 2014, many other industry participants continued to see weakness through the entire second half of 2014. Any reductions in capital expenditures by service providers in any future period could adversely affect our operating results and future growth.
Our revenue may become more volatile due to changes in historical seasonal patterns. We have experienced in the past, and may continue to experience, seasonal fluctuations in our revenue as a result of our customers’ spending patterns. For example, in years prior to 2013 and again in 2014, we experienced an increase in business activity as we approached December, due at least in part to some of our customers accelerating spending to use remaining capital budgets. Similarly, we have historically experienced a decrease in business activity in our first quarter as some of our customers delay spending until they finalize their capital budgets and project initiatives become clarified. However, these historical patterns may not recur in any given period. For example, in the fourth quarter of 2013, we experienced a decrease in business activity as some of our customers had largely depleted their 2013 capital budgets by the end of the third quarter. In addition, from time to time, customers may place large orders that are unrelated to seasonality but may significantly affect what appear to be seasonal trends.
Furthermore, we may experience volatility in gross margin in any particular period as a result of factors including product mix sold, large initial deployments as well as other factors including adjustments to warranty accrual, inventory obsolescence charges and the level of revenue experienced in any particular period. Large initial deployments typically involve a lower margin product mix, as initial deployments are generally comprised of thinly configured chassis. As our customers expand their networks after the initial deployments, they typically purchase additional higher-margin line cards. For example, gross margin decreased by 1.5%, from 40.5% to 39.0%, for the three months ended March 31, 2014 compared to the three months ended December 31, 2013. The decrease in gross margin was driven primarily by the overall decreased revenue for the quarter which resulted in a higher percentage impact of overhead costs associated with our manufacturing operations. The decrease in gross margin was also impacted by initial network deployments by customers, which typically involve a lower margin product mix. We expect to continue to experience this volatility in gross margin from quarter-to-quarter, which could negatively affect our operating results and financial condition.
Our cost reduction plans may not produce anticipated benefits and may lead to charges that will adversely affect our results and operations.
In the fourth quarter of 2014, we implemented a cost reduction plan that was designed to reduce our operating expenses. These cost reduction efforts resulted in a restructuring charge of $0.6 million in the fourth quarter of 2014. Additionally, actual costs related to such efforts may exceed the amounts that we previously estimated or we may undertake additional restructuring efforts in the future, leading to additional charges as actual costs are incurred. Reducing our operating expenses will involve, among other things, reducing the number of people we employ. This reduction in personnel may lead to additional voluntary departures and may negatively impact our ability to achieve our near-term business objectives, including our product development and sales efforts, which could adversely affect out results of operations in the near term and our competitiveness in the longer term.
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We have a limited operating history, which makes it difficult to evaluate our current business and future prospects.
We were incorporated in 2006, and began selling our solutions and generating revenue in 2009. Our limited operating history makes financial forecasting and evaluation of our business difficult. Moreover, we compete in markets characterized by rapid technological change, changing customer needs, evolving industry standards and frequent introductions of new products and services. We continue to increase the breadth and scope of our solutions and, correspondingly, the breadth and scope of our operations. For example, in December 2012, we released for general availability our Blue Planet carrier-grade software-defined networking platform. We have limited historical data and have had a relatively limited time period in which to implement and evaluate our business strategies as compared to companies with longer operating histories. As a result, it is difficult to forecast our future revenue growth, if any, and to plan our operating expenses appropriately, which in turn makes it difficult to predict our future operating results. In the course of our development efforts, we may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new solutions, services and enhancements, any of which could result in lower sales, which would harm our business, operating results and financial condition.
We currently generate the majority of our revenue from the sale of our Z-Series platforms and therefore a decrease in purchases of these platforms would adversely affect our revenue and our operating results.
Historically, our Z-Series platforms have accounted for substantially all of our revenue, and we expect to continue to derive a substantial majority of our revenue from sales of these platforms in the near term. As a result, our future financial performance will depend heavily on our ability to continue to sell existing, and to develop and sell enhanced, versions of our Z-Series platforms as well as our recently introduced N-Series platforms, both to existing and new customers. If current market demand for these products diminishes, or we fail to deliver product enhancements, new releases or new products that customers want, overall demand for our solutions and related services would decrease, and our operating results would be harmed.
If the SDN and NFV markets do not develop as we anticipate, or if we are unable to increase market awareness of our company and our solutions within those markets, demand for our Blue Planet solution may not grow, and our future results would be adversely affected.
Fundamental to our solution is our Blue Planet SDN and network functions virtualization NFV platform. As a result, our long-term success will depend to a significant extent on potential customers recognizing the benefits of our solutions over legacy systems and products, and the willingness of service providers and high-performance data center and other network operators to increase their use of SDN and NFV solutions in their networks. The market for SDN and NFV solutions is at an early stage and it is difficult to predict important trends, including the potential growth, if any, of this market.
If the market for SDN and NFV solutions does not evolve in the way we anticipate or if customers do not recognize the benefits of our solutions, we likely would not be able to increase sales of our Blue Planet platform. To date, some network operators have been reluctant to switch to SDN and NFV solutions because they have invested substantial resources to maintain and integrate legacy solutions into their networks. These network operators may continue allocating their network budgets to the maintenance and upgrading of their legacy systems and products and therefore not adopt our SDN or NFV solutions in addition to or as a replacement for these legacy systems and products. We also what appear to be delays in service provider purchasing decisions to traditional network equipment, including our Z-Series products, as the service providers pause to evaluate their plans for these technologies.
Even if the market for SDN and NFV solutions develops as we anticipate, market awareness of our SDN and NFV solutions will be essential to our long-term growth. We cannot assure you that network operators will accept the value proposition that we believe our solutions provide. If we are not successful in creating market awareness of our company and our full suite of SDN and NFV solutions, our business, financial condition and operating results would be adversely affected.
If our SDN platform, Blue Planet, or any other new solutions we develop face challenges for market acceptance, our revenue and operating results would be adversely affected.
We initially released Blue Planet in December 2012. Currently, our Blue Planet offering has an unproven revenue model and has accounted for an immaterial amount of our revenue. If network operators do not perceive the benefits of Blue Planet, the market for Blue Planet may not develop or may develop more slowly than we expect, either of which would adversely affect our revenue growth prospects. The widespread acceptance of Blue Planet will require not only the recognition and adoption of SDN and NFV as a whole over legacy systems and products, but also the adoption of Blue Planet by our current and potential customers to meet their SDN and NFV requirements. We also face the risk of having a limited time to market in order to establish Blue Planet over any alternative solutions or technologies that network operators utilize for SDN,
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NFV and other network management. In addition, we have limited experience in pricing Blue Planet separately from our Z-Series platforms, which could result in underpricing that adversely affects our expected financial performance, or overpricing that inhibits our customer acceptance of Blue Planet. Moreover, many network equipment providers, including us, provide basic element management software at little or no additional cost to hardware customers. As a result, network operators are not accustomed to paying for software and may not be willing to pay meaningful amounts for such software regardless of the value it creates for them. Even if the initial development and commercial introduction of Blue Planet is successful, we cannot assure you that it will achieve widespread market acceptance or that any market acceptance will be sustainable over the longer term. If Blue Planet does not gain market acceptance at a sufficient rate of growth, our business and operating results would be adversely affected.
We operate in highly competitive markets, and competitive pressures from existing and new companies may adversely affect our business, operating results and market share.
The markets in which we operate are highly competitive and characterized by rapidly changing customer needs and evolving industry standards. We expect competition to intensify in the future as existing competitors and new market entrants introduce new products or enhance existing products. Our business will be adversely affected if we are unable to compete effectively to meet the demand for existing products as well as innovate to bring new products and solutions to market.
We compete either directly or indirectly with large networking and optical companies, such as Alcatel-Lucent SA, Ciena Corporation, Cisco Systems, Inc., Fujitsu Limited, Huawei Technologies Co. Limited and Juniper Networks, Inc., and specialized technology providers that offer solutions that address a portion of the issues that we address. In addition, we seek to replace legacy network control tools and processes that network operators have either already purchased or internally developed, and potential customers may be reluctant to adopt a solution that replaces or changes existing systems and processes in which they have made significant investments. In the future, in selling Blue Planet we may also compete with companies that are focused on providing virtualization software solutions for other end-markets as they may try to adapt their solutions to meet the needs of network operators or compete with networking companies that develop or acquire SDN or NFV solutions. Some of our competitors have made, or may make, acquisitions of businesses that may allow them to offer solutions that are more directly competitive and comprehensive than those they currently offer.
We expect competition and competitive pressure from both new and existing competitors to increase in the future. Additionally, many of our competitors have greater name recognition, longer operating histories, well-established relationships with customers or channel partners in our markets and substantially greater financial, technical, personnel and other resources than we have. Our competitors may be able to anticipate, influence or adapt more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the promotion and sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisitions or other opportunities more readily and develop and expand their product and service offerings more quickly than we can. In addition, competitors with substantially larger installed customer bases may leverage their relationships and incorporate functionality into their existing products in a manner that may discourage customers from purchasing our solutions. These larger competitors may also have more diversified businesses that allow them to better withstand significant reductions in capital spending by customers. Moreover, potential customers may also prefer to purchase from their existing providers rather than a new provider, regardless of product performance or features, because our solutions may require additional investment of time and funds to install the solutions and to train operations personnel. In addition, some of our competitors may offer substantial discounts, rebates or financing to win new or retain existing customers, or may bundle different products and services together in a package to their customers where they include products and services that directly compete with our solutions at very low prices or even for free. If we are unable to win customers, or if we are forced to reduce prices in order to secure customers, our business and operating results may be adversely affected.
We operate in a rapidly evolving market and if we are unable to develop and introduce new solutions or make enhancements to existing solutions that successfully respond to emerging technological trends and achieve market acceptance, our revenue and growth prospects would likely be adversely affected.
Our market is characterized by rapidly changing technology, changing customer needs, evolving industry standards and frequent introductions of new products and services. Our future success will depend significantly on our ability to effectively anticipate and timely adapt to such changes, and to develop and offer, on a timely and cost-effective basis, hardware and software solutions with features that meet changing customer demands, technology trends and industry standards. Our solutions have been developed to rely upon open standards for integration and functionality with legacy networks and third-party vendor network equipment and applications, and we cannot assure you that these standards will continue to receive market acceptance. Additionally, such open standard design could make it easier for competitors to more quickly and inexpensively develop and offer their own products and services based on the same technology. If our competitors introduce
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new products and services that compete with ours, we may be required to reposition our solutions or introduce new solutions in response to such competitive pressure. If we fail to develop new products or product enhancements, or our customers or potential customers do not perceive our solutions to have compelling advantages, our business, revenue and growth prospects would be adversely affected.
We intend to continue making significant investments in further developing and enhancing the functionality of our Blue Planet, Z-Series and N-Series platforms. Developing our solutions is expensive, complex and involves uncertainties. We intend to continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, we may not have sufficient resources to successfully manage these hardware and software development cycles, and these investments may take several years to generate positive returns, if ever.
The future growth of our business depends, in significant part, on increasing our international sales, and even if we are successful in expanding internationally, our business will be susceptible to risks associated with international operations.
We currently generate a significant majority of our sales from customers in the United States, and only in 2012 did we begin significant efforts to offer our solutions internationally. We have limited experience managing the sales, support and administrative aspects of a worldwide operation. For the years ended December 31, 2014 and 2013 and the three months ended March 31, 2015, revenue from customers outside of the United States was approximately 22% and 9% and 10%, respectively. The future growth of our business depends, in significant part, on increasing our international sales. We may not be successful in our efforts to expand our international operations, including as a result of not being able to increase or maintain international market demand for our solutions, and entry into additional international markets will require significant management attention and financial resources. Our failure to successfully grow internationally could limit the future growth of our business and, consequently, affect our business, operating results and financial condition.
In the course of expanding our international operations and operating overseas, we will be subject to a variety of risks, directly and indirectly through our channel partners, including:
• | longer than expected sales cycles; |
• | international trade costs and restrictions, including trade laws, tariffs, export quotas, custom duties or other trade restrictions, affecting our sales; |
• | treatment of revenue from international sources and changes to tax codes, including being subject to foreign tax laws and responsibility for paying withholding income or other taxes in foreign jurisdictions; |
• | compliance with multiple, conflicting and changing governmental laws and regulations, including employment, tax, privacy, data protection, communications and Internet laws and regulations, and the risks and costs of non-compliance; |
• | compliance with U.S. laws and regulations applicable to foreign operations, including the Foreign Corrupt Practices Act, import and export control laws, tariffs, trade barriers, economic sanctions and other regulatory limitations on our ability to sell our solutions in certain foreign markets, and the risks and costs of non-compliance; |
• | challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement appropriate systems, policies, compensation and benefits and compliance programs; |
• | difficulties in and the potentially high costs of staffing foreign operations; |
• | difficulties in enforcing contracts, longer accounts receivable payment cycles and the potential corresponding adverse impact on our days sales outstanding; |
• | the imperative to adapt our solutions to meet the differing standards of one or more other countries; |
• | the risk of change in political or economic conditions for foreign countries, and the potential for political unrest, acts of terrorism, hostilities or war; |
• | localization of products and services, including translation into foreign languages and associated expenses; |
• | differing laws and business practices, which may favor local competitors; |
• | foreign currency fluctuations and controls; and |
• | limited or unfavorable intellectual property protection in foreign jurisdictions. |
Each of these risks could have an adverse effect on our overall business, operating results and financial condition.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable investment of time and expense. As a result, our sales and revenue are difficult to predict and may vary substantially from period to period, which may cause our operating results to fluctuate significantly.
Our sales process entails planning discussions with prospective customers, analyzing their existing networks and identifying how these potential customers can leverage our solutions within their networks. The sales cycle for a new customer
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deployment, from the time of prospect qualification to the completion of the first sale, may span multiple quarters. The sales cycles with larger carriers, potential customers in international markets and customers evaluating shifting from legacy hardware-based solutions to SDN and/or NFV based solutions can be even longer. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales of our solutions. If we invest substantial resources pursuing unsuccessful sales opportunities, our business, operating results and financial condition would be harmed. In addition, purchases by network operators of our solutions are subject to budget constraints, multiple approvals and unplanned administrative, processing and other delays. If sales expected from a specific customer for a particular quarter are not realized in that quarter, or at all, we may not achieve our revenue expectations.
We engage channel partners to promote, sell, install and support our solutions internationally, and we intend to continue to expand our international channel partner network. Any failure to effectively develop and manage this distribution channel could adversely affect our business, operating results and market share.
We engage channel partners who provide sales and support services for our solutions to reach customers outside of the United States. If we do not properly identify, engage and train our channel partners to sell, install and service our solutions, or if a new channel partner is not able to execute on our sales strategy, our business, financial condition and operating results may suffer. The loss of a key channel partner or the failure of a channel partner to provide adequate customer service could have a negative effect on customer satisfaction and could cause harm to our business. Our use of channel partners and other third-party support partners, and the associated risks, are likely to increase as we seek to expand our international sales. Generally, our channel partners do not have long-term contractual commitments or exclusivity to us. We also compete with other network systems providers for our channel partners’ business as many of our channel partners market competing products. If a channel partner promotes a competitor’s products to the detriment of our solutions or otherwise fails to market our solutions effectively, we would lose market share.
Changes in government-sponsored programs, especially decreases in government funding, could affect the timing and buying patterns of certain of our customers, which would cause reduced sales of our solutions and fluctuations in our operating results.
Over the past several years, our customer base has included Independent Operating Companies (IOCs) and other telecommunications network providers that benefited from federal and state subsidies. Approximately 13% of our revenue for the years ended December 31, 2014 and 2013, was attributable to sales of our solutions to IOCs and other service providers that used government-supported loan programs or grants to fund purchases from us, such as those originating from the Rural Utility Service (RUS) program administered by the U.S. Department of Agriculture, and broadband stimulus programs under the American Recovery and Reinvestment Act of 2009. During 2014, while we recognized revenue as a result of acceptance of earlier stimulus-funded projects, our bookings of new stimulus-related projects were substantially lower than in prior years. While we expect stimulus-related investment to generally increase in 2015 over the 2014 level, there can be no assurance that IOCs that we serve will benefit from such programs or that even if benefiting, their spending will be targeted at the portions of the networks served by our products. To the extent that any of our customers have received grants or loans under these RUS and stimulus programs but no longer have access to such assistance, or to the extent that they are focusing on other elements of their networks, they may substantially reduce or curtail future purchases of our solutions.
Our business and operations have experienced rapid growth in recent periods, and if we are unable to effectively manage this growth and expansion, or if our business does not continue to grow as we expect, including with respect to our recruitment of qualified personnel, our operating results may suffer.
We experienced rapid growth and have significantly expanded our operations since our inception, which has placed a strain on our management, administrative, operational and financial infrastructure. Our success will depend in part upon our ability to manage our business effectively.
We believe that our future success will depend in large part upon our ability to identify, attract and retain highly qualified and skilled personnel, particularly engineers and sales personnel. Competition for skilled personnel is intense, particularly for those specializing in network and software engineering and sales, and those located in the San Francisco Bay Area. In addition, our headquarters location in Petaluma, in the northern part of the San Francisco Bay Area, may make it more difficult to attract qualified personnel that live in other parts of the Bay Area. In addition, declines in the trading price of our common stock may make attracting and retaining our employees more difficult given the competitive compensatory environment we face recruiting technology employees in the San Francisco Bay Area. We cannot be certain that we will be successful in attracting and retaining qualified personnel, or that newly hired personnel will function effectively, both individually and as a group.
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Our ability to manage our operations will further require us to refine our operational, financial and management controls, human resource policies, and reporting systems and procedures. If we fail to efficiently expand our sales force, engineering, operations, IT or financial systems, or otherwise manage our business, our costs and expenses may increase more than we plan and we may lose the ability to close customer opportunities, enhance our existing products and services, satisfy customer requirements, respond to competitive pressures or otherwise execute our business plan. These additional investments will increase our operating costs, which will make it more difficult for us to offset any future revenue shortfalls in the short term by reducing expenses. Moreover, if we fail to scale our operations successfully, our business and operating results could be adversely affected.
We do not have long-term, committed-volume purchase contracts with our customers for our products, and therefore have no guarantee of future revenue from any customer, which may cause our operating results to be adversely affected.
Sales of our Z-Series platforms are made, and we expect sales of our N-Series platforms to be made, pursuant to purchase orders, and we have not entered into long-term, committed-volume purchase contracts with our customers, including our largest customer, Windstream. As a result, any of our customers may cease to purchase our hardware solutions at any time. In addition, our customers may attempt to renegotiate their terms of purchase, including price and quantity, or may delay or cancel already submitted purchase orders. If any of our customers stop purchasing our hardware solutions for any reason, or purchase fewer solutions, our operating results and financial condition would be harmed.
We currently rely upon a single contract manufacturer to manufacture our hardware solutions, and if we encounter problems with the contract manufacturer, our operations could be disrupted, which would adversely affect our business, operating results, financial condition and customer relationships.
We contract with Flextronics International, Ltd., or Flextronics, as the sole manufacturer of all of our Z-Series and N-Series platforms. Our reliance on Flextronics makes us vulnerable to possible capacity constraints and reduced control over delivery schedules, manufacturing yields and costs. We have limited direct control over the quality and control systems of Flextronics, and therefore may not be able to ensure levels of quality suitable for our customers. The revenue that Flextronics generates from our orders represents a very small percentage of its revenue. As a result, fulfilling our orders may not be considered a priority by Flextronics. If Flextronics were unable or unwilling to continue manufacturing our Z-Series platforms or commence and maintain manufacturing of our N-Series platforms, in required volumes and at high quality levels, or if Flextronics significantly increased our costs to have them manufacture our products, we would have to identify, qualify and select an acceptable alternative contract manufacturer. Such alternatives may not be available to us when needed, may take a significant amount of time to contract with and establish manufacturing or supply relationships, and may not be in a position to timely satisfy our production requirements at commercially reasonable prices and quality. Any significant interruption in manufacturing would require us to reduce the amount of Z-Series and N-Series platforms available to our customers, which in turn would reduce our revenue and adversely affect our business, operating results, financial condition and customer relationships.
If we fail to accurately forecast our manufacturing requirements or manage our inventory with our contract manufacturer, we could incur additional costs, lose revenue and harm our business, operating results, financial condition and customer relationships.
The suppliers of the components used in our Z-Series and N-Series platforms generally deliver the components directly to our contract manufacturer, Flextronics, but we bear the inventory risk under our arrangements with Flextronics. As of December 31, 2014 and 2013 and March 31, 2015 we had commitments to Flextronics totaling $9.7 million, $7.9 million and $19.1 million, respectively. Lead times for the materials and components that we order through Flextronics vary significantly and depend on numerous factors, including the specific supplier, contract terms and market demand for a component at a given time. The lead times for certain key materials and components could be lengthy depending on overall market demand, requiring us or Flextronics to order materials and components several months in advance of their use in manufacturing our products. If we overestimate our production requirements, Flextronics may purchase excess components and build excess inventory. If Flextronics purchases excess components or builds excess products, we could be required to pay for these excess components or products and recognize related inventory write-down costs. We also are required to reimburse Flextronics if our inventory is rendered obsolete for any reason. If we experience inventory write-downs associated with excess or obsolete inventory in any significant amount, this would have an adverse effect on our financial condition and operating results. Conversely, if we underestimate our product requirements, our contract manufacturer may maintain inadequate component inventory and be unable to manufacture our Z-Series and N-Series platforms in sufficient quantities to timely meet customer demand. Any shortfall in available products could result in delays or cancellation of orders by our customers, which could have an adverse effect on our business, operating results, financial condition and customer relationships.
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Certain component parts used in the manufacture of our products are sourced from single or limited source suppliers. If we are unable to source these components on a timely basis, we will not be able to meet our customers’ product delivery requirements, which could adversely affect our business, operating results, financial condition and customer relationships.
We depend on certain sole-source and limited source suppliers for key components that Flextronics, our contract manufacturer, uses in the manufacture of our Z-Series and N-Series platforms. Any of the sole-source and limited source suppliers upon whom we rely could stop producing our components, cease operations or be acquired by, or enter into exclusive arrangements with, our competitors. In particular, our reliance on Broadcom Corporation for certain key semiconductors and other third parties for certain optical components used in our hardware solutions makes us vulnerable to shortages or pricing pressure on these important components. Neither we nor Flextronics generally has long-term supply agreements with component suppliers, and our purchase volumes currently may be considered too low for us to be a priority customer by many of such suppliers. As such, we cannot be guaranteed a continuous source of, or favorable pricing for, components from any of these suppliers. Furthermore, patent infringement lawsuits between semiconductor companies could have an adverse effect on our ability to acquire components that are sole sourced and integrated into our Z-Series and N-Series platforms, leading to production delays and additional engineering costs, potentially harming our business and customer relationships. Any such interruption or delay may force us to seek similar components or products from alternative sources, which may not be available on commercially reasonable terms, or at all. Switching suppliers may require that we redesign our Z-Series and/or N-Series platforms to accommodate new components, and to re-qualify these solutions, which would be costly and time-consuming. Any interruption in the supply of sole-source or limited source components for our solutions would adversely affect our ability to meet scheduled product deliveries to our customers and could result in lost revenue or higher expenses, any of which would harm our business, operating results, financial condition and customer relationships.
Our future success depends in part on revenue from Blue Planet and our other services, and because we generally recognize revenue from Blue Planet over the term of the relevant contractual period, downturns or upturns in sales will not likely be reflected in full in our operating results for the period in which such downturns or upturns occur.
Sales of new or renewed term licenses, support and maintenance contracts, especially with respect to Blue Planet, may decline and fluctuate as a result of a number of factors, including our customers’ level of satisfaction with our solutions, the prices of our solutions, the prices of products and services offered by our competitors and reductions in our customers’ spending levels. If our sales of new or renewals of term licenses, support and maintenance contracts decline, our revenue and revenue growth will decline and our business will suffer. In addition, we generally recognize Blue Planet and service contract revenue ratably over the term of the relevant contractual period. As a result, much of the term license and service revenue that we report each quarter is the recognition of deferred revenue from term licenses and service contracts entered into during previous quarters. Accordingly, any decline in new or renewed term licenses or service contracts in any one quarter will not be fully reflected in revenue in that quarter but will negatively affect our revenue in future quarters. In addition, it may be difficult for us to rapidly increase our revenue through additional sales in any period, as Blue Planet revenue is generally recognized over the term of the contract.
Our solutions are highly complex and may contain undetected hardware errors or software bugs, which could harm our reputation and increase our warranty obligations and service costs.
Our solutions are highly technical and, when deployed, are critical to the operation of our customers’ networks. Our solutions have from time to time contained and may in the future contain undetected errors, bugs, defects or security vulnerabilities. Some errors in our solutions may only be discovered after a solution has been deployed and used by customers, and may in some cases only be detected under certain circumstances or after extended use. Any errors, bugs, defects or security vulnerabilities discovered in our solutions after commercial release could result in loss of our revenue or delay in revenue recognition, loss of customer goodwill and customer relationships, harm to our reputation and increased service costs, any of which would adversely affect our business, operating results and financial condition. Quality or performance problems related to our Z-Series or N-Series platforms that are covered under warranty could require us to repair or replace defective products at no additional cost to the customer. For example, in the second quarter of 2013, we experienced higher than expected failure rates with certain Z-Series line cards used by a number of our customers that were manufactured between 2010 and the spring of 2012. After extensive analysis of the root cause, we identified a line card power supply as the source of the failures. We elected to undertake a proactive warranty repair and replacement program for line cards we have determined to be at risk of early failure. While in this instance we were able to negotiate an agreement for the manufacturer of the defective components to reimburse us for a substantial portion of the costs of the repair and replacement program and we believe that our warranty reserve is sufficient to cover expected costs, including any unreimbursed costs, if we experience quality or performance problems in the future related to our Z-Series or N-Series platforms or other products that are covered under warranty, we could be required to repair or replace defective products without the benefit of manufacturer reimbursement, which could have a material adverse effect on our reputation and results of operations. In addition, any errors discovered in Blue Planet could cause
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customers and potential customers to abandon or never adopt Blue Planet, which could adversely affect our ability to grow our business. Moreover, we could face claims for product liability, tort or breach of contract from our customers, or be required to indemnify our customers for damages and third-party claims for a variety of reasons. Any increased costs, liabilities and diversion of resources associated with a warranty or other claim related to errors or alleged errors in our solutions could adversely affect our business, operating results and financial condition.
Our solutions must interoperate with existing legacy and competitor software applications and hardware products found in our customers’ networks. If our solutions do not interoperate properly, future sales of our solutions could be negatively affected, which would harm our business.
Our solutions must interoperate with our customers’ existing and planned networks, which often have varied and complex specifications, utilize multiple protocol standards, software applications and products from multiple vendors and may contain multiple generations of products that have been added over time. Our solutions must communicate, manage and analyze networks and the traffic across these networks, often across differing legacy protocols and technologies. As a result, we have developed and are continuing to develop interfaces that enable our solutions to achieve the desired level of interoperability with these existing and planned networks and network components, including legacy networks that operate on technology originally designed several decades ago. To meet these interoperability requirements, we continuously engage in development efforts that require substantial resources. If we fail to develop or maintain compatibility with other software or equipment included in our customers’ existing and planned networks, our opportunity to sell our solutions may be adversely impacted and we may incur significant warranty, support and repair costs, cause significant customer relations problems and divert the attention of our engineering personnel from our product development efforts, and our business and operating results would be adversely affected. In addition, if our competitors, whose software or equipment incorporate these protocols and technologies, fail to make available to us on an ongoing basis the interfaces and other information we require to maintain the interoperability of our solutions with their software and equipment, our business and operating results would be adversely affected.
If we fail to comply with evolving network industry technical requirements and standards, sales of our existing and future solutions would be adversely affected, which could adversely affect our operating results and growth prospects.
The markets for our solutions are characterized by a significant number of standards, both domestic and international, which are evolving as new network technologies are deployed. Our solutions must comply with these standards in order to be widely marketable. In some cases and particularly in international markets, we may be required to obtain certifications or authorizations before our solutions can be introduced, marketed or sold in new markets or to new customers. In addition, our ability to expand our international operations and create international market demand for our solutions may be constrained by regulations or standards adopted by other countries that may require us to redesign our existing solutions or develop new products suitable for sale in those countries. We cannot assure you that we will be able to design our solutions to comply with evolving standards and regulations. The cost of complying with evolving standards and regulations, or our failure to obtain timely domestic or foreign regulatory approvals or certifications, may prevent us from selling our solutions where such standards or regulations apply, which could adversely affect our operating results and growth prospects.
Our ability to sell our solutions is highly dependent on the quality of our support and service offerings, and our failure to offer high quality support and services would have an adverse effect on our business, reputation and operating results.
Once our solutions are deployed within our customers’ networks, our customers depend on our support organization to quickly resolve any issues relating to those products. A high level of support is critical for the successful marketing and sale of our solutions. If we do not effectively assist our customers in deploying our solutions, succeed in helping them quickly resolve post-deployment issues or provide effective ongoing support, it could adversely affect our ability to sell our solutions to existing customers and harm our reputation with potential new customers, which would have an adverse effect on our business, reputation and operating results.
Uncertain global economic conditions may harm our industry, business, operating results and financial condition.
Our overall performance depends in large part on global economic conditions which have been challenging in recent periods and may continue to be challenging for the foreseeable future. Global financial developments seemingly unrelated to us or the network industry may harm our business by negatively affecting the demand for networking equipment. The United States, Europe and China have been adversely affected in the recent past, and continue to face economic uncertainty. These conditions can affect the rate of spending on network services, could adversely affect our customers’ ability or willingness to purchase our solutions and could delay prospective customers’ purchasing decisions. In addition, a prolonged economic
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downturn could affect the viability of our current business strategy. All of these factors could reduce our revenue and harm our business, operating results and financial condition.
Third parties may assert that we are infringing upon their intellectual property rights, which could harm our business, operating results, financial condition and growth prospects.
There is considerable patent and other intellectual property development activity, and litigation related to intellectual property rights, in the technology industry in general and the networking industry in particular. From time to time, our competitors, other third-party developers of technology, non-practicing entities and other third party intellectual property owners, commonly referred to as “patent trolls,” have and may claim that we are infringing upon their patent, trademark and other intellectual property rights. Regardless of the merit of any such claim, responding to such claims can be time consuming, divert management’s attention and resources and may cause us to incur significant expenses. We cannot assure you that we would be successful in defending against any such claims. In addition, patent applications in the United States and most other countries are confidential for a period of time before being published, so we cannot be certain that we were the first to conceive inventions covered by our patents or patent applications. Moreover, we cannot be certain that we are not infringing third parties’ patent or other intellectual property rights. An adverse outcome with respect to any intellectual property claim could invalidate our proprietary rights and/or force us to, among other things, do one or more of the following:
• | obtain from a third party claiming infringement a license to sell or use the relevant technology, which may not be available on reasonable terms, or at all; |
• | stop manufacturing, selling, or using our solutions that embody the asserted intellectual property and refund to customers all or a portion of the fees related to the purchase or license of such solutions; |
• | pay substantial monetary damages; |
• | indemnify our customers and/or commercial partners against third-party claims for intellectual property infringement pursuant to indemnification obligations under our contracts, generally without limit; |
• | expend significant resources to redesign our solutions that use the infringing technology and to develop or acquire non-infringing technology; or |
• | rebrand or rename our products and services in a manner that does not infringe third party trademark or other intellectual property rights, which could harm our brand recognition in the marketplace. |
Additionally, if we offer employment to personnel employed or formerly employed by competitors, we may become subject to claims of unfair hiring practices and/or breaches of confidentiality related to the intellectual property of such competitors, and incur substantial costs in defending ourselves against these claims, regardless of their merits. Any of these actions could adversely affect our business, operating results, financial condition and growth prospects.
If we are unable to successfully manage our use of “open source” software, our ability to sell our products and services could be harmed, which could result in competitive disadvantages, and subject us to possible litigation.
We incorporate open source software code in our proprietary software that is part of both our Z-Series and N-Series infrastructure platforms and our Blue Planet software platform. Use of open source software can lead to greater risks than the use of proprietary or third-party commercial software since open source licensors generally do not provide warranties or controls with respect to origin, functionality or other features of the software. Some open source software licenses require users who distribute open source software as part of their products to publicly disclose all or part of the source code in their software and make any derivative works of the open source code generally available in source code form for limited fees or at no cost. In addition, some customers may seek restrictions on the way in which we utilize open source software in solutions that would be deployed in their networks. Although we monitor our use of open source software, open source license terms may be ambiguous, and many of the risks associated with the use of open source software cannot be eliminated. If we were found to have inappropriately used open source software in our solutions, we may be required to release our proprietary source code, re-engineer our software, discontinue the sale of certain solutions in the event re-engineering cannot be accomplished on a timely basis, or take other remedial action. Furthermore, if we fail to comply with applicable open source licenses, we may be subject to costly claims of intellectual property infringement or demands for the public release of proprietary source code. Any of the foregoing could harm our business and put us at a competitive disadvantage.
If we are unable to protect our intellectual property rights, our competitive position, ability to protect our proprietary technology and our brand could be harmed or we could be required to incur significant expense to enforce our rights.
Our success depends in part on our ability to protect our core technology and intellectual property. We rely on a combination of intellectual property rights, including trade secret laws, copyrights, patents and trademarks, as well as customary contractual provisions. To date we have only five issued U.S. patents, and do not have any patents issued outside the
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United States. Moreover, our issued patents and the patent applications that we have filed may not cover important aspects of our technology, and may not be enforceable. We also license software from third parties for integration into our products, including open source software and other commercially available software. Furthermore, from time to time, we may enter into development arrangements with third parties where the resulting intellectual property is jointly owned. We generally control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including contractual protections with employees, contractors, customers and partners. We also incorporate certain generally available software programs into Blue Planet and our other software solutions pursuant to license agreements with third parties. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors.
The steps we have taken to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our intellectual property rights. We may initiate claims against third parties that we believe are infringing our intellectual property rights if we are unable to resolve matters satisfactorily through negotiation. If we fail to protect our intellectual property rights adequately, our competitors could offer similar products, potentially harming our business. In some cases, third parties with whom we may jointly own intellectual property rights may be able to use their joint ownership rights to compete with us. Our intellectual property rights may be challenged by others or invalidated through administrative process or litigation. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel. Effective trademark, copyright, trade secret and patent protection may not be available to us in every country in which we provide our solutions. The laws of some foreign countries are not as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights in these jurisdictions may be inadequate. We may be required to spend significant resources to monitor and protect our intellectual property rights, and such monitoring may be insufficient to detect all misappropriation or infringement of our rights. In addition, in some instances, for cost-benefit reasons we may choose not to pursue, or to abandon, applications for certain patents, registered trademarks and other registered intellectual property in particular jurisdictions. We may initiate claims or litigation against third parties for infringement of our intellectual property rights or to establish the validity of such rights.
If we lose key members of our management or engineering teams or are unable retain executives and employees that we need to support our operations and growth, our business and operating results may be harmed.
Our success depends, in large part, on the continued contributions of our key management, engineering, sales personnel and other employees, many of whom are highly skilled and would be difficult to replace. None of our senior management or key technical or sales personnel is bound by a written employment contract to remain with us for a specified period. Moreover, any of our employees may terminate their employment at any time. Many of our key employees have become, or will soon become, vested in a substantial amount of their shares of common stock or stock options or are holding options with exercise prices above the recent trading price of our common stock. Employees may be more likely to leave us if the shares they own, or the shares underlying their stock options, have vested or are not viewed as competitive on a compensatory nature. In addition, we do not maintain key man life insurance covering our key personnel. The loss of the services of any of our key personnel may harm our business and operating results.
Our failure to comply with laws and regulations, including regulations affecting the import or export of products and anti-bribery laws, could harm our business.
Our business is subject to regulation by various federal, state, local and foreign governmental agencies, including agencies responsible for monitoring and enforcing employment and labor laws, workplace safety, product safety, environmental laws, consumer protection laws, anti-bribery laws, import/export controls, federal securities laws, and tax laws and regulations.
In certain jurisdictions, these regulatory requirements may be more stringent than those in the United States. Noncompliance with applicable regulations or requirements could subject us to investigations, sanctions, product recalls, enforcement actions, disgorgement of profits, fines, damages, civil and criminal penalties or injunctions. If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, operating results, and financial condition could be adversely affected. In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions could harm our business, reputation, operating results and financial condition. Any change in laws, regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could negatively affect our ability to sell our solutions and could adversely affect our business, operating results and financial condition. Our recent international expansion creates additional regulatory challenges. Future international shipments of our solutions may require export licenses or export license exceptions. In addition, the import laws of other countries may limit our ability to distribute our solutions, or our customers’ ability to buy and use our solutions, in those countries. Changes in our solutions or changes in export and import regulations may create delays in the introduction of our
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solutions in international markets, prevent our customers with international operations from deploying our solutions or, in some cases, prevent the export or import of our solutions to certain countries altogether. We expect that our global operations will require us to import and export to and from several countries, resulting in additional compliance obligations.
The U.S. Foreign Corrupt Practices Act (FCPA) the United Kingdom Bribery Act 2010 (Bribery Act) and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to government officials and others for the purpose of obtaining or retaining business. Under these laws, companies are required to maintain records that accurately and fairly represent their transactions and have an adequate system of internal accounting controls. We are expanding to operate in areas of the world, including in conjunction with our channel partners, in which corruption may be more prevalent and in certain circumstances, compliance with anti-bribery laws may conflict with local customs and practices. In addition, network operators in various foreign countries are owned, in whole or in part, by foreign governments or instrumentalities. In such cases, the people with whom we engage in connection with our selling activities may be government officials. We cannot assure you that our employees, channel partners or other agents will not engage in prohibited conduct and render us responsible under the FCPA, the Bribery Act or any similar anti-bribery laws in another jurisdiction. If we are found to be in violation of the FCPA, the Bribery Act or other anti-bribery laws, either due to our nascent compliance system or the acts or omission of our employees, channel partners or other agents, we could suffer criminal or civil penalties or other sanctions, which could have an adverse effect on our business.
Changes in telecommunications and Internet laws, regulations, rules and tariffs could impede the growth in network activity or otherwise harm our customers, which could have a negative effect on our business and operating results.
Increased regulation of telecommunications and Internet network activity or access in the United States or any country in which we do business, particularly those that have the effect of impeding, or lessening the rate of growth in, network activity, could decrease demand for our solutions. New or increased access charges for telecommunications service providers and tariffs on certain communications services could negatively affect our customers’ businesses. Further, many of our customers are subject to the Federal Communications Commission (FCC) rate regulation of interstate telecommunications services, and are recipients of federal universal service fund payments, which are intended to subsidize telecommunications services in areas that are expensive to serve. In addition, many of our customers are subject to state regulation of intrastate telecommunications services, including rates for such services, and may also receive funding from state universal service funds. Changes in rate regulations or universal service funding rules, either at the federal or state level, could adversely affect such customers’ revenue and capital spending plans. Any adoption of new laws, regulations, rules or tariffs, or changes to existing laws, regulations, rules or tariffs, that negatively affects network activity or growth or otherwise adversely affects the business of our customers could harm our business and operating results. For example, while our business is not directly subject to regulation by the FCC, the FCC’s recent “Open Internet” or “Net Neutrality” rules may impact the business of our U.S. customers which, in turn, may negatively impact their capital spending, including their purchases from us.
Industry consolidation may lead to increased competition or a decreased customer base, which could harm our business and operating results.
Consolidation in the network equipment industry has been common. Some of our competitors have made acquisitions or entered into partnerships or other strategic relationships to offer a more comprehensive solution than they had offered individually. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry are acquired for a variety of strategic reasons or are unable to continue operations. Consolidation in our industry may result in stronger competitors that may create more compelling product offerings, be able to offer greater pricing flexibility and or terms and conditions of sale, including providing customers with substantial financing, and be better able to compete as sole-source vendors for customers. This would make it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs and breadth of technology or product offerings. In addition, companies with which we have strategic partnerships may acquire or form alliances with our competitors, thereby reducing their business with us. Furthermore, continued industry consolidation may adversely affect customers’ perceptions of the viability of smaller and even medium-sized technology companies such as us and, consequently, customers’ willingness to purchase from such companies.
In addition, consolidation of network operators may lead to a reduction in the number of potential customers, with the effect that the loss of any major customer could have a greater effect on operating results than in a customer marketplace composed of more numerous participants. Consolidation among our customers may also cause delays or reductions in their capital expenditure plans and increased competitive pricing pressures as the number of available customers declines and their relative purchasing power increases in relation to suppliers. Consolidation in the number of potential customers could lead to more variability in our operating results and could have an adverse effect on our business.
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Unanticipated changes in effective tax rates or adverse outcomes resulting from examination of our income or other tax returns could adversely affect our operating results and financial condition.
We are subject to income taxes in the United States and various foreign jurisdictions, and our domestic and international tax liabilities will be subject to the allocation of expenses in differing jurisdictions. Our future effective tax rates could be subject to volatility or adversely affected by a number of factors, including:
• | changes in the valuation of our deferred tax assets and liabilities; |
• | expected timing and amount of the release of tax valuation allowances; |
• | expiration of, or detrimental changes in, research and development tax credit laws; |
• | expiration or non-utilization of net operating losses; |
• | tax effects of stock-based compensation; |
• | costs related to intercompany restructurings; |
• | changes in tax laws, regulations, accounting principles or interpretations thereof; or |
• | future earnings being lower than anticipated in countries where we have lower statutory tax rate and higher than anticipated earnings in countries where we have higher statutory tax rates. |
In addition, we may be subject to audits of our income and sales taxes by the Internal Revenue Service and other foreign and state tax authorities. Outcomes from these audits could have an adverse effect on our operating results and financial condition.
We may not be able to utilize a significant portion of our net operating loss or research and development tax credit carryforwards, which could adversely affect our operating results and financial condition.
As of December 31, 2014, we had $108.1 million of federal and $84.1 million of state net operating loss carryforwards available to reduce future taxable income. These net operating loss carryforwards begin to expire in 2026 for U.S. federal income tax and 2015 for state income tax purposes, and the research tax credit carryforwards begin to expire in 2027 for federal purposes, but do not expire for California purposes. U.S. federal and state income tax laws limit the amount of these carryforwards we can utilize in any given year upon a greater than 50% cumulative shift of stock ownership over a three-year period, including shifts due to the issuance of additional shares of our common stock, or securities convertible into our common stock. We may experience subsequent shifts in our stock ownership and, accordingly, there is a risk that our ability to use our existing carryforwards in the future could be limited and that existing carryforwards would be unavailable to offset future income tax liabilities, which could adversely affect our operating results and financial condition.
We are obligated to develop and maintain proper and effective internal control over financial reporting. We may not complete our analysis of our internal control over financial reporting in a timely manner, or these internal controls may not be determined to be effective, which may adversely affect investor confidence in the accuracy and completeness of our financial reports and the market price of our securities may be negatively affected.
Pursuant to Section 404 of the Sarbanes-Oxley Act we are required to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. In general, this assessment from year-to-year includes disclosure of any material weaknesses identified by our management in our internal control over financial reporting in compliance with Section 404. For any given period, we may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to certify that our internal controls are effective, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our common stock to decline, and we may be subject to investigation or sanctions by the SEC. We will be required to disclose changes made in our internal control and procedures on a quarterly basis. However, our independent registered public accounting firm will not be required to report on the effectiveness of our internal control over financial reporting pursuant to Section 404 until the later of the year following our first annual report required to be filed with the SEC, or the date we are no longer an “emerging growth company” as defined in the Jumpstart our Business Startups, or JOBS Act, if we take advantage of the exemptions contained in the JOBS Act. At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating. In addition, any remediation efforts we undertake may be costly and may not be successful or enable us to avoid a material weakness in the future.
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We may expand through acquisitions of, or investments in, other companies, business or technologies which may divert our management’s attention and result in additional dilution to our stockholders, and we may be unable to integrate acquired businesses and technologies successfully or achieve the expected benefits of such acquisitions or investments.
While we have not consummated any acquisitions to date, we may evaluate and consider potential strategic transactions, including acquisitions of, or investments in, complementary businesses, technologies, services, products and other assets in the future. We also may enter into relationships with other businesses to expand our product and service offerings, which could involve preferred or exclusive licenses, additional channels of distribution, discount pricing, investments in other companies or strategic or joint venture partnership agreements. Acquisitions may disrupt our business, divert our resources and require significant management attention that would otherwise be available for development of our existing business. The anticipated benefits of any acquisition, investment or business relationship may not be realized, or we may be exposed to risks or liabilities that were unknown at the time of the acquisition or that are different from those that faced our business prior to the acquisition. Negotiating and consummating these transactions can be time-consuming, difficult and expensive, and our ability to close these transactions may often be subject to approvals that are beyond our control. Consequently, these transactions, even if undertaken and announced, may not close. For one or more of those transactions, we may:
• | use cash that we may need in the future to operate our business; |
• | incur debt on terms unfavorable to us or that we are unable to repay; |
• | issue additional equity securities that would dilute our stockholders; |
• | increase our working capital requirements; |
• | incur substantial liabilities or large charges, such as impairment of goodwill or intangible assets, at the time of the transaction or for some period long after the transaction; |
• | encounter difficulties retaining key employees of the acquired company or integrating diverse solutions or business cultures; |
• | acquire companies with inadequate financial or operational reporting or control environments; and |
• | become subject to adverse tax consequences, substantial depreciation or deferred compensation charges. |
We may not be able to address these risks successfully, or at all, without incurring significant costs, delays or other operating problems that could disrupt our business and have an adverse effect on our operating results and financial condition.
Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as network security breaches, computer viruses or terrorism.
Our corporate headquarters, the manufacturing facilities of some of our suppliers, as well as our contract manufacturer’s current manufacturing facility for our Z-Series and N-Series platforms, are all located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, a fire or a flood, occurring near our headquarters, or near the facilities of our suppliers or contract manufacturer, could have an adverse effect on our business, operating results and financial condition. Despite our implementation of network security measures, our networks and outside data center, by which we provide our Blue Planet platform, also may be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our products. In addition, natural disasters, acts of terrorism or war could cause disruptions in our or our customers’ businesses, our suppliers’ and contract manufacturers’ operations or the economy as a whole. We also rely on information technology systems to communicate among our workforce and with third parties. Any disruption to our communications, whether caused by a natural disaster or by manmade problems, such as power disruptions, could adversely affect our business. To the extent that any such disruptions result in delays or cancellations of customer orders or impede our suppliers’ and contract manufacturer’s ability to timely deliver our solutions and components, the deployment of our solutions and our business, operating results and financial condition would be adversely affected.
Risks Relating to Capitalization Matters
Our share price has been and may continue to be volatile.
Technology stocks, including those of companies in the network industry, have historically experienced high levels of volatility. The trading price of our common stock has been and is likely to continue to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control and may not be related to our operating performance. The relatively small trading volume of our stock has in the past resulted in, and may in the future continue to result in small transactions having a large impact on our stock price. Such fluctuations could cause you to lose all or part of your investment in our common stock. Factors that may cause the market price of our common stock to fluctuate include:
• | actual or anticipated changes in our operating results or fluctuations in our operating results; |
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• | actual or anticipated changes in the expectations of investors or securities analysts, and whether our operating results meet these expectations; |
• | price and volume fluctuations in the overall stock market from time to time; |
• | significant volatility in the market price and trading volume of technology companies in general, and of companies in the network industry in particular; |
• | new product or service introductions and market demand for these and our existing solutions; |
• | failure to meet investor expectations as a result of the timing of large customer orders; |
• | actual or anticipated developments in our competitors’ businesses or the competitive landscape generally; |
• | litigation involving us, our industry or both; |
• | regulatory developments in the United States, internationally or both; |
• | general economic conditions and trends; |
• | major catastrophic events; |
• | sales of large blocks of our stock; |
• | departures of key personnel; or |
• | the failure to consummate the Merger. |
In addition, if either the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to events that affect other companies in the network industry even if these events do not directly affect us.
In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. The price of our common stock since our initial public offering (IPO) in May 2013 has been highly volatile and, in April 2014 two law suits alleging violations of securities laws were filed against us, our directors and of our certain executive officers. This and any future shareholder litigation could result in substantial costs and divert our management’s attention and resources from our business, and this could have an adverse effect on our business, operating results and financial condition.
If securities analysts cease to publish research or reports about our business, or if they downgrade our stock, the price of our stock could decline.
The trading market for our common stock is influenced by any research and reports that securities or industry analysts publish about us or our business. In the event securities or industry analysts cover our company and one or more of these analysts downgrade our stock or publish unfavorable research about our business, our stock price, and the trading price of the notes, could decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price, price of the notes, and trading volume to decline.
The concentration of ownership among our existing directors, executive officers and principal stockholders provide them, collectively, with substantial control which could limit your ability to influence the outcome of key transactions, including a change of control.
Our directors, executive officers and their affiliates, in the aggregate, beneficially own approximately 45% of the outstanding shares of our common stock based on the number of shares outstanding as of March 31, 2015. As a result, these stockholders, if acting together, may be able to influence or control matters requiring approval by our stockholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock.
We use a significant amount of capital to meet our business objectives.
We require a significant amount of cash resources to operate our business. We used approximately $42.0 million of cash and cash equivalents in the year ended December 31, 2014 for operating activities. Our liquidity is affected by many factors including, among others, fluctuations in revenue, gross margin and operating expenses, as well as changes in operating assets and liabilities. Any future softening in the demand for our products and services may result in higher than anticipated losses in the future and require us to raise additional capital. We may also need to make changes to our operating model and capital expenditures to extend our available resources or we may have to significantly reduce our business activities which could adversely affect our ability to compete effectively in the markets in which we participate which could, in turn, adversely
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affect our results of operations. The indenture related to our 8.0% Convertible Notes Due 2019 includes certain restrictions on additional indebtedness. As a result, our capital raising options are limited. There can be no assurance that we would be able to raise additional capital on acceptable terms or at all.
As a public company we may be exposed to costly and time consuming securities class action suits.
As a public company, we face the risk of shareholder lawsuits, particularly if we experience sharp declines in the price of our common stock. For example, on April 1, 2014 a purported stockholder class action lawsuit was filed in the Superior Court of California, County of San Francisco, against our company, the members of our Board of Directors, our former Chief Financial Officer and the underwriters of our IPO. On April 30, 2014 a substantially similar lawsuit was filed in the same court against the same defendants. These two lawsuits have been consolidated under the caption Beaver County Employees Retirement Fund, et al. v. Cyan, Inc. et al., Case No. CGC-14-539008. We intend to defend this litigation vigorously. While we cannot predict the outcome of this litigation, defending this litigation-and any other lawsuits filed against us-will require us to expend significant time and money, and will distract management from its primary responsibilities. In addition, as a result of this litigation our director and officer insurance costs have increased significantly and may increase again the next time we renew such policies.
The requirements of being a public company subject us to increased costs and may strain our resources.
As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (Exchange Act) the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of The New York Stock Exchange and other applicable securities rules and regulations. Compliance with these rules and regulations has and will continue to increase our legal, accounting and financial compliance costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources, particularly after we are no longer an “emerging growth company,” as defined in the JOBS Act.
The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight will be required. As a result, management’s attention may be diverted from other business concerns, which could adversely affect our business and operating results. We will likely need to hire more employees in the future or engage outside consultants to comply with these regulations, which will increase our costs and expenses.
In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards are unsuccessful or differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be adversely affected.
We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.
For as long as we remain an “emerging growth company” under the JOBS Act, we may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We may take advantage of these reporting exemptions until we are no longer an “emerging growth company.” We would cease to be an “emerging growth company” upon the earliest of:
• | January 1, 2019; |
• | the first fiscal year after our annual gross revenue is $1.0 billion or more; |
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• | the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities; or |
• | the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year. |
We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
In addition, under the JOBS Act, “emerging growth companies” can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not “emerging growth companies.”
We do not intend to pay dividends for the foreseeable future.
We have never declared or paid any dividends on our stock. We currently intend to retain any earnings to finance the operation and expansion of our business, and we do not anticipate paying any cash dividends for the foreseeable future. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws and under Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:
• | establish a classified Board of Directors so that not all members of our Board of Directors are elected at one time; |
• | authorize the issuance of “blank check” preferred stock that our Board of Directors could issue to increase the number of outstanding shares to discourage a takeover attempt; |
• | prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders; |
• | prohibit stockholders from calling a special meeting of our stockholders; |
• | provide that the Board of Directors is expressly authorized to make, alter or repeal our bylaws; |
• | require that the Court of Chancery of the State of Delaware be the sole and exclusive forum for various legal actions related to fiduciary and corporate actions under Delaware law; and |
• | establish advance notice requirements for nominations for elections to our Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings. |
Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder and which may discourage, delay or prevent a change of control of our company.
Any provision of our amended and restated certificate of incorporation or amended and restated bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.
Risks Related to our Outstanding 8.0% Convertible Notes Due 2019
We may not have sufficient cash flow from our business to pay our debt.
We have a significant amount of indebtedness and substantial debt service requirements. As of December 31, 2014, our aggregate principal amount of indebtedness for borrowed money was $50.0 million. Subject to certain conditions and limitations in the indenture, we may also incur additional indebtedness, including secured debt, to meet future financing needs. Our ability to make scheduled interest payments, including, if applicable, interest make-whole payments on, or to repay the
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principal or conversion value, as applicable of our outstanding convertible notes depends on our future performance, which is subject to economic, financial, competitive, regulatory and other factors beyond our control. Our business may not generate cash flow from operations sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
Our significant level of indebtedness could adversely affect our business, financial condition and results of operations and prevent us from fulfilling our obligations under the notes.
We have a significant amount of indebtedness and substantial debt service requirements. As of December 31, 2014, our aggregate principal amount of indebtedness for borrowed money was $50.0 million. Subject to certain conditions and limitations in the indenture, we may also incur additional indebtedness, including secured debt, to meet future financing needs.
Our substantial indebtedness could have significant effects on our business, financial condition and results of operations. For example, it could among other effects:
• | make it more difficult for us to satisfy our financial obligations, including with respect to the notes; |
• | result in an event of default if we fail to comply with the covenants contained in the indenture or the related security documents related to the notes and any agreement governing our existing or future indebtedness, if any, which event of default could result in all of our debt becoming immediately due and payable; |
• | increase our vulnerability to general adverse economic, industry and competitive conditions; |
• | reduce the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes because we will be required to dedicate a substantial portion of our cash flow from operations to the payment of principal and interest on our indebtedness; |
• | subject us to increased sensitivity to interest rate increases on our existing and future indebtedness, if any, with variable interest rates; |
• | limit our flexibility in planning for, or reacting to, and increasing our vulnerability to changes in our business, the industry in which we operate and the general economy; |
• | prevent us from raising funds necessary to repay the notes at maturity, purchase notes tendered to us if there is a “fundamental change” such as the merger with Ciena, or pay the interest make-whole payment that may be due in cash in connection with certain conversions of the notes under the indenture governing the notes; |
• | place us at a competitive disadvantage compared to our competitors that have less indebtedness or are less highly leveraged and that, therefore, may be able to take advantage of opportunities that our debt levels or leverage prevent us from exploiting; and |
• | limit our ability to obtain additional financing. |
Each of these factors may have a material and adverse effect on our business, financial condition and results of operations and our ability to meet our payment obligations under the notes and our future indebtedness, if any.
Our ability to make payments with respect to the notes and to satisfy any other debt obligations will depend on our future operating performance and our ability to generate significant cash flow in the future, which will be affected by prevailing economic conditions and financial, business, competitive, legislative and regulatory factors as well as other factors affecting our company and industry, many of which are beyond our control.
Our failure to obtain the requisite stockholder approvals could adversely affect our liquidity and may result in our auditor issuing a “going concern” opinion, which would question our ability to continue as a going concern and could impair revenue and our ability to raise additional capital.
The $50 million in principal amount of 8.0% convertible notes we issued December 2014 would be convertible into an aggregate of approximately 20.47 million shares of our common stock. The related warrants represent the right to purchase an additional 11.25 million shares of our common stock. Under applicable New York Stock Exchange (NYSE) rules unless we obtain stockholder approval we will only be permitted to issue an aggregate of approximately 9.4 million shares of common stock to settle the conversion of the notes and exercise of the warrants. This limitation represents 19.99% of the number of shares of our common stock outstanding on the day the note offering was priced. Unless and until we have stockholder approval to issue the full number of shares issuable on conversion of the notes and exercise of the warrants, (i) we will be required to satisfy our conversion obligation with respect to the notes by delivering a combination of cash and shares of our common stock with a specified dollar amount per $1,000 principal amount of notes of at least $1,000 for all notes submitted for
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conversion, and (ii) if the number of shares of common stock deliverable for the settlement amount in excess of the specified dollar amount would result in the issuance of shares in excess of the conversion share cap, then we will pay cash in lieu of the shares that otherwise would have been deliverable. Of the $50 million in principal amount of notes issued, $17 million in principal amount were issued to affiliates. Unless and until we have obtained the requisite stockholder approvals, conversions of affiliate notes will be required to be settled entirely in cash. With respect to our outstanding warrants, unless and until we have obtained the requisite stockholder approvals, we will be required to cash settle any exercises of warrants determined according to the formula set forth in the warrants. Moreover, because the cash settlement amount of the notes and warrants increases if our stock price increases, increases in our stock price would result in an increase in the amount we would have to pay upon conversion of the notes and exercise of the warrants. For example, prior to obtaining stockholder approval-or if we don’t obtain stockholder approval if the price of our common stock used for purposes of measuring the settlement amount of the notes and warrants were $4.00 per share, we would be obligated to issue approximately 5.3 million shares of our common stock and pay cash of approximately $65.1 million to settle full conversion of the notes and exercise of the warrants. If the price of our common stock used for these calculations were $5.00 per share, the amounts would be approximately 6.9 million shares and $83.3 million in cash.
As a result, if we do not receive the requisite stockholder approvals, we will require a substantial amount of cash to settle the conversion of the notes and exercise of the warrants which we may not have, and we may not be able to secure financing to meet these obligations.
In addition, if we do not obtain the requisite stockholder approvals, our independent certified public accountant could issue a “going concern” qualified opinion given the potential for the cash settlement obligations related to the notes and warrants exceeding our available resources. A "going concern" opinion could impair our ability to raise funds and may adversely impact our revenue and business if customers delay or discontinue purchases from us due to concerns about our viability. There can be no assurance that we will be successful in obtaining the requisite stockholder approvals.
The indenture governing the notes contains restrictions that limit our operating flexibility, and we may incur additional debt in the future that may include similar or additional restrictions.
The indenture governing the notes contains covenants that, among other things, restrict our and our existing and future subsidiaries’ ability to take specific actions, even if we believe them to be in our best interest. These covenants include restrictions on our ability to:
• | incur additional indebtedness and issue certain types of preferred stock; and |
• | limit the transfer of intellectual property to non-subsidiary guarantors. |
In addition, the related security documents impose restrictions on our ability to incur liens, other than permitted liens. These covenants and restrictions limit our operational flexibility and could prevent us from taking advantage of business opportunities as they arise, growing our business or competing effectively.
A breach of any of these covenants or other provisions in our debt agreements could result in an event of default, which if not cured or waived, could result in the notes or such debt becoming immediately due and payable. This, in turn, could cause any of our other debt to become due and payable as a result of cross-default or cross-acceleration provisions contained in the agreements governing such other debt. In the event that some or all of our debt is accelerated and becomes immediately due and payable, we may not have the funds to repay, or the ability to refinance, such debt.
The accounting method for the notes and the warrants could have a material effect on our reported financial results.
Upon stockholder approval to issue the full number of shares issuable on conversion of the notes and exercise of the warrants, the notes will be subject to Accounting Standards Codification 470-20, Debt with Conversion and Other Options, which we refer to as ASC 470-20. Under ASC 470-20, an entity must separately account for the liability and equity components of convertible debt instruments that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. ASC 470-20 requires the liability component to be initially recognized in an amount equal to the fair value of similar nonconvertible debt and the difference between the proceeds of the convertible debt and the value allocated to the liability component is recorded as the initial carrying amount of the equity component (i.e., the conversion option). The effect of ASC 470-20 on the accounting for the notes will be that the equity component would be required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet, and the value of the equity component will be treated as original issue discount for purposes of accounting for the debt component of the notes. As a result, we will be required to record a greater amount of non-cash interest expense in current periods presented as a result of the amortization of the discounted carrying value of the notes to their face amount over the term of the notes. We will report lower
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net income in our financial results because ASC 470-20 would require interest to include both the current period’s amortization of the debt discount and the instrument’s coupon interest, which could adversely affect our reported or future financial results, the trading price of our common stock and the trading price of the notes.
In addition, prior to our receipt of the requisite stockholder approvals, we will be required to cash or partially cash settle conversions of the notes and cash settle exercises of the warrants. As a result, we will be required to account for the conversion option embedded in the notes and the warrants (and any interest make-whole payment) as derivatives, meaning we will be recording gain or loss on a quarterly basis with regard to the mark-to-market value of those securities. This accounting treatment could have a material impact on, and could result in significant volatility in, our quarterly results of operations.
Under certain circumstances, convertible debt instruments that may be settled entirely or partly in cash (as the notes will be) may be accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of such convertible debt instruments are not included in the calculation of diluted earnings per share except to the extent that the conversion value of such convertible debt instruments exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, are issued. However, we cannot be sure that the accounting standards in the future will continue to permit our use of the treasury stock method. If we are unable to use the treasury stock method in accounting for the shares issuable upon conversion of the notes, then our diluted earnings per share would be adversely affected.
The conditional conversion feature of the notes, if triggered, may adversely affect our financial condition and operating results.
In the event the conditional conversion feature of the notes is triggered, holders of notes will be entitled to convert the notes at any time during specified periods at their option. In addition, we will in certain circumstances make an interest make-whole payment to converting holders payable in cash prior to our receipt of the requisite stockholder approvals and payable in cash or shares of our common stock at our election following the requisite stockholder approvals. If one or more holders elect to convert their notes prior to our receipt of the requisite stockholder approvals, (i) with respect to notes other than affiliate notes, we will be required to satisfy our conversion obligation by delivering a combination of cash and shares of our common stock with a specified dollar amount per $1,000 principal amount of notes of at least $1,000 for all notes submitted for conversion and (ii) with respect to affiliate notes, we will be required to pay cash for the settlement amount of all affiliate notes submitted for conversion, and pay any applicable interest make-whole payment through the payment of cash, which could adversely affect our liquidity. Once we have obtained the requisite stockholder approvals, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than cash in lieu of any fractional share) and pay any applicable interest make-whole payment in shares of our common stock, we would be required to settle a portion or all of our conversion obligation and the interest make-whole payment, if applicable, through the payment of cash, which could adversely affect our liquidity. In addition, even if holders do not elect to convert their notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the notes as a current rather than long-term liability, which may result in a material reduction of our net working capital.
Subject to certain conditions and limitations, the indenture governing the notes permits us to incur a certain amount of additional indebtedness, including secured debt, and does not require us to maintain financial ratios or specified levels of net worth or liquidity; if we incur substantial additional indebtedness it may adversely affect our ability to make payments on the notes.
Subject to certain conditions and limitations, the indenture governing the notes will permit us to incur a certain amount of additional indebtedness, including secured debt, and will not require us to maintain financial ratios or specified levels of net worth or liquidity. We and our future and existing subsidiaries may be able to incur substantial additional debt in the future. If we incur substantial additional indebtedness in the future, these higher levels of indebtedness may affect our ability to pay the principal of and interest on the notes, or any fundamental change purchase price or any cash due upon conversion, and our creditworthiness generally.
We may not be permitted, by the agreements governing our future indebtedness, to pay any interest make-whole payment upon conversion of the notes in cash, requiring us to issue shares for such amounts, which could result in significant dilution to our stockholders.
On or after January 15, 2016, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending within five trading days prior to a conversion date, the last reported sale price of our common stock exceeds the applicable conversion price on each such trading day, we will in addition to certain consideration paid under the
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notes, pay any converting holder an interest make-whole payment in cash or common stock for the notes being converted. Prior to receipt of the requisite stockholder approvals, we must pay any interest make-whole in cash. After receipt of the requisite stockholder approvals, we will have the option to issue our common stock to any converting holder in lieu of making the interest make-whole payment in cash. If we elect to issue our common stock for such payment, then the stock will be valued at 95% of the simple average of the daily volume weighted average price of our common stock for the 10 trading days ending on and including the trading day immediately preceding the conversion date. Agreements governing our future indebtedness may prohibit us from making cash payments in respect of the interest make-whole amount upon a conversion.
We may not have the ability to repay the principal amount of the notes at maturity, to raise the funds necessary to settle conversions of the notes or to purchase the notes upon a fundamental change, and instruments governing our future debt may contain limitations on our ability to pay cash upon conversion or purchase of the notes.
At maturity, the entire outstanding principal amount of the notes will become due and payable by us. Holders of the notes will also have the right to require us to purchase their notes upon the occurrence of a fundamental change, such as the acquisition by Ciena, at a purchase price equal to 100% of the principal amount of the notes to be purchased, plus accrued and unpaid interest. In addition, unless we have obtained the requisite stockholder approvals and elected to deliver solely shares of our common stock to settle such conversion (other than cash in lieu of any fractional share), we will be required to make cash payments in respect of the notes being converted. As a result of the acquisition, the notes will become convertible for a period beginning 25 trading days prior to anticipated effective date of the acquisition. We may not have enough available cash or be able to obtain financing at the time we are required to repay the principal amount of the notes, make purchases of notes surrendered therefor or cash settle conversions of the notes.
In addition, our ability to purchase the notes or to pay cash upon conversions of the notes may be limited by law, by regulatory authority or by agreements governing our future indebtedness. Our failure to repay the principal amount of the notes, purchase notes at a time when the purchase is required by the indenture or to pay any cash payable on future conversions of the notes as required by the indenture would constitute a default under the indenture. A default under the indenture or the fundamental change itself could also lead to a default under agreements governing our future indebtedness including the Loan and Security Agreement. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and purchase the notes or make cash payments upon conversions thereof.
The fundamental change provisions may delay or prevent an otherwise beneficial takeover attempt of us.
The fundamental change purchase rights, which will allow holders to require us to purchase all or a portion of their notes upon the occurrence of a fundamental change, as defined in the indenture relating to the notes, and the provisions requiring an increase to the conversion rate for conversions in connection with a make-whole fundamental change may in certain circumstances delay or prevent a takeover of us and the removal of incumbent management that might otherwise be beneficial to investors.
We expect that the trading price of the notes will be significantly affected by the market price of our common stock, which may be volatile, as well as the general level of interest rates and our credit quality.
The stock market in recent years has experienced significant price and volume fluctuations that have often been unrelated to the operating performance of companies. The market price of our common stock could fluctuate significantly for many reasons, including in response to the risks described in this section or for reasons unrelated to our operations, such as reports by industry analysts, investor perceptions or negative announcements by our customers, competitors or suppliers regarding their own performance, as well as industry conditions and general financial, economic and political instability. A decrease in the market price of our common stock would likely adversely impact the trading price of the notes. The market price of our common stock could also be affected by possible sales of our common stock by investors who view the notes as a more attractive means of equity participation in us and by hedging or arbitrage trading activity that may develop involving our common stock. This trading activity could, in turn, affect the trading prices of the notes.
We also cannot predict whether interest rates will rise or fall. During the term of the notes, interest rates will be influenced by a number of factors, most of which are beyond our control. Interest rate movements may adversely affect the value of the embedded conversion option and the trading price of the notes.
In addition, our credit quality may vary substantially during the term of the notes and will be influenced by a number of factors, including variations in our cash flows and the amount of indebtedness we have outstanding. Any decrease in our credit quality would likely negatively impact the trading price of the notes.
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Future sales of our common stock in the public market could lower the market price for our common stock and adversely impact the trading price of the notes.
In the future, we may sell additional shares of our common stock to raise capital. In addition, a substantial number of shares of our common stock are reserved for issuance upon the exercise of stock options, restricted stock units and other equity awards, in connection with certain deferred purchase price obligations, and upon conversion of the notes. We cannot predict the size of future issuances or the effect, if any, that they may have on the market price for our common stock. The issuance and sale of substantial amounts of shares of our common stock, or the perception that such issuances and sales may occur, could adversely affect the trading price of the notes and the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities.
Risks Related to the Pending Merger with Ciena Corporation
Our pending merger with Ciena is subject to various closing conditions, including governmental approvals, and other uncertainties and there can be no assurances as to whether and when it may be completed.
On May 3, 2015, we entered into a merger agreement with Ciena pursuant to which Ciena will acquire us. The consummation of the merger is subject to customary closing conditions and a number of the conditions are not within our control, and may prevent, delay or otherwise materially adversely affect the completion of the transaction. These conditions include, among other things:
• | the expiration of the applicable waiting period under the Hard-Scott-Rodino Antitrust Improvements Act of 1976; |
• | the issuance of legal opinions that the merger considered together as a single integrated transaction, will constitute a reorganization within the meaning of Section 368(a) of the Code; |
• | the affirmative vote of holders of a majority of the outstanding shares of our common stock at our annual meeting to adopt the merger agreement; and |
• | the affirmative vote by a majority of the votes cast at our annual meeting approving issuances of our common stock upon conversion of the Notes and exercise of the warrants issued in connection with the Notes, including approval of such issuances to certain of our affiliates. |
It is also possible that a change, event, fact, effect or circumstance could occur that could lead to a material adverse effect to us, which may give Ciena the ability to not complete the merger. We cannot predict with certainty whether and when any of the required closing conditions will be satisfied or if another uncertainty may arise.
If the merger does not receive, or timely receive, the required regulatory approvals and clearance, or if another event occurs delaying or preventing the merger, such delay or failure to complete the merger may cause uncertainty or other negative consequences that may materially and adversely affect our sales, financial performance and operating results, and the price per share for our common stock and perceived acquisition value.
Additionally, if the merger is not completed for any reason, to the extent that the current market price of our common stock reflects an increase resulting from a market assumption that the transaction will be completed, the market price of our common stock may decline by the value attributed to this assumption, or could decline even more. Furthermore, we will be required to pay certain costs relating to the merger, whether or not it is completed, such as significant fees and expenses relating to legal, accounting and other services, and we may be required to cash settle any conversions of the Notes as discussed above. In addition, we could be subject to litigation related to any failure to complete the merger. If it is not completed, these risks may materially and adversely affect our stock price, operating results and ongoing business.
Our obligation to pay a termination fee to Ciena under certain circumstances could require us to use available cash that would have otherwise been available for general corporate purposes and may discourage other companies from trying to acquire us.
If the merger agreement is terminated, in certain circumstances, we would be required to pay Ciena a termination fee of $15.0 million, which may require us to use available cash that would have otherwise been available for general corporate purposes. Furthermore, until the merger is completed or the merger agreement is terminated, with limited exceptions, we are prohibited from entering into or soliciting any acquisition proposals, and these provisions coupled with a potential termination fee, if any, could discourage other companies from trying to acquire us for a higher price. For these and other reasons, a failed merger could materially and adversely affect our business, operating results or financial condition, which in turn would
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materially and adversely affect our business or financial condition, the price per share of our common stock or our perceived acquisition value.
While the merger is pending, we are subject to business uncertainties and contractual restrictions that could materially adversely affect our operations and the future of our business or result in a loss of employees.
The merger agreement includes restrictions on the conduct of our business prior to the completion of the merger, generally requiring us to conduct our business in the ordinary course, consistent with past practice, and subjecting us to a variety of specified limitations absent Ciena’s prior written consent. We may find that these and other contractual arrangements in the merger agreement may delay or prevent us from or limit our ability to respond effectively to competitive pressures, industry developments and future business opportunities that may arise during such period, even if our management and board of directors think they may be advisable. The pendency of the merger may also divert management’s attention and our resources from ongoing business and operations. Our employees, customers and advertisers may have uncertainties about the effects of the merger. In connection with the pending merger, it is possible that some customers and other persons with whom we have a business relationship may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationship with us as a result of the merger. Similarly, current and prospective employees may experience uncertainty about their future roles with us following completion of the merger, which may materially adversely affect our ability to attract and retain key employees. If any of these effects were to occur, it could materially and adversely impact our revenues, earnings and cash flows and other business results and financial condition, as well as the market price of our common stock and our perceived acquisition value, regardless of whether the merger is completed. In addition, whether or not the merger is completed, while it is pending we will continue to incur costs, fees, expenses and charges related to the proposed merger, which may materially and adversely affect our business results and financial condition.
We may be subject to purported class action lawsuits relating to the merger, which could materially adversely affect our business, financial condition and operating results.
Litigation in connection with acquisitions of public companies is very common, regardless of any merits related to the underlying acquisition. We, our directors and Ciena may be subject to purported class action lawsuits relating to the merger and other additional lawsuits may be filed. While we will evaluate and defend against any actions vigorously, the costs of the defense of such lawsuits and other effects of such litigation could have an adverse effect on our business, financial condition and operating results. Furthermore, we have obligations to hold harmless and indemnify each of our directors against judgments, fines, settlements and expenses related to claims against such directors and otherwise to the fullest extent permitted under Delaware law and our bylaws and certificate of incorporation.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Sales of Unregistered Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits
The documents listed in the Exhibit Index of this Quarterly Report on Form 10-Q are incorporated by reference or are filed with this Quarterly Report on Form 10-Q, in each case as indicated therein (numbered in accordance with Item 601 of Regulation S-K).
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
/s/ Mark A. Floyd | Chief Executive Officer and | May 13, 2015 | ||
Mark A. Floyd | Chairman of the Board of Directors | |||
(Principal Executive Officer) | ||||
/s/ Jeffrey G. Ross | Vice President and Chief Financial | May 13, 2015 | ||
Jeffrey G. Ross | Officer (Principal Accounting and Financial Officer) |
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EXHIBIT INDEX
Exhibit number | Description of Document | |
2.1 (1) | Agreement and Plan Merger, dated as of May 3 2015, by and among Ciena Corporation, Neptune Acquisition Subsidiary, Inc. and the Registrant | |
4.1 (1) | Form of Voting Agreement | |
4.2 | First Supplemental Indenture dated April 27, 2015 by and between Cyan, Inc. and U.S. Bank National Association, as trustee and collateral agent. | |
31.1 | Certification of Principal Executive Officer Required Under Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended. | |
31.2 | Certification of Principal Financial Officer Required Under Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended. | |
32.1 (2) | Certification of Chief Executive Officer Required Under Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. §1350 | |
32.2 (2) | Certification of Chief Financial Officer Required Under Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. §1350 | |
101.INS | XBRL Instance Document | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
(1) | Incorporated by reference to the exhibit filed with the Registrant's Form 8-K (File No. 001-35904), filed on May 5, 2015. |
(2) | This certification is deemed not filed for purpose of section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act. |
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