e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2008
OR
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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: 001-33435
CAVIUM NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
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DELAWARE
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77-0558625 |
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(State or other jurisdiction
of incorporation or organization)
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(I.R.S. Employer Identification No.) |
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805 E. Middlefield Road Mountain View, California
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94043 |
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(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code: (650) 623-7000
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 þ No o
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):
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer þ
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
The number of shares of the Registrants Common Stock, $.001 par value, outstanding at May 1, 2008
was: 40,480,633
CAVIUM NETWORKS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2008
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements
CAVIUM NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
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March 31, |
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December 31, |
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2008 |
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2007 |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
95,612 |
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$ |
98,462 |
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Accounts receivable, net of allowance of $215 and $177, respectively |
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13,747 |
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9,768 |
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Inventories |
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10,767 |
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9,573 |
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Prepaid expenses and other current assets |
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952 |
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946 |
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Total current assets |
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121,078 |
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118,749 |
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Property and equipment, net |
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11,498 |
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11,608 |
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Intangible assets, net |
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3,774 |
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4,096 |
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Other assets |
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295 |
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157 |
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Total assets |
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$ |
136,645 |
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$ |
134,610 |
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Liabilities and Stockholders Equity |
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Current liabilities: |
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Accounts payable |
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$ |
4,985 |
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$ |
5,311 |
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Accrued expenses and other current liabilities |
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2,449 |
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2,253 |
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Deferred revenue |
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2,506 |
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1,666 |
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Capital lease and technology license obligations, current portion |
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3,501 |
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4,471 |
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Total current liabilities |
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13,441 |
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13,701 |
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Capital lease and technology license obligations, net of current portion |
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3,432 |
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4,059 |
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Total liabilities |
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16,873 |
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17,760 |
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Commitments and contingencies (Note 12) |
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Stockholders equity |
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Preferred stock, par value $0.001: |
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10,000,000 shares authorized, no shares issued and outstanding as of March 31,
2008 and December 31, 2007 |
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Common stock, par value $0.001: |
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200,000,000 shares authorized; 40,391,131 and 40,307,361 shares issued and
outstanding as of March 31, 2008 and December 31, 2007 |
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40 |
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40 |
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Additional paid-in capital |
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176,490 |
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175,540 |
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Accumulated deficit |
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(56,758 |
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(58,730 |
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Total stockholders equity |
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119,772 |
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116,850 |
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Total liabilities and stockholders equity |
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$ |
136,645 |
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$ |
134,610 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
CAVIUM NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
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Three Months Ended |
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March 31, |
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2008 |
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2007 |
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Revenue |
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$ |
18,342 |
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$ |
11,141 |
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Cost of revenue |
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6,587 |
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4,182 |
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Gross profit |
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11,755 |
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6,959 |
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Operating expenses: |
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Research and development |
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5,820 |
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4,326 |
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Sales, general and administrative |
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4,555 |
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3,209 |
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Total operating expenses |
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10,375 |
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7,535 |
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Income (loss) from operations |
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1,380 |
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(576 |
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Other income (expense), net: |
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Interest expense |
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(153 |
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(208 |
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Warrant revaluation expense |
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(225 |
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Interest income and other |
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992 |
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69 |
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Total other income (expense), net |
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839 |
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(364 |
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Income (loss) before income tax expense |
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2,219 |
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(940 |
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Income tax expense |
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(247 |
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(57 |
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Net income (loss) |
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$ |
1,972 |
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$ |
(997 |
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Net income (loss) per common share, basic |
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$ |
0.05 |
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$ |
(0.12 |
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Shares used in computing basic net income (loss) per common share |
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39,966 |
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8,579 |
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Net income (loss) per common share, diluted |
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0.05 |
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(0.12 |
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Shares used in computing diluted net income (loss) per common share |
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42,135 |
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8,579 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
4
CAVIUM NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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Three Months Ended |
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March 31, |
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2008 |
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2007 |
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Cash flows from operating activities |
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Net income (loss) |
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$ |
1,972 |
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$ |
(997 |
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Adjustments to reconcile net income (loss) to net cash provided by operating activities |
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Stock-based compensation expense |
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767 |
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357 |
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Amortization of warrant costs to interest expense |
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19 |
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Revaluation of warrants to fair value |
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225 |
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Depreciation and amortization |
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2,221 |
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1,229 |
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Changes in assets and liabilities |
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Accounts receivable, net |
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(3,980 |
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(377 |
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Inventories |
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(1,162 |
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(371 |
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Prepaid expenses and other current assets |
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(5 |
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69 |
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Other assets |
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(137 |
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(165 |
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Accounts payable |
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(201 |
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136 |
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Accrued expenses and other current and non-current liabilities |
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216 |
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(594 |
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Deferred revenue |
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841 |
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2,914 |
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Net cash provided by operating activities |
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532 |
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2,445 |
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Cash flows used in investing activities |
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Purchases of property and equipment |
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(1,915 |
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(731 |
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Net cash used in investing activities |
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(1,915 |
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(731 |
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Cash flows used in financing activities |
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Proceeds from issuance of common stock upon exercise of options |
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131 |
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56 |
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Payments of initial public offering costs |
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(1,266 |
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Repayment of term loan financing |
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(355 |
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Principal payment of captial lease and technology license obligations |
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(1,598 |
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(849 |
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Repurchases of shares of unvested common stock |
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(10 |
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Net cash used in financing activities |
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(1,467 |
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(2,424 |
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Net decrease in cash and cash equivalents |
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(2,850 |
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(710 |
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Cash and cash equivalents, beginning of period |
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98,462 |
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10,154 |
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Cash and cash equivalents, end of period |
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$ |
95,612 |
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$ |
9,444 |
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Supplemental disclosure of cash flow information |
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Cash paid for interest |
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$ |
153 |
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$ |
189 |
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Supplemental disclosure of non-cash activities |
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Capital lease and technology license obligations |
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$ |
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$ |
115 |
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Vesting of early exercised options |
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$ |
21 |
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$ |
32 |
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Additions to property and equipment included in accounts payable and accrued expenses |
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$ |
931 |
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$ |
152 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
5
CAVIUM NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Organization and Significant Accounting Policies
Organization
Cavium Networks, Inc., or the Company, was incorporated in the State of California on November
21, 2000 and was reincorporated in the State of Delaware effective February 6, 2007. The Company
designs, develops and markets semiconductor processors for intelligent and secure networks.
Initial Public Offering
In May 2007, the Company completed its initial public offering, or IPO, of common stock in
which it sold and issued 7,762,500 shares of common stock, including 1,012,500 shares of
underwriters over-allotment, at an issue price of $13.50 per share. A total of $104.8 million in
gross proceeds was raised from the IPO, or approximately $94.7 million in net proceeds after
deducting underwriting discounts and commissions of $7.3 million and other offering costs of $2.8
million. Upon the closing of the IPO, all shares of convertible preferred stock outstanding
automatically converted into 22,364,378 shares of common stock, and 102,619 warrants to purchase
mandatorily redeemable convertible preferred stock were converted into warrants to purchase common
stock.
Summary of Significant Accounting Policies
Basis of Presentation
The unaudited condensed consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America, or GAAP, and with
the instructions to Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC
Regulation S-X. Accordingly, they do not include all of the information and footnotes required by
GAAP for complete financial statements. For further
information, these financial statements should be read in conjunction with the Companys Annual
Report on Form 10-K (File No. 001-33435) on file with the SEC for the year ended December 31, 2007.
The unaudited condensed consolidated financial statements contain all normal recurring
accruals and adjustments that, in the opinion of management, are necessary to present fairly the
Companys consolidated financial position at March 31, 2008, and the consolidated results of its
operations for the three months ended March 31, 2008 and 2007, and the consolidated cash flows for
the three months ended March 31, 2008 and 2007. The results of operations for the three months
ended March 31, 2008 are not necessarily indicative of the results to be expected for the full
year.
The condensed consolidated balance sheet at December 31, 2007 has been derived from the
audited consolidated financial statements at that date but does not include all of the information
and footnotes required by GAAP.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the amounts reported in its consolidated financial statements
and accompanying notes. Management bases its estimates on historical experience and on various
other assumptions it believes to be reasonable under the circumstances, the results of which form
the basis of making judgments about the carrying values of assets and liabilities. Actual results
could differ from those estimates.
Cash & Cash Equivalents
The Company considers all highly liquid investments with an original or remaining maturity of
90 days or less at the date of purchase to be cash equivalents. Cash equivalents consist primarily
of money market instruments.
6
Allowance for Doubtful Accounts
The Company reviews its allowance for doubtful accounts quarterly by assessing individual
accounts receivable over a specific age and amount. The Companys allowance for doubtful accounts
was $35,000 and $38,000 as of March 31, 2008 and December 31, 2007, respectively.
Inventories
Inventories consist of work-in-process and finished goods. Inventories are stated at the lower
of cost (determined using the first-in, first-out method), or market value (estimated net
realizable value). The Company writes down inventory by establishing inventory reserves based on
aging and forecasted demand. These factors are impacted by market and economic conditions,
technology changes, new product introductions and changes in strategic direction and require
estimates that may include uncertain elements. Actual demand may differ from forecasted demand and
such differences may have a material effect on recorded inventory values. Inventory reserves, once
established, are not released until the related inventories have been sold or scrapped.
Property and Equipment
Property and equipment are stated at cost and depreciated over their estimated useful lives
using the straight-line method. Leasehold improvements are amortized over the shorter of estimated
useful lives or unexpired lease term. Additions and improvements that increase the value or extend
the life of an asset are capitalized. Upon retirement or sale, the cost of assets disposed of and
the related accumulated depreciation are removed from the accounts and any resulting gain or loss
is credited or charged to income. Repairs and maintenance costs are expensed as incurred.
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Estimated |
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Useful Lives |
Software and computer equipment
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1 to 5 years |
Test equipment
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1 to 3 years |
Furniture, office equipment and leasehold improvements
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1 to 5 years |
The Company capitalizes the cost of fabrication masks that are reasonably expected to be used
during production manufacturing. Such amounts are included within property and equipment and
depreciated to cost of revenue generally over a period of twelve months. If the Company does not
reasonably expect to use the fabrication mask during production manufacturing, the related mask
costs are expensed to research and development in the period in which the costs are incurred. The
Company has capitalized $1,272,000 and $527,000 for the three months ended March 31, 2008 and 2007,
respectively.
Impairment of Long-Lived Assets
The Company reviews long-lived assets, including property and equipment, for impairment
whenever events or changes in business circumstances indicate that the carrying amount of the
assets may not be fully recoverable. According to the Companys accounting policy, when such
indicators are present, if the undiscounted cash flows expected to be generated from operations
from those long-lived assets are less than the carrying value of those long-lived assets, the
Company compares the fair value of the assets (estimated using discounted future net cash flows to
be generated from the lowest common level of operations utilizing the assets) to the carrying value
of the long-lived assets to determine any impairment charges. The Company reduces the carrying
value of the long-lived assets if the carrying value of the long-lived assets is greater than their
fair value.
Fair Value of Financial Instruments
The carrying amounts of certain of the Companys financial instruments, including cash and
cash equivalents, accounts receivable, other assets, accounts payable, accrued expenses and
liabilities, approximate their fair values due to their short-term nature.
Concentration of Risk
The Companys products are currently manufactured, assembled and tested by third-party
contractors in Asia. There are no long-term agreements with any of these contractors. A significant
disruption in the operations of one or more of these contractors would impact the production of the
Companys products for a substantial period of time, which could have a material adverse effect on
the Companys business, financial condition and results of operations.
7
Financial instruments that potentially subject the Company to a concentration of credit risk
consist of cash, cash equivalents and accounts receivable. The Company deposits cash and cash
equivalents with credit worthy financial institutions. The Company has not experienced any losses
on its deposits of cash and cash equivalents. Management believes that the financial institutions
are reputable and, accordingly, minimal credit risk exists.
A majority of the Companys accounts receivable are derived from revenue earned from customers
primarily headquartered in the United States. The Company performs ongoing credit evaluations of
its customers financial condition and, generally, requires no collateral from its customers. The
Company provides an allowance for doubtful accounts receivable based upon the expected
collectibility of accounts receivable. Summarized below are individual customers whose accounts
receivable balances or revenues were 10% or higher of respective total consolidated amounts.
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For the three months |
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ended March 31, |
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2008 |
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2007 |
Percentage of total revenue |
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Customer A |
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30 |
% |
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24 |
% |
Customer B |
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* |
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20 |
% |
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* |
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Less than 10% of the consolidated revenue for the respective period end. |
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As of March 31, |
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As of December 31, |
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2008 |
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2007 |
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Percentage of gross accounts receivable |
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Customer C |
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19 |
% |
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23 |
% |
Customer D |
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13 |
% |
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13 |
% |
Intangible Assets
Prepaid technology licenses and acquired technologies, which includes technologies acquired
from other companies either as a result of acquisitions or licensing, are capitalized and amortized
on the straight-line method over the estimated useful life of the technologies, which generally
does not exceed five years. Technology license obligations payable in installments are capitalized
using the present value of the payments.
Revenue Recognition
The Company derives its revenue primarily from sales of semiconductor products. The Company
recognizes revenue from product sales when persuasive evidence of a binding arrangement exists,
delivery has occurred, the price is deemed fixed or determinable and free of contingencies and
significant uncertainties, and collection is probable. The price is considered fixed or
determinable at the execution of an agreement, based on specific products and quantities to be
delivered at specified prices, which is often memorialized with a customer purchase order.
Agreements with non-distributor customers do not include rights of return or acceptance provisions.
The Company assesses the ability to collect from the Companys customers based on a number of
factors, including credit worthiness and any past transaction history of the customer. If the
customer is not deemed credit worthy, or the price is not considered fixed or determinable, the
Company will defer all revenue from the arrangement until payment is received and all other revenue
recognition criteria is met.
Shipping charges billed to customers are included in product revenue and the related shipping
costs are included in cost of product revenue. The Company generally recognizes revenue at the time
of shipment to the Companys customers. Revenue consists primarily of sales of the Companys
products to networking original equipment manufacturers, or OEMs, their contract manufacturers or
to its distributors. Initial sales of the Companys products for a new design are usually made
directly to networking OEMs as they design
and develop their product. Once their design enters production, they often outsource their
manufacturing to contract manufacturers that purchase the Companys products directly from the
Company or from the Companys distributors.
8
Revenue is recognized upon shipment for sales to distributors with limited rights of returns
and price protection if the Company concludes it can reasonably estimate the credits for returns
and price adjustments issuable. The Company records an estimated allowance, at the time of
shipment, based on the Companys historical patterns of returns and pricing credits of sales
recognized upon shipment. The credits issued to distributors or other customers were not material
in the three months ended March 31, 2008 and 2007.
Revenue and costs relating to sales to distributors are deferred if the Company grants more
than limited rights of returns and price credits or if it cannot reasonably estimate the level of
returns and credits issuable. During the quarter ended June 30, 2007, the Company signed a
distribution agreement with Avnet, Inc. to distribute the Companys products primarily in the
United States. Given the terms of the distribution agreement, for sales to Avnet revenue and costs
will be deferred until products are sold by Avnet to its end customers. For the quarter ended March
31, 2008, 3.8% of the Companys net revenues were from products sold by Avnet. Revenue recognition
depends on notification from the distributor that product has been sold to Avnets end customers.
Avnet reports to the Company, on at least a monthly basis, the product resale price, quantity and
end customer shipment information, as well as inventory on hand. Reported distributor inventory on
hand is reconciled monthly to the Companys deferred revenue balances. Deferred income on shipments
to Avnet is included in deferred revenue. Accounts receivable from Avnet is recognized and
inventory is relieved when title to inventories transfers, which typically takes place at the time
of shipment, which is the point in time at which the Company has a legal enforceable right to
collection under normal payment terms.
The Company also derives revenue in the form of license and maintenance fees through licensing
its software products. Revenue from such arrangements is recorded by applying the provisions of
Statement of Position, or SOP No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9,
Modification of SOP No. 97-2, Software Revenue Recognition with Respect to Certain Transactions.
Revenue from such arrangements totaled $266,000 and $318,000 for the three months ended March 31,
2008 and 2007, respectively. The value of any support services is recognized as services revenue on
a straight-line basis over the term of the related support period, which is typically one year.
The Company also enters into development agreements with some of its customers. Development
revenue is recognized under the proportional performance method, with the associated costs included
in cost of revenue. The Company estimates the proportional performance of the development contracts
based on an analysis of progress toward completion. The Company periodically evaluates the actual
status of each project to ensure that the estimates to complete each contract remain accurate. If
the amount billed exceeds the amount of revenue recognized, the excess amount is recorded as
deferred revenue. Revenue recognized in any period is dependent on progress toward completion of
projects in progress. To the extent the Company is unable to estimate the proportional performance
then the revenue is recognized on a completed contract basis. Revenue from such arrangements
totaled $674,000 and $575,000 for the three months ended March 31, 2008 and 2007, respectively.
Total deferred revenue was $2,506,000 and $1,666,000 as of March 31, 2008 and December 31,
2007, respectively, which includes deferred revenue associated with license and maintenance fees,
development revenue and deferred income on shipment to Avnet.
Warranty Accrual
The Companys products are subject to a one-year warranty period. The Company provides for the
estimated future costs of replacement upon shipment of the product as cost of revenue. The warranty
accrual is estimated based on historical claims compared to historical revenue. The following table
presents a reconciliation of the Companys product warranty liability, which is included within
accrued expenses and other current liabilities in the consolidated balance sheets:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
Beginning balance |
|
$ |
261 |
|
|
$ |
161 |
|
Accruals for warranties issued |
|
|
17 |
|
|
|
39 |
|
Settlements made |
|
|
(18 |
) |
|
|
(30 |
) |
|
|
|
|
|
|
|
Ending balance |
|
$ |
260 |
|
|
$ |
170 |
|
|
|
|
|
|
|
|
9
Indemnities
In the ordinary course of business the Company enters into agreements with customers that
include indemnity provisions. Based on historical experience and other available information the
Company believes its exposure related to the above indemnity provisions was immaterial for each of
the periods presented.
Research and Development
Research and development costs are expensed as incurred and primarily include personnel costs,
prototype expenses, which include the cost of fabrication mask costs not reasonably expected to be
used in production manufacturing, and allocated facilities costs as well as depreciation of
equipment used in research and development.
Advertising
The Company expenses advertising costs as incurred. Advertising costs were $42,000 and
$127,000 for the three months ended March 31, 2008 and 2007, respectively.
Operating Leases
The Company recognizes rent expense on a straight-line basis over the term of the lease. The
difference between rent expense and rent paid is recorded as accrued rent in accrued expenses and
other current and non-current liabilities components of the consolidated balance sheets.
Income Taxes
The Company provides for deferred income taxes under the asset and liability method. Under
this method, deferred tax assets, including those related to tax loss carryforwards and credits,
and liabilities are determined based on the differences between the financial statement and tax
basis of assets and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. A valuation allowance is recorded to reduce deferred tax
assets when it is more likely than not that the net deferred tax asset will not be recovered.. The
Company monitors the status of the deferred tax assets on a regular basis. Once sustained
profitability has been achieved in certain tax jurisdictions, the Company will release the
valuation allowance per Statement of Financial Accounting Standards No. 109.
Accounting for Stock-Based Compensation
The Company recognizes stock-based compensation for options granted to employees in accordance
with FAS 123(R). The Company estimates the grant date fair value of stock option awards under the
provisions of SFAS 123(R) using the Black-Scholes option valuation model, which requires, among
other inputs, an estimate of the Companys fair value of the underlying common stock on the date of
grant. For the three months ended March 31, 2008 and 2007, the Company recorded stock-based
compensation expense of $767,000 and $357,000, respectively. In future periods, stock-based
compensation expense may increase as the Company issues additional stock-based awards to continue
to attract and retain key employees. SFAS 123(R) also requires that the Company recognize
stock-based compensation expense only for the portion of stock options that are expected to vest,
based on the Companys estimated forfeiture rate. If the actual number of future forfeitures
differs from that estimated by management, the Company may be required to record adjustments to
stock-based compensation expense in future periods.
The Company accounts for stock-based compensation arrangements with non-employees in
accordance with SFAS 123(R) and Emerging Issues Task Force, or EITF No. 96-18, Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, using a fair value approach. The fair value of the stock options
granted to non-employees was estimated using the Black-Scholes option valuation model. This model
utilizes the estimated fair value of the Companys common stock, the contractual term of the
option, the expected volatility of the price of the Companys common stock, risk-free interest
rates and the expected dividend yields of the Companys common stock. Stock-based compensation
expense related to non-employees was none and $68,000 for the three months ended March 31, 2008 and
2007, respectively.
10
The following table presents the detail of stock-based compensation expense amounts included
in the consolidated statement of operations for each of the periods presented:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands) |
|
Cost of revenue |
|
$ |
29 |
|
|
$ |
4 |
|
Research and development |
|
|
328 |
|
|
|
138 |
|
Sales, general and administrative |
|
|
410 |
|
|
|
215 |
|
|
|
|
|
|
|
|
|
|
$ |
767 |
|
|
$ |
357 |
|
|
|
|
|
|
|
|
The total stock-based compensation cost capitalized as part of inventory as of March 31, 2008
and 2007 was $74,000 and $4,000, respectively.
Other Comprehensive Income (Loss)
Comprehensive income (loss) includes all changes in equity that are not the result of
transactions with stockholders. For the three months ended March 31, 2008 and 2007, there are no
components of comprehensive income (loss) which are excluded
from the net income (loss) and, therefore, no
separate statement of comprehensive income (loss) has been presented.
Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, or
SFAS No. 141R, which replaces SFAS No 141. The statement retains the purchase method of accounting
for acquisitions, but requires a number of changes, including changes in the way assets and
liabilities are recognized in the purchase accounting. It also changes the recognition of assets
acquired and liabilities assumed arising from contingencies, requires the capitalization of
in-process research and development at fair value, and requires the expensing of
acquisition-related costs as incurred. SFAS No. 141R is effective for financial statements issued
for fiscal years beginning after December 15, 2008 and will apply prospectively to business
combinations completed on or after that date. The Company is currently evaluating the impact, if
any, of adopting this standard on the Companys financial position, results of operations and
liquidity.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements, or SFAS No. 160. SFAS No. 160 clarifies that a noncontrolling or minority
interest in a subsidiary is considered an ownership interest and, accordingly, requires all
entities to report such interests in subsidiaries as equity in the consolidated financial
statements. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The
Company is currently evaluating the impact, if any, of adopting this standard on the Companys
financial position, results of operations and liquidity.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities, or SFAS No. 161. SFAS No. 161 is intended to improve financial reporting about
derivative instruments and hedging activities by requiring enhanced disclosures to enable investors
to better understand their effects on an entitys financial position, financial performance, and
cash flows. It is effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application encouraged. The Company is currently
evaluating the impact, if any, of adopting this standard on the Companys financial position,
results of operations and liquidity.
2. Net Income (Loss) Per Common Share
The
Company calculates net income (loss) per
share in accordance with SFAS No. 128, Earnings per
Share, or SFAS 128. Under SFAS 128, basic net income (loss) per common share is computed by
dividing net income (loss) by the weighted average number of common shares outstanding during the
period (excluding shares subject to repurchase). Diluted net income (loss) per common share is
computed by dividing net income (loss) by the weighted-average number of common and potentially
dilutive
common equivalent shares outstanding during the period. Potentially dilutive securities,
composed of incremental common shares issuable upon the exercise of stock options and common stock
subject to repurchase, are included in diluted net income per share for the three months ended
March 31, 2008 and 2007, respectively.
11
The following table sets forth the computation of income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands) |
|
Net income (loss) |
|
$ |
1,972 |
|
|
$ |
(997 |
) |
|
|
|
|
|
|
|
Weighted average common shares outstanding basic |
|
|
39,966 |
|
|
|
8,579 |
|
Dilutive effect of employee stock plans |
|
|
2,169 |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding diluted |
|
|
42,135 |
|
|
|
8,579 |
|
|
|
|
|
|
|
|
Basic net income (loss) per share |
|
|
0.05 |
|
|
$ |
(0.12 |
) |
|
|
|
|
|
|
|
Diluted net income (loss) per share |
|
|
0.05 |
|
|
|
(0.12 |
) |
|
|
|
|
|
|
|
3. Fair Value
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, or SFAS No. 157.
SFAS No. 157 defines fair value, establishes a framework and provides guidance regarding the
methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS
No. 157 was effective for the Company as of January 1, 2008. In February 2008, the FASB issued
FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which provides a one
year deferral of the effective date of SFAS 157 for non-financial assets and non-financial
liabilities, except those that are recognized or disclosed in the financial statements at fair
value at least annually. Therefore, the Company has adopted the provisions of SFAS 157 with respect
to its financial assets and liabilities only.
Fair value is defined under SFAS 157 as the exchange price that would be received for an asset
or paid to transfer a liability (an exit price) in the principal or most advantageous market for
the asset or liability in an orderly transaction between market participants on the measurement
date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of
observable inputs and minimize the use of unobservable inputs. The standard describes a fair value
hierarchy based on three levels of inputs, of which the first two are considered observable and the
last unobservable, that may be used to measure fair value which are the following:
|
|
Level 1 Quoted prices in active markets for identical assets or liabilities. |
|
|
Level 2 Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term
of the assets or liabilities. |
|
|
Level 3 Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets or
liabilities. |
The adoption of this statement did not have a material impact on the Companys consolidated results
of operations and financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities, or SFAS No. 159, which permits entities to choose to measure eligible
financial instruments and certain other items at fair value that are not currently required to be
measured at fair value. Unrealized gains and losses on items for which the fair value option has
been elected are reported in earnings at each subsequent reporting date. SFAS No. 159 is effective
for fiscal years beginning after
November 15, 2007. Effective January 1, 2008, the Company adopted SFAS No. 159 The Fair Value
Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 allows an entity the
irrevocable option to elect fair value for the initial and subsequent measurement for specified
financial assets and liabilities on a contract-by-contract basis. The Company did not elect to
adopt the fair value option for assets or liabilities under this Statement.
12
In accordance with SFAS 157, the following table represents the Companys fair value hierarchy
for its financial assets (cash equivalents and investments) measured at fair value on a recurring
basis as of March 31, 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
Money Market Fund |
|
$ |
95,612 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
95,612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
95,612 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
95,612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4. Inventories
Inventories are stated at the lower of cost (determined using the first-in, first-out method),
or market value (estimated net realizable value) and are comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
As of |
|
|
|
March 31, 2008 |
|
|
December 31, 2007 |
|
|
|
(In thousands) |
|
Work-in-process |
|
$ |
9,132 |
|
|
$ |
8,092 |
|
Finished goods |
|
|
1,635 |
|
|
|
1,481 |
|
|
|
|
|
|
|
|
|
|
$ |
10,767 |
|
|
$ |
9,573 |
|
|
|
|
|
|
|
|
5. Property and Equipment, net
Property and equipment, net, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
As of |
|
|
|
March 31, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Test equipment |
|
$ |
7,119 |
|
|
$ |
5,587 |
|
Software and computer equipment |
|
|
12,995 |
|
|
|
12,738 |
|
Furniture, office equipment and leasehold
improvements |
|
|
57 |
|
|
|
57 |
|
|
|
|
|
|
|
|
|
|
|
20,171 |
|
|
|
18,382 |
|
Less: accumulated depreciation and amortization |
|
|
(8,673 |
) |
|
|
(6,774 |
) |
|
|
|
|
|
|
|
|
|
$ |
11,498 |
|
|
$ |
11,608 |
|
|
|
|
|
|
|
|
Depreciation and amortization expense was $1,899,000 and $833,000 for the three months ended
March 31, 2008 and 2007, respectively.
Capital leases included in property and equipment were $7,873,000 at March 31, 2008 and
December 31, 2007. Amortization expense related to assets recorded under capital lease was $666,000
and $315,000 for the three months March 31, 2008 and 2007, respectively.
13
6. Intangible Assets, net
Intangible assets consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2008 |
|
|
As of December 31, 2007 |
|
|
|
(in thousands) |
|
Developed technology |
|
$ |
3,343 |
|
|
$ |
3,343 |
|
Technology license |
|
|
9,205 |
|
|
|
9,205 |
|
|
|
|
|
|
|
|
|
|
|
12,548 |
|
|
|
12,548 |
|
Less: accumulated amortization |
|
|
|
|
|
|
|
|
Developed technology |
|
|
(3,323 |
) |
|
|
(3,235 |
) |
Technology license |
|
|
(5,451 |
) |
|
|
(5,217 |
) |
|
|
|
|
|
|
|
|
|
$ |
3,774 |
|
|
$ |
4,096 |
|
|
|
|
|
|
|
|
Amortization expense was $322,000 and $396,000 for the three months ended March 31, 2008 and
2007, respectively. The weighted-average remaining estimated lives for intangible assets are
approximately 1 month for developed technology and 2 years for technology license. The weighted
average remaining estimated life of intangible assets in total is approximately 1.8 years. Future
amortization expenses are estimated to be $688,000 for 2008, $1,530,000 for 2009, $1,250,000 for
2010, and $307,000 thereafter.
7. Accrued Expenses and Other Current Liabilities
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
As of |
|
|
|
March 31, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Accrued compensation and related benefit |
|
$ |
1,007 |
|
|
$ |
1,010 |
|
Accrued warranty |
|
|
260 |
|
|
|
261 |
|
Refundable deposits related to unvested
employee stock option exercises |
|
|
49 |
|
|
|
70 |
|
Professional fees |
|
|
272 |
|
|
|
285 |
|
Income tax payable |
|
|
474 |
|
|
|
231 |
|
Other |
|
|
387 |
|
|
|
396 |
|
|
|
|
|
|
|
|
|
|
$ |
2,449 |
|
|
$ |
2,253 |
|
|
|
|
|
|
|
|
8. Common Stock
In May 2007, the Company completed its IPO in which the Company sold and issued 7,762,500
shares of common stock, including 1,012,500 shares of the underwriters over-allotment, at an issue
price of $13.50 per share. The Company received gross proceeds of $104.8 million from the IPO, or
approximately $94.7 million in net proceeds after deducting underwriting discounts and commissions
of $7.3 million and other offering costs of $2.8 million. Upon the closing of the IPO, all shares
of mandatorily redeemable convertible preferred stock outstanding automatically converted into
22,364,378 shares of common stock.
|
|
|
|
|
Common stock outstanding at December 31, 2006 |
|
|
9,365,600 |
|
Common stock issued in IPO |
|
|
7,762,500 |
|
Conversion of mandatorily redeemable convertible preferred stock to common stock |
|
|
22,364,378 |
|
Common stock issued in connection with exercises of stock options from January 1, 2007 through March 31, 2008 |
|
|
826,482 |
|
Common stock issued in connection with the common stock warrant exercises |
|
|
86,756 |
|
Repurchases of shares of unvested common stock |
|
|
(14,585 |
) |
|
|
|
|
|
Common stock outstanding at March 31, 2008 |
|
|
40,391,131 |
|
|
|
|
|
|
Stock Options and Unvested Common Stock
Upon completion of its IPO in May 2007, the Company adopted the 2007 Stock Incentive Plan, or
the 2007 Plan, which reserved 5,000,000 shares of the Companys common stock. The number of shares
of the common stock reserved for issuance increased in January 2008 by 2,015,368 shares, pursuant
to the automatic provision of the 2007 Plan. The 2007 Plan provides for the grant of incentive
stock options, nonstatutory stock options, restricted stock awards, restricted stock unit awards,
stock appreciation rights, performance stock awards, and other forms of equity compensation, or
collectively, the stock awards, and performance cash awards, all of which may be granted to
employees (including officers), directors, and consultants or affiliates. Awards granted under the
2007 Plan vest at the rate specified by the plan administrator, typically with 1/8th of the shares
vesting six months after the date of grant and
14
1/48th of the shares vesting monthly thereafter over the next three and one half years. The term of awards expires seven to ten years from the date of
grant. As of March 31, 2008, 1,693,075 shares have been granted under the 2007 Plan.
Prior to the IPO, the Company issued stock options pursuant to the 2001 Stock Incentive Plan,
or the 2001 Plan. As of March 31, 2008, 364,618 shares of the Companys common stock were reserved
for issuance to employees, officers, consultants and advisors of the Company pursuant to
outstanding options. Options granted under the 2001 Plan were either incentive stock options or
non-statutory stock options as determined by the Companys board of directors. Options granted
under the 2001 Plan vest at the rate specified by the plan administrator, typically with 1/8th of
the shares vesting six months after the date of grant and 1/48th of the shares vesting monthly
thereafter over the next three and one half years to four and one half years. The term of option
expires ten years from the date of grant. No options to purchase shares have been granted under
the 2001 Plan in the three months ended March 31, 2008.
Under the Companys 2001 Plan, certain employees have the right to early-exercise unvested
stock options, subject to rights held by the Company to repurchase unvested shares in the event of
voluntary or involuntary termination. For options granted prior to March 2005, the Company has the
right to repurchase any such shares at the shares original purchase price. For options granted
after March 2005, the Company has the right to repurchase such shares at the lower of market value
or the original purchase price.
For those options granted prior to March 2005, in accordance with EITF 00-23, Working Group
Work Plan Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25,
Accounting for Stock Issued to Employees, and FASB Interpretation No. 44 Accounting for Certain
Transactions involving Stock Compensation, the Company accounts for cash received in consideration
for the early-exercise of unvested stock options as a current liability, included as a component of
accrued liabilities in the Companys consolidated balance sheets. For those shares issued in
connection with options granted prior to March 2005, there were 81,418 and 123,895 unvested shares
outstanding as of March 31, 2008 and December 31, 2007, respectively, and $49,000 and $70,000
related liabilities, respectively.
Detail related to activity of early-exercise unvested shares of common stock is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average |
|
|
Number of Unvested |
|
Exercise/Purchase |
|
|
Shares Outstanding |
|
Price |
Balance as of December 31, 2007 |
|
|
436,662 |
|
|
$ |
2.45 |
|
Issued |
|
|
|
|
|
|
|
|
Vested |
|
|
(87,125 |
) |
|
|
1.89 |
|
Cancelled and forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2008 |
|
|
349,537 |
|
|
|
2.59 |
|
|
|
|
|
|
|
|
|
|
Detail related to stock option activity is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
Number of |
|
Exercise |
|
|
Shares |
|
Price |
|
|
Outstanding |
|
per Share |
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007 |
|
|
3,920,001 |
|
|
$ |
3.86 |
|
Options granted |
|
|
1,476,975 |
|
|
|
15.24 |
|
Options exercised |
|
|
(81,395 |
) |
|
|
1.61 |
|
Options cancelled and forfeited |
|
|
(20,754 |
) |
|
|
7.34 |
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2008 |
|
|
5,294,827 |
|
|
|
7.06 |
|
|
|
|
|
|
|
|
|
|
15
The total intrinsic value for options exercised for the three months ended March 31, 2008 and
2007 amounted to $1,397,000 and $365,000, respectively, representing the difference between the
estimated fair value of the Companys common stock at the date of exercise and the exercise price
paid.
The following table summarizes information about stock options outstanding as of March 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding Options |
|
|
Exercisable Options |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number |
|
|
Average |
|
|
Weighted |
|
|
Number |
|
|
Weighted |
|
|
Aggregate |
|
|
|
Outstanding |
|
|
Remaining |
|
|
Average |
|
|
Exercisasble |
|
|
Average |
|
|
Intrinsic |
|
Exercise Prices |
|
As of 3/31/08 |
|
|
Contractual Term |
|
|
Exercise Price |
|
|
As of 3/31/08 |
|
|
Exercise Price |
|
|
Value |
|
$0.190.80 |
|
|
514,445 |
|
|
|
5.93 |
|
|
$ |
0.29 |
|
|
|
452,683 |
|
|
$ |
0.28 |
|
|
|
|
|
1.02 1.50 |
|
|
1,047,397 |
|
|
|
7.33 |
|
|
|
1.04 |
|
|
|
667,311 |
|
|
|
1.03 |
|
|
|
|
|
3.04 3.74 |
|
|
1,593,026 |
|
|
|
7.93 |
|
|
|
3.07 |
|
|
|
612,909 |
|
|
|
3.07 |
|
|
|
|
|
8.52 8.52 |
|
|
483,118 |
|
|
|
8.83 |
|
|
|
7.35 |
|
|
|
119,939 |
|
|
|
7.01 |
|
|
|
|
|
14.80 14.80 |
|
|
1,346,975 |
|
|
|
6.96 |
|
|
|
14.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
18.18 27.00 |
|
|
222,366 |
|
|
|
7.86 |
|
|
|
22.71 |
|
|
|
18,662 |
|
|
|
27.00 |
|
|
|
|
|
28.46 31.54 |
|
|
87,500 |
|
|
|
9.51 |
|
|
|
30.73 |
|
|
|
6,665 |
|
|
|
29.68 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.19 31.54 |
|
|
5,294,827 |
|
|
|
7.47 |
|
|
|
7.06 |
|
|
|
1,878,169 |
|
|
|
2.26 |
|
|
|
52,130,600 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable |
|
|
1,878,169 |
|
|
|
|
|
|
|
2.26 |
|
|
|
|
|
|
|
|
|
|
|
26,852,749 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected
to vest |
|
|
4,875,349 |
|
|
|
|
|
|
|
6.93 |
|
|
|
|
|
|
|
|
|
|
|
48,571,796 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of each employee option grant for the three months ended March 31, 2008 and
2007 under SFAS 123(R) was estimated on the date of grant using the Black-Scholes option pricing
model with the following assumptions.
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
Ended March 31, |
|
|
2008 |
|
2007 |
Risk-free interest rate |
|
|
2.33 |
% |
|
|
4.72 |
% |
Expected life |
|
4.53 4.75 years |
|
4 years |
Dividend yield |
|
None |
|
None |
Volatility |
|
|
56 |
% |
|
|
55 |
% |
The Company determined that it was not practical to calculate the historical volatility of its
share price since the Company has limited information on its past volatility as its securities were
not publicly traded prior to May 2007, before which there was no readily determinable market value
for its stock. Further, the Company is a high-growth technology company whose future operating
results are not comparable to its prior operating results. Therefore, the Company estimated its
expected volatility based on reported market value data for a group of publicly traded companies,
which it selected from certain market indices, that the Company believed was relatively comparable
after consideration of their size, stage of life cycle, profitability, growth, and risk and return
on investment. The expected term represents the period that stock-based awards are expected to be
outstanding, giving consideration to the contractual terms of the stock-based awards, vesting
schedules and expectations of future employee behavior as influenced by changes to the terms of our
stock-based awards. For the period ended March 31, 2008, the Company used the simplified method of
determining the expected term as permitted by the provisions of Staff Accounting Bulletin No. 110,
Year-End Help for Expensing Employee Stock Options.
The estimated weighted-average grant date fair value of options granted for the three months
ended March 31, 2008 and 2007 were $7.28 and $5.93, respectively.
As of March 31, 2008, there was $15.8 million of unrecognized compensation costs related to
stock options granted under the companys 2001 Plan and 2007 Plan. The unrecognized compensation
cost is expected to be recognized over a weighted average period of 3.01 years.
16
Restricted Stock Unit Awards
The company began issuing restricted stock units, or RSUs, in the fourth quarter of 2007.
Shares are issued on the date the restricted stock units vest, and the fair value of the underlying
stock on the dates of grant is recognized as stock-based compensation over the vesting periods.
Below is the information as of March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
Average |
|
|
Average |
|
|
|
|
|
|
|
|
|
|
Grant Date |
|
|
Remaining |
|
|
Aggregate |
|
|
|
Number of |
|
|
Fair Value |
|
|
Contractual |
|
|
Intrinsic |
|
|
|
Shares |
|
|
Per Share |
|
|
Term (years) |
|
|
Value (1) |
|
Balance as of December 31, 2007 |
|
|
12,000 |
|
|
$ |
31.54 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
18,400 |
|
|
|
14.80 |
|
|
|
|
|
|
|
|
|
Issued and released |
|
|
(2,375 |
) |
|
|
31.54 |
|
|
|
|
|
|
|
|
|
Cancelled and forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2008 |
|
|
28,025 |
|
|
$ |
20.55 |
|
|
|
1.06 |
|
|
$ |
459,610 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest as of March 31, 2008 |
|
|
26,312 |
|
|
|
20.55 |
|
|
|
1.05 |
|
|
$ |
431,519 |
|
|
|
|
(1) |
|
Aggregate intrinsic value for RSUs represents the closing price per
share of the Companys stock on March 31, 2008, multiplied by the number of
unvested RSUs expected to vest as of March 31, 2008. |
For RSUs, stock-based compensation expense is calculated based on the market price of the
Companys common stock on the date of grant, multiplied by the number of RSUs granted. The grant
date fair value of RSUs, less estimated forfeitures, is recorded on a straight-line basis, over the
vesting period.
On March 17, 2008, the Company granted 18,400 shares of RSUs to certain employees, issuable on
February 28, 2009. As of March 31, 2008, there was $553,000 of unrecognized compensation costs
related to restricted stock units granted under the Companys 2007 Equity Incentive Plan. The
unrecognized compensation cost is expected to be recognized over a weighted average period of 1.49
years.
9. Current and Deferred Income Taxes
For the three months ended March 31, 2008 and 2007, the provision for income taxes was based
on the estimated annual effective tax rate in compliance with SFAS 109 and other related guidance.
The Company updates its estimate of its annual effective tax rate at the end of each quarterly
period. The estimate takes into account estimations of annual pre-tax income, the geographic mix of
pre-tax income and interpretations of tax laws and the possible outcomes of current and future
audits.
The following table presents the provision and benefit for income taxes and the effective tax
rates for the three months ended March 31, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
( in thousands) |
|
Income (loss) before income taxes |
|
$ |
2,219 |
|
|
$ |
(940 |
) |
Income tax provision |
|
|
247 |
|
|
|
57 |
|
|
|
|
|
|
|
|
Effective tax rate |
|
|
11.1 |
% |
|
|
6.1 |
% |
|
|
|
|
|
|
|
17
The provision for income taxes was $247,000 and $57,000 for the three months ended March 31,
2008 and 2007. The income tax expense was primarily related to the federal alternative minimum tax
on profits in the United States adjusted by certain non-deductible items, international taxes and
state income taxes.
The difference between the provision for income that would be derived by applying the
statutory rate to income before tax for the three months ended March 31, 2008 and the provision
actually recorded was due to the impact of non-deductible SFAS 123R stock option compensation
expenses offset by the benefit from net operating loss carryforwards and utilization of research
credits carryforwards.
As a result of the implementation of FIN 48, the Company did not recognize any adjustment to
the liability for uncertain tax positions and therefore did not record any adjustment to the
beginning balance of retained earnings. As of December 31, 2007 the Company had $3.6 million of
unrecognized tax benefits, which is netted against deferred tax assets and is fully offset by a
valuation allowance. There were no significant changes to the unrecognized tax benefit during the
three months ended March 31, 2008.
The Companys major tax jurisdictions are the United States federal government and the State
of California. The Company files income tax returns in the United States federal jurisdiction, the
State of California and various state and foreign tax jurisdictions in which it has a subsidiary or
branch operation. The United States federal corporation income tax returns beginning with the 2000
tax year remain subject to examination by the Internal Revenue Service, or IRS. The California
corporation income tax returns beginning with the 2000 tax year remain subject to examination by
the California Franchise Tax Board. There are no on-going tax audits in the major tax
jurisdictions.
10. Retirement Plan
The Company has established a defined contribution savings plan under Section 401(k) of the
Internal Revenue Code. This plan covers substantially all employees who meet minimum age and
service requirements and allows participants to defer a portion of their annual compensation on a
pre-tax basis. Company contributions to the plan may be made at the discretion of the board of
directors. For the year ending December 31, 2008 the Company
matches 50% of the employees
contribution up to $2,000 per year per employee.
11. Segment Information
SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, establishes
standards for reporting information about operating segments. Operating segments are defined as
components of an enterprise for which separate financial information is available and evaluated
regularly by the chief operating decision-maker, or decision-making group, in deciding how to
allocate resources and in assessing performance. The Company is organized as, and operates in, one
reportable segment: the development and sale of semiconductor processor solutions for
next-generation intelligent networking equipment. The chief operating decision-maker is the Chief
Executive Officer. The Companys Chief Executive Officer reviews financial information presented on
a consolidated basis, accompanied by information about revenue by customer and geographic region,
for purposes of evaluating financial performance and allocating resources. The Company and its
Chief Executive Officer evaluate performance based primarily on revenue to the customers and in the
geographic locations in which the Company operates. Revenue is attributed by geographic
18
location based on the ship-to location of customers. The Companys assets are primarily located in the
United States of America and not allocated to any specific region. Therefore, geographic information is presented only for
total revenue. Substantially all of the Companys long-lived assets are located in the United
States of America.
The following table is based on the geographic location of the OEMs or the distributors who
purchased the Companys products. For sales to the distributors, their geographic location may be
different from the geographic locations of the ultimate end users. Sales by geography for the
periods indicated were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands) |
|
|
(unaudited) |
|
United States |
|
$ |
10,428 |
|
|
$ |
6,768 |
|
Taiwan |
|
|
3,110 |
|
|
|
2,406 |
|
Japan |
|
|
1,311 |
|
|
|
849 |
|
China |
|
|
1,322 |
|
|
|
479 |
|
Other countries |
|
|
2,171 |
|
|
|
639 |
|
|
|
|
|
|
|
|
Total |
|
$ |
18,342 |
|
|
$ |
11,141 |
|
|
|
|
|
|
|
|
19
12. Commitments and Contingencies
The
Company leases its facilities under non-cancelable operating leases, which contain renewal
options and escalation clauses, and expires through May 2012.
The Company also acquires certain
assets under capital leases.
Minimum commitments under non-cancelable capital and operating lease agreements as of March
31, 2008 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital lease |
|
|
|
|
|
|
|
|
|
and technology |
|
|
|
|
|
|
|
|
|
license |
|
|
Operating |
|
|
|
|
|
|
obligations |
|
|
leases |
|
|
Total |
|
|
|
(in thousands) |
|
Remainder of 2008 |
|
$ |
3,219 |
|
|
$ |
956 |
|
|
$ |
4,175 |
|
2009 |
|
|
2,595 |
|
|
|
1,065 |
|
|
|
3,660 |
|
2010 |
|
|
1,774 |
|
|
|
1,110 |
|
|
|
2,884 |
|
2011 |
|
|
|
|
|
|
844 |
|
|
|
844 |
|
2012 |
|
|
|
|
|
|
199 |
|
|
|
199 |
|
thereafter |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,588 |
|
|
$ |
4,174 |
|
|
$ |
11,762 |
|
Less: Interest component |
|
|
(655 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Present value of minimum lease
payment |
|
|
6,933 |
|
|
|
|
|
|
|
|
|
Less: current portion |
|
|
(3,501 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term portion of obligations |
|
$ |
3,432 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rent expense incurred under operating leases was $310,000 and $225,000 for the three months
ended March 31, 2008 and 2007, respectively.
The Company is not currently a party to any legal proceedings that management believes would
have a material adverse effect on the consolidated financial position, results of operations or
cash flows of the Company.
The technology license obligations include future cash payments payable primarily for license
agreements with outside vendors. One of the license agreements is with Cadence Design Systems for
its electronic design automation software which is used in the design of the Companys products.
The term of the license is two years and will expire in June 2009. The second license agreement is
with MIPS Technologies, Inc. which includes a non-exclusive, non-transferable right to develop
multiple licensed MIPS cores that implement the MIPS architecture. This second license agreement
required the Company to pay $1.9 million after the completion of its IPO for an automatic two-year
extension of the license. The term of the license after the two-year extension is seven years and
will expire in December 2010. As of March 31, 2008, $875,000 was paid, and the balance is accrued
within capital lease and technology license obligations on consolidated balance sheets.
The Company also has a purchase agreement with Synopsys Inc., or Synopsys, to purchase certain
intellectual property which is to be used for the Companys future products. The Company has an
agreement to pay $1.15 million over the two-year period for various intellectual properties. The
agreement will expire in October 2008. As of March 31, 2008, $815,000 has been paid to purchase
certain intellectual property.
In October 2007, the Company signed a license agreement with Synopsys for certain design tools
totaling $7.0 million, with 12 installment payments. The term of the license is three years and
will expire in October 2010. The present value of the installment payments has been capitalized and
is amortized over three years, and included within capital lease and technology license obligations
on consolidated balance sheets. As of March 31, 2008, $1,082,000 was paid.
20
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, which are subject to the safe harbor created by those sections.
Forward-looking statements are based on our managements beliefs and assumptions and on information
currently available to our management. In some cases, you can identify forward-looking statements
by terms such as may, will, should, could, would, expect, plan, anticipate,
believe, estimate, project, predict, potential and similar expressions intended to
identify forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors, which may cause our actual results, performance, time frames or
achievements to be materially different from any future results, performance, time frames or
achievements expressed or implied by the forward-looking statements. We discuss many of these
risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail
under the heading Risk Factors. Given these risks, uncertainties and other factors, you should
not place undue reliance on these forward-looking statements. Also, these forward-looking
statements represent our estimates and assumptions only as of the date of this filing. You should
read this Quarterly Report on Form 10-Q completely and with the understanding that our actual
future results may be materially different from what we expect. We hereby qualify our
forward-looking statements by these cautionary statements. Except as required by law, we assume no
obligation to update these forward-looking statements publicly, or to update the reasons actual
results could differ materially from those anticipated in these forward-looking statements, even if
new information becomes available in the future.
Overview
We are a provider of highly integrated semiconductor products that enable intelligent
processing for networking, communications and security applications. We market and sell our
products to providers of networking equipment that sell their products into the enterprise network,
data center, broadband and consumer, and access and service provider markets. Our products are used
in a broad array of networking equipment, including routers, switches, content-aware switches,
unified threat management, or UTM and other security appliances, application-aware gateways,
voice/video/data, or triple-play, gateways, wireless local area network, or WLAN and
third-generation, or 3G access and aggregation devices, storage networking equipment, servers and
intelligent network interface cards. We focus our resources on the design, sales and marketing of
our products, and outsource the manufacturing of our products.
From our incorporation in 2000 through 2003, we were primarily engaged in the design and
development of our first processor family, NITROX, which we began shipping commercially in 2003. In
2004, we introduced and commenced commercial shipments of NITROX Soho. In 2006, we commenced our
first commercial shipments of our OCTEON family of multi-core MIPS64 processors. We introduced a
number of new products within all three of these product families in 2006. In 2007 we introduced
our new line of OCTEON based storage services processors designed to address the specific needs in
the storage market, as well as other new products in the OCTEON and NITROX families. Since
inception, we have invested heavily in new product development and achieved our first quarter of
profitability during the quarter ended September 30, 2007. Our revenue has grown from $19.4 million
in 2005 to $34.2 million in 2006, $54.2 million in 2007, and $18.3 million for the first three
months ended March 31, 2008, driven primarily by demand in the enterprise network and data center
markets. We expect sales of our products for use in the enterprise network and data center markets
to continue to represent a substantial portion of our revenue in the foreseeable future. However,
we expect sales into those markets to decline as a percentage of overall sales as sales in the
broadband and consumer and the access and service provider markets are expected to increase at a
rate faster than the expected increase in sales into the enterprise network and data center
markets.
We primarily sell our products to OEMs, either directly or through their contract
manufacturers. Contract manufacturers purchase our products only when an OEM incorporates our
product into the OEMs product, not as commercial off-the-shelf products. Our customers products
are complex and require significant time to define, design and ramp to volume production.
Accordingly, our sales cycle is long. This cycle begins with our technical marketing, sales and
field application engineers engaging with our customers system designers and management, which is
typically a multi-month process. If we are successful, a customer will decide to incorporate our
product in its product, which we refer to as a design win. Because the sales cycles for our
products are long, we incur expenses to develop and sell our products, regardless of whether we
achieve the design win and well in advance of generating revenue, if any, from those expenditures.
We do not have long-term purchase commitments from any of our customers, as sales of our products
are generally made under individual purchase orders. However, once one of our products is
incorporated into a customers design, it is likely to remain designed in for the life cycle of its
product. We believe this to be the case because a redesign would generally be time consuming and
expensive. We have experienced revenue growth due to an increase in the number of our products, an
expansion of our customer base, an increase in the number of average design wins within any one
customer and an increase in the average revenue per design win.
21
Key Business Metrics
Design Wins. We closely monitor design wins by customer and end market on a periodic basis. We
consider design wins to be a key ingredient in our future success, although the revenue generated
by each design can vary significantly. Our long-term sales expectations are based on internal
forecasts from specific customer design wins based upon the expected time to market for end
customer products deploying our products and associated revenue potential.
Pricing and Margins. Pricing and margins depend on the features of the products we provide to
our customers. In general, products with more complex configurations and higher performance tend to
be priced higher and have higher gross margins. These configurations tend to be used in high
performance applications that are focused on the enterprise network, data center, and access and
service provider markets. We tend to experience price decreases over the life cycle of our
products, which can vary by market and application. In general, we experience less pricing
volatility with customers that sell to the enterprise and data center markets.
Sales Volume. A typical design win can generate a wide range of sales volumes for our
products, depending on the end market demand for our customers products. This can depend on
several factors, including the reputation, market penetration, the size of the end market that the
product addresses, and the marketing and sales effectiveness of our customers. In general, our
customers with greater market penetration and better branding tend to develop products that
generate larger volumes over the product life cycle. In addition, some markets generate large
volumes if the end market product is adopted by the mass market.
Customer Product Life Cycle. We typically commence commercial shipments from nine months to
three years following the design win. Once our product is in production, revenue from a particular
customer may continue for several years. We estimate our customers product life cycles based on
the customer, type of product and end market. In general, products that go into the enterprise
network and data center take longer to reach volume production but tend to have longer lives.
Products for other markets, such as broadband and consumer, tend to ramp relatively quickly, but
generally have shorter life cycles. We estimate these life cycles based on our managements
experience with providers of networking equipment and the semiconductor market as a whole.
Results of Operations
Three Months Ended March 31, 2008 and 2007
Revenue. Our revenue consists primarily of sales of our semiconductor products to providers of
networking equipment and their contract manufacturers and through distributors. Initial sales of
our products for a new design are usually made directly to providers of networking equipment as
they design and develop their product. Once their design enters production, they often outsource
their manufacturing to contract manufacturers that purchase our products directly from us or from
our distributors. We price our products based on market and competitive conditions and periodically
reduce the price of our products, as market and competitive conditions change, and as manufacturing
costs are reduced. We do not experience different margins on direct sales to providers of
networking equipment and indirect sales through contract manufacturers because in all cases we
negotiate product pricing directly with the providers of networking equipment. To date, all of our
revenue has been denominated in U.S. dollars.
We also derive revenue in the form of license and maintenance fees through licensing our
software products which help our customers build products around our systems-on-a-chip, or SoCs in
a more time and cost efficient manner. Revenue from such arrangements totaled $266,000 and $318,000
for the three months ended March 31, 2008 and 2007, respectively.
Our customers representing greater than 10% of revenue for each of the periods were:
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
|
ended March 31, |
|
|
2008 |
|
2007 |
Percentage of total revenue |
|
|
|
|
|
|
|
|
Cisco |
|
|
30 |
% |
|
|
24 |
% |
F5 Networks |
|
|
* |
|
|
|
20 |
% |
|
|
|
* |
|
Represents less than 10% |
22
Our distributors are used primarily to support international sale logistics in Asia, including
importation and credit management. Total revenue through distributors were $5.5 million and $3.3
million for the three months ended March 31, 2008 and 2007, respectively, which accounted for 30.0%
and 29.7% of revenue, respectively. While we have purchase agreements with our distributors, the
distributors do not have long-term contracts with any of the equipment providers. Our distributor
agreements limit the distributors ability to return product up to a portion of purchases in the
preceding quarter. Given our experience, along with our distributors limited contractual return
rights, we believe we can reasonably estimate expected returns from our distributors. Accordingly,
we recognize sales through distributors at the time of shipment, reduced by our estimate of
expected returns.
Revenue and costs relating to sales to distributors are deferred if we grant more than limited
rights of returns and price credits or if we cannot reasonably estimate the level of returns and
credits issuable. During the quarter ended June 30, 2007, we signed a distribution agreement with
Avnet, Inc. to distribute our products primarily in the United States. Given the terms of the
distribution agreement, for sales to Avnet, revenue and costs will be deferred until products are
sold by Avnet to their end customers. For the three months ended March 31, 2008, 3.8% of our net
revenues were from products sold by Avnet. Revenue recognition depends on notification from Avnet
that product has been sold to Avnets end customers.
The following table is based on the geographic location of the original equipment
manufacturers or the distributors who purchased our products. For sales to our distributors, their
geographic location may be different from the geographic locations of the ultimate end customers.
Revenue by geography for the periods indicated were:
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands) |
|
|
(unaudited) |
|
United States |
|
$ |
10,428 |
|
|
$ |
6,768 |
|
Taiwan |
|
|
3,110 |
|
|
|
2,406 |
|
Japan |
|
|
1,311 |
|
|
|
849 |
|
China |
|
|
1,322 |
|
|
|
479 |
|
Other countries |
|
|
2,171 |
|
|
|
639 |
|
|
|
|
|
|
|
|
Total |
|
$ |
18,342 |
|
|
$ |
11,141 |
|
|
|
|
|
|
|
|
Cost of Revenue and Gross Margin. We outsource wafer fabrication, assembly and test functions
of our products. A significant portion of our cost of revenue consists of payments for the purchase
of wafers and for assembly and test services. To a lesser extent, cost of revenue includes expenses
relating to our internal operations that manage our contractors, stock-based compensation, the cost
of shipping and logistics, royalties, inventory valuation expenses for excess and obsolete
inventories, warranty costs and changes in product cost due to changes in sort, assembly and test
yields. In general, our cost of revenue associated with a particular product declines over time as
a result of yield improvements, primarily associated with design and test enhancements.
We use third-party foundries and assembly and test contractors, which are primarily located in
Asia, to manufacture, assemble and test our semiconductor products. We purchase processed wafers on
a per wafer basis from our fabrication suppliers, which are currently TSMC and UMC. We also
outsource the sort, assembly, final testing and other processing of our product to third-party
contractors, primarily ASE and ISE. We negotiate wafer fabrication on a purchase order basis and do
not have long-term agreements with any of our third-party contractors. A significant disruption in
the operations of one or more of these contractors would impact the production of our products
which could have a material adverse effect on our business, financial condition and results of
operations.
Cost of revenue also includes amortized costs related to certain acquired technology assets in
2004 and 2005. In August 2004, we acquired certain assets of Brecis Communications Corporation,
which included the purchase of its secure communication processor product line. We capitalized a
total of $2.3 million of developed technology and amortized that amount on a straight-line basis
over the expected useful life of three years. In April 2005, we acquired Menlo Logic, LLC, which
included the purchase of technology used for secure communication. We capitalized a total of $1.1
million of developed technology and are amortizing that amount on a straight-line basis over the
expected useful life of three years. The total estimated purchase price was allocated to tangible
and identifiable intangible assets and liabilities assumed based on their estimated fair value. The
total intangible assets amortization expense included in cost of revenue was $88,000 and $279,000
for the three months March 31, 2008 and 2007, respectively.
23
In addition, we incur costs for the fabrication of masks used by our contract manufacturers to
manufacture wafers that incorporate our products. The cost of fabrication mask sets has increased
as we began transitioning from a 130-nanometer to a 90-nanometer process in our next-generation
products in 2007. During the three months ended March 31, 2008 and 2007, we capitalized $1,272,000
and $527,000 of mask costs, respectively. As our product processes continue to mature and as we
develop more history and experience, we expect that, in the future, a large percentage of mask costs will be used
directly for production manufacturing and will be capitalized. We amortize the cost of fabrication
masks that we reasonably expect to use for production manufacturing over a 12-month period and
include them in cost of revenue. Total amortized expenses for the masks included in the cost of
revenue was $326,000 and $135,000 for the three months ended March 31, 2008 and 2007. The balance
of capitalized mask costs at March 31, 2008 and
December 31, 2007 was $2,501,000 and $2,845,000,
respectively. As our products mature and there is increasing assurance that any particular product
design will likely go into production, we anticipate that a large percentage of our total mask
costs will be capitalized and amortized to cost of revenue.
Our revenue, cost of revenue, gross profit and gross margin for the three months ended March
31, 2008 and 2007 were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
|
|
|
|
|
|
|
|
ended March 31, |
|
|
|
|
|
|
|
|
|
2008 |
|
|
2007 |
|
|
change |
|
|
% change |
|
|
|
(In thousands) |
|
|
|
|
|
|
Revenue |
|
$ |
18,342 |
|
|
$ |
11,141 |
|
|
$ |
7,201 |
|
|
|
64.6 |
% |
Cost of revenue |
|
|
6,587 |
|
|
|
4,182 |
|
|
|
2,405 |
|
|
|
57.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit |
|
$ |
11,755 |
|
|
$ |
6,959 |
|
|
$ |
4,796 |
|
|
|
68.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Margin |
|
|
64.1 |
% |
|
|
62.5 |
% |
|
|
1.6 |
% |
|
|
2.6 |
% |
Our gross margin has been and will continue to be affected by a variety of factors, including
average sales prices of our products, the product mix, the timing of cost reductions for fabricated
wafers and assembly and test service costs, inventory valuation charges and the timing and changes
in sort, assembly and test yields. Overall product margin is impacted by the mix between higher
performance, higher margin products and lower performance, lower margin products. In addition, we
typically experience lower yields and higher associated costs on new products, which improve as
production volumes increase.
Three Months Ended March 31, 2008 Compared to the Three Months Ended March 31, 2007: Revenue.
Our revenue was $18.3 million in the three months ended March 31, 2008, as compared to $11.1
million in the three months ended March 31, 2007, an increase of 64.6%. The majority of the
increase is related to an increase in sales of $6.8 million in the three months ended March 31,
2008, to existing customers, which was primarily a result of new design wins reaching commercial
production. In the three months ended March 31, 2008 and 2007, a substantial majority of our sales
were to customers that sell into the enterprise network and data center markets. In the three
months ended March 31, 2008 we derived 30.0% of our revenue from distributors compared to 29.7% in
the three months ended March 31, 2007.
Three Months Ended March 31, 2008 Compared to the Three Months Ended March 31, 2007: Gross
Margin. Gross margin increased 1.6 percentage points to 64.1 % in the three months ended March 31,
2008 from 62.5% in the three months ended March 31, 2007. The increase in gross margin in the three
months ended March 31, 2008 compared to the three months ended March 31, 2007 were primarily due to
a slight shift in product mix to more complex, higher performance products, manufacturing cost
improvements due to lower unit wafer costs, and lower amortization costs related to acquired
intangible assets.
Research and Development Expenses
Research and development expenses primarily include personnel costs, engineering design
development software and hardware tools, allocated facilities expenses and depreciation of
equipment used in research and development, and stock-based compensation under SFAS 123(R).
24
We expect research and development expenses to continue to increase in total dollars although
we expect these expenses to generally decrease as a percentage of revenue. Additionally, as a
percentage of revenue, these costs fluctuate from one period to another. Total research and
development expenses for the three months ended March 31, 2008 and 2007 were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
|
|
|
|
|
ended March 31, |
|
|
|
|
|
|
2008 |
|
2007 |
|
change |
|
% change |
|
|
(In thousands) |
|
|
|
|
Research and development expenses |
|
$ |
5,820 |
|
|
$ |
4,326 |
|
|
$ |
1,494 |
|
|
|
34.5 |
% |
Percent of total revenue |
|
|
31.7 |
% |
|
|
38.8 |
% |
|
|
-7.1 |
% |
|
|
-18.3 |
% |
Three Months Ended March 31, 2008 Compared to the Three Months Ended March 31, 2007: Research
and development expenses increased by $1.5 million, or 34.5% to $5.8 million in the three months
ended March 31, 2008 from $4.3 million in the three months ended March 31, 2007. Of the $1.5
million increase, salaries and benefits accounted for $0.8 million, stock-based compensation
expenses accounted for $0.2 million, design tools accounted for $0.3 million and professional
services and other miscellaneous expenses accounted for $0.2 million in the three months ended
March 31, 2008. Research and development headcount increased to 135 at the end of March 2008 from
109 at the end of March 2007.
Sales, General and Administrative Expenses
Sales, general and administrative expenses primarily include personnel costs, accounting and
legal fees, information systems, sales commissions, trade shows, marketing programs, depreciation,
allocated facilities expenses and stock-based compensation under SFAS 123(R). We plan to continue
to increase hiring of our sales and marketing organization to enable us to expand into existing and
new markets. We also plan to continue to invest in expanding our domestic and international sales
and marketing activities and building brand awareness. We incurred significant additional,
accounting and legal compliance costs as well as additional insurance, and investor relations and
other costs associated with being a public company. We expect sales, general and administrative
expenses to increase significantly in absolute dollars and to generally decrease as a percentage of
revenue in the future due to our expected growth and economies of scale. Total sales, general and
administrative costs for the three months ended March 31, 2008 and 2007 were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
|
|
|
|
|
ended March 31, |
|
change |
|
% change |
|
|
2008 |
|
2007 |
|
|
|
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
Sales, general and administrative |
|
$ |
4,555 |
|
|
$ |
3,209 |
|
|
$ |
1,346 |
|
|
|
41.9 |
% |
Percent of total revenue |
|
|
24.8 |
% |
|
|
28.8 |
% |
|
|
-4.0 |
% |
|
|
-13.9 |
% |
Three Months Ended March 31, 2008 Compared to the Three Months Ended March 31, 2007: Sales,
general and administrative expenses increased $1.3 million, or 41.9% to $4.6 million in the three
months ended March 31, 2008 from $3.2 million in the three months ended March 31, 2007. Of the $1.3
million increase, salaries, benefits and commissions accounted for $0.4 million, and stock-based
compensation expense accounted for $0.3 million, for the three months ended March 31, 2008.
Marketing programs, accounting, legal fees and other services accounted for $0.6 million in the
three months ended March 31, 2008 due to the implementation of internal systems and other costs
associated with being a public company. Sales, general and administrative headcount increased to 63
at the end of March 2008 from 58 at the end of March 2007.
Other Income (Expense), Net. Other income (expense), net, primarily includes interest income
on cash and cash equivalents and interest expense on capitalized licenses. It also includes
adjustments we made to record our preferred stock warrants at fair value in accordance with FSP
150-5. These warrants have converted into warrants to purchase shares of our common stock in May
2007. As a result, there were no warrant revaluation expenses in the three months ended March 31,
2008.
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
|
|
|
|
|
|
|
|
ended March 31 |
|
|
change |
|
|
% change |
|
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
Interest income and other |
|
$ |
992 |
|
|
$ |
69 |
|
|
$ |
923 |
|
|
|
1337.7 |
% |
Interest expense |
|
|
(153 |
) |
|
|
(208 |
) |
|
|
55 |
|
|
|
-26.4 |
% |
Warrant revaluation expense |
|
|
|
|
|
|
(225 |
) |
|
|
225 |
|
|
|
-100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other income (expense), net |
|
|
839 |
|
|
|
(364 |
) |
|
|
1,203 |
|
|
|
-330.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2008 Compared to the Three Months Ended March 31, 2007: Other
income (expense), net increased in the three months ended March 31, 2008 due primarily to the
increase in interest income as a result of higher cash balances and termination of warrant
revaluation.
Income Tax Expense. For the three months ended March 31, 2008 and 2007, the provision for
income taxes was based on our estimated annual effective tax rate in compliance with SFAS 109 and
other related guidance. We update our estimate of our annual effective tax rate at the end of each
quarterly period. Our estimate takes into account estimations of annual pre-tax income, the
geographic mix of pre-tax income and our interpretations of tax laws and the possible outcomes of
current and future audits.
The following table presents the provision and benefit for income taxes and the effective tax
rates for the three months ended March 31, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
( in thousands) |
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
$ |
2,219 |
|
|
$ |
(940 |
) |
Income tax provision |
|
|
247 |
|
|
|
57 |
|
|
|
|
|
|
|
|
Effective tax rate |
|
|
11.1 |
% |
|
|
6.1 |
% |
|
|
|
|
|
|
|
The provision for income taxes of $247,000 for the three months ended March 31, 2008 related
to alternative minimum tax on the Companys United States profits adjusted by certain
non-deductible items, international taxes and state income taxes. The difference between the
provision for income that would be derived by applying the statutory rate to income before tax for
the three months ended March 31, 2008 and the provision actually recorded was due to the impact of
non-deductible SFAS 123(R) stock-based compensation expenses offset by the benefit from net
operating loss carryforwards and utilization of research credits carryforwards.
As a result of the implementation of FIN 48, we did not recognize any adjustment to the
liability for uncertain tax positions and therefore did not record any adjustment to the beginning
balance of retained earnings. As of December 31, 2007 we had $3.6 million of unrecognized tax
benefits, which is netted against deferred tax assets and is fully offset by a valuation allowance.
There were no significant changes to the unrecognized tax benefit during the three months ended
March 31, 2008.
Our major tax jurisdictions are the United States federal government and the State of
California. We file income tax returns in the United States federal jurisdiction, the State of
California and various state and foreign tax jurisdictions in which we have a subsidiary or branch
operation. The United States federal corporation income tax returns beginning with the 2000 tax
year remain subject to
26
examination by the Internal Revenue Service, or IRS. The California
corporation income tax returns beginning with the 2000 tax year remain subject to examination by
the California Franchise Tax Board. There are no on-going tax audits in the major tax
jurisdictions.
Liquidity and Capital Resources
In May 2007, we received net proceeds of approximately $94.7 million (after underwriters
discounts of $7.3 million and additional offering related costs of approximately $2.8 million). Our
other primary sources of cash historically have been proceeds from issuances of convertible
preferred stock, cash collections from customers, a working capital line of credit and term loan
and cash received from the exercise of employee stock options. As of March 31, 2008, we had cash
and cash equivalents of $95.6 million and net accounts receivable of $13.7 million.
In October 2005, we entered into a Loan and Security Agreement with Silicon Valley Bank to
provide a revolving line of credit for $6.0 million collateralized by eligible receivables and all
of our other assets except intellectual property. Upon our IPO in May 2007, we have cancelled the
line of credit.
In October 2005, we also entered into a Term Loan and Security Agreement with Silicon Valley
Bank and Gold Hill Venture Lending that provided a $4.0 million term loan line of credit, the Term
Loan. The Term Loan was secured by all of our other assets except intellectual property. In June
2006, we borrowed $4.0 million against this Term Loan. This Term Loan was paid off as of May 3,
2007.
Following is a summary of our working capital and cash and cash equivalents as of March 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
March 31, |
|
December 31, |
|
|
2008 |
|
2007 |
|
|
(in thousands) |
Working capital |
|
$ |
107,637 |
|
|
$ |
105,048 |
|
Cash and cash equivalents |
|
|
95,612 |
|
|
|
98,462 |
|
Cash Flows from Operating Activities
Net cash provided by operating activities was $0.5 million for the three months ended March
31, 2008. Net cash provided by operating activities primarily consisted of $2.0 million of net
income and $3.0 million in non-cash operating expenses offset by $4.4 million in changes in
operating assets and liabilities. Non-cash items in the three months ended March 31, 2008 included
depreciation and amortization expense of $2.2 million and stock-based compensation of $0.8 million.
Net cash provided by operating activities was $2.4 million for the three months ended March 31,
2007. This primarily consisted of our net loss of $1.0 million, $1.8 million in non-cash operating
expenses and $1.6 million in changes in operating assets and liabilities. Non-cash items included
in net loss for the three months ended March 31, 2007 included depreciation and amortization
expense of $1.2 million, stock-based compensation of $0.4 million, warrant revaluation and
amortization of $0.2 million. Changes in operating activities from first quarter of 2008 in
comparison to 2007 were primarily driven by an increase of $3.6 million in accounts receivable due
to increased revenue and decrease of $2.1 million in deferred revenue.
Cash Flows used in Investing Activities
Net cash used in investing activities was $1.9 million and $0.7 million for the three months
ended March 31, 2008 and 2007, respectively. Net cash flows used in investing activities were
primarily due to capital expenditures to support product development and general growth.
Cash Flows used in Financing Activities
Net cash used in financing activities was $1.5 million and $2.4 million for the three months
ended March 31, 2008 and 2007, respectively. Net cash used by financing activities in the three
months ended March 31, 2008 was primarily due to principal payments of capital lease and technology
license obligations of $1.6 million, offset by proceeds from stock option exercises. Net cash
used by financing activities in the three months ended March 31, 2007 was primarily due to a $1.3
million payment of initial public offering costs, $0.8 million in principal payments of capital
lease and technology license obligations and $0.4 million in repayment of the term loan, offset by
proceeds from stock option exercises.
27
We believe that our $95.6 million of cash and cash equivalents at March 31, 2008 and expected
cash flow from operations will be sufficient to fund our projected operating requirements for at
least the next twelve months. However, we may need to raise additional capital or incur additional
indebtedness to continue to fund our operations in the future. Our future capital requirements will
depend on many factors, including our rate of revenue growth, the expansion of our engineering,
sales and marketing activities, the timing and extent of our expansion into new territories, the
timing of introductions of new products and enhancements to existing products and the continuing
market acceptance of our products. Although we currently are not a party to any agreement or letter
of intent with respect to potential material investments in, or acquisitions of, complementary
businesses, services or technologies, we may enter into these types of arrangements in the future,
which could also require us to seek additional equity or debt financing. Additional funds may not
be available on terms favorable to us or at all.
Indemnities
In the ordinary course of business, we have entered into agreements with customers that
include indemnity provisions. Based on historical experience and information known as of March 31,
2008, we believe our exposure related to the above indemnities at March 31, 2008 is not material.
We also enter into indemnification agreements with our officers and directors and our certificate
of incorporation and bylaws include similar indemnification obligations to our officers and
directors. It is not possible to determine the amount of our liability related to these
indemnification agreements and obligations to our officers and directors due to the limited history
of prior indemnification claims and the unique facts and circumstances involved in each particular
agreement.
Off-Balance Sheet Arrangements
During the periods presented, we did not have, nor do we currently have, any relationships
with unconsolidated entities or financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which would have been established for the purpose
of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual Obligations
The following table describes our commitments to settle contractual obligations in cash as of
March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due By Period |
|
|
|
Less Than 1 |
|
|
|
|
|
|
|
|
|
|
More Than 5 |
|
|
|
|
|
|
Year |
|
|
1 to 2 Years |
|
|
3 to 5 Years |
|
|
Years |
|
|
Total |
|
|
|
(in thousands) |
|
Operating leases |
|
$ |
956 |
|
|
$ |
2,175 |
|
|
$ |
1,043 |
|
|
$ |
|
|
|
$ |
4,174 |
|
Capital lease and
technology license
obligations |
|
|
3,219 |
|
|
|
4,369 |
|
|
|
|
|
|
|
|
|
|
|
7,588 |
|
Purchase commitments |
|
|
685 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
685 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
4,860 |
|
|
$ |
6,544 |
|
|
$ |
1,043 |
|
|
$ |
|
|
|
$ |
12,447 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We adopted FIN 48 on January 1, 2007. As of March 31, 2008, we had $0.2 million of total gross
unrecognized tax benefits and related interest. The timing of any payments which could result from
these unrecognized tax benefits will depend upon a number of factors. Accordingly, the timing of
payment cannot be estimated. We do not expect a significant tax payment related to these
obligations to occur within the next 12 months.
Critical Accounting Policies and Estimates
The preparation of our financial statements and accompanying disclosures in conformity with
GAAP requires estimates and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosures of contingent assets and liabilities in the
consolidated financial statements and the accompanying notes. The SEC has defined a companys
critical accounting policies as policies that are most important to the portrayal of a companys
financial condition and results of operations, and which require a company to make its most
difficult and subjective judgments, often as a result of the need to make estimates of matters that
are inherently uncertain. Based on this definition, we have identified our most critical accounting
policies and estimates to be as follows: (1) revenue recognition; (2) product warranty accrual; (3)
stock-based compensation; (4) inventory valuation; (5) accounting for income tax; and (6) mask
costs. Although we believe that our estimates, assumptions and judgments are reasonable, they are
based upon information not presently available. Actual results may differ significantly from these
estimates if the
28
assumptions, judgements and conditions upon which they are based turn out to be
inaccurate. A further discussion can be found in, Managements Discussion and Analysis of Financial
Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December
31, 2007 filed on March 10, 2008.
Recent Accounting Pronouncements
Please refer to the recent accounting pronouncements listed in the footnote 1 of the financial
statements.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
During the three months ended March 31, 2008, there were no material changes to our
quantitative and qualitative disclosures about market risk related to our investment activities as
disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007 as filed with the
SEC on March 10, 2008.
Item 4T. Controls and Procedures
Disclosure Controls and Procedures
Our Chief Executive Officer and our Chief Financial Officer evaluated with the participation
of our management, the effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of March 31, 2008.
Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have
concluded that our disclosure controls and procedures are effective to ensure that information we
are required to disclose in reports that we file or submit under the Securities Exchange Act of
1934, as amended, is recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms, and that such information is accumulated and communicated to management as
appropriately to allow for timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during the first quarter
of 2008 that has materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may become involved in legal proceedings arising in the ordinary course
of our business. We are not presently a party to any legal proceedings the outcome of which, if
determined adversely against us, would individually or in the aggregate have a material adverse
effect on our business, operating results, financial condition or cash flows.
Item 1A. Risk Factors
The following risks and uncertainties may have a material adverse effect on our business,
financial condition or results of operations. Investors should carefully consider the risks
described below before making an investment decision. The risks described below are not the only
ones we face. Additional risks not presently known to us or that we currently believe are
immaterial may also significantly impair our business operations. Our business could be harmed by
any of these risks. The trading price of our common stock could decline due to any of these risks,
and investors may lose all or part of their investment.
We have marked with an asterisk(*) those risks described below that reflect substantive
changes from the risks described under Item 1A. Risk Factors included in our Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March 10, 2008.
Risks Related to Our Business and Industry
We have a history of losses, and we may not achieve or sustain profitability in the future, on
a quarterly or annual basis.*
We were established in 2000 and have not been profitable in any fiscal period until the
quarter ended September 30, 2007. We experienced net income of $2.0 million and net loss of $1.0
million for the three months ended March 31, 2008 and 2007, respectively. As of March 31, 2008, our
accumulated deficit was $56.8 million. We expect to make significant expenditures related to the
development of our products and expansion of our business, including research and development and
sales and administrative expenses. As a public company, we also incur significant legal, accounting
and other expenses that we did not incur as a private company. Additionally, we may encounter
unforeseen difficulties, complications, product delays and other unknown factors that require
additional expenditures. As a result of these increased expenditures, we may have to generate and
sustain substantially increased revenue to achieve profitability. Our revenue growth trends in
prior periods may not be sustainable. Accordingly, we may not be able to achieve or maintain
profitability and we may continue to incur significant losses in the future.
We face intense competition and expect competition to increase in the future, which could
reduce our revenue and customer base.
The market for our products is highly competitive and we expect competition to intensify in
the future. This competition could make it more difficult for us to sell our products, and result
in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and
failure to increase, or the loss of, market share or expected market share, any of which would
likely seriously harm our business, operating results and financial condition. For instance,
semiconductor products have a history of declining prices as the cost of production is reduced.
However, if market prices decrease faster than product costs, gross and operating margins can be
adversely affected. Currently, we face competition from a number of established companies,
including Broadcom Corporation, Freescale Semiconductor, Inc., Intel Corporation, Marvell
Technology Group Ltd., PMC-Sierra, Inc., Hifn, Inc., and others. We also face competition from a
number of private companies, including Raza Microelectronics, Inc., P.A. Semi and others. A few of
our current competitors operate their own fabrication facilities and have, and some of our
potential competitors could have, longer operating histories, greater name recognition, larger
customer bases and significantly greater financial, technical, sales, marketing and other resources
than we have. Potential customers may prefer to purchase from their existing suppliers rather than
a new supplier regardless of product performance or features.
We expect increased competition from other established and emerging companies both
domestically and internationally. Our current and potential competitors may also establish
cooperative relationships among themselves or with third parties. If so, new competitors or
alliances that include our competitors may emerge that could acquire significant market share. We
expect these trends to continue as companies attempt to strengthen or maintain their market
positions in an evolving industry. In the future, further development by our competitors could
cause our products to become obsolete. We expect continued competition from incumbents as well as
from new entrants into the markets we serve. Our ability to compete depends on a number of factors,
including:
30
|
|
our success in identifying new and emerging markets, applications and technologies; |
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|
|
our products performance and cost effectiveness relative to that of our competitors
products; |
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|
|
our ability to deliver products in large volume on a timely basis at a competitive price; |
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|
|
our success in utilizing new and proprietary technologies to offer products and features
previously not available in the marketplace; |
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|
|
our ability to recruit design and application engineers and sales and marketing personnel;
and |
|
|
|
our ability to protect our intellectual property. |
In addition, we cannot assure you that existing customers or potential customers will not
develop their own products, purchase competitive products or acquire companies that use alternative
methods to enable networking, communication or security applications to facilitate network-aware
processing in their systems. Any of these competitive threats, alone or in combination with others,
could seriously harm our business, operating results and financial condition.
Our customers may cancel their orders, change production quantities or delay production, and
if we fail to forecast demand for our products accurately, we may incur product shortages, delays
in product shipments or excess or insufficient product inventory.
We generally do not obtain firm, long-term purchase commitments from our customers. Because
production lead times often exceed the amount of time required to fulfill orders, we often must
build in advance of orders, relying on an imperfect demand forecast to project volumes and product
mix. Our demand forecast accuracy can be adversely affected by a number of factors, including
inaccurate forecasting by our customers, changes in market conditions, adverse changes in our
product order mix and demand for our customers products. Even after an order is received, our
customers may cancel these orders or request a decrease in production quantities. Any such
cancellation or decrease subjects us to a number of risks, most notably that our projected sales
will not materialize on schedule or at all, leading to unanticipated revenue shortfalls and excess
or obsolete inventory which we may be unable to sell to other customers. Alternatively, if we are
unable to project customer requirements accurately, we may not build enough products, which could
lead to delays in product shipments and lost sales opportunities in the near term, as well as force
our customers to identify alternative sources, which could affect our ongoing relationships with
these customers. We have in the past had customers dramatically increase their requested production
quantities with little or no advance notice. If we do not timely fulfill customer demands, our
customers may cancel their orders and we may be subject to customer claims for cost of replacement.
Either underestimating or overestimating demand would lead to insufficient, excess or obsolete
inventory, which could harm our operating results, cash flow and financial condition, as well as
our relationships with our customers.
We receive a substantial portion of our revenues from a limited number of customers, and the
loss of, or a significant reduction in, orders from one or a few of our major customers would
adversely affect our operations and financial condition.*
We receive a substantial portion of our revenues from a limited number of customers. We
received an aggregate of approximately 54% and 60% of our revenues from our top five customers for
the three months ended March 31, 2008 and 2007, respectively. We anticipate that we will continue
to be dependent on a limited number of customers for a significant portion of our revenues in the
immediate future and in some cases the portion of our revenues attributable to certain customers
may increase in the future. However, we may not be able to maintain or increase sales to certain of
our top customers for a variety of reasons, including the following:
|
|
our agreements with our customers do not require them to purchase a minimum quantity of our
products; |
|
|
|
some of our customers can stop incorporating our products into their own products with
limited notice to us and suffer little or no penalty; and |
|
|
|
many of our customers have pre-existing or concurrent relationships with our current or
potential competitors that may affect the customers decisions to purchase our products. |
In the past, we have relied in significant part on our strategic relationships with customers
that are technology leaders in our target markets. We intend to pursue the expansion of such
relationships and the formation of new strategic relationships but we cannot
31
assure you that we will be able to do so. These relationships often require us to develop new
products that may involve significant technological challenges. Our customers frequently place
considerable pressure on us to meet their tight development schedules. Accordingly, we may have to
devote a substantial amount of our resources to our strategic relationships, which could detract
from or delay our completion of other important development projects. Delays in development could
impair our relationships with our strategic customers and negatively impact sales of the products
under development. Moreover, it is possible that our customers may develop their own product or
adopt a competitors solution for products that they currently buy from us. If that happens, our
sales would decline and our business, financial condition and results of operations could be
materially and adversely affected.
In addition, our relationships with some customers may also deter other potential customers
who compete with these customers from buying our products. To attract new customers or retain
existing customers, we may offer certain customers favorable prices on our products. In that event,
our average selling prices and gross margins would decline. The loss of a key customer, a reduction
in sales to any key customer or our inability to attract new significant customers could seriously
impact our revenue and materially and adversely affect our results of operations.
We expect our operating results to fluctuate.
We expect our revenues and expense levels to vary in the future, making it difficult to
predict our future operating results. In particular, we experience variability in demand for our
products as our customers manage their product introduction dates and their inventories.
Additional factors that could cause our results to fluctuate include, among other things:
|
|
fluctuations in demand, sales cycles, product mix and prices for our products; |
|
|
|
the timing of our product introductions, and the variability in lead time between the time
when a customer begins to design in one of our products and the time when the customers end
system goes into production and they begin purchasing our products; |
|
|
|
the forecasting, scheduling, rescheduling or cancellation of orders by our customers; |
|
|
|
our ability to successfully define, design and release new products in a timely manner that
meet our customers needs; |
|
|
|
changes in manufacturing costs, including wafer, test and assembly costs, mask costs,
manufacturing yields and product quality and reliability; |
|
|
|
the timing and availability of adequate manufacturing capacity from our manufacturing
suppliers; |
|
|
|
the timing of announcements by our competitors or us; |
|
|
|
future accounting pronouncements and changes in accounting policies; |
|
|
|
volatility in our stock price, which may lead to higher stock compensation expenses; |
|
|
|
general economic and political conditions in the countries where we operate or our products
are sold or used; costs associated with litigation, especially related to intellectual
property; and |
|
|
|
productivity and growth of our sales and marketing force. |
Unfavorable changes in any of the above factors, most of which are beyond our control, could
significantly harm our business and results of operations.
We may not sustain our growth rate, and we may not be able to manage any future growth
effectively.*
We have experienced significant growth in a short period of time. Our revenues increased from
approximately $7.4 million in 2004 to approximately $34.2 million in 2006, $54.2 million in 2007
and $18.3 million in the first quarter of 2008. We may not achieve similar growth rates in future
periods. You should not rely on our operating results for any prior quarterly or annual periods as
an
32
indication of our future operating performance. If we are unable to maintain adequate revenue
growth, our financial results could suffer and our stock price could decline.
To manage our growth successfully and handle the responsibilities of being a public company,
we believe we must effectively, among other things:
|
|
recruit, hire, train and manage additional qualified engineers for our research and
development activities, especially in the positions of design engineering, product and test
engineering, and applications engineering; |
|
|
|
add additional sales personnel and expand sales offices; |
|
|
|
implement and improve our administrative, financial and operational systems, procedures and
controls; and |
|
|
|
enhance our information technology support for enterprise resource planning and design
engineering by adapting and expanding our systems and tool capabilities, and properly training
new hires as to their use. |
If we are unable to manage our growth effectively, we may not be able to take advantage of market
opportunities or develop new products and we may fail to satisfy customer requirements, maintain
product quality, execute our business plan or respond to competitive pressures.
The average selling prices of products in our markets have historically decreased over time
and will likely do so in the future, which could harm our revenues and gross profits.
Average selling prices of semiconductor products in the markets we serve have historically
decreased over time. Our gross profits and financial results will suffer if we are unable to offset
any reductions in our average selling prices by reducing our costs, developing new or enhanced
products on a timely basis with higher selling prices or gross profits, or increasing our sales
volumes. Additionally, because we do not operate our own manufacturing, assembly or testing
facilities, we may not be able to reduce our costs as rapidly as companies that operate their own
facilities, and our costs may even increase, which could also reduce our margins. We have reduced
the prices of our products in anticipation of future competitive pricing pressures, new product
introductions by us or our competitors and other factors. We expect that we will have to do so
again in the future.
We may be unsuccessful in developing and selling new products or in penetrating new markets.
We operate in a dynamic environment characterized by rapidly changing technologies and industry
standards and technological obsolescence. Our competitiveness and future success depend on our
ability to design, develop, manufacture, assemble, test, market and support new products and
enhancements on a timely and cost effective basis. A fundamental shift in technologies in any of
our product markets could harm our competitive position within these markets. Our failure to
anticipate these shifts, to develop new technologies or to react to changes in existing
technologies could materially delay our development of new products, which could result in product
obsolescence, decreased revenues and a loss of design wins to our competitors. The success of a new
product depends on accurate forecasts of long-term market demand and future technological
developments, as well as on a variety of specific implementation factors, including:
|
|
timely and efficient completion of process design and transfer to manufacturing, assembly and
test processes; |
|
|
|
the quality, performance and reliability of the product; and |
|
|
|
effective marketing, sales and service. |
If we fail to introduce new products that meet the demand of our customers or penetrate new markets
that we target our resources on, our revenues will likely decrease over time and our financial
condition could suffer.
Fluctuations in the mix of products sold may adversely affect our financial results.
Because of the wide price differences among our processors, the mix and types of performance
capabilities of processors sold affect the average selling price of our products and have a
substantial impact on our revenue. Generally, sales of higher performance products have higher
gross margins than sales of lower performance products. We currently offer both higher and lower
performance
33
products within each of our NITROX and OCTEON product families. To the extent our sales mix shifts
toward increased sales of lower performance products, our overall gross margins will be negatively
affected. Fluctuations in the mix and types of our products may also affect the extent to which we
are able to recover our fixed costs and investments that are associated with a particular product,
and as a result can negatively impact our financial results.
Our products must meet exact specifications, and defects and failures may occur, which may
cause customers to return or stop buying our products.
Our customers generally establish demanding specifications for quality, performance and reliability
that our products must meet. However, our products are highly complex and may contain defects and
failures when they are first introduced or as new versions are released. If defects and failures
occur in our products during the design phase or after, we could experience lost revenues,
increased costs, including warranty expense and costs associated with customer support, delays in
or cancellations or rescheduling of orders or shipments, product returns or discounts, diversion of
management resources or damage to our reputation and brand equity, and in some cases consequential
damages, any of which would harm our operating results. In addition, delays in our ability to fill
product orders as a result of quality control issues may negatively impact our relationship with
our customers. We cannot assure you that we will have sufficient resources, including any available
insurance, to satisfy any asserted claims.
We may have difficulty selling our products if our customers do not design our products into
their systems, and the nature of the design process requires us to incur expenses prior to
recognizing revenues associated with those expenses which may adversely affect our financial
results.
One of our primary focuses is on winning competitive bid selection processes, known as design
wins, to develop products for use in our customers products. We devote significant time and
resources in working with our customers system designers to understand their future needs and to
provide products that we believe will meet those needs and these bid selection processes can be
lengthy. If a customers system designer initially chooses a competitors product, it becomes
significantly more difficult for us to sell our products for use in that system because changing
suppliers can involve significant cost, time, effort and risk for our customers. Thus, our failure
to win a competitive bid can result in our foregoing revenues from a given customers product line
for the life of that product. In addition, design opportunities may be infrequent or may be
delayed. Our ability to compete in the future will depend, in large part, on our ability to design
products to ensure compliance with our customers and potential customers specifications. We
expect to invest significant time and resources and to incur significant expenses to design our
products to ensure compliance with relevant specifications.
We often incur significant expenditures in the development of a new product without any assurance
that our customers system designers will select our product for use in their applications. We
often are required to anticipate which product designs will generate demand in advance of our
customers expressly indicating a need for that particular design. Even if our customers system
designers select our products, a substantial period of time will elapse before we generate revenues
related to the significant expenses we have incurred.
The reasons for this delay generally include the following elements of our product sales and
development cycle timeline and related influences:
|
|
our customers usually require a comprehensive technical evaluation of our products before
they incorporate them into their designs; |
|
|
|
it can take from nine months to three years from the time our products are selected to
commence commercial shipments; and our customers may experience changed market conditions or
product development issues. The resources devoted to product development and sales and
marketing may not generate material revenue for us, and from time to time, we may need to
write off excess and obsolete inventory if we have produced product in anticipation of
expected demand. We may spend resources on the development of products that our customers may
not adopt. If we incur significant expenses and investments in inventory in the future that we
are not able to recover, and we are not able to compensate for those expenses, our operating
results could be adversely affected. In addition, if we sell our products at reduced prices in
anticipation of cost reductions but still hold higher cost products in inventory, our
operating results would be harmed. |
Additionally, even if system designers use our products in their systems, we cannot assure you that
these systems will be commercially successful or that we will receive significant revenue from the
sales of processors for those systems. As a result, we may be unable to accurately forecast the
volume and timing of our orders and revenues associated with any new product introductions.
34
If customers do not believe our products solve a critical need, our revenues will decline.
Our products are used in networking and security equipment including routers, switches, UTM
appliances, intelligent switches, application-aware gateways, triple-play gateways, WLAN and 3G
access and aggregation devices, storage networking equipment, servers, and intelligent network
interface cards.
In order to meet our growth and strategic objectives, providers of networking equipment must
continue to incorporate our products into their systems and the demands for their systems must grow
as well. Our future depends in large part on factors outside our control, and the sale of
next-generation networks may not meet our revenue growth and strategic objectives.
In the event we terminate one of our distributor arrangements, it could lead to a loss of
revenues and possible product returns.
A portion of our sales are made through third-party distribution agreements. Termination of a
distributor relationship, either by us or by the distributor, could result in a temporary or
permanent loss of revenues, until a replacement distributor can be established to service the
affected end-user customers. We may not be successful in finding suitable alternative distributors
on satisfactory terms or at all and this could adversely affect our ability to sell in certain
locations or to certain end-user customers. Additionally, if we terminate our relationship with a
distributor, we may be obligated to repurchase unsold products. We record a reserve for estimated
returns and price credits. If actual returns and credits exceed our estimates, our operating
results could be harmed. Our arrangements with our distributors typically also include price
protection provisions if we reduce our list prices.
We rely on our ecosystem partners to enhance our product offerings and our inability to
continue to develop or maintain such relationships in the future would harm our ability to remain
competitive.
We have developed relationships with third parties, which we refer to as ecosystem partners, which
provide operating systems, tool support, reference designs and other services designed for specific
uses with our SoCs. We believe that these relationships enhance our customers ability to get their
products to market quickly. If we are unable to continue to develop or maintain these
relationships, we might not be able to enhance our customers ability to commercialize their
products in a timely fashion and our ability to remain competitive would be harmed.
The loss of any of our key personnel could seriously harm our business, and our failure to
attract or retain specialized technical, management or sales and marketing talent could impair our
ability to grow our business.
We believe our future success will depend in large part upon our ability to attract, retain
and motivate highly skilled managerial, engineering, sales and marketing personnel. The loss of any
key employees or the inability to attract, retain or motivate qualified personnel, including
engineers and sales and marketing personnel, could delay the development and introduction of and
harm our ability to sell our products. We believe that our future success is highly dependent on
the contributions of Syed Ali, our co- founder, President and Chief Executive Officer, and others.
None of our employees have fixed-term employment contracts; they are all at-will employees. The
loss of the services of Mr. Ali, other executive officers or certain other key personnel could
materially and adversely affect our business, financial condition and results of operations. For
instance, if any of these individuals were to leave our company unexpectedly, we could face
substantial difficulty in hiring qualified successors and could experience a loss in productivity
during the search for and while any such successor is integrated into our business and operations.
There is currently a shortage of qualified technical personnel with significant experience in
the design, development, manufacturing, marketing and sales of integrated circuits. In particular,
there is a shortage of engineers who are familiar with the intricacies of the design and
manufacture of networking processors, and competition for these engineers is intense. Our key
technical personnel represent a significant asset and serve as the source of our technological and
product innovations. We may not be successful in attracting, retaining and motivating sufficient
numbers of technical personnel to support our anticipated growth.
To date, we have relied primarily on our direct marketing and sales force to drive new
customer design wins and to sell our products. Because we are looking to expand our customer base
and grow our sales to existing customers, we will need to hire additional qualified sales personnel
in the near term and beyond if we are to achieve revenue growth. The competition for qualified
marketing and sales personnel in our industry, and particularly in Silicon Valley, is very intense.
If we are unable to hire, train, deploy and manage qualified sales personnel in a timely manner,
our ability to grow our business will be impaired. In addition, if we are unable to retain our
existing sales personnel, our ability to maintain or grow our current level of revenues will be
adversely affected.
35
Stock options generally comprise a significant portion of our compensation packages for all
employees. The FASB requirement to expense the fair value of stock options awarded to employees
beginning in the first quarter of our fiscal 2006 has increased our operating expenses and may
cause us to reevaluate our compensation structure for our employees. Our inability to attract,
retain and motivate additional key employees could have an adverse effect on our business,
financial condition and results of operations.
We have a limited operating history, and we may have difficulty accurately predicting our
future revenues for the purpose of appropriately budgeting and adjusting our expenses.*
We were established in 2000. We have not been profitable in any fiscal period until the
quarter ended September 30, 2007. We experienced net income of $2.0 million for the three months
ended March 31, 2008. Since we have only three quarters of operating profitability, we do not have
an extended history from which to predict and manage profitability. Our limited operating
experience, a dynamic and rapidly evolving market in which we sell our products, our dependence on
a limited number of customers, as well as numerous other factors beyond our control, impede our
ability to forecast quarterly and annual revenues accurately. As a result, we could experience
budgeting and cash flow management problems, unexpected fluctuations in our results of operations
and other difficulties, any of which could make it difficult for us to gain and maintain
profitability and could increase the volatility of the market price of our common stock.
Some of our operations and a significant portion of our customers and contract manufacturers
are located outside of the United States, which subjects us to additional risks, including
increased complexity and costs of managing international operations and geopolitical instability.
We have sales offices and research and development facilities and we conduct, and expect to
continue to conduct, a significant amount of our business with companies that are located outside
the United States, particularly in Asia and Europe. Even customers of ours that are based in the
U.S. often use contract manufacturers based in Asia to manufacture their systems, and it is the
contract manufacturers that purchase products directly from us. As a result of our international
focus, we face numerous challenges, including:
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increased complexity and costs of managing international operations; |
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longer and more difficult collection of receivables; |
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difficulties in enforcing contracts generally; |
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|
geopolitical and economic instability and military conflicts; |
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limited protection of our intellectual property and other assets; |
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|
compliance with local laws and regulations and unanticipated changes in local laws and
regulations, including tax laws and regulations; |
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trade and foreign exchange restrictions and higher tariffs; |
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travel restrictions; |
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|
timing and availability of import and export licenses and other governmental approvals,
permits and licenses, including export classification requirements; |
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foreign currency exchange fluctuations relating to our international operating activities; |
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transportation delays and limited local infrastructure and disruptions, such as large scale
outages or interruptions of service from utilities or telecommunications providers; |
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difficulties in staffing international operations; |
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heightened risk of terrorism; |
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local business and cultural factors that differ from our normal standards and practices; |
36
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differing employment practices and labor issues; |
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regional health issues (e.g., SARS) and natural disasters; and |
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work stoppages. |
We outsource our wafer fabrication, assembly, testing, warehousing and shipping operations to
third parties, and rely on these parties to produce and deliver our products according to requested
demands in specification, quantity, cost and time.
We rely on third parties for substantially all of our manufacturing operations, including
wafer fabrication, assembly, testing, warehousing and shipping. We depend on these parties to
supply us with material of a requested quantity in a timely manner that meets our standards for
yield, cost and manufacturing quality. We do not have any long-term supply agreements with our
manufacturing suppliers. Any problems with our manufacturing supply chain could adversely impact
our ability to ship our products to our customers on time and in the quantity required, which in
turn could cause an unanticipated decline in our sales and possibly damage our customer
relationships.
The fabrication of integrated circuits is a complex and technically demanding process. Our
foundries could, from time to time, experience manufacturing defects and reduced manufacturing
yields. Changes in manufacturing processes or the inadvertent use of defective or contaminated
materials by our foundries could result in lower than anticipated manufacturing yields or
unacceptable performance. Many of these problems are difficult to detect at an early stage of the
manufacturing process and may be time consuming and expensive to correct. Poor yields from our
foundries, or defects, integration issues or other performance problems in our products could cause
us significant customer relations and business reputation problems, harm our financial results and
result in financial or other damages to our customers. Our customers could also seek damages from
us for their losses. A product liability claim brought against us, even if unsuccessful, would
likely be time consuming and costly to defend.
Our products are manufactured at a limited number of locations. If we experience manufacturing
problems at a particular location, we would be required to transfer manufacturing to a backup
location or supplier. Converting or transferring manufacturing from a primary location or supplier
to a backup fabrication facility could be expensive and could take one to two quarters. During such
a transition, we would be required to meet customer demand from our then-existing inventory, as
well as any partially finished goods that can be modified to the required product specifications.
We do not seek to maintain sufficient inventory to address a lengthy transition period because we
believe it is uneconomical to keep more than minimal inventory on hand. As a result, we may not be
able to meet customer needs during such a transition, which could delay shipments, cause a
production delay or stoppage for our customers, result in a decline in our sales and damage our
customer relationships. In addition, we have no long-term supply contracts with the foundries that
we work with. Availability of foundry capacity has in the recent past been reduced due to strong
demand. The ability of each foundry to provide us with semiconductor devices is limited by its
available capacity and existing obligations. Foundry capacity may not be available when we need it
or at reasonable prices.
In addition, a significant portion of our sales is to customers that practice just-in-time
order management from their suppliers, which gives us a very limited amount of time in which to
process and complete these orders. As a result, delays in our production or shipping by the parties
to whom we outsource these functions could reduce our sales, damage our customer relationships and
damage our reputation in the marketplace, any of which could harm our business, results of
operations and financial condition.
Any increase in the manufacturing cost of our products could reduce our gross margins and
operating profit.
The semiconductor business exhibits ongoing competitive pricing pressure from customers and
competitors. Accordingly, any increase in the cost of our products, whether by adverse purchase
price variances or adverse manufacturing cost variances, will reduce our gross margins and
operating profit. We do not have any long-term supply agreements with our manufacturing suppliers
and we typically negotiate pricing on a purchase order by purchase order basis. Consequently, we
may not be able to obtain price reductions or anticipate or prevent future price increases from our
suppliers.
Some of our competitors may be better financed than we are, may have long-term agreements with
our main foundries and may induce our foundries to reallocate capacity to those customers. This
reallocation could impair our ability to secure the supply of components that we need. Although we
use several independent foundries to manufacture substantially all of our semiconductor products,
most of our components are not manufactured at more than one foundry at any given time, and our
products typically are designed to be manufactured in a specific process at only one of these
foundries. Accordingly, if one of our foundries is unable to
37
provide us with components as needed, we could experience significant delays in securing
sufficient supplies of those components. We cannot assure you that any of our existing or new
foundries will be able to produce integrated circuits with acceptable manufacturing yields, or that
our foundries will be able to deliver enough semiconductor devices to us on a timely basis, or at
reasonable prices. These and other related factors could impair our ability to meet our customers
needs and have a material and adverse effect on our operating results.
In order to secure sufficient foundry capacity when demand is high and mitigate the risks
described in the foregoing paragraph, we may enter into various arrangements with suppliers that
could be costly and harm our operating results, such as nonrefundable deposits with or loans to
foundries in exchange for capacity commitments and contracts that commit us to purchase specified
quantities of integrated circuits over extended periods. We may not be able to make any such
arrangement in a timely fashion or at all, and any arrangements may be costly, reduce our financial
flexibility, and not be on terms favorable to us. Moreover, if we are able to secure foundry
capacity, we may be obligated to use all of that capacity or incur penalties. These penalties may
be expensive and could harm our financial results.
If we fail to maintain an effective system of internal controls, we may not be able to
accurately report our financial results or prevent fraud.
Effective internal controls are necessary for us to provide reliable financial reports and
effectively prevent fraud. Any inability to provide reliable financial reports or prevent fraud
could harm our business. The Sarbanes-Oxley Act of 2002 requires management and our auditors to
evaluate and assess the effectiveness of our internal control over financial reporting. We will be
required to adhere to these requirements by the end of 2008. These Sarbanes-Oxley Act requirements
may be modified, supplemented or amended from time to time. Implementing these changes may take a
significant amount of time and may require specific compliance training of our personnel. In the
future, we may discover areas of our internal controls that need improvement. If our auditors or we
discover a material weakness, the disclosure of that fact, even if quickly remedied, could reduce
the markets confidence in our financial statements and harm our stock price. We may not be able to
effectively and timely implement necessary control changes and employee training to ensure
continued compliance with the Sarbanes-Oxley Act and other regulatory and reporting requirements.
Our rapid growth in recent periods, and our possible future expansion through acquisitions, present
challenges to maintain the internal control and disclosure control standards applicable to public
companies. If we fail to maintain effective internal controls, we could be subject to regulatory
scrutiny and sanctions and investors could lose confidence in the accuracy and completeness of our
financial reports. We cannot assure you that we will be able to fully comply with the requirements
of the Sarbanes-Oxley Act or that management or our auditors will conclude that our internal
controls are effective in future periods.
We rely on third-party technologies for the development of our products and our inability to
use such technologies in the future would harm our ability to remain competitive.
We rely on third parties for technologies that are integrated into our products, such as wafer
fabrication and assembly and test technologies used by our contract manufacturers, as well as
licensed MIPS architecture technologies. If we are unable to continue to use or license these
technologies on reasonable terms, or if these technologies fail to operate properly, we may not be
able to secure alternatives in a timely manner and our ability to remain competitive would be
harmed. In addition, if we are unable to successfully license technology from third parties to
develop future products, we may not be able to develop such products in a timely manner or at all.
Our failure to protect our intellectual property rights adequately could impair our ability to
compete effectively or to defend ourselves from litigation, which could harm our business,
financial condition and results of operations.*
We rely primarily on patent, copyright, trademark and trade secret laws, as well as
confidentiality and nondisclosure agreements and other methods, to protect our proprietary
technologies and know-how. We have been issued 13 patents in the United States and two
patents in foreign countries and have an additional 26 patent applications pending in the
United States and 21 patent applications pending in foreign countries. Even if the pending
patent applications are granted, the rights granted to us may not be meaningful or provide us with
any commercial advantage. For example, these patents could be opposed, contested, circumvented or
designed around by our competitors or be declared invalid or unenforceable in judicial or
administrative proceedings. The failure of our patents to adequately protect our technology might
make it easier for our competitors to offer similar products or technologies. Our foreign patent
protection is generally not as comprehensive as our U.S. patent protection and may not protect our
intellectual property in some countries where our products are sold or may be sold in the future.
Many U.S.-based companies have encountered substantial intellectual property infringement in
foreign countries, including countries where we sell products. Even if foreign patents are granted,
effective enforcement in foreign countries may not be available.
38
Monitoring unauthorized use of our intellectual property is difficult and costly. Although we
are not aware of any unauthorized use of our intellectual property in the past, it is possible that
unauthorized use of our intellectual property may have occurred or may occur without our knowledge.
We cannot assure you that the steps we have taken will prevent unauthorized use of our intellectual
property.
Our failure to effectively protect our intellectual property could reduce the value of our
technology in licensing arrangements or in cross-licensing negotiations, and could harm our
business, results of operations and financial condition. We may in the future need to initiate
infringement claims or litigation. Litigation, whether we are a plaintiff or a defendant, can be
expensive, time consuming and may divert the efforts of our technical staff and managerial
personnel, which could harm our business, whether or not such litigation results in a determination
favorable to us.
Some of the software used with our products, as well as that of some of our customers, may be
derived from so called open source software that is generally made available to the public by its
authors and/or other third parties. Such open source software is often made available to us under
licenses, such as the GNU General Public License, which impose certain obligations on us in the
event we were to make available derivative works of the open source software. These obligations may
require us to make source code for the derivative works available to the public, and/or license
such derivative works under a particular type of license, rather than the forms of license
customarily used to protect our intellectual property. In addition, there is little or no legal
precedent for interpreting the terms of certain of these open source licenses, including the
determination of which works are subject to the terms of such licenses. While we believe we have
complied with our obligations under the various applicable licenses for open source software, in
the event the copyright holder of any open source software were to successfully establish in court
that we had not complied with the terms of a license for a particular work, we could be required to
release the source code of that work to the public and/or stop distribution of that work.
Assertions by third parties of infringement by us of their intellectual property rights could
result in significant costs and cause our operating results to suffer.
The semiconductor industry is characterized by vigorous protection and pursuit of intellectual
property rights and positions, which has resulted in protracted and expensive litigation for many
companies. We expect that in the future we may receive, particularly as a public company,
communications from various industry participants alleging our infringement of their patents, trade
secrets or other intellectual property rights. Any lawsuits resulting from such allegations could
subject us to significant liability for damages and invalidate our proprietary rights. Any
potential intellectual property litigation also could force us to do one or more of the following:
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stop selling products or using technology that contain the allegedly infringing intellectual
property; |
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lose the opportunity to license our technology to others or to collect royalty payments based
upon successful protection and assertion of our intellectual property against others; incur
significant legal expenses; |
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pay substantial damages to the party whose intellectual property rights we may be found to be
infringing; |
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redesign those products that contain the allegedly infringing intellectual property; or |
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attempt to obtain a license to the relevant intellectual property from third parties, which
may not be available on reasonable terms or at all. |
Any significant impairment of our intellectual property rights from any litigation we face
could harm our business and our ability to compete.
Our customers could also become the target of litigation relating to the patent and other
intellectual property rights of others. This could trigger technical support and indemnification
obligations in some of our licenses or customer agreements. These obligations could result in
substantial expenses, including the payment by us of costs and damages relating to claims of
intellectual property infringement. In addition to the time and expense required for us to provide
support or indemnification to our customers, any such litigation could disrupt the businesses of
our customers, which in turn could hurt our relationships with our customers and cause the sale of
our products to decrease. We cannot assure you that claims for indemnification will not be made or
that if made, such claims would not have a material adverse effect on our business, operating
results or financial conditions.
39
Our third-party contractors are concentrated primarily in Taiwan, an area subject to
earthquake and other risks. Any disruption to the operations of these contractors could cause
significant delays in the production or shipment of our products.
Substantially all of our products are manufactured by third-party contractors located in
Taiwan. The risk of an earthquake in Taiwan and elsewhere in the Pacific Rim region is significant
due to the proximity of major earthquake fault lines to the facilities of our foundries and
assembly and test subcontractors. For example, in March 2002 and June 2003, major earthquakes
occurred in Taiwan. Although our third-party contractors did not suffer any significant damage as a
result of these most recent earthquakes, the occurrence of additional earthquakes or other natural
disasters could result in the disruption of our foundry or assembly and test capacity. Any
disruption resulting from such events could cause significant delays in the production or shipment
of our products until we are able to shift our manufacturing, assembling or testing from the
affected contractor to another third-party vendor. We may not be able to obtain alternate capacity
on favorable terms, if at all.
The semiconductor and communications industries have historically experienced significant
fluctuations with prolonged downturns, which could impact our operating results, financial
condition and cash flows.
The semiconductor industry has historically exhibited cyclical behavior, which at various
times has included significant downturns in customer demand. Though we have not yet experienced any
of these industry downturns, we may in the future. Because a significant portion of our expenses is
fixed in the near term or is incurred in advance of anticipated sales, we may not be able to
decrease our expenses rapidly enough to offset any unanticipated shortfall in revenues. If this
situation were to occur, it could adversely affect our operating results, cash flow and financial
condition. Furthermore, the semiconductor industry has periodically experienced periods of
increased demand and production constraints. If this happens in the future, we may not be able to
produce sufficient quantities of our products to meet the increased demand. We may also have
difficulty in obtaining sufficient wafer, assembly and test resources from our subcontract
manufacturers. Any factor adversely affecting the semiconductor industry in general, or the
particular segments of the industry that our products target, may adversely affect our ability to
generate revenue and could negatively impact our operating results.
The communications industry has, in the past, experienced pronounced downturns, and these
cycles may continue in the future. To respond to a downturn, many networking equipment providers
may slow their research and development activities, cancel or delay new product development, reduce
their inventories and take a cautious approach to acquiring our products, which would have a
significant negative impact on our business. If this situation were to occur, it could adversely
affect our operating results, cash flow and financial condition. In the future, any of these trends
may also cause our operating results to fluctuate significantly from year to year, which may
increase the volatility of the price of our stock.
We may experience difficulties in transitioning to new wafer fabrication process technologies
or in achieving higher levels of design integration, which may result in reduced manufacturing
yields, delays in product deliveries and increased expenses.
In order to remain competitive, we expect to continue to transition our semiconductor products
to increasingly smaller line width geometries. This transition requires us to modify our designs to
work with the manufacturing processes of our foundries. We periodically evaluate the benefits, on a
product-by-product basis, of migrating to new process technologies to reduce cost and improve
performance. We may face difficulties, delays and expenses as we continue to transition our
products to new processes. We are dependent on our relationships with our foundry contractors to
transition to new processes successfully. We cannot assure you that the foundries that we use will
be able to effectively manage the transition or that we will be able to maintain our existing
foundry relationships or develop new ones. If any of our foundry contractors or we experience
significant delays in this transition or fail to efficiently implement this transition, we could
experience reduced manufacturing yields, delays in product deliveries and increased expenses, all
of which could harm our relationships with our customers and our results of operations. As new
processes become more prevalent, we expect to continue to integrate greater levels of
functionality, as well as customer and third-party intellectual property, into our products.
However, we may not be able to achieve higher levels of design integration or deliver new
integrated products on a timely basis.
Any acquisitions we make could disrupt our business and harm our financial condition.
In the future, we may choose to acquire companies that are complementary to our business,
including for the purpose of expanding our new product design capacity, introducing new design,
market or application skills or enhancing and expanding our existing product lines. In connection
with any such future acquisitions, we may need to use a significant portion of our available cash,
issue additional equity securities that would dilute current stockholders percentage ownership and
incur substantial debt or contingent liabilities. Such actions could adversely impact our operating
results and the market price of our common stock. In addition, difficulties in assimilating any
acquired workforce, merging operations or avoiding unplanned attrition could disrupt or harm our
business. Furthermore, the purchase price of any acquired businesses may exceed the current fair
values of the net tangible assets of
40
the acquired businesses. As a result, we would be required to record material amounts of
goodwill, and acquired in-process research and development charges and other intangible assets,
which could result in significant impairment and acquired in-process research and development
charges and amortization expense in future periods. These charges, in addition to the results of
operations of such acquired businesses, could have a material adverse effect on our business,
financial condition and results of operations. We cannot forecast the number, timing or size of
future acquisitions, or the effect that any such acquisitions might have on our operating or
financial results.
We may need to raise additional capital, which might not be available or which, if available,
may be on terms that are not favorable to use.
We believe our existing cash balances and cash expected to be generated from our operations
will be sufficient to meet our working capital, capital expenditures and other needs for at least
the next twelve months. In the future, we may need to raise additional funds, and we cannot be
certain that we will be able to obtain additional financing on favorable terms, if at all. If we
issue equity securities to raise additional funds, the ownership percentage of our stockholders
would be reduced, and the new equity securities may have rights, preferences or privileges senior
to those of existing holders of our common stock. If we borrow money, we may incur significant
interest charges, which could harm our profitability. Holders of debt would also have rights,
preferences or privileges senior to those of existing holders of our common stock. If we cannot
raise needed funds on acceptable terms, we may not be able to develop or enhance our products, take
advantage of future opportunities or respond to competitive pressures or unanticipated
requirements, which could harm our business, operating results and financial condition.
Our future effective tax rates could be affected by the allocation of our income among
different geographic regions, which could affect our future operating results, financial condition
and cash flows.
We are in the process of expanding our international operations and staff to better support
our expansion into international markets. This expansion includes the implementation of an
international structure that includes, among other things, a research and development cost-sharing
arrangement, certain licenses and other contractual arrangements between us and our wholly-owned
domestic and foreign subsidiaries. As a result of these changes, we anticipate that our
consolidated pre-tax income will be subject to foreign tax at relatively lower tax rates when
compared to the U.S. federal statutory tax rate and, as a consequence, our effective income tax
rate is expected to be lower than the U.S. federal statutory rate. Our future effective income tax
rates could be adversely affected if tax authorities challenge our international tax structure or
if the relative mix of U.S. and international income changes for any reason. Accordingly, there can
be no assurance that our income tax rate will be less than the U.S. federal statutory rate.
Risks Related to our Common Stock
The market price of our common stock may be volatile, which could cause the value of your
investment to decline.
The trading prices of the securities of technology companies have been highly volatile.
Further, our common stock has a limited trading history. Since our initial public offering in May
2007 through March 31, 2008, our stock price has fluctuated from a low of $13.50 to a high of
$35.60. We cannot predict the extent to which the trading market will continue to develop or how
liquid the market may become. The trading price of our common stock is therefore likely to be
highly volatile and could be subject to wide fluctuations in price in response to various factors,
some of which are beyond our control. These factors include:
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quarterly variations in our results of operations or those of our competitors; |
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general economic conditions and slow or negative growth of related markets; |
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announcements by us or our competitors of design wins, acquisitions, new products,
significant contracts, commercial relationships or capital commitments; |
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our ability to develop and market new and enhanced products on a timely basis; |
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commencement of, or our involvement in, litigation; |
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disruption to our operations; |
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the emergence of new sales channels in which we are unable to compete effectively; |
41
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any major change in our board of directors or management; |
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changes in financial estimates including our ability to meet our future revenue and operating
profit or loss projections; |
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changes in governmental regulations; and |
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changes in earnings estimates or recommendations by securities analysts. |
Furthermore, the stock market in general, and the market for semiconductor and other
technology companies in particular, have experienced price and volume fluctuations that have often
been unrelated or disproportionate to the operating performance of those companies. These broad
market and industry factors may seriously harm the market price of our common stock, regardless of
our actual operating performance. These trading price fluctuations may also make it more difficult
for us to use our common stock as a means to make acquisitions or to use options to purchase our
common stock to attract and retain employees. In addition, in the past, following periods of
volatility in the overall market and the market price of a companys securities, securities class
action litigation has often been instituted against these companies. This litigation, if instituted
against us, could result in substantial costs and a diversion of our managements attention and
resources.
A limited number of stockholders may have the ability to influence the outcome of director
elections and other matters requiring stockholder approval.*
Our directors, executive officers and principal stockholders and their affiliates beneficially
own approximately 45% of our outstanding common stock as of April 25, 2008. These stockholders, if
they acted together, could exert substantial influence over matters requiring approval by our
stockholders, including electing directors, adopting new compensation plans and approving mergers,
acquisitions or other business combination transactions. This concentration of ownership may
discourage, delay or prevent a change of control of our company, which could deprive our
stockholders of an opportunity to receive a premium for their stock as part of a sale of our
company and might reduce our stock price. These actions may be taken even if they are opposed by
our other stockholders.
Delaware law and our amended and restated certificate of incorporation and bylaws contain
provisions that could delay or discourage takeover attempts that stockholders may consider
favorable.
Provisions in our amended and restated certificate of incorporation and bylaws may have the
effect of delaying or preventing a change of control or changes in our management. These provisions
include the following:
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the division of our board of directors into three classes; |
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the right of the board of directors to elect a director to fill a vacancy created by the
expansion of the board of directors or due to the resignation or departure of an existing
board member; |
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the prohibition of cumulative voting in the election of directors, which would otherwise
allow less than a majority of stockholders to elect director candidates; |
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the requirement for the advance notice of nominations for election to the board of directors
or for proposing matters that can be acted upon at a stockholders meeting; |
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the ability of our board of directors to alter our bylaws without obtaining stockholder
approval; |
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the ability of the board of directors to issue, without stockholder approval, up to
10,000,000 shares of preferred stock with terms set by the board of directors, which rights
could be senior to those of our common stock; |
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the elimination of the rights of stockholders to call a special meeting of stockholders and
to take action by written consent in lieu of a meeting; |
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the required approval of at least 662/3% of the shares entitled to vote at an election of
directors to adopt, amend or repeal our bylaws or repeal the provisions of our amended and
restated certificate of incorporation regarding the election and removal of directors and the
inability of stockholders to take action by written consent in lieu of a meeting; and |
42
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the required approval of at least a majority of the shares entitled to vote at an election of
directors to remove directors without cause. |
In addition, because we are incorporated in Delaware, we are governed by the provisions of
Section 203 of the Delaware General Corporation Law. These provisions may prohibit large
stockholders, particularly those owning 15% or more of our outstanding voting stock, from merging
or combining with us. These provisions in our amended and restated certificate of incorporation and
bylaws and under Delaware law could discourage potential takeover attempts, could reduce the price
that investors are willing to pay for shares of our common stock in the future and could
potentially result in the market price being lower than they would without these provisions.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Use of Proceeds from Sale of Registered Securities
Our initial public offering of common stock was effected through a Registration Statement on
Form S-1 (File No. 333-140660), that was declared effective by the SEC on May 1, 2007. We
registered 7,762,500 shares of our common stock with a proposed maximum aggregate offering price of
$104.8 million, all of which we sold. The offering was completed after the sale of all 7,762,500
shares. Morgan Stanley & Co. Incorporated and Lehman Brothers Inc. were the joint book-running
managing underwriters of our initial public offering and Thomas Weisel Partners LLC, Needham &
Company, LLC and JMP Securities LLC acted as co-managers. As of March 31, 2008, $90.2 million of
the approximately $94.7 million in net proceeds received by us in the offering, after deducting
approximately $7.3 million in underwriting discounts, commissions, and $2.8 million in other
offering costs, were invested in various interest-bearing instruments, and $4.5 million of the net
proceeds had been used for general corporate purposes, including the repayment of the outstanding
balances under the term loan with Silicon Valley Bank, general and administrative and manufacturing
expenses. None of the expenses were paid, directly or indirectly, to directors, officers or persons
owning 10% or more of our common stock, or to our affiliates other than payments in the ordinary
course of business to officers for salaries and to non-employee directors as compensation for board
or board committee service.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
On April 18, 2008, our 2008 annual meeting of stockholders was held at our corporate offices
located in Mountain View, California. During this meeting, our stockholders voted on the
following two proposals:
(a) Proposal to elect two directors to hold office until the 2011 annual meeting of
stockholders:
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Votes |
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Shares |
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Shares |
Nominee |
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For |
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Withheld |
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Anthony J, Pantuso |
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34,949,723 |
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125,542 |
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C. N. Reddy |
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34,863,023 |
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212,242 |
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Our Class II directors, Kris Chellam and John Jarve, will each continue to serve on our Board
of Directors until our 2009 annual meeting of stockholders and until his successor is elected and
has qualified, or until his earlier death, resignation or removal. Our Class III directors, Syed
Ali and Anthony Thornley will each continue to serve on our Board of Directors until our 2010
annual meeting of stockholders and until his successor is elected and has qualified, or until his
earlier death, resignation or removal.
43
(b) Proposal to ratify the selection by the audit committee of our board of directors of
PricewaterhouseCoopers LLP as our independent registered public accounting firm for the fiscal year
ending December 31, 2008:
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Votes For |
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Votes Against |
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Abstain |
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34,188,647
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883,340 |
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3,278 |
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Item 5. Other Information
We appointed Sandeep Vij, age 42, as our Vice President of Strategic Markets & Business
Development, effective May 1, 2008. Prior to joining us, Mr. Vij held the position of Vice
President of Worldwide Marketing, Services and Support for Xilinx Inc., a digital programmable
logic device provider, since December 2007. From 2001 to 2006, he held the position of Vice
President of Worldwide Marketing at Xilinx. From 1997 to 2001, he served as Vice President and
General Manager of the General Products Division at Xilinx. Mr. Vij joined Xilinx in 1996 as
Director of FPGA marketing. Mr. Vij serves on the board of directors of Coherent, Inc., a laser and
photonics company. Mr. Vij received his MS in electrical engineering from Stanford University and BS in
electrical engineering from San Jose State Univerisity.
Pursuant to the terms of an offer letter dated May 1, 2008 with Mr. Vij, the Offer Letter, Mr.
Vij will receive an annual base salary of $275,000. Mr. Vij was also granted a
stock option to purchase 225,000 shares of our common stock, the Vij Stock Option, at an exercise
price of $20.98, the closing price of our common stock as listed on the NASDAQ Global Market on May
1, 2008. The Vij Stock Option is vesting in equal monthly installments over four years. The Vij Stock
Option was granted under our 2007 Equity Incentive Plan and will terminate 7 years from the date of
grant. The salary and stock incentive
awards for Mr. Vij were based on the analysis of an independent
compensation consultant whom our compensation committee engaged.
The compensation consultant held discussions with members of the
compensation committee and senior management to learn more about
our business operations and strategy, key performance metrics and
strategic goals, as well as the labor markets in which we compete.
In the
event
Mr. Vij is terminated without cause (as defined in the Offer Letter) or resigns
for good reason (as defined in the Offer Letter) he will be entitled to severance pay equal to 12
months of his base salary then in effect as of such termination or resignation, health care
continuation coverage for up to 12 months and vesting of two thirds of the unvested Vij Stock
Option will be accelerated. In addition, vesting of all of the Vij Stock Option will be
accelerated in full if we terminate Mr. Vijs employment or
he resigns for good reason within three
months prior to or 12 months following a change in control (as defined in the Offer Letter) or Mr.
Vij is not offered a similar position with the surviving or continuing entity within three months
following a change in control. Mr. Vij has agreed to assist us with the transition following a
change in control for up to three months.
The foregoing description of the Offer Letter does not purport to be
complete and is qualified in its entirety by the terms
and conditions of the Offer Letter, which is attached hereto as Exhibit 10.23.
Item 6. Exhibits
|
|
|
Exhibit |
|
|
Number |
|
Description |
3.1
|
|
Amended and Restated Certificate of Incorporation of the Registrant (1) |
|
|
|
3.2
|
|
Amended and Restated Bylaws (2) |
|
|
|
4.1
|
|
Reference is made to Exhibits 3.1 and 3.2 |
|
|
|
4.2
|
|
Specimen of Common Stock Certificate (3) |
|
|
|
10.23
|
|
Employment Offer Letter, dated May 1, 2008, between the Registrant and Sandeep Vij |
|
|
|
10.24
|
|
Form of Option Agreement under 2007 Equity Incentive Plan |
|
|
|
31.1
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 of Syed B. Ali, President and Chief Executive Officer |
|
|
|
31.2
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 of Arthur D. Chadwick, Chief Financial Officer |
|
|
|
32.1*
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 of Syed B. Ali, President and Chief Executive Officer and
Arthur D. Chadwick, Chief Financial Officer (4) |
44
|
|
|
(1) |
|
Filed as Exhibit 3.3 to the Registrants registration statement on Form S-1 (No. 333-140660),
filed with the SEC on February 13, 2007, as amended, and incorporated herein by reference. |
|
(2) |
|
Filed as Exhibit 3.5 to the Registrants registration statement on Form S-1 (No. 333-140660),
filed with the SEC on February 13, 2007, as amended, and incorporated herein by reference. |
|
(3) |
|
Filed as Exhibit 4.2 to the Registrants registration statement on Form S-1 (No. 333-140660),
filed with the SEC on February 13, 2007, as amended, and incorporated herein by reference. |
|
(4) |
|
This certification accompanies the Form 10-Q to which it relates, is not deemed filed with
the Securities and Exchange Commission and is not to be incorporated by reference into any
filing of the Registrant under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q),
irrespective of any general incorporation language contained in such filing. |
45
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
CAVIUM NETWORKS, INC.
|
|
Date May 2, 2008 |
By: |
/s/ ARTHUR D. CHADWICK
|
|
|
|
Arthur D. Chadwick |
|
|
|
Chief Financial Officer |
|
46
EXHIBIT INDEX
|
|
|
Exhibit |
|
|
Number |
|
Description |
|
|
|
3.1
|
|
Amended and Restated Certificate of Incorporation of the Registrant (1) |
|
|
|
3.2
|
|
Amended and Restated Bylaws (2) |
|
|
|
4.1
|
|
Reference is made to Exhibits 3.1 and 3.2 |
|
|
|
4.2
|
|
Specimen of Common Stock Certificate (3) |
|
|
|
10.23
|
|
Employment Offer Letter, dated May 1, 2008, between the Registrant and Sandeep Vij |
|
|
|
10.24
|
|
Form of Option Agreement under 2007 Equity Incentive Plan |
|
|
|
31.1
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 of Syed B. Ali, President and Chief Executive Officer |
|
|
|
31.2
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 of Arthur D. Chadwick, Chief Financial Officer |
|
|
|
32.1*
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 of Syed B. Ali, President and Chief Executive Officer and
Arthur D. Chadwick, Chief Financial Officer (4) |
|
|
|
(1) |
|
Filed as Exhibit 3.3 to the Registrants registration statement on Form S-1 (No. 333-140660),
filed with the SEC on February 13, 2007, as amended, and incorporated herein by reference. |
|
(2) |
|
Filed as Exhibit 3.5 to the Registrants registration statement on Form S-1 (No. 333-140660),
filed with the SEC on February 13, 2007, as amended, and incorporated herein by reference. |
|
(3) |
|
Filed as Exhibit 4.2 to the Registrants registration statement on Form S-1 (No. 333-140660),
filed with the SEC on February 13, 2007, as amended, and incorporated herein by reference. |
|
(4) |
|
This certification accompanies the Form 10-Q to which it relates, is not deemed filed with
the Securities and Exchange Commission and is not to be incorporated by reference into any
filing of the Registrant under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q),
irrespective of any general incorporation language contained in such filing. |