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, 2010
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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
1-33350
SOURCEFIRE, INC.
(Exact name of Registrant as Specified in its Charter)
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Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
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52-2289365
(I.R.S. Employer
Identification No.) |
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9770 Patuxent Woods Drive
Columbia, Maryland
(Address of Principal Executive Offices)
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21046
(Zip Code) |
Registrants telephone number, including area code: (410) 290-1616
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 has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o 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 definitions of large
accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the
Exchange Act.
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Large Accelerated Filer o
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Accelerated Filer þ
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Non-Accelerated Filer o
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Smaller reporting Company o |
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(Do not check if 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
As of April 30, 2010, there were 27,473,833 outstanding shares of the registrants Common
Stock.
SOURCEFIRE, INC.
Form 10-Q
TABLE OF CONTENTS
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3 |
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3 |
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4 |
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5 |
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6 |
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7 |
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19 |
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32 |
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32 |
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33 |
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33 |
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45 |
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45 |
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45 |
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45 |
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45 |
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46 |
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2
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
SOURCEFIRE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts)
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March 31, |
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December 31, |
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2010 |
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2009 |
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(unaudited) |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
58,022 |
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$ |
53,071 |
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Short-term investments |
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50,550 |
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49,074 |
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Accounts receivable, net of
allowances of $700 as of March
31, 2010 and
$1,157 as of December 31,
2009 |
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25,554 |
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32,771 |
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Inventory |
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4,728 |
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4,414 |
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Prepaid expenses and other
current assets |
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3,698 |
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4,428 |
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Total current assets |
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142,552 |
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143,758 |
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Property and equipment, net |
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7,800 |
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7,447 |
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Investments |
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25,586 |
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21,075 |
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Other assets |
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1,969 |
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1,887 |
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Total assets |
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$ |
177,907 |
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$ |
174,167 |
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Liabilities and Stockholders Equity |
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Current liabilities: |
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Accounts payable |
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$ |
1,501 |
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$ |
2,846 |
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Accrued compensation and related
expenses |
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3,627 |
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5,074 |
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Other accrued expenses |
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2,932 |
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3,025 |
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Current portion of deferred
revenue |
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30,035 |
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29,294 |
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Other current liabilities |
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819 |
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464 |
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Total current liabilities |
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38,914 |
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40,703 |
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Deferred revenue, less current
portion |
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6,216 |
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4,883 |
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Other long-term liabilities |
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128 |
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92 |
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Total liabilities |
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45,258 |
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45,678 |
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Commitments and contingencies |
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Stockholders equity: |
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Preferred stock, $0.001 par value;
19,700,000 shares authorized; no
shares
issued or outstanding as of
March 31, 2010 and December 31,
2009 |
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Series A junior participating
preferred stock, $0.001 par value;
300,000 shares
authorized; no shares issued or
outstanding at March 31, 2010 or
December 31, 2009 |
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Common stock, $0.001 par value;
240,000,000 shares authorized;
27,447,578 and 27,117,051
shares issued and outstanding as
of March 31, 2010 and December
31, 2009, respectively |
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27 |
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26 |
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Additional paid-in capital |
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173,532 |
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170,157 |
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Accumulated deficit |
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(40,906 |
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(41,716 |
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Accumulated other comprehensive
income (loss) |
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(4 |
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22 |
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Total stockholders equity |
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132,649 |
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128,489 |
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Total liabilities and stockholders
equity |
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$ |
177,907 |
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$ |
174,167 |
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See accompanying notes to consolidated financial statements.
3
SOURCEFIRE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except share and per share amounts)
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Three Months Ended |
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March 31, |
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2010 |
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2009 |
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Revenue: |
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Products |
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$ |
14,338 |
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$ |
9,868 |
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Technical support and professional services |
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11,493 |
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8,732 |
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Total revenue |
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25,831 |
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18,600 |
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Cost of revenue: |
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Products |
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3,796 |
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2,767 |
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Technical support and professional services |
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1,405 |
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1,382 |
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Total cost of revenue |
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5,201 |
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4,149 |
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Gross profit |
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20,630 |
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14,451 |
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Operating expenses: |
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Research and development |
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3,795 |
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3,320 |
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Sales and marketing |
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10,619 |
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7,870 |
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General and administrative |
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4,319 |
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3,843 |
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Depreciation and amortization |
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814 |
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821 |
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Total operating expenses |
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19,547 |
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15,854 |
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Income (loss) from operations |
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1,083 |
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(1,403 |
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Other income, net: |
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Interest and investment income |
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118 |
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384 |
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Interest expense |
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(9 |
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(10 |
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Other expense |
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(109 |
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(13 |
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Total other income, net |
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361 |
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Income (loss) before income taxes |
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1,083 |
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(1,042 |
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Provision for income taxes |
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273 |
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75 |
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Net income (loss) |
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$ |
810 |
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$ |
(1,117 |
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Net income (loss) per share: |
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Basic |
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$ |
0.03 |
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$ |
(0.04 |
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Diluted |
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$ |
0.03 |
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$ |
(0.04 |
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Weighted average shares outstanding used in
computing per share amounts: |
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Basic |
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27,220,667 |
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25,934,259 |
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Diluted |
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29,060,559 |
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25,934,259 |
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See accompanying notes to consolidated financial statements.
4
SOURCEFIRE, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY (UNAUDITED)
(in thousands, except share amounts)
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Accumulated |
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Additional |
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Other |
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Common Stock |
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Paid-in |
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Accumulated |
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Comprehensive |
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Shares |
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Amount |
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Capital |
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Deficit |
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Income (Loss) |
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Total |
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Balance as of January 1, 2010 |
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27,117,051 |
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$ |
26 |
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$ |
170,157 |
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$ |
(41,716 |
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$ |
22 |
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$ |
128,489 |
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Exercise of common stock options |
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256,654 |
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1 |
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1,236 |
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1,237 |
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Issuance of restricted common stock |
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76,246 |
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Cancellation of restricted common stock |
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(2,373 |
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Stock-based compensation expense |
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1,926 |
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1,926 |
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Excess tax benefits relating to share-based payments |
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213 |
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213 |
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Comprehensive income: |
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Net income for the three months ended March 31, 2010 |
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810 |
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810 |
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Change in unrealized loss on investments, net of tax |
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(26 |
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(26 |
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Total comprehensive income: |
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784 |
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Balance as of March 31, 2010 |
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27,447,578 |
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$ |
27 |
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$ |
173,532 |
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$ |
(40,906 |
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$ |
(4 |
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$ |
132,649 |
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See accompanying notes to consolidated financial statements.
5
SOURCEFIRE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
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Three Months Ended |
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March 31, |
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2010 |
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2009 |
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Operating activities |
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Net income (loss) |
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$ |
810 |
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$ |
(1,117 |
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Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
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Depreciation and amortization |
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866 |
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834 |
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Stock-based compensation |
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1,926 |
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1,202 |
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Excess tax benefits related to share-based payments |
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(213 |
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Amortization of premium (discount) on investments |
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285 |
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(105 |
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Loss on disposal of assets |
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22 |
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Changes in operating assets and liabilities: |
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Accounts receivable, net |
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7,217 |
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5,920 |
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Inventory |
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(325 |
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167 |
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Prepaid expenses and other assets |
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657 |
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(528 |
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Accounts payable |
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(1,345 |
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(2,863 |
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Accrued expenses |
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(1,327 |
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(1,468 |
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Deferred revenue |
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2,074 |
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2,360 |
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Other liabilities |
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340 |
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(133 |
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Net cash provided by operating activities |
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10,987 |
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4,269 |
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Investing activities |
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Purchase of property and equipment |
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(1,185 |
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(639 |
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Purchase of investments |
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(30,499 |
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(15,335 |
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Proceeds from maturities of investments |
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24,200 |
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22,650 |
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Net cash (used in) provided by investing activities |
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(7,484 |
) |
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6,676 |
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Financing activities |
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Repayments of capital lease obligations |
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(2 |
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(32 |
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Proceeds from exercise of stock options |
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1,237 |
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128 |
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Excess tax benefits relating to share-based payments |
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213 |
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Net cash provided by financing activities |
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1,448 |
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96 |
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Net increase in cash and cash equivalents |
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4,951 |
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11,041 |
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Cash and cash equivalents at beginning of period |
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53,071 |
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39,768 |
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Cash and cash equivalents at end of period |
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$ |
58,022 |
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$ |
50,809 |
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See accompanying notes to consolidated financial statements.
6
SOURCEFIRE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Description of Business
We are a leading provider of intelligent cybersecurity solutions for information technology,
or IT, environments of commercial enterprises, including healthcare, financial services,
manufacturing, energy, education, retail and telecommunications companies, and federal, state and
local government organizations worldwide. Our solutions are comprised of multiple hardware and
software product and service offerings, enabling a comprehensive, intelligent approach to network
security. Our security solutions provide our customers with an efficient and effective network
security defense of assets and applications before, during and after an attack.
We are also the creator of Snort® and the owner of ClamAV®. Snort is an open source intrusion
prevention technology that is incorporated into the IPS software component of our comprehensive
Intrusion Detection and Prevention System. ClamAV is an open source anti-virus and anti-malware
project.
In addition to our commercial and open source network security products, we offer a variety of
services to help our customers install and support our solutions. Available services include
Customer Support, Education, Professional Services and Vulnerability Research Team, or VRT, and
Snort rule subscriptions.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial reporting and in accordance
with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and
footnote disclosures normally included in annual financial statements prepared in accordance with
generally accepted accounting principles in the United States have been condensed or omitted
pursuant to those rules or regulations. The interim financial statements are unaudited, but reflect
all adjustments which are, in the opinion of management, considered necessary for a fair
presentation. These financial statements should be read in conjunction with the audited
consolidated financial statements and the notes included in our Annual Report on Form 10-K for the
year ended December 31, 2009 filed with the Securities and Exchange Commission on March 12, 2010.
The results of operations for the interim periods are not necessarily indicative of results to be
expected in future periods.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States requires us to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual results could
differ materially from those estimates.
On an ongoing basis, we evaluate our estimates, including those related to the accounts
receivable allowance, sales return allowance, warranty reserve, reserve for excess and obsolete
inventory, useful lives of long-lived assets (including intangible assets), income taxes, and our
assumptions used for the purpose of determining stock-based compensation, among other things. We
base our estimates on historical experience and on various other assumptions that are believed to
be reasonable, the results of which can affect the reported amounts of assets and liabilities as of
the date of the consolidated financial statements, as well as the reported amounts of revenue and
expenses during the periods presented.
Investments
We determine the appropriate classification of our investments at the time of purchase and
reevaluate such classification as of each balance sheet date. Our investments are comprised of
money market funds, corporate debt investments, commercial paper, government-sponsored enterprise
securities, government securities and certificates of deposit. These investments have been
classified as available-for-sale. Available-for-sale investments are stated at fair value, with the
unrealized gains and losses,
net of tax, reported in accumulated other comprehensive income (loss). The amortization of
premiums and accretion of
7
discounts to maturity are computed using the effective interest method.
Amortization is included in interest and investment income. Interest on securities classified as
available-for-sale is also included in interest and investment income. See Note 3 for further
discussion of the classification of our investments.
We evaluate our investments on a regular basis to determine whether an other-than-temporary
decline in fair value has occurred. If an investment is in an unrealized loss position and we have
the intent to sell the investment, or it is more likely than not that we will have to sell the
investment before recovery of its amortized cost basis, the decline in value is deemed to be
other-than-temporary and is charged against earnings for the period. For investments that we do
not intend to sell or it is more likely than not that we will not have to sell the investment, but
we expect that we will not fully recover the amortized cost basis, the credit component of the
other-than-temporary impairment is charged against earnings for the applicable period and the
non-credit component of the other-than-temporary impairment is recognized in other comprehensive
income on our consolidated statement of changes in stockholders equity. Unrealized losses
entirely caused by non-credit related factors related to investments for which we expect to fully
recover the amortized cost basis are recorded in accumulated other comprehensive income.
Fair Value of Financial Instruments
Our financial instruments consist primarily of cash and cash equivalents, investments,
accounts receivable, cash surrender value on our split-dollar life insurance policy, accounts
payable and deferred revenue. The fair value of these financial instruments approximates their
carrying amounts reported in the consolidated balance sheets. The fair value of available-for-sale
investments is determined using quoted market prices for those investments.
Allowance for Doubtful Accounts and Sales Return Allowance
We make estimates regarding the collectability of our accounts receivable. When we evaluate
the adequacy of our allowance for doubtful accounts, we consider multiple factors, including
historical write-off experience, the need for specific customer reserves, the aging of our
receivables, customer creditworthiness and changes in customer payment cycles. Historically, our
allowance for doubtful accounts has been adequate based on actual results. If any of the factors
used to calculate the allowance for doubtful accounts change or if the allowance does not reflect
our actual ability to collect outstanding receivables, additional provisions for doubtful accounts
may be needed, and our future results of operations could be materially affected. As of March 31,
2010 and December 31, 2009, the allowance for doubtful accounts was $360,000 and $777,000,
respectively.
We also use our judgment to make estimates regarding potential future product returns related
to reported product revenue in each period. We analyze factors such as our historical return
experience, current product sales volumes, and changes in product warranty claims when evaluating
the adequacy of the sales returns allowance. If any of the factors used to calculate the sales
return allowance were to change, we may experience a material difference in the amount and timing
of our product revenue for any given period. As of March 31, 2010 and December 31, 2009, the sales
return allowance was $340,000 and $380,000, respectively.
Inventories
Inventories consist of hardware and related component parts and are stated at the lower of
cost on a first-in, first-out basis, or market, except for evaluation and advance replacement units
which are stated at the lower of cost, on a specific identification basis, or market. Evaluation
units are used for customer testing and evaluation and are predominantly located at the customers
premises. Advance replacement units, which include replacement units and spare parts, are used to
provide replacement units under technical support arrangements if a customers unit is not
functioning. In prior periods, advance replacement units were included in other assets and
depreciated using the straight-line method. In the third quarter of 2009, we reclassified these
assets to inventory to better reflect the nature of the assets. We make estimates of forecasted
demand for our products, and inventory that is obsolete or in excess of our estimated demand is
written down to its estimated net realizable value based on historical usage, expected demand, the
timing of new product introductions and age. It is reasonably possible that our estimate of future
demand for our products could change in the near term and result in additional inventory
write-downs, which would negatively impact our gross margin.
8
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2010 |
|
|
2009 |
|
Finished goods |
|
$ |
2,863 |
|
|
$ |
2,850 |
|
Evaluation units |
|
|
889 |
|
|
|
733 |
|
Advance replacement units |
|
|
976 |
|
|
|
831 |
|
|
|
|
|
|
|
|
Total inventory |
|
$ |
4,728 |
|
|
$ |
4,414 |
|
|
|
|
|
|
|
|
Inventory write-downs, mostly related to evaluation units and excess and obsolete inventory,
are reflected as cost of revenues and amounted to approximately $43,000 and $211,000 for the three
months ended March 31, 2010 and 2009, respectively.
Revenue Recognition
We derive revenue from arrangements that include hardware products with embedded software, software
licenses and royalties, technical support, and professional services. Revenue from products in the
accompanying consolidated statements of operations consists primarily of sales of software-based
appliances, but also includes fees and royalties for the license of our technology in a
software-only format and subscriptions to receive rules released by the VRT that are used to update
the appliances for current exploits and vulnerabilities. Technical support, which generally has a
contractual term of 12 months, includes telephone and web-based support, software updates, and
rights to software upgrades on a when-and-if-available basis. Professional services include
training and consulting.
For each arrangement, we recognize revenue when: (a) persuasive evidence of an arrangement
exists (e.g., a signed contract); (b) delivery of the product has occurred and there are no
remaining obligations or substantive customer acceptance provisions; (c) the fee is fixed or
determinable; and (d) collection of the fee is deemed probable.
We allocate the total arrangement fee among each deliverable based on the fair value of each
of the deliverables, determined based on vendor-specific objective evidence, or VSOE. If VSOE of
fair value does not exist for each of the deliverables, all revenue from the arrangement is
deferred until the earlier of the point at which sufficient VSOE of fair value can be determined
for any undelivered elements or all elements of the arrangement have been delivered. If the only
undelivered elements are elements for which we currently have VSOE of fair value, we recognize
revenue for the delivered elements based on the residual method. When VSOE of fair value does not
exist for undelivered elements such as maintenance and support, the entire arrangement fee is
recognized ratably over the performance period.
We have established VSOE of fair value for substantially all of our technical support based
upon actual renewals of each type of technical support that is offered and for each customer class.
Technical support and technical support renewals are currently priced based on a percentage of the
list price of the respective product or software and historically have not varied from a narrow
range of values in the substantial majority of our arrangements. Revenue related to technical
support is deferred and recognized ratably over the contractual period of the technical support
arrangement, which is generally 12 months. The VSOE of fair value of our other services is based on
the price for these same services when they are sold separately. Revenue for professional services
that are sold either on a stand-alone basis or included in multiple element arrangements is
deferred and recognized as the services are performed.
All amounts billed or received in excess of the revenue recognized are included in deferred
revenue. In addition, we defer all direct costs associated with revenue that has been deferred.
These amounts are included in either prepaid expenses and other current assets or inventory in the
accompanying balance sheets, depending on the nature of the costs and the reason for the deferral.
For sales through resellers and distributors, we recognize revenue upon the shipment of the
product only if those resellers and distributors provide us, at the time of placing their order,
with the identity of the end-user customer to whom the product has been sold. To the extent that a
reseller or distributor requests an inventory or stock of products, we defer revenue on that
product until we receive notification that it has been sold through to an identified end-user.
We record taxes collected on revenue-producing activities on a net basis.
9
For the three months ended March 31, 2010, two customers, one a reseller and the other a
distributor of our products to the U.S. government, accounted for 10% and 12%, respectively, of
total revenue. For the three months ended March 31, 2009 we had no customers that accounted for
greater than 10% of total revenue.
As of March 31, 2010, two customers, both resellers, accounted for 15% and 11%, respectively,
of our accounts receivable. As of March 31, 2009, we had no customers that accounted for greater
than 10% of our accounts receivable.
Warranty
Under our standard warranty arrangement, we warrant that our software will perform in
accordance with its documentation for a period of 90 days from the date of shipment. Similarly, we
warrant that the hardware will perform in accordance with its documentation for a period of one
year from date of shipment. We further agree to repair or replace software or products that do not
conform to those warranties. The one year warranty on hardware coincides with the hardware warranty
that we obtain from the manufacturer. We estimate the additional costs, if any, that may be
incurred under our warranties outside of the warranties supplied by the manufacturer and record a
liability at the time product revenue is recognized. Factors that affect our warranty liability
include the number of units sold, historical and anticipated rates of warranty claims and the
estimated cost per claim. We periodically assess the adequacy of our recorded warranty liability
and adjust the amounts as necessary. While actual warranty costs have historically been within our
cost estimations, it is possible that warranty rates could increase in the future due to new
hardware introductions, general hardware component cost and availability, among other factors.
Income Taxes
We account for income taxes using the liability method, which requires the recognition of
deferred tax assets or liabilities for the temporary differences between financial reporting and
tax bases of our assets and liabilities and for tax carry-forwards at enacted statutory tax rates
in effect for the years in which the differences are expected to reverse.
We continue to assess the realizability of our deferred tax assets, which primarily consists
of net operating loss, or NOL, carry-forwards, stock-based compensation expense and deferred
revenue. In assessing the realizability of these deferred tax assets, we consider whether it is
more likely than not that some portion or all of the deferred tax assets will be realized. As of
March 31, 2010 and December 31, 2009, our deferred tax assets were fully reserved except for
foreign deferred tax assets of $63,000, which are expected to be available to offset foreign tax
liabilities in the future. Our provision for income taxes for the three months ended March 31, 2010
consists principally of federal, state and foreign income tax expense. Our provision for income
taxes for the three months ended March 31, 2009 consists principally of foreign income tax expense.
With respect to foreign earnings, it is our policy to invest the earnings of foreign
subsidiaries indefinitely outside the U.S. With respect to stock-based compensation expense, the
benefit of the deferred tax asset is being recognized as the related stock options are exercised.
The excess tax benefit from the exercise of stock options is recorded in additional paid-in-capital
in the consolidated balance sheets to the extent that cash taxes payable are reduced.
We have determined there are no material uncertain tax positions that would require a reserve
as of March 31, 2010.
Because tax laws are complex and subject to different interpretations, significant judgment is
required. As a result, we make certain estimates and assumptions, in (i) calculating our provision
for income taxes, deferred tax assets and deferred tax liabilities, (ii) determining any valuation
allowance recorded against deferred tax assets and (iii) evaluating the amount of unrecognized tax
benefits, as well as the interest and penalties related to such uncertain tax positions. Our
estimates and assumptions may differ significantly from tax benefits ultimately realized.
Stock-Based Compensation
Stock-based awards granted include stock options, restricted stock awards, restricted stock
units and stock purchased under our Amended and Restated 2007 Employee Stock Purchase Plan, or
ESPP. Stock-based compensation expense is measured at the grant date, based on the fair value of
the awards, and is recognized as expense over the requisite service period, net of estimated
forfeitures.
10
We use the Black-Scholes option pricing model for estimating the fair value of stock options
granted and for employee stock purchases under the ESPP. For a prior option award that contained a
market condition relating to our stock price achieving specified levels, we used a Lattice option
pricing model. The use of option valuation models requires the input of highly subjective
assumptions, including the expected term and the expected stock price volatility. Additionally, the
recognition of expense requires the estimation of the number of options that will ultimately vest
and the number of options that will ultimately be forfeited. See Note 4 for additional discussion
of stock-based compensation.
Net Income (Loss) Per Share
Basic net income (loss) per share is computed on the basis of the weighted-average number of
shares of common stock outstanding during the period. Diluted net income (loss) per share is
computed on the basis of the weighted-average number of shares of common stock plus the effect of
dilutive potential common shares outstanding during the period using the treasury stock method.
Dilutive potential common shares include outstanding stock options and restricted stock units. See
Note 5 for additional discussion of our net income (loss) per share.
Recent Accounting Pronouncements
In October 2009, the FASB clarified the accounting guidance for sales of tangible products
containing both software and hardware elements and issued new guidance that amends the criteria for
evaluating the individual items in a multiple deliverable revenue arrangement and how to allocate
the consideration received to the individual items. The guidance is effective for revenue
arrangements entered into or materially modified in fiscal years beginning on or after June 15,
2010, with early adoption permitted. We believe this literature is applicable to our revenue
arrangements. We are currently evaluating the impact this guidance will have on our consolidated
financial statements.
In January 2010, the FASB issued revised guidance intended to improve disclosures related to
fair value measurements. This guidance requires new disclosures as well as clarifies certain
existing disclosure requirements. New disclosures under this guidance require separate information
about significant transfers in and out of Level 1 and Level 2 and the reason for such transfers,
and also require purchases, sales, issuances, and settlements information for Level 3 measurement
to be included in the rollforward of activity on a gross basis. The guidance also clarifies the
requirement to determine the level of disaggregation for fair value measurement disclosures and the
requirement to disclose valuation techniques and inputs used for both recurring and nonrecurring
fair value measurements in either Level 2 or Level 3. This accounting guidance is effective for
interim and annual reporting periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair
value measurements, which is effective for fiscal years beginning after December 15, 2010 and for
interim periods within those fiscal years. The adoption of this guidance did not have an affect on
our consolidated financial statements.
Reclassifications
Certain reclassifications have been made to the prior year consolidated financial statements
to conform with the current year presentation.
11
3. Investments
The following is a summary of available-for-sale investments as of March 31, 2010 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Money market funds |
|
$ |
12,965 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
12,965 |
|
Corporate debt investments |
|
|
18,958 |
|
|
|
22 |
|
|
|
(15 |
) |
|
|
18,965 |
|
Commercial paper |
|
|
5,296 |
|
|
|
|
|
|
|
|
|
|
|
5,296 |
|
Government-sponsored enterprises |
|
|
46,189 |
|
|
|
19 |
|
|
|
(43 |
) |
|
|
46,165 |
|
Government securities |
|
|
1,996 |
|
|
|
13 |
|
|
|
|
|
|
|
2,009 |
|
Certificate of deposit |
|
|
3,702 |
|
|
|
|
|
|
|
|
|
|
|
3,702 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
|
89,106 |
|
|
|
54 |
|
|
|
(58 |
) |
|
|
89,102 |
|
Amounts classified as cash equivalents * |
|
|
(12,966 |
) |
|
|
|
|
|
|
|
|
|
|
(12,966 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale investments |
|
$ |
76,140 |
|
|
$ |
54 |
|
|
$ |
(58 |
) |
|
$ |
76,136 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
50,532 |
|
|
|
|
|
|
|
|
|
|
$ |
50,550 |
|
Due after one year through five years |
|
|
25,608 |
|
|
|
|
|
|
|
|
|
|
|
25,586 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
76,140 |
|
|
|
|
|
|
|
|
|
|
$ |
76,136 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Does not include cash held in our bank accounts |
The following is a summary of available-for-sale investments as of December 31, 2009 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Money market funds |
|
$ |
17,617 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
17,617 |
|
Corporate debt investments |
|
|
17,715 |
|
|
|
15 |
|
|
|
(17 |
) |
|
|
17,713 |
|
Commercial paper |
|
|
7,543 |
|
|
|
2 |
|
|
|
|
|
|
|
7,545 |
|
Government-sponsored enterprises |
|
|
39,218 |
|
|
|
41 |
|
|
|
(27 |
) |
|
|
39,232 |
|
Government securities |
|
|
1,995 |
|
|
|
8 |
|
|
|
|
|
|
|
2,003 |
|
Certificate of deposit |
|
|
4,905 |
|
|
|
|
|
|
|
|
|
|
|
4,905 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
|
88,993 |
|
|
|
66 |
|
|
|
(44 |
) |
|
|
89,015 |
|
Amounts classified as cash equivalents * |
|
|
(18,866 |
) |
|
|
|
|
|
|
|
|
|
|
(18,866 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale investments |
|
$ |
70,127 |
|
|
$ |
66 |
|
|
$ |
(44 |
) |
|
$ |
70,149 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Does not include cash held in our bank accounts |
The following tables show the gross unrealized losses and fair value of our investments
as of March 31, 2010 with unrealized losses that are not deemed to be other-than-temporarily
impaired, aggregated by investment category and length of time that individual securities have been
in a continuous unrealized loss position (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less Than 12 Months |
|
|
12 Months or More |
|
|
Total |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
Corporate debt investments |
|
$ |
10,423 |
|
|
$ |
15 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
10,423 |
|
|
$ |
15 |
|
Government-sponsored enterprises |
|
|
24,429 |
|
|
|
43 |
|
|
|
|
|
|
|
|
|
|
|
24,429 |
|
|
|
43 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
34,852 |
|
|
$ |
58 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
34,852 |
|
|
$ |
58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2010, the net unrealized holding loss on available-for-sale securities
included in accumulated other comprehensive loss totaled $4,000. We have evaluated our investments
and have determined there were no other-than-temporary impairments as of March 31, 2010. There are
eleven corporate debt investments and fourteen government-sponsored
12
enterprise investments with
unrealized losses that have existed for less than one year. The unrealized losses related to these
investments are entirely caused by non-credit related factors. We do not have the intent to sell
these securities and we expect to fully recover the amortized cost basis of these investments. For
the three months ended March 31, 2010, the deferred tax benefit recorded in other comprehensive
loss was fully offset by the increase of the valuation allowance we recorded for related deferred
tax assets.
4. Stock-Based Compensation
In March 2007, our Board of Directors and stockholders approved the Sourcefire, Inc. 2007
Stock Incentive Plan, or 2007 Plan, which provides for the granting of equity-based awards,
including stock options, restricted or unrestricted stock awards, and stock appreciation rights to
employees, officers, directors, and other individuals as determined by the Board of Directors. As
of December 31, 2009, we had reserved an aggregate of 5,164,850 shares of common stock for issuance
under the 2007 Plan. On January 1, 2010, under the terms of the 2007 Plan, the aggregate number of
shares reserved for issuance under the 2007 Plan was increased by an amount equal to 4% of our
outstanding common stock as of December 31, 2009, or 1,084,682 shares. Therefore, as of March 31,
2010, we have reserved an aggregate of 6,249,532 shares of common stock for issuance under the 2007
Plan. Prior to adoption of the 2007 Plan, we granted stock options and restricted stock awards
under the Sourcefire, Inc. 2002 Stock Incentive Plan, or 2002 Plan.
The 2002 Plan and the 2007 Plan are administered by the Compensation Committee of our Board of
Directors. The vesting period for awards under the plans is generally between three and five
years. Options granted prior to March 2010 have a maximum term of ten years, and options granted
beginning March 2010 have a maximum term of seven years. The exercise price of stock option awards
is equal to at least the fair value of the common stock on the date of grant. The fair value of our
common stock is determined by reference to the closing trading price of the common stock on the
Nasdaq Global Market on the date of grant.
Valuation of Stock-Based Compensation
We use the Black-Scholes option pricing model for estimating the fair value of stock options
granted and for employee stock purchases under the ESPP. For a prior option award that contained a
market condition relating to our stock price achieving specified levels, we used a Lattice option
pricing model. The use of option valuation models requires the input of highly subjective
assumptions, including the expected term and the expected stock price volatility. Additionally, the
recognition of expense requires the estimation of the number of options that will ultimately vest
and the number of options that will ultimately be forfeited. The fair value of stock-based awards
is recognized as expense over the requisite service period, net of estimated forfeitures. We rely
on historical experience of employee turnover to estimate our expected forfeitures.
The following are the weighted-average assumptions and fair values used in the Black-Scholes option
valuation of stock options granted under the 2002 Plan and the 2007 Plan and ESPP grants.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
2010 |
|
2009 |
Stock options: |
|
|
|
|
|
|
|
|
Average risk-free interest rate |
|
|
2.7 |
% |
|
|
2.2 |
% |
Expected dividend yield |
|
|
|
% |
|
|
|
% |
Expected life (years) |
|
|
6.06 |
|
|
|
6.25 |
|
Expected volatility |
|
|
61.4 |
% |
|
|
64.7 |
% |
Weighted-average fair value at grant date |
|
$ |
14.22 |
|
|
$ |
4.00 |
|
|
|
|
|
|
|
|
|
|
Employee stock purchase plan: |
|
|
|
|
|
|
|
|
Average risk-free interest rate |
|
|
|
% |
|
|
|
% |
Expected dividend yield |
|
|
|
|
|
|
|
|
Expected life (years) |
|
|
|
|
|
|
|
|
Expected volatility |
|
|
|
% |
|
|
|
% |
Weighted-average fair value at grant date |
|
$ |
|
|
|
$ |
|
|
Average risk-free interest rate This is the average U.S. Treasury rate, with a term
that most closely resembles the expected life of the option, as of the grant date.
13
Expected dividend yield We use an expected dividend yield of zero, as we have never declared
or paid dividends on our common stock and do not anticipate paying dividends in the foreseeable
future.
Expected life This is the period of time that the stock options granted under our equity
incentive plans and ESPP grants are expected to remain outstanding.
We have elected to use the simplified method of determining the expected term of stock
options. This estimate is derived from the average midpoint between the weighted-average vesting
period and the contractual term. In future periods, we expect to begin to incorporate our own data
in estimating the expected life as we develop appropriate historical experience of employee
exercise and post-vesting termination behavior considered in relation to the contractual life of
the option.
For ESPP grants, the expected life is the plan period.
Expected volatility Volatility is a measure of the amount by which a financial variable such
as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected
volatility) during a period.
For stock options granted, since we only have historical stock data from our IPO in March
2007, which is less than the expected life of the stock options, we have used a blended volatility
to estimate expected volatility. The blended volatility includes a weighting of our historical
volatility from the date of our IPO to the respective grant date and an average of our peer group
historical volatility consistent with the expected life of the option. Our peer group historical
volatility includes the historical volatility of companies that are similar in revenue size, in the
same industry or are competitors. We expect to continue to use a larger proportion of our
historical volatility in future periods as we develop additional historical experience of our own
stock price fluctuations considered in relation to the expected life of the option.
For ESPP grants, we use our historical volatility since we have historical data available
since our IPO, which is consistent with the expected life.
If we had made different assumptions about the stock price volatility rates, expected life,
expected forfeitures and other assumptions, the related stock-based compensation expense and net
income could have been significantly different.
The following table summarizes stock-based compensation expense included in the accompanying
consolidated statements of operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2010 |
|
|
2009 |
|
Product cost of revenue |
|
$ |
31 |
|
|
$ |
11 |
|
Services cost of revenue |
|
|
71 |
|
|
|
33 |
|
|
|
|
|
|
|
|
Stock-based compensation expense included in cost of revenue |
|
|
102 |
|
|
|
44 |
|
|
|
|
|
|
|
|
Research and development |
|
|
318 |
|
|
|
205 |
|
Sales and marketing |
|
|
666 |
|
|
|
383 |
|
General and administrative |
|
|
840 |
|
|
|
570 |
|
|
|
|
|
|
|
|
Stock-based compensation expense included in operating expenses |
|
|
1,824 |
|
|
|
1,158 |
|
|
|
|
|
|
|
|
Total stock-based compensation expense |
|
$ |
1,926 |
|
|
$ |
1,202 |
|
|
|
|
|
|
|
|
14
Stock Options
The following table summarizes stock option activity under the plans for the three months
ended March 31, 2010 (in thousands, except share and per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
Average Remaining |
|
|
Aggregate |
|
|
|
Number of |
|
|
Range of |
|
|
Average |
|
|
Contractual |
|
|
Intrinsic |
|
|
|
Shares |
|
|
Exercise Prices |
|
|
Exercise Price |
|
|
Term |
|
|
Value |
|
Outstanding at December 31, 2009 |
|
|
2,542,038 |
|
|
$ |
0.24 to 15.49 |
|
|
$ |
7.75 |
|
|
|
|
|
|
$ |
5,878 |
|
Granted |
|
|
221,400 |
|
|
|
22.27 to 27.09 |
|
|
|
24.30 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(256,654 |
) |
|
|
0.24 to 13.10 |
|
|
|
4.82 |
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(33,154 |
) |
|
|
5.26 to 27.09 |
|
|
|
15.46 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2010 |
|
|
2,473,630 |
|
|
$ |
0.24 to 27.09 |
|
|
$ |
9.43 |
|
|
|
7.48 |
|
|
$ |
33,816 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and exercisable at March 31, 2010 |
|
|
1,202,011 |
|
|
$ |
0.24 to 15.49 |
|
|
$ |
5.33 |
|
|
|
6.26 |
|
|
$ |
21,182 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at March 31, 2010 |
|
|
2,122,628 |
|
|
|
|
|
|
$ |
8.94 |
|
|
|
7.31 |
|
|
$ |
30,023 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes information about stock options outstanding as of March
31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
Options Exercisable |
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
Average |
|
|
|
|
|
|
Weighted- |
|
Range of |
|
Number of |
|
|
Average |
|
|
Contractual |
|
|
Number of |
|
|
Average |
|
Exercise Prices |
|
Shares |
|
|
Exercise Prices |
|
|
Life (Years) |
|
|
Shares |
|
|
Exercise Prices |
|
$ 0.24 to 6.32 |
|
|
624,072 |
|
|
$ |
2.33 |
|
|
|
5.08 |
|
|
|
546,967 |
|
|
$ |
1.84 |
|
$ 6.41 to 6.77 |
|
|
800,209 |
|
|
|
6.71 |
|
|
|
8.27 |
|
|
|
367,119 |
|
|
|
6.72 |
|
$ 7.10 to 18.25 |
|
|
622,749 |
|
|
|
10.63 |
|
|
|
7.59 |
|
|
|
287,925 |
|
|
|
10.17 |
|
$19.11 to 27.09 |
|
|
426,600 |
|
|
|
23.19 |
|
|
|
9.36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,473,630 |
|
|
$ |
9.43 |
|
|
|
7.48 |
|
|
|
1,202,011 |
|
|
$ |
5.33 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value of all options exercised during the three months ended
March 31, 2010 and 2009 was $5.3 million and $378,000, respectively.
Outstanding stock option awards are generally subject to service-based vesting; however, in
some instances, awards contain provisions for acceleration of vesting upon performance measures,
change in control and in certain other circumstances. On a quarterly basis, we evaluate the
probability of achieving performance measures and adjust compensation expense accordingly. Based
on the estimated grant date fair value of employee stock options granted, we recognized
compensation expense of $892,000 and $641,000 for the three months ended March 31, 2010 and 2009,
respectively. The grant date aggregate fair value of options, net of estimated forfeitures, not
yet recognized as expense as of March 31, 2010 was $7.7 million, which is expected to be recognized
over a weighted average period of 2.76 years.
Restricted Stock Awards
The following table summarizes the unvested restricted stock award activity during the three
months ended March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average |
|
|
|
Number of |
|
|
Grant Date |
|
|
|
Shares |
|
|
Fair Value |
|
Unvested at December 31, 2009 |
|
|
435,222 |
|
|
$ |
7.85 |
|
Granted |
|
|
|
|
|
|
|
|
Vested |
|
|
(84,865 |
) |
|
|
7.88 |
|
Forfeited |
|
|
(2,373 |
) |
|
|
8.47 |
|
|
|
|
|
|
|
|
Unvested at March 31, 2010 |
|
|
347,984 |
|
|
$ |
7.84 |
|
|
|
|
|
|
|
|
15
Restricted stock awards are generally subject to service-based vesting; however, in some
instances, awards contain provisions for acceleration of vesting upon performance measures, change
in control and in certain other circumstances. Holders of restricted stock awards have the right
to vote such shares and receive dividends. The restricted stock awards are considered issued and
outstanding at the date the award is granted. On a quarterly basis, we evaluate the probability of
achieving performance measures and adjust compensation expense accordingly. The compensation
expense is recognized ratably over the estimated vesting period. The vesting restrictions for
outstanding restricted stock awards generally lapse over a period of 36 to 60 months.
The vest date fair value of restricted stock awards that vested during the three months ended
March 31, 2010 and 2009 was $2.1 million and $529,000, respectively.
The fair value of the unvested restricted stock awards is measured using the closing price of
our stock on the date of grant. The total compensation expense related to restricted stock awards
for the three months ended March 31, 2010 and 2009 was $448,000 and $506,000, respectively.
As of March 31, 2010, there was $1.3 million of unrecognized compensation expense, net of
estimated forfeitures, related to unvested restricted stock awards. This amount is expected to be
recognized over a weighted-average period of 1.85 years.
Restricted Stock Units
The following table summarizes the unvested restricted stock unit activity during the three
months ended March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average |
|
|
|
Number of |
|
|
Grant Date |
|
|
|
Shares |
|
|
Fair Value |
|
Unvested at December 31, 2009 |
|
|
604,400 |
|
|
$ |
10.91 |
|
Granted |
|
|
173,500 |
|
|
|
23.80 |
|
Vested |
|
|
(76,246 |
) |
|
|
25.33 |
|
Forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested at March 31, 2010 |
|
|
701,654 |
|
|
$ |
14.44 |
|
|
|
|
|
|
|
|
Restricted stock units are generally subject to service-based vesting; however, in some
instances, restricted stock units contain provisions for acceleration of vesting upon performance
measures, change in control and in certain other circumstances. On a quarterly basis, we evaluate
the probability of achieving performance measures and adjust compensation expense accordingly. The
compensation expense is recognized ratably over the estimated vesting period. The vesting
restrictions for outstanding restricted stock units generally lapse over a period of 36 to 60
months.
The fair value of the unvested restricted stock units is measured using the closing price of
our stock on the date of grant. The total compensation expense related to restricted stock units
for the three months ended March 31, 2010 was $485,000 and $18,000, respectively.
As of March 31, 2010, there was $5.9 million of unrecognized compensation expense, net of
estimated forfeitures, related to unvested restricted stock units. This amount is expected to be
recognized over a weighted-average period of 3.68 years.
Employee Stock Purchase Plan
The ESPP allows eligible employees to purchase our common stock at 85% of the lower of the
stock price at the beginning or end of the offering period, which generally is a six-month period.
An aggregate of 1,000,000 shares of our common stock have been reserved for issuance under the
ESPP. For the three months ended March 31, 2010 and 2009, no shares were purchased under the ESPP.
The total compensation expense related to the ESPP for the three months ended March 31, 2010 and
2009 was $102,000 and $37,000, respectively.
16
5. Net Income (Loss) Per Share
The calculation of basic and diluted net income (loss) per share for the three months ended
March 31, 2010 and 2009 is summarized as follows (in thousands, except share and per share data):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2010 |
|
|
2009 |
|
Numerator: |
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
810 |
|
|
$ |
(1,117 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
Weighted average shares outstanding basic |
|
|
27,220,667 |
|
|
|
25,934,259 |
|
Dilutive effect of employee stock plans |
|
|
1,839,892 |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding diluted |
|
|
29,060,559 |
|
|
|
25,934,259 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share: |
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.03 |
|
|
$ |
(0.04 |
) |
Diluted |
|
$ |
0.03 |
|
|
$ |
(0.04 |
) |
|
|
|
|
|
|
|
The following potential weighted-average common shares were excluded from the computation
of diluted earnings per share, as their effect would have been anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2010 |
|
|
2009 |
|
Options to purchase common stock |
|
|
381,979 |
|
|
|
1,868,387 |
|
Restricted stock units |
|
|
|
|
|
|
51,104 |
|
|
|
|
|
|
|
|
|
|
|
381,979 |
|
|
|
1,919,491 |
|
|
|
|
|
|
|
|
6. Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2010 |
|
|
2009 |
|
Net income (loss) |
|
$ |
810 |
|
|
$ |
(1,117 |
) |
Comprehensive income (loss): |
|
|
|
|
|
|
|
|
Change in net unrealized gains (losses) on investments |
|
|
(26 |
) |
|
|
(96 |
) |
|
|
|
|
|
|
|
Total comprehensive income (loss) |
|
$ |
784 |
|
|
$ |
(1,213 |
) |
|
|
|
|
|
|
|
7. Fair Value Measurement
We measure the fair value of assets and liabilities using a three-level fair value hierarchy
that prioritizes the inputs used to measure fair value. This hierarchy requires us to maximize the
use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs
used to measure fair value are as follows:
|
|
|
Level 1 Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical unrestricted assets or liabilities. |
|
|
|
|
Level 2 Quoted prices in markets that are not active or financial instruments for
which all significant inputs are observable, either directly or indirectly. |
|
|
|
|
Level 3 Prices or valuations that require inputs that are both significant to the
fair value measurement and unobservable.
|
17
The fair value measurement of an asset or liability is based on the lowest level of any input
that is significant to the fair value assessment. Our investments that are measured at fair value
on a recurring basis are generally classified within Level 1 or Level 2 of the fair value
hierarchy. The fair value of investments classified as Level 2 utilized the market approach.
There were no transfers between Level 1 and Level 2 for the three months ended March 31, 2010.
The following table presents our financial assets and liabilities that were accounted for at
fair value as of March 31, 2010 by level within the fair value hierarchy (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement Using |
|
|
|
Fair Value |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds |
|
$ |
12,965 |
|
|
$ |
12,965 |
|
|
$ |
|
|
|
$ |
|
|
Investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt investments |
|
|
18,965 |
|
|
|
|
|
|
|
18,965 |
|
|
|
|
|
Commercial paper |
|
|
5,296 |
|
|
|
|
|
|
|
5,296 |
|
|
|
|
|
Government-sponsored enterprises |
|
|
46,165 |
|
|
|
|
|
|
|
46,165 |
|
|
|
|
|
Government securities |
|
|
2,009 |
|
|
|
2,009 |
|
|
|
|
|
|
|
|
|
Certificate of deposit |
|
|
3,702 |
|
|
|
|
|
|
|
3,702 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
89,102 |
|
|
$ |
14,974 |
|
|
$ |
74,128 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8. Business and Geographic Segment Information
We manage our operations on a consolidated basis for purposes of assessing performance and
making operating decisions. Accordingly, we do not have reportable segments. Revenues by geographic
area for the three months ended March 30, 2010 and 2009 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2010 |
|
|
2009 |
|
United States |
|
$ |
18,306 |
|
|
$ |
12,195 |
|
All foreign countries. |
|
|
7,525 |
|
|
|
6,405 |
|
|
|
|
|
|
|
|
Consolidated total |
|
$ |
25,831 |
|
|
$ |
18,600 |
|
|
|
|
|
|
|
|
9. Commitments and Contingencies
We purchase components for our products from a variety of suppliers and use several contract
manufacturers to provide manufacturing services for our products. During the normal course of
business, in order to manage manufacturing lead times and help ensure adequate component supply, we
enter into agreements with contract manufacturers and suppliers that allow them to procure
inventory based upon information we provide. In certain instances, these agreements allow us the
option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm
orders being placed. A portion of our reported purchase commitments arising from these agreements
are firm, non-cancelable, and unconditional commitments. As of March 31, 2010, we had total
purchase commitments for inventory of approximately $7.3 million due within the next 12 months.
We maintain office space in the United Kingdom for which the lease agreement requires that we
return the office space to its original condition upon vacating the premises. The present value of
the costs associated with this retirement obligation is
approximately $140,000, payable upon termination of the lease. This cost is being accreted
based on estimated discounted cash flows over the lease term.
18
|
|
|
Item 2. |
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Certain statements contained in this Quarterly Report on Form 10-Q may constitute
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. The words or phrases
would be, will allow, intends to, will likely result, are expected to, will continue,
is anticipated, estimate, project, or similar expressions, or the negative of such words or
phrases, are intended to identify forward-looking statements. We have based these forward-looking
statements on our current expectations and projections about future events. Because such statements
include risks and uncertainties, actual results may differ materially from those expressed or
implied by such forward-looking statements. Factors that could cause or contribute to these
differences include those below and elsewhere in this Quarterly Report on Form 10-Q, particularly
in Risk Factors, and our other filings with the Securities and Exchange Commission. Statements
made herein are as of the date of the filing of this Form 10-Q with the Securities and Exchange
Commission and should not be relied upon as of any subsequent date. Unless otherwise required by
applicable law, we do not undertake, and we specifically disclaim, any obligation to update any
forward-looking statements to reflect occurrences, developments, unanticipated events or
circumstances after the date of such statement.
The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with our consolidated financial statements and related notes that
appear elsewhere in this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K for
the fiscal year ended December 31, 2009.
Introduction
Managements discussion and analysis of financial condition, changes in financial condition
and results of operations is provided as a supplement to the accompanying consolidated financial
statements and notes to help provide an understanding of Sourcefire, Inc.s financial condition and
results of operations. This item of our Quarterly Report on Form 10-Q is organized as follows:
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Overview. This section provides a general description of our business, the key
financial metrics that we use in assessing our performance, and anticipated trends that
we expect to affect our financial condition and results of operations. |
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Results of Operations. This section provides an analysis of our results of
operations for the three months ended March 31, 2010 and 2009. |
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Non-GAAP Financial Measures. This section discusses non-GAAP financial results that
we use in evaluating the operating performance of our business. These measures should be
considered in addition to results prepared in accordance with United States generally
accepted accounting principles, or GAAP, but should not be considered a substitute for,
or superior to, GAAP results. The non-GAAP measures discussed have been reconciled to the
nearest GAAP measure in a table included in this section. |
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Liquidity and Capital Resources. This section provides an analysis of our cash
flows for the three months ended March 31, 2010 and a discussion of our capital
requirements and the resources available to us to meet those requirements. |
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Critical Accounting Policies and Estimates. This section discusses accounting
policies that are considered important to our financial condition and results of
operations, require significant judgment or require estimates on our part in applying
them. Our significant accounting policies, including those considered to be critical
accounting policies, are summarized in Note 2 to the accompanying consolidated financial
statements. |
Overview
We are a leading provider of intelligent cybersecurity solutions for information technology,
or IT, environments of commercial enterprises, including healthcare, financial services,
manufacturing, energy, education, retail and telecommunications companies, and federal, state and
local government organizations worldwide. Our solutions are comprised of multiple hardware and
software product and service offerings, enabling a comprehensive, intelligent approach to network
security. Our security solutions provide customers with an efficient and effective network
security defense of assets and applications before, during and after an attack.
19
We sell our network security solutions to a diverse customer base that includes Global 2000
companies, global enterprises, U.S. and international government agencies and small and mid-size
businesses. We also manage two of the security industrys
leading open source initiatives, Snort® and ClamAV®.
Key Financial Metrics and Trends
Our financial results are affected by a number of factors, including general economic
conditions in the United States and globally, the amount and type of technology spending of our
customers, and the financial condition of our customers and other entities in the industries and
geographic areas that we serve. Beginning in the second half of 2008, the industries and geographic
areas that we serve experienced weakness as macroeconomic conditions, credit market conditions and
levels of business confidence and activity deteriorated. We are continuing to monitor economic
conditions and their potential effect on our customers and on us. An additional economic downturn
could adversely affect our customers financial condition and the levels of business activity. This
could reduce demand and depress pricing for our products and services, which could have a material
adverse effect on our results of operations or financial condition.
During the first quarter of 2010, a significant portion of our revenue growth resulted from
sales of our products and services to U.S. federal and state government agencies. Contracts with
the U.S. federal and state government agencies collectively accounted for 24% and 14% of our total
revenue for the three months ended March 31, 2010 and 2009, respectively. We expect sales to U.S.
federal and state government agencies to continue to account for a significant portion of our total
revenue in 2010. A reduction in the amount of U.S. government purchases of our products could have
a material adverse effect on our results of operations or financial condition.
We evaluate our performance on the basis of several key financial metrics, including revenue,
cost of revenue, gross profit, and operating expenses. We compare these key performance indicators,
on a quarterly basis, to both target amounts established by management and to our performance for
prior periods. We also evaluate performance on the basis of adjusted income (loss) from
operations, adjusted net income and adjusted net income per share, which are non-GAAP financial
measures. Information regarding our non-GAAP financial measures and a reconciliation to the
nearest GAAP measure is provided under Non-GAAP Financial Measures below.
Revenue
We currently derive revenue from product sales and services. Product revenue is principally
derived from the sale of our network security solutions. Our network security solutions include a
perpetual software license bundled with a third-party hardware platform. Services revenue is
principally derived from technical support and professional services. We typically sell technical
support to complement our network security product solutions. Technical support entitles a customer
to product updates and new rule releases on a when and if available basis and both telephone and
web-based assistance for using our products. Our professional services revenue includes optional
installation, configuration and tuning, which we refer to collectively as network security
deployment services. These services typically occur on-site after delivery has occurred.
Product sales are typically recognized as revenue upon shipment of the product to the
customer. For sales through resellers and distributors, we recognize revenue upon the shipment of
the product only if those resellers and distributors provide us, at the time of placing their
order, with the identity of the end-user customer to whom the product has been sold. We recognize
revenue from services when the services are performed. For technical support services, we recognize
revenue ratably over the term of the support arrangement, which is generally 12 months. Our support
agreements generally provide for payment in advance.
We sell our network security solutions globally. However, 71% and 66% of our revenue for the
three months ended March 31, 2010 and 2009, respectively, was generated by sales to U.S.-based
customers. We expect that our revenue from customers based outside of the United States will
increase in absolute dollars and as a percentage of revenue as we strengthen our international
presence. We also expect that our revenue from sales through our indirect sales channel, comprised
of resellers, distributors, managed security service providers, or MSSPs, government integrators
and other partners, will increase in amount and as a percentage of total revenue as we expand our
current relationships and establish new relationships with these third parties.
We continue to generate a majority of our product revenue through sales to existing customers,
both for new locations and for additional technology to protect existing networks and locations.
Product sales to existing customers accounted for 68% and
20
78% of total product revenue for the three months ended March 31, 2010 and 2009, respectively.
We expect product sales to existing customers to continue to account for a significant portion of
our product revenue in 2010.
Historically, our product revenue has been seasonal, with a significant portion of our total
product revenue in recent fiscal years generated in the third and fourth quarters. Revenue from our
government customers has been influenced by the September 30th fiscal year-end of the U.S. federal
government, which has historically resulted in our revenue from government customers being highest
in the second half of the year. While we expect these historical trends to continue, they could be
affected by a number of factors, including another decline in general economic conditions, changes
in the timing or amounts of U.S. government spending and our planned international expansion.
Notwithstanding these general seasonal patterns, our revenue within a particular quarter is often
affected significantly by the unpredictable procurement patterns of our customers. Our prospective
customers usually spend a long time evaluating and making purchase decisions for network security
solutions. Historically, many of our customers have not finalized their purchasing decisions until
the final weeks or days of a quarter. We expect these purchasing patterns to continue in the
future. Therefore, a delay in even one large order beyond the end of the quarter could materially
reduce our anticipated revenue for a quarter. In addition, because we typically recognize revenue
upon shipment, the timing of our quarter-end and year-end shipments could materially affect our
reported product revenue for a given quarter or year. Because many of our expenses are incurred
before we recognize revenue, delayed orders could negatively impact our results of operations and
cash flows for a particular period and could therefore cause us to fail to meet the financial
performance expectations of financial and industry research analysts or investors.
Cost of Revenue
Cost of product revenue includes the cost of the hardware platform, royalties for third-party
software, materials and labor, logistics, warranty, shipping and handling costs, expense for
inventory excess and obsolescence and depreciation in the instances where we lease our network
security solutions to our customers. We allocate overhead costs, including facilities, supplies,
communication and information systems and employee benefits, to the cost of product revenue.
Overhead costs are reflected in each cost of revenue and operating expense category. As our
product volume increases, we anticipate incurring an increased amount of both direct and overhead
expenses to supply and manage the increased volume. Hardware unit costs, our most significant cost
item, have generally remained constant on a per unit basis; however, hardware unit costs or other
costs of manufacturing could increase in the future.
Cost of services revenue includes the direct labor costs of our employees and outside
consultants engaged to furnish those services, as well as their travel and associated direct
material costs. Additionally, we include in cost of services revenue an allocation of overhead
costs, as well as the cost of time and materials to service or repair the hardware component of our
products covered under a renewed support arrangement beyond the manufacturers warranty and the
expense for advance replacement unit inventory excess and obsolescence. As our customer base
continues to grow, we anticipate incurring an increasing amount of these service and repair costs,
as well as costs for additional personnel to provide support and service to our customers.
Gross Profit
Our gross profit is affected by a variety of factors, including competition, the mix and
average selling prices of our products, our pricing policy, technical support and professional
services, new product introductions, the cost of hardware platforms, expense for inventory excess
and obsolescence, warranty expense, the cost of labor and materials and the mix of distribution
channels through which our products are sold. Our gross profit would be adversely affected by price
declines or pricing discounts if we are unable to reduce costs on existing products and fail to
introduce new products with higher margins. Currently, product sales typically have a lower gross
profit as a percentage of revenue than our services due to the cost of the hardware platform. Our
gross profit for any particular quarter could be adversely affected if we do not complete a
sufficient level of sales of higher-margin products by the end of the quarter. As discussed above,
many of our customers do not finalize purchasing decisions until the final weeks or days of a
quarter, so a delay in even one large order of a high-margin product could reduce our total gross
profit percentage for that quarter.
Operating Expenses
Research and Development. Research and development expenses consist primarily of salaries,
incentive compensation and allocated overhead costs for our engineers; costs for professional
services to design, test and certify our products; and costs associated with data used by us in our
product development.
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We have expanded our research and development capabilities and expect to continue to expand
these capabilities in the future. We are committed to increasing the level of innovative design and
development of new products as we strive to enhance our ability to serve our existing commercial
and federal government markets as well as new markets for security solutions. To meet the changing
requirements of our customers, we will need to fund investments in several development projects in
parallel. Accordingly, we anticipate that our research and development expenses will continue to
increase in absolute dollars for the year ending December 31, 2010; however, we expect these
expenses to remain flat or decline slightly as a percentage of revenue.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries, incentive
compensation and allocated overhead costs for sales and marketing personnel; trade show,
advertising, marketing and other brand-building costs; marketing consultants and other professional
services; training, seminars and conferences; and travel and related costs.
As we continue to focus on increasing our market penetration, expanding internationally,
increasing our indirect sales channel and building brand awareness, we anticipate that selling and
marketing expenses will continue to increase in absolute dollars for the year ending December 31,
2010 but remain relatively flat as a percentage of our revenue.
General and Administrative. General and administrative expenses consist primarily of
salaries, incentive compensation and allocated overhead costs for executive, legal, finance,
information technology, human resources and administrative personnel; corporate development
expenses and professional fees related to legal, audit, tax and regulatory compliance; travel and
related costs; and corporate insurance. We anticipate that general and administrative expenses
will increase in absolute dollars for the year ending December 31, 2010.
Stock-Based Compensation. Stock-based compensation expense is based on the grant date fair
value of stock awards granted or modified after January 1, 2006 using the prospective transition
method.
We use the Black-Scholes option pricing model to estimate the fair value of stock options
granted and employee stock purchases. For a prior option award that contained a market condition
relating to our stock price achieving specified levels, we used a Lattice option pricing model. The
use of option valuation models requires the input of highly subjective assumptions, including the
expected term and the expected stock price volatility. Based on the estimated grant date fair
value of stock-based awards, we recognized aggregate stock-based compensation expense of $1.9
million and $1.2 million for the three months ended March 31, 2010 and 2009, respectively.
Results of Operations
Revenue. The following table shows products and technical support and professional services
revenue (in thousands):
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Three Months Ended |
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March 31, |
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Variance |
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2010 |
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2009 |
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$ |
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% |
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Products |
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$ |
14,338 |
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$ |
9,868 |
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$ |
4,470 |
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45 |
% |
Percentage of total revenue |
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56 |
% |
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53 |
% |
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Technical support and professional services |
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11,493 |
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8,732 |
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|
2,761 |
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32 |
% |
Percentage of total revenue |
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44 |
% |
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47 |
% |
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Total revenue |
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$ |
25,831 |
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$ |
18,600 |
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$ |
7,231 |
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39 |
% |
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The increase in our product revenue for the three months ended March 31, 2010, as
compared to the prior-year period, was primarily due to higher volume demand for our sensor
products, mainly our higher performance products, and increased sales of our software licenses.
For 2010, sensor product revenue increased $2.3 million over the prior-year period, including a
$1.2 million increase in revenue from our higher performance products, and software licenses
increased $1.8 million, including $431,000 in revenue from our virtual appliances that became
generally available in the fourth quarter of 2009.
The increase in our services revenue for the three months ended March 31, 2010, as compared to
the prior-year period, resulted from an increase in our installed customer base due to new product
sales in which associated support was purchased, as well as technical support renewals by our
existing customers.
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Cost of revenue. The following table shows products and technical support and professional
services cost of revenue (in thousands):
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Three Months Ended |
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March 31, |
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Variance |
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2010 |
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2009 |
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$ |
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% |
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Products |
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$ |
3,796 |
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$ |
2,767 |
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$ |
1,029 |
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37 |
% |
Percentage of total revenue |
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15 |
% |
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15 |
% |
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Technical support and professional services |
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1,405 |
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|
1,382 |
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|
23 |
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2 |
% |
Percentage of total revenue |
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|
5 |
% |
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|
7 |
% |
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Total cost of revenue |
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$ |
5,201 |
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$ |
4,149 |
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$ |
1,052 |
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25 |
% |
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Percentage of total revenue |
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20 |
% |
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22 |
% |
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The increase in our product cost of revenue for the three months ended March 31, 2010, as
compared to the prior-year period, was primarily due to higher volume demand for our sensor
products, for which we must procure and provide the hardware platform to our customers.
The increase in our services cost of revenue for the three months ended March 31, 2010, as
compared to the prior-year period, was primarily attributable to our hiring of additional personnel
to both service our larger installed customer base and to provide training and professional
services to our customers, partially offset by decreased hardware service expense we pay to our
third-party integrators to help maintain our install base.
Gross profit. The following table shows products and technical support and professional
services gross profit (in thousands):
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Three Months Ended |
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March 31, |
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Variance |
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2010 |
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2009 |
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|
$ |
|
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% |
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Products |
|
$ |
10,542 |
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$ |
7,101 |
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$ |
3,441 |
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48 |
% |
Products gross margin |
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|
74 |
% |
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|
72 |
% |
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Technical support and professional services |
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|
10,088 |
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|
7,350 |
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|
|
2,738 |
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|
37 |
% |
Technical support and professional services gross margin |
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|
88 |
% |
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|
84 |
% |
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|
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Total gross profit |
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$ |
20,630 |
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$ |
14,451 |
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$ |
6,179 |
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43 |
% |
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Total gross margin |
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80 |
% |
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78 |
% |
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Products gross margin for the three months ended March 31, 2010 increased compared to the
prior-year period primarily due to the product mix sold favoring products with higher gross margins
and a decrease in inventory write-downs related to evaluation units and excess and obsolete
inventory.
Technical support and professional services gross margin for the three months ended March 31,
2010, as compared to the prior-year period, increased primarily due to service revenue increasing
at a higher rate than service expense.
Operating expenses. The following table highlights our operating expenses (in thousands):
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Three Months Ended |
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March 31, |
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|
Variance |
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2010 |
|
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2009 |
|
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$ |
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% |
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Research and development |
|
$ |
3,795 |
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|
$ |
3,320 |
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$ |
475 |
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14 |
% |
Percentage of total revenue |
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|
15 |
% |
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|
18 |
% |
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Sales and marketing |
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10,619 |
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|
7,870 |
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|
2,749 |
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35 |
% |
Percentage of total revenue |
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|
41 |
% |
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|
42 |
% |
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General and administrative |
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|
4,319 |
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|
3,843 |
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|
476 |
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12 |
% |
Percentage of total revenue |
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|
17 |
% |
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|
21 |
% |
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Depreciation and amortization |
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814 |
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|
821 |
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(7 |
) |
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(1 |
%) |
Percentage of total revenue |
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|
3 |
% |
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|
4 |
% |
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|
|
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Total operating expenses |
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$ |
19,547 |
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$ |
15,854 |
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$ |
3,693 |
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|
23 |
% |
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|
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Percentage of total revenue |
|
|
76 |
% |
|
|
85 |
% |
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|
|
|
|
|
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|
23
Research and development expenses for the three months ended March 31, 2010 increased
over the prior-year period, primarily due to an increase of $308,000 in salaries, incentive
compensation, benefits and allocated overhead costs as a result of additional personnel and
increased overhead costs and an increase of $113,000 in stock-based compensation expense.
Sales and marketing expenses for the three months ended March 31, 2010 increased over the
prior-year period, primarily due to an increase of $1.7 million in salaries, commissions and
incentive compensation, benefits and allocated overhead costs as a result of additional sales and
marketing personnel, increased revenue and increased overhead costs, an increase of $390,000 in
advertising, promotion, partner-marketing programs and trade show expenses and an increase of
$283,000 in stock-based compensation expense.
General and administrative expenses for the three months ended March 31, 2010 increased from
the prior-year period, primarily due to an increase of $401,000 in salaries, incentive
compensation, benefits and allocated overhead costs for personnel hired in our accounting,
information technology, human resources and legal departments and increased overhead costs and an
increase of $270,000 in stock-based compensation expense, offset by a decrease of $116,000 in
professional fees related to legal, accounting, information technology, audit and tax services, as
well as reduced regulatory compliance and corporate development expenses.
Depreciation and amortization expense for the three months ended March 31, 2010 remained
relatively flat over the prior-year period.
Other income, net and provision for income taxes. The following table shows our other income,
net and provision for income taxes (in thousands):
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|
Three Months Ended |
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|
March 31, |
|
|
2010 |
|
2009 |
Other income, net |
|
$ |
|
|
|
$ |
361 |
|
Percentage of total revenue |
|
|
0 |
% |
|
|
2 |
% |
Provision for income taxes |
|
|
273 |
|
|
|
75 |
|
Percentage of total revenue |
|
|
1 |
% |
|
|
0 |
% |
Other income, net for the three months ended March 31, 2010 decreased from the prior-year
period, primarily due to a decrease in interest and investment income as a result of lower average
interest rates on invested cash and investment balances.
Our provision for income taxes for the three months ended March 31, 2010 was $273,000, which
is calculated using a projected effective tax rate as of March 31, 2010 of 25%. Our projected
effective tax rate differs from the U.S. federal statutory rate of 34% primarily due to the benefit
of projected net operating loss utilization, adjustments for book stock compensation
expense and foreign income taxed at different rates. The provision for income taxes for the
three months ended March 31, 2010 consisted of $213,000 of federal and state income tax expense and
$60,000 of foreign income tax expense. Our provision for income taxes for the three months ended
March 31, 2009 was $75,000, which resulted in an annual effective tax rate of negative 7%. Our
annual effective tax rate for the three months ended March 31, 2009 differed from the U.S. federal
statutory rate of 34% primarily due to the increase of the valuation allowance on certain deferred
tax assets, state income taxes and the foreign income taxed at different rates. The provision for
income taxes for the three months ended March 31, 2009, consisted of $75,000 of foreign income tax
expense.
We continue to assess the realizability of our deferred tax assets, which primarily consists
of net operating loss, or NOL, carry-forwards, stock-based compensation expense and deferred
revenue. In assessing the realizability of these deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets will be realized. As
of March 31, 2010 and December 31, 2009, our deferred tax assets were fully reserved except for
foreign deferred tax assets of $63,000, which are expected to be available to offset foreign tax
liabilities in the future.
If our recent trend of profitability continues, we may determine, based
on generally accepted accounting principles, that there is sufficient
positive evidence to support a reversal of, or decrease in, the valuation allowance. If we were to
reverse all or some part of our valuation allowance and recognize all or part of our deferred tax
assets, we would likely record an increase in assets on our consolidated balance sheet in the
period of reversal and a corresponding tax benefit in our consolidated statement of operations for
the amount of the reversal. Such amounts could be material to our financial statements and could
occur as soon as our quarter ending June 30, 2010.
24
Seasonality
Our product revenue has tended to be seasonal, with a significant portion generated in the
third and fourth quarters. Revenue from our government customers has been influenced by the
September 30th fiscal year-end of the U.S. federal government, which has historically resulted in
our revenue from government customers being highest in the second half of the year. In the fourth
quarter, revenues have historically been strong due to purchases by North American enterprise
customers, which operate on a calendar year budget and often wait until the fourth quarter to make
their most significant capital equipment purchases. In addition, increased fourth quarter sales in
Europe have historically resulted in higher fourth quarter revenues following a decline in sales in
the summer months due to vacation practices in Europe and the resulting delay in capital purchase
activities until the fall. While we expect these historical trends to continue, they could be
affected by a number of factors, including another decline in general economic conditions, changes
in the timing or amounts of U.S. government spending, and our planned international expansion. The
timing of transactions could materially affect our quarterly or annual product revenue.
Quarterly Timing
On a quarterly basis, we have usually generated the majority of our sales in the final month
of the quarter. We believe this occurs for two reasons. First, many customers wait until the end of
the quarter to extract favorable pricing terms from their vendors, including Sourcefire. Second,
our sales personnel, who have a strong incentive to meet quarterly sales targets, have tended to
increase their sales activity as the end of a quarter nears, while their participation in sales
management review and planning activities is typically scheduled at the beginning of a quarter.
The timing of our quarter-end and year-end shipments also affects our quarterly and annual product
revenue, since we typically recognize revenue upon shipment of the product.
Non-GAAP Financial Measures
In evaluating the operating performance of our business, we exclude certain charges and
credits that are required by GAAP. These non-GAAP results provide useful information to us and
investors by excluding (i) stock-based compensation, which does not involve the expenditure of
cash, and (ii) items that we believe may not be indicative of our operating performance, because
either they are unusual and we do not expect them to recur in the ordinary course of our business
or they are unrelated to the ongoing operation of the business in the ordinary course. The
non-GAAP results have also been adjusted to reflect the effect of an assumed tax rate of 35%, which
differs from our GAAP tax rate. We believe this adjustment provides useful information to us and
investors because it more accurately reflects our expected long-term tax rate. These non-GAAP
financial measures should be considered in addition to results prepared in accordance with GAAP,
but should not be considered a substitute for, or superior to, GAAP results.
25
The following table shows a reconciliation of non-GAAP financial measures to the nearest GAAP
measure (in thousands, except share and per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2010 |
|
|
2009 |
|
Reconciliation to adjusted income (loss) from operations: |
|
|
|
|
|
|
|
|
GAAP income (loss) from operations |
|
$ |
1,083 |
|
|
$ |
(1,403 |
) |
Stock-based compensation expense |
|
|
1,926 |
|
|
|
1,202 |
|
|
|
|
|
|
|
|
Adjusted income (loss) from operations |
|
$ |
3,009 |
|
|
$ |
(201 |
) |
|
|
|
|
|
|
|
Adjusted income (loss) from operations as % of revenue |
|
|
11.6 |
% |
|
NA |
|
|
|
|
|
|
|
|
|
|
Reconciliation to adjusted net income: |
|
|
|
|
|
|
|
|
GAAP net income (loss) |
|
$ |
810 |
|
|
$ |
(1,117 |
) |
Stock-based compensation expense |
|
|
1,926 |
|
|
|
1,202 |
|
Income tax adjustment * |
|
|
(780 |
) |
|
|
19 |
|
|
|
|
|
|
|
|
Adjusted net income |
|
$ |
1,956 |
|
|
$ |
104 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted net income per share basic |
|
$ |
0.07 |
|
|
$ |
|
|
Adjusted net income per share diluted |
|
$ |
0.07 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding basic |
|
|
27,220,667 |
|
|
|
25,934,259 |
|
Weighted average shares outstanding diluted ** |
|
|
29,060,559 |
|
|
|
27,012,955 |
|
|
|
|
|
|
|
|
|
|
|
* |
|
Income tax adjustment is used to adjust the GAAP provision for income taxes
to a non-GAAP provision for income taxes utilizing an estimated tax rate of 35%. |
|
** |
|
For the three months ended March 31, 2009, the effect of dilutive securities was excluded
from GAAP diluted weighted average shares outstanding due to the reported net loss under GAAP, but
is included for non-GAAP diluted weighted average shares outstanding since we have
non-GAAP net income. |
Liquidity and Capital Resources
Cash Flows
The following table summarizes our cash flow activities for the periods indicated (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2010 |
|
|
2009 |
|
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
Provided by operating activities |
|
$ |
10,987 |
|
|
$ |
4,269 |
|
(Used in) provided by investing activities |
|
|
(7,484 |
) |
|
|
6,676 |
|
Provided by financing activities |
|
|
1,448 |
|
|
|
96 |
|
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
4,951 |
|
|
|
11,041 |
|
Cash and cash equivalents at beginning of period |
|
|
53,071 |
|
|
|
39,768 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
|
58,022 |
|
|
|
50,809 |
|
Investments |
|
|
76,136 |
|
|
|
54,492 |
|
|
|
|
|
|
|
|
Total cash, cash equivalents and investments |
|
$ |
134,158 |
|
|
$ |
105,301 |
|
|
|
|
|
|
|
|
Operating Activities. Cash provided by operating activities for the three months ended March
31, 2010 is the result of our net income of $810,000, $2.9 million of net non-cash revenues and
expenses and changes in our operating assets and liabilities
of $7.3 million. Cash provided by operating activities for the three months ended March 31,
2009 is the result of $1.9 million of net non-cash revenues and expenses and changes in our
operating assets and liabilities of $3.5 million, offset by our net loss of $1.1 million.
26
Investing Activities. Cash used in investing activities for the three months ended March 31,
2010 was primarily the result of purchases of investments of $30.5 million and capital expenditures
of $1.2 million, offset by maturities of investments of $24.2 million. Cash provided by investing
activities for the three months ended March 31, 2009 was primarily the result of maturities of
investments of $22.7 million, offset by purchases of investments of $15.3 million and capital
expenditures of $639,000.
Financing Activities. Cash provided by financing activities for the three months ended March
31, 2010 and 2009 was primarily the result of proceeds from the issuance of common stock under our
employee stock-based plans.
Liquidity Requirements
We manufacture our products through contract manufacturers and other third parties. This
approach provides us with the advantage of relatively low capital expenditure requirements and
significant flexibility in scheduling production and managing inventory levels. The majority of our
products are delivered to our customers directly from our contract manufacturers. Accordingly, our
contract manufacturers are responsible for purchasing and stocking the components required to
produce our products, and they invoice us when the finished goods are shipped. By leasing our
office facilities, we also minimize the cash needed for expansion. Our capital spending is
generally limited to leasehold improvements, computers, office furniture and lab and test
equipment.
Our short-term liquidity requirements through March 31, 2011 consist primarily of the funding
of working capital requirements and capital expenditures. We expect to meet these short-term
requirements primarily through cash flow from operations. To the extent that cash flow from
operations is not sufficient to meet these requirements, we expect to fund these amounts through
the use of existing cash and investment resources. As of March 31, 2010, we had cash, cash
equivalents and investments of $134.2 million and working capital of $103.6 million.
As described above, our product sales are, and are expected to continue to be, highly
seasonal. We believe that our current cash reserves are sufficient for any short-term needs
arising from the seasonality of our business.
Our long-term liquidity requirements consist primarily of obligations under our operating
leases. We expect to meet these long-term requirements primarily through cash flow from operations.
In addition, we may utilize cash resources, equity financing or debt financing to fund
acquisitions or investments in complementary businesses, technologies or product lines.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these consolidated financial
statements requires us to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue, costs and expenses and related disclosures. We evaluate our estimates
and assumptions on an ongoing basis. Our actual results may differ from these estimates.
We believe that, of our significant accounting policies, which are described in Note 2 to the
consolidated financial statements contained in this report, the following accounting policies
involve a greater degree of judgment and complexity. Accordingly, we believe that the following
accounting policies are the most critical to aid in fully understanding and evaluating our
consolidated financial condition and results of operations.
Revenue Recognition. We derive revenue from arrangements that include hardware products with embedded
software, software licenses and royalties, technical support, and professional services. Revenue
from products in the accompanying consolidated statements of operations consists primarily of sales
of software-based appliances, but also includes fees and royalties for the license of our
technology in a software-only format and subscriptions to receive rules released by the VRT that
are used to update the appliances for current exploits and vulnerabilities. Technical support,
which generally has a contractual term of 12 months, includes telephone and web-based support,
software updates, and rights to software upgrades on a when-and-if-available basis. Professional
services include training and consulting.
For each arrangement, we recognize revenue when: (a) persuasive evidence of an arrangement
exists (e.g., a signed contract); (b) delivery of the product has occurred and there are no
remaining obligations or substantive customer acceptance provisions; (c) the fee is fixed or
determinable; and (d) collection of the fee is deemed probable.
27
We allocate the total arrangement fee among each deliverable based on the fair value of each
of the deliverables, determined based on vendor-specific objective evidence, or VSOE. If VSOE of
fair value does not exist for each of the deliverables, all revenue from the arrangement is
deferred until the earlier of the point at which sufficient VSOE of fair value can be determined
for any undelivered elements or all elements of the arrangement have been delivered. If the only
undelivered elements are elements for which we currently have VSOE of fair value, we recognize
revenue for the delivered elements based on the residual method. When VSOE of fair value does not
exist for undelivered elements such as maintenance and support, the entire arrangement fee is
recognized ratably over the performance period.
We have established VSOE of fair value for substantially all of our technical support based
upon actual renewals of each type of technical support that is offered and for each customer class.
Technical support and technical support renewals are currently priced based on a percentage of the
list price of the respective product or software and historically have not varied from a narrow
range of values in the substantial majority of our arrangements. Revenue related to technical
support is deferred and recognized ratably over the contractual period of the technical support
arrangement, which is generally 12 months. The VSOE of fair value of our other services is based on
the price for these same services when they are sold separately. Revenue for professional services
that are sold either on a stand-alone basis or included in multiple element arrangements is
deferred and recognized as the services are performed.
All amounts billed or received in excess of the revenue recognized are included in deferred
revenue. In addition, we defer all direct costs associated with revenue that has been deferred.
These amounts are included in either prepaid expenses and other current assets or inventory in the
accompanying balance sheets, depending on the nature of the costs and the reason for the deferral.
For sales through resellers and distributors, we recognize revenue upon the shipment of the
product only if those resellers and distributors provide us, at the time of placing their order,
with the identity of the end-user customer to whom the product has been sold. To the extent that a
reseller or distributor requests an inventory or stock of products, we defer revenue on that
product until we receive notification that it has been sold through to an identified end-user.
Changes in our judgments and estimates about these assumptions could materially impact the
timing of our revenue recognition.
Accounting for Stock-Based Compensation. Stock-based awards granted include stock options,
restricted stock awards, restricted stock units and stock purchased under our Amended and Restated
2007 Employee Stock Purchase Plan, or ESPP. Stock-based compensation expense is measured at the
grant date, based on the fair value of the awards, and is recognized as expense over the requisite
service period, net of estimated forfeitures.
We use the Black-Scholes option pricing model for estimating the fair value of stock options
granted and for employee stock purchases under the ESPP. For a prior option award that contained a
market condition relating to our stock price achieving specified levels, we used a Lattice option
pricing model. The use of option valuation models requires the input of highly subjective
assumptions, including the expected term and the expected stock price volatility. Additionally, the
recognition of expense requires the estimation of the number of options that will ultimately vest
and the number of options that will ultimately be forfeited. The fair value of stock-based awards
is recognized as expense over the requisite service period, net of estimated forfeitures. We rely
on historical experience of employee turnover to estimate our expected forfeitures.
Average risk-free interest rate This is the average U.S. Treasury rate, with a term that
most closely resembles the expected life of the option, as of the grant date.
Expected dividend yield We use an expected dividend yield of zero, as we have never declared
or paid dividends on our common stock and do not anticipate paying dividends in the foreseeable
future.
Expected life This is the period of time that the stock options granted under our equity
incentive plans and ESPP grants are expected to remain outstanding.
We have elected to use the simplified method of determining the expected term of stock
options. This estimate is derived from the average midpoint between the weighted-average vesting
period and the contractual term. In future periods, we expect
28
to begin to incorporate our own data
in estimating the expected life as we develop appropriate historical experience of employee
exercise and post-vesting termination behavior considered in relation to the contractual life of
the option.
For ESPP grants, the expected life is the plan period.
Expected volatility Volatility is a measure of the amount by which a financial variable such
as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected
volatility) during a period.
For stock options granted, since we only have historical stock data from our IPO in March
2007, which is less than the expected life of the stock options, we have used a blended volatility
to estimate expected volatility. The blended volatility includes a weighting of our historical
volatility from the date of our IPO to the respective grant date and an average of our peer group
historical volatility consistent with the expected life of the option. Our peer group historical
volatility includes the historical volatility of companies that are similar in revenue size, in the
same industry or are competitors. We expect to continue to use a larger proportion of our
historical volatility in future periods as we develop additional historical experience of our own
stock price fluctuations considered in relation to the expected life of the option.
For ESPP grants, we use our historical volatility since we have historical data available
since our IPO, which is consistent with the expected life.
If we were to employ different assumptions for estimating stock-based compensation expense in
future periods, or if we were to decide to use a different valuation model, the amount of expense
recorded in future periods could differ significantly from what we have recorded in recent periods.
The Black-Scholes option pricing model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable, which are
characteristics that are not present in our option grants. Existing valuation models, including the
Black-Scholes and Lattice models, may not provide reliable measures of the fair values of our
stock-based compensation awards. Consequently, there is a risk that our estimates of the fair
values of our stock-based compensation awards on the grant dates may be significantly different
than the actual values upon the exercise, expiration, early termination or forfeiture of those
stock-based payments in the future. Certain stock-based payments, such as employee stock options,
may expire worthless or otherwise result in zero intrinsic value as compared to the fair values
originally estimated on the grant date and reported in our financial statements. Alternatively,
values may be realized from these instruments that are significantly higher than the fair values
originally estimated on the grant date and reported in our financial statements.
The application of these principles may be subject to further interpretation and refinement
over time. There are significant differences among valuation models, and there is a possibility
that we will adopt different valuation models in the future. This may result in a lack of
consistency between past and future periods and materially affect the fair value estimate of
stock-based payments. It may also result in a lack of comparability with other companies that use
different models, methods, and assumptions.
Accounting for Income Taxes. We account for income taxes using the liability method, which
requires the recognition of deferred tax assets or liabilities for the temporary differences
between financial reporting and tax bases of our assets and liabilities and for tax carry-forwards
at enacted statutory tax rates in effect for the years in which the differences are expected to
reverse.
We continue to assess the realizability of our deferred tax assets, which primarily consists
of net operating loss, or NOL, carry-forwards, stock-based compensation expense and deferred
revenue. In assessing the realizability of these deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets will be realized. As
of March 31, 2010 and December 31, 2009, our deferred tax assets were fully reserved except for
foreign deferred tax assets of $63,000, which are expected to be available to offset foreign tax
liabilities in the future. Our provision for income taxes for the three months ended March 31, 2010
consists principally of federal, state and foreign income tax expense. Our provision for income
taxes for the three months ended March 31, 2009 consists principally of foreign income tax expense.
If our recent trend of profitability continues, we may determine, based
on generally accepted accounting principles, that there is sufficient
positive evidence to support a reversal of, or decrease in, the valuation allowance. If we were to
reverse all or some part of our valuation allowance and recognize all or
part of our deferred tax assets, we would likely record an increase in assets on our
consolidated balance sheet in the period of reversal and a corresponding tax benefit in our
consolidated statement of operations for the amount of the reversal. Such amounts could be
material to our financial statements and could occur as soon as our quarter ending June 30, 2010.
29
With respect to foreign earnings, it is our policy to invest the earnings of foreign
subsidiaries indefinitely outside the U.S. With respect to stock-based compensation expense, the
benefit of the deferred tax asset is being recognized as the related stock options are exercised.
The excess tax benefit from the exercise of stock options is recorded in additional paid-in-capital
in the consolidated balance sheets to the extent that cash taxes payable are reduced.
We have determined that there are no material uncertain tax positions that would require a
reserve as of March 31, 2010.
Because tax laws are complex and subject to different interpretations, significant judgment is
required. As a result, we make certain estimates and assumptions in (i) calculating our provision
for income taxes, deferred tax assets and deferred tax liabilities, (ii) determining any valuation
allowance recorded against deferred tax assets and (iii) evaluating the amount of unrecognized tax
benefits, if any, as well as the interest and penalties related to such uncertain tax positions.
Our estimates and assumptions may differ significantly from tax benefits ultimately realized.
Allowance for Doubtful Accounts and Sales Return Allowance. We make estimates regarding the
collectability of our accounts receivable. When we evaluate the adequacy of our allowance for
doubtful accounts, we consider multiple factors, including historical write-off experience, the
need for specific customer reserves, the aging of our receivables, customer creditworthiness and
changes in customer payment cycles. Historically, our allowance for doubtful accounts has been
adequate based on actual results. If any of the factors used to calculate the allowance for
doubtful accounts change or if the allowance does not reflect our future ability to collect
outstanding receivables, additional provisions for doubtful accounts may be needed, and our future
results of operations could be materially affected. As of March 31, 2010 and December 31, 2009,
the allowance for doubtful accounts was $360,000 and $777,000, respectively.
We also use our judgment to make estimates regarding potential future product returns related
to reported product revenue in each period. We analyze factors such as our historical return
experience, current product sales volumes, and changes in product warranty claims when evaluating
the adequacy of the sales returns allowance. If any of the factors used to calculate the sales
return allowance were to change, we may experience a material difference in the amount and timing
of our product revenue for any given period. As of March 31, 2010 and December 31, 2009, the sales
return allowance was $340,000 and $380,000, respectively.
Inventories. Inventories consist of hardware and related component parts and are stated at
the lower of cost on a first-in, first-out basis, or market, except for evaluation and advance
replacement units which are stated at the lower of cost, on a specific identification basis, or
market. Evaluation units are used for customer testing and evaluation and are predominantly located
at the customers premises. Advance replacement units, which include replacement units and spare
parts, are used to provide replacement units under technical support arrangements if a customers
unit is not functioning. In prior periods, advance replacement units were included in other assets
and depreciated using the straight-line method. In the third quarter of 2009, we reclassified
these assets to inventory to better reflect the nature of the assets. We make estimates of
forecasted demand for our products, and inventory that is obsolete or in excess of our estimated
demand is written down to its estimated net realizable value based on historical usage, expected
demand, the timing of new product introductions and age. It is reasonably possible that our
estimate of future demand for our products could change in the near term and result in additional
inventory write-downs, which would negatively impact our gross margin.
Inventory write-downs, mostly related to evaluation units and excess and obsolete inventory,
are reflected as cost of revenues and amounted to approximately $43,000 and $211,000 for the three
months ended March 31, 2010 and 2009, respectively.
Investments. We determine the appropriate classification of our investments at the time of
purchase and reevaluate such classification as of each balance sheet date. Our investments are
comprised of money market funds, corporate debt investments, commercial paper, government-sponsored
enterprise securities, government securities and certificates of deposit. These investments have
been classified as available-for-sale. Available-for-sale investments are stated at fair value,
with the unrealized gains and losses, net of tax, reported in accumulated other comprehensive
income. The amortization of premiums and accretion of discounts to maturity are computed using the
effective interest method. Amortization is included in interest and investment
income. Interest on securities classified as available-for-sale is also included in interest
and investment income. See Note 3 for further discussion of the classification of our investments.
We evaluate our investments on a regular basis to determine whether an other-than-temporary
decline in fair value has occurred. If an investment is in an unrealized loss position and we have
the intent to sell the investment, or it is more likely than
30
not that we will have to sell the
investment before recovery of its amortized cost basis, the decline in value is deemed to be
other-than-temporary and is charged against earnings for the period. For investments that we do
not intend to sell or it is more likely than not that we will not have to sell the investment, but
we expect that we will not fully recover the amortized cost basis, the credit component of the
other-than-temporary impairment is charged against earnings for the applicable period and the
non-credit component of the other-than-temporary impairment is recognized in other comprehensive
income on our statement of stockholders equity. Unrealized losses entirely caused by non-credit
related factors related to investments for which we expect to fully recover the amortized cost
basis are recorded in accumulated other comprehensive income.
Recent Accounting Pronouncements
In October 2009, the FASB clarified the accounting guidance for sales of tangible products
containing both software and hardware elements and issued new guidance that amends the criteria for
evaluating the individual items in a multiple deliverable revenue arrangement and how to allocate
the consideration received to the individual items. The guidance is effective for revenue
arrangements entered into or materially modified in fiscal years beginning on or after June 15,
2010, with early adoption permitted. We believe this literature is applicable to our revenue
arrangements. We are currently evaluating the impact this guidance will have on our consolidated
financial statements.
In January 2010, the FASB issued revised guidance intended to improve disclosures related to
fair value measurements. This guidance requires new disclosures as well as clarifies certain
existing disclosure requirements. New disclosures under this guidance require separate information
about significant transfers in and out of Level 1 and Level 2 and the reason for such transfers,
and also require purchases, sales, issuances, and settlements information for Level 3 measurement
to be included in the rollforward of activity on a gross basis. The guidance also clarifies the
requirement to determine the level of disaggregation for fair value measurement disclosures and the
requirement to disclose valuation techniques and inputs used for both recurring and nonrecurring
fair value measurements in either Level 2 or Level 3. This accounting guidance is effective for
interim and annual reporting periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair
value measurements, which is effective for fiscal years beginning after December 15, 2010 and for
interim periods within those fiscal years. The adoption of this guidance did not have an affect on
our consolidated financial statements.
31
|
|
|
Item 3. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
No material changes in our market risk occurred from December 31, 2009 through March 31, 2010.
Information regarding our market risk at December 31, 2009, is contained in Item 7A, Quantitative
and Qualitative Disclosures About Market Risk, in our Annual
Report on Form 10-K for the year
ended December 31, 2009.
|
|
|
Item 4. |
|
CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as amended (the Exchange Act), which are controls and other procedures that are designed to
ensure that information required to be disclosed by a company in the reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SECs rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information required to be
disclosed by a company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the companys management, including its principal executive and
principal financial officers, as appropriate to allow timely decisions regarding required
disclosure. Management recognizes that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving their objectives and management
necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. In addition, the design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future conditions; over time,
controls may become inadequate because of changes in conditions, or the degree of compliance with
policies or procedures may deteriorate. Because of the inherent limitations in a control system,
misstatements due to error or fraud may occur and not be detected.
Under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of the period covered by this
report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of the period covered by this report, our disclosure controls and
procedures were effective at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting. No change in our internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred
during the period covered by this report that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
32
PART II. OTHER INFORMATION
|
|
|
Item 1. |
|
LEGAL PROCEEDINGS |
On May 29, 2009 and August 3, 2009, Enhanced Security Research, LLC, or ESR, filed two nearly
identical complaints in the United States District Court for the District of Delaware against 10
defendants, including Cisco Systems, Inc., International Business Machines Corporation, Check Point
Software Technologies, Ltd., Check Point Software Technologies, Inc., SonicWALL, Inc., 3Com
Corporation, Nokia Corporation, Nokia, Inc., Fortinet, Inc., and us. The only significant
difference between the first and second complaints is the addition of Security Research Holdings
LLC as a plaintiff. The complaints allege, among other things, that our network security
appliances and software infringe two U.S. patents. Plaintiffs seek unspecified damages,
enhancement of those damages, an attorneys fee award and an injunction against further
infringement. We believe that the allegations of infringement against us are without merit, and we
intend to defend this case vigorously on that basis. Both patents in this litigation are currently
undergoing reexamination by the United States Patent and Trademark Office (USPTO), and the USPTO
has rejected all claims of one of the patents as not patentable, and the patent owner has filed a
response arguing that the claims are patentable. The USPTO has not yet issued its final decision
on that patent. In the other of the two patents, the USPTO only recently agreed to reexamine the
patent, determining that new information brought to the attention of the USPTO raises a
substantial question of patentability of the patent claims. The patent owner now has the
opportunity to file a response arguing why the patentability of the claims should be confirmed.
Given the inherent unpredictability of litigation and jury trials, we cannot at this early stage of
the matter estimate the possible outcome of this litigation. Because patent litigation is time
consuming and costly to defend, we may incur significant costs related to this matter in future
periods. In addition, an unfavorable outcome in this matter could have a material adverse effect on
our future results of operations or cash flows.
Set forth below and elsewhere in this report and in other documents we file with the
Securities and Exchange Commission are risks and uncertainties that could cause actual results to
differ materially from the results contemplated by the forward-looking statements contained in this
report. The descriptions below include any material changes to and supersede the description of the
risk factors affecting our business previously disclosed in Part I, Item 1A. Risk Factors of our
Annual Report on Form 10-K for the year ended December 31, 2009.
Risks Relating to Our Business, Operations and Industry
Economic, market and political conditions, including the global recession, may adversely affect
our revenue and results of operations.
Our business depends significantly on a range of factors that are beyond our control. These
include:
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general economic and business conditions; |
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the overall demand for network security products and services; and |
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constraints on budgets and changes in spending priorities of corporations and government
agencies. |
The global financial recession has resulted in the significant weakening of the U.S. and
global economies, the lack of availability of credit, the reduction in business confidence and
activity, and other factors that may affect one or more of the industries to which we sell our
products and services. Our customers include, but are not limited to, financial institutions,
defense contractors, health care providers, information technology companies, telecommunications
companies and retailers. These customers may suffer from reduced operating budgets, which could
cause them to defer or forego purchases of our products or services. In addition, negative effects
on the financial condition of our resellers and distributors could affect their ability or
willingness to market our product and service offerings; negative effects on the financial
condition of our product manufacturers could affect their ability to manufacture our products; and
declines in economic and market conditions could impair our short-term investment portfolio. Any of
these developments could adversely affect our revenue and results of operations.
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We face intense competition in our market, especially from larger, better-known companies, and we
may lack sufficient financial or other resources to maintain or improve our competitive position.
The market for network security monitoring, detection, prevention and response solutions is
intensely competitive, and we expect competition to increase in the future. We may not compete
successfully against our current or potential competitors, especially those with significantly
greater financial resources or brand name recognition. Our chief competitors include: large
software companies; software or hardware network infrastructure companies; smaller software
companies offering applications for network and Internet security monitoring, detection, prevention
or response; and small and large companies offering point solutions that compete with components of
our product offerings.
For example, Cisco Systems, Inc., IBM Corporation, Juniper Networks, Inc., Hewlett-Packard
Company as a result of its acquisition of 3Com Corporation, Check Point Software Technologies, Ltd. and McAfee, Inc., have intrusion detection or
prevention technologies that compete with our product offerings. Large companies may have
advantages over us because of their longer operating histories, greater brand name recognition,
larger customer bases or greater financial, technical and marketing resources. As a result, they
may be able to adapt more quickly to new or emerging technologies and changes in customer
requirements. They also have greater resources to devote to the promotion and sale of their
products than we have. In addition, in some cases our competitors have aggressively reduced, and
could continue to reduce, the price of their security monitoring, detection, prevention and
response products, managed security services, and maintenance and support services which
intensifies pricing pressures within our market.
Several companies currently sell software products (such as encryption, firewall, operating
system security and virus detection software) that our customers and potential customers have
broadly adopted. Some of these companies sell products that perform functions comparable to some of
our products. In addition, the vendors of operating system software or networking hardware may
enhance their products to include functions similar to those that our products currently provide.
The widespread inclusion of features comparable to our software in operating system software or
networking hardware could render our products less competitive or obsolete, particularly if such
features are of a high quality. Even if security functions integrated into operating system
software or networking hardware are more limited than those of our products, a significant number
of customers may accept more limited functionality to avoid purchasing additional products such as
ours.
One of the characteristics of open source software is that anyone can offer new software
products for free under an open source licensing model in order to gain rapid and widespread market
acceptance. Such competition can develop without the degree of overhead and lead time required by
traditional technology companies. It is possible for new competitors with greater resources than
ours to develop their own open source security solutions, potentially reducing the demand for our
solutions. We may not be able to compete successfully against current and future competitors.
Competitive pressure and/or the availability of open source software may result in price
reductions, reduced revenue, reduced operating margins and loss of market share, any one of which
could seriously harm our business.
New competitors could emerge and could impair our sales.
New sources of competition for sales of our products could emerge. These include:
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emerging companies as well as larger companies who have not previously entered the market
for network security products; |
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established companies that develop their own network intrusion detection and prevention
products, or acquire or establish product integration, distribution or other cooperative
relationships with our current competitors; and |
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new competitors or alliances among competitors that emerge and rapidly acquire
significant market share due to factors such as greater brand name recognition, a larger
installed customer base and significantly greater financial, technical, marketing and other
resources and experience. |
We achieved profitability on an annual basis for the first time in 2009, which we may not be able
to maintain.
We incurred operating losses each year from our inception in 2001 through 2008. We achieved
profitability on an annual basis for the first time in 2009. Maintaining profitability will depend
in large part on our ability to generate and sustain increased revenue levels in future periods.
Although our revenue has generally been increasing, there can be no assurances that we will
maintain or increase our level of profitability. Our operating expenses may continue to increase as
we seek to expand
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our customer base, increase our sales and marketing efforts and continue to invest in research
and development of our technologies and products. These efforts may be more costly than we expect
and we may not be able to increase our revenue to offset our operating expenses. If we cannot
increase our revenue at a greater rate than our expenses, we will not remain profitable.
Our quarterly operating results are likely to vary significantly and be unpredictable, in part
because of the purchasing and budget practices of our customers, which could cause the trading
price of our stock to decline.
Our operating results have historically varied significantly from period to period, and we
expect that they will continue to do so as a result of a number of factors, most of which are
outside of our control, including:
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the budgeting cycles, internal approval requirements and funding available to our
existing and prospective customers for the purchase of network security products; |
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the timing, size and contract terms of orders received, which have historically been
highest in the fourth quarter, but may fluctuate seasonally in different ways; |
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the level of perceived threats to network security, which may fluctuate from period to
period; |
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the level of demand for products sold by resellers, distributors, MSSPs, government
integrators and other partners; |
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the market acceptance of open source software solutions; |
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the announcement or introduction of new product offerings by us or our competitors, and
the levels of anticipation and market acceptance of those products; |
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price competition; |
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general economic conditions, both domestically and in our foreign markets; |
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the product mix of our sales; and |
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the timing of revenue recognition for our sales. |
In particular, the network security technology procurement practices of many of our customers
have had a measurable influence on the historical variability of our operating performance. Our
prospective customers usually exercise great care and invest substantial time in their network
security technology purchasing decisions. As a result, our sales cycles are long, generally between
six and twelve months or sometimes longer, which further impacts the variability of our results.
Additionally, many of our customers have historically finalized purchase decisions in the last
weeks or days of a quarter. A delay in even one large order beyond the end of a particular quarter
can substantially diminish our anticipated revenue for that quarter. In addition, many of our
expenses must be incurred before we generate revenue. As a result, the negative impact on our
operating results would increase if our revenue fails to meet expectations in any period.
The cumulative effect of these factors may result in larger fluctuations and unpredictability
in our quarterly operating results than in the operating results of many other software and
technology companies. This variability and unpredictability could result in our failing to meet the
revenue or operating results expectations of securities industry analysts or investors for a
particular period. If we fail to meet or exceed such expectations for these or any other reasons,
the market price of our shares could fall substantially, and we could face costly securities class
action suits as a result. Therefore, you should not rely on our operating results in any quarter as
being indicative of our operating results for any future period, nor should you rely on other
expectations, predictions or projections of our future revenue or other aspects of our results of
operations.
Federal and state governmental agencies have contributed to our revenue growth and have become
important customers for us. If we cannot attract sufficient government agency customers, our
revenue and competitive position will suffer.
Federal and state governments have become important customers for the network security market
and for us. There can be no assurance that we will maintain or grow our revenue from these
customers. Contracts with the U.S. federal and state government
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agencies collectively accounted for 29%, 21% and 11% of our total revenue for the years ended
December 31, 2009, 2008 and 2007, respectively. Our reliance on government customers subjects us to
a number of risks, including:
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Procurement. Contracting with public sector customers is highly competitive and can be
expensive and time-consuming, often requiring that we incur significant upfront time and
expense without any assurance that we will win a contract; |
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Budgetary Constraints and Cycles. Demand and payment for our products and services are
impacted by public sector budgetary cycles and funding availability. Reductions or delays in
funding, including delays caused by continuing resolutions or other temporary funding
arrangements, could adversely impact public sector demand for our products; |
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Modification or Cancellation of Contracts. Public sector customers often have
contractual or other legal rights to terminate current contracts for convenience or due to a
default. If a contract is cancelled for convenience, which can occur if the customers
product needs change, we may only be able to collect for products and services delivered
prior to termination. If a contract is cancelled because of our default, we may only be able
to collect for products and alternative products and services delivered to the customer; |
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Governmental Audits. National governments and state and local agencies routinely
investigate and audit government contractors administrative processes. They may audit our
performance and pricing and review our compliance with applicable rules and regulations. If
they find that we improperly allocated costs, they may require us to refund those costs or
may refuse to pay us for outstanding balances related to the improper allocation. An
unfavorable audit could result in a reduction of revenue, and may result in civil or
criminal liability if the audit uncovers improper or illegal activities; and |
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Replacing Existing Products. Many government agencies already have installed network
security products of our competitors. It can be very difficult to convince government
agencies or other prospective customers to replace their existing network security solutions
with our products, even if we can demonstrate the superiority of our products. |
If we do not continue to establish and effectively manage our indirect distribution channels, or
if our resellers, distributors and other partners fail to perform as expected, our revenue could
suffer.
Our ability to sell our network security software products in new markets and to increase our
share of existing markets will be impaired if we fail to manage or expand our indirect distribution
channels. Our sales strategy involves the establishment of multiple distribution channels
domestically and internationally through strategic resellers, distributors, MSSPs, government
integrators and other partners. We have agreements with third parties for the distribution of our
products and we cannot predict the extent to which these companies will be successful in marketing
or selling our products. There is a risk that our pace of entering into such agreements may slow.
In addition, our agreements with these companies could be terminated on short notice, and the
agreements do not prevent these companies from selling the network security software of other
companies, including our competitors. Any distributor of our products could give higher priority to
other companies products or to their own products than they give to ours, which could cause our
revenue to decline. There is also a risk that some or all of our resellers, distributors and other
partners may be acquired, change their business models or go out of business, any of which could
adversely affect our business.
We are subject to risks of operating internationally that could impair our ability to grow our
revenue abroad.
We market and sell our software in the United States and internationally, and we plan to
increase our international sales presence. Therefore, we are subject to risks associated with
having worldwide operations. Sales to customers located outside of the United States accounted for
23%, 24% and 25% of our total revenue for the years ended December 31, 2009, 2008 and 2007,
respectively. The expansion of our existing operations and entry into additional worldwide markets
will require significant management attention and financial resources. We are also subject to a
number of risks customary for international operations, including:
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economic or political instability in foreign markets; |
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greater difficulty in accounts receivable collection and longer collection periods; |
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unexpected changes in regulatory requirements;
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difficulties and costs of staffing and managing foreign operations; |
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import and export controls; |
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the uncertainty of protection for intellectual property rights in some countries; |
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costs of compliance with foreign laws and laws applicable to companies doing business in
foreign jurisdictions; |
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management communication and integration problems resulting from cultural differences and
geographic dispersion; |
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compliance with tax laws in multiple jurisdictions; and |
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foreign currency exchange rate fluctuations. |
To date, a substantial portion of our sales have been denominated in U.S. dollars, although
the majority of our expenses that we incur in our international operations are denominated in local
currencies. To date, we have not used risk management techniques or hedged the risks associated
with fluctuations in foreign currency exchange rates. As a result, our results of operations are
subject to losses from fluctuations in foreign currency exchange rates.
The market for network security products is rapidly evolving, and the complex technology
incorporated in our products makes them difficult to develop. If we do not accurately predict,
prepare for and respond promptly to technological and market developments and changing customer
needs, our competitive position and prospects could be harmed.
The market for network security products is expected to continue to evolve rapidly. Moreover,
many customers operate in markets characterized by rapidly changing technologies and business
plans, which require them to add numerous network access points and adapt increasingly complex
enterprise networks, incorporating a variety of hardware, software applications, operating systems
and networking protocols. In addition, computer hackers and others who try to attack networks
employ increasingly sophisticated techniques to gain access to and attack systems and networks.
Customers look to our products to continue to protect their networks against these threats in this
increasingly complex environment without sacrificing network efficiency or causing significant
network downtime. The software in our products is especially complex because it needs to
effectively identify and respond to new and increasingly sophisticated methods of attack, without
impeding the high network performance demanded by our customers. Although the market expects speedy
introduction of software to respond to new threats, the development of these products is difficult
and the timetable for commercial release of new products is uncertain. Therefore, in the future we
may experience delays in the introduction of new products or new versions, modifications or
enhancements of existing products. If we do not quickly respond to the rapidly changing and
rigorous needs of our customers by developing and introducing on a timely basis new and effective
products, upgrades and services that can respond adequately to new security threats, our
competitive position and business prospects will be harmed.
If our new products and product enhancements do not achieve sufficient market acceptance, our
results of operations and competitive position could suffer.
We spend substantial amounts of time and money to research and develop new products and
enhance versions of our open source and proprietary commercial products. We incorporate additional
features, improve functionality or add other enhancements in order to meet our customers rapidly
evolving demands for network security in our highly competitive industry. When we develop a new
product or an advanced version of an existing product, we typically expend significant money and
effort upfront to market, promote and sell the new offering. Therefore, when we develop and
introduce new or enhanced products, they must achieve high levels of market acceptance in order to
justify the amount of our investment in developing and bringing the products to market.
Our new products or enhancements could fail to attain sufficient market acceptance for many
reasons, including:
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delays in introducing new, enhanced or modified products; |
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defects, errors or failures in any of our products; |
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inability to operate effectively with the networks of our prospective customers; |
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inability to protect against new types of attacks or techniques used by hackers; |
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negative publicity about the performance or effectiveness of our network security
products; |
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reluctance of customers to purchase products based on open source software; and |
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disruptions or delays in the availability and delivery of our products, including
products from our contract manufacturers. |
If our new products or enhancements do not achieve adequate acceptance in the market, our
competitive position could be impaired, our revenue will be diminished and the effect on our
operating results may be particularly acute because of the significant research, development,
marketing, sales and other expenses we incurred in connection with the new product.
If existing customers do not make subsequent purchases from us or renew their support arrangements
with us, or if our relationships with our largest customers are impaired, our revenue could
decline.
For the years ended December 31, 2009 and 2008, existing customers that purchased additional
products and services from us, whether for new locations or additional technology to protect
existing networks and locations, generated a majority of our total revenue. Part of our growth
strategy is to sell additional products to our existing customers. We may not be effective in
executing this or any other aspect of our growth strategy. Our revenue could decline if our current
customers do not continue to purchase additional products from us. In addition, as we deploy new
versions of our existing products or introduce new products, our current customers may not require
the functionality of these products and may not purchase them.
We also depend on our installed customer base for future service revenue from annual
maintenance fees. Our maintenance and support agreements typically have durations of one year. If
customers choose not to continue their maintenance service or seek to renegotiate the terms of
maintenance and support agreements prior to renewing such agreements, our revenue may decline.
Defects, errors or vulnerabilities in our products could harm our reputation and business and
divert our resources.
Because our products are complex, they may contain defects, errors or vulnerabilities that are
not detected until after our commercial release and installation by our customers. We may not be
able to correct any errors or defects or address vulnerabilities promptly, or at all. Any defects,
errors or vulnerabilities in our products could result in:
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expenditure of significant financial and product development resources in efforts to
analyze, correct and eliminate defects, to address and eliminate vulnerabilities or to
create alternative solutions; |
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loss of existing or potential customers; |
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delayed or lost revenue; |
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failure to timely attain or maintain market acceptance; |
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increased service, warranty, product replacement and product liability insurance
costs; and |
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negative publicity, which could harm our reputation. |
In addition, because our products and services provide and monitor network security and may
protect valuable information, we could face claims for product liability, tort or breach of
warranty. Anyone who circumvents our customers security measures using our products could
misappropriate the confidential information or other valuable property of, or interrupt the
operations of our customers. If that happens, affected customers or others could sue us. In
addition, we may face liability for breaches of our product warranties or product failures.
Provisions in our contracts relating to warranty disclaimers and liability limitations may be
deemed by a court to be unenforceable. Some courts, for example, have found contractual limitations
of liability in standard computer and software contracts to be unenforceable in some circumstances.
Defending a lawsuit, regardless of its merit, could be costly and divert management attention from
the operation of our business. Our business liability insurance coverage may be inadequate or
future coverage may be unavailable on acceptable terms or at all.
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Our networks, products and services may be targeted by hackers.
Like other companies, our websites, networks, information systems, products and services may
be targets for sabotage, disruption or misappropriation by hackers. As a leading network security
solutions company, we are a high profile target and our networks, products and services may be
targeted by hackers. Although we believe we have sufficient controls in place to prevent disruption
and misappropriation, and to respond to such situations, we expect these efforts by hackers to
continue. If these efforts are successful, our operations, reputation and sales could be adversely
affected.
We may acquire additional businesses, products or technologies as part of our long-term growth
strategy, and such acquisitions may not ultimately be successful or may not result in expected
strategic benefits.
We may seek to buy or make investments in complementary or competitive businesses, products or
technologies as part of our long-term growth strategy. We may not be successful in making these
acquisitions. We may face competition for acquisition opportunities from other companies, including
larger companies with greater financial resources. We may incur substantial expenses in identifying
and negotiating acquisition opportunities, whether or not completed.
Acquisitions may not result in the expected strategic benefits, and completed acquisitions, if
any, could negatively affect our operating results and financial position because of the following
and other factors:
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we may not effectively integrate an acquired business, product or technology into our
existing business and operations; |
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completing a potential acquisition and integrating an acquired business into our existing
business could significantly divert managements time and resources from the operation of
our business; |
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a completed acquisition may not be accretive to earnings; |
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acquisitions may result in substantial accounting charges for restructuring and other
expenses, write-offs of in-process research and development, amortization of intangible
assets and stock-based compensation expense; |
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acquired companies, particularly privately held and non-U.S. companies, may have internal
controls, policies and procedures that do not meet the requirements of the Sarbanes-Oxley
Act of 2002 and public company accounting standards; |
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we may use a significant portion of our cash resources to fund acquisitions; and |
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we may issue stock to fund acquisitions, which could dilute the interests of our existing
stockholders. |
In the future, we may not be able to secure financing necessary to make acquisitions or to operate
and grow our business as planned.
In the future, we may need to raise additional funds to make acquisitions or to expand our
sales and marketing and research and development efforts. Additional equity or debt financing may
not be available on favorable terms, or at all. If adequate funds are not available on acceptable
terms, we may be unable to take advantage of acquisition or other opportunities or to fund the
expansion of our sales and marketing and research and development efforts, which could seriously
harm our business and operating results. If we issue debt, the debt holders could have rights
senior to common stockholders to make claims on our assets and the terms of any debt could restrict
our operations, including our ability to pay dividends on our common stock. Furthermore, if we
issue additional equity securities, stockholders would experience dilution, and the new equity
securities could have rights senior to those of our common stock.
If other parties claim commercial ownership rights to Snort or ClamAV, our reputation, customer
relations and results of operations could be harmed.
While we created a majority of the current Snort code base and the current ClamAV code base, a
portion of the current code for both Snort and ClamAV was created by the combined efforts of
Sourcefire and the open source software community, and a portion was created solely by the open
source community. We believe that the portions of the Snort code base and the ClamAV code base
created by anyone other than us are required to be licensed by us pursuant to the GNU General
Public License, or GPL, which is how we currently license Snort and ClamAV. There is a risk,
however, that a third party could claim some ownership rights in Snort or ClamAV, attempt to
prevent us from commercially licensing Snort or ClamAV in the future (rather than pursuant to the
GPL as currently licensed) or claim a right to licensing royalties. Any such claim, regardless of
its merit or
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outcome, could be costly to defend, harm our reputation and customer relations or result in
our having to pay substantial compensation to the party claiming ownership.
We rely on software licensed from other parties, the loss of which could increase our costs and
delay delivery of our products.
We utilize various types of software licensed from unaffiliated third parties. For example, we
license MySQL database software that we use in our products. Our agreement with Oracle Corporation
permits us to distribute MySQL software on our products to our customers worldwide until June 30,
2014. Our agreement with Oracle gives us the unlimited right to distribute MySQL software in
exchange for a one-time lump-sum payment. We believe that the MySQL agreement is material to our
business because we have spent a significant amount of development resources to allow the MySQL
software to function in our products. If we were forced to find replacement database software or
replacements for any of the other software we license from others for our products, our business
would be disrupted and we could be required to expend significant resources, and there would be no
guarantee that we would be able to procure the replacement on the same or similar commercial terms
and conditions, or at all.
Additionally, we would be required to either redesign our products to function with software
available from other parties or develop these components ourselves, which could result in increased
costs and could result in delays in our product shipments and the release of new product offerings.
Furthermore, we might be forced to limit the features available in our current or future products.
If we fail to maintain or renegotiate any of these software licenses, we could face significant
delays and diversion of resources in attempting to license and integrate a functional equivalent of
the software.
Our inability to hire or retain key personnel, or to effectively manage headcount increases, could
impair our intended growth.
Our business is dependent on our ability to hire, retain, motivate and manage highly qualified
personnel, including senior management and sales and technical professionals. In particular, as
part of our growth strategy, we intend to expand the size of our sales force domestically and
internationally and to hire additional customer support and professional services personnel.
However, competition for qualified services personnel is intense, and if we are unable to attract,
train or retain the number of highly qualified sales and services personnel that our business
needs, our reputation, customer satisfaction and potential revenue growth could be seriously
harmed. To the extent that we hire personnel from competitors, we may also be subject to
allegations that they have been improperly solicited or divulged proprietary or other confidential
information. Our intended future growth may also place a significant strain on our management,
financial, personnel and other resources.
In addition, our future success will depend to a significant extent on the continued services
of our executive officers and senior personnel. Although we have adopted retention plans applicable
to certain of these officers, there can be no assurance that we will be able to retain their
services. The loss of the services of one or more of these individuals could adversely affect our
business and could divert other senior management time in searching for their replacements.
Our business is subject to corporate governance, public disclosure, accounting and tax
requirements that have increased both our costs and the risk of noncompliance.
Because our common stock is publicly traded, we are subject to the rules and regulations of
federal, state and financial market exchange entities, such as the Public Company Accounting
Oversight Board, the SEC, and the Nasdaq stock exchange, that are charged with the protection of
investors and the oversight of companies whose securities are publicly traded. Our efforts to
comply with these rules and regulations have resulted in, and are likely to continue resulting in,
increased general and administrative expenses and diversion of management time and attention from
revenue-generating activities to compliance activities.
We completed our evaluation of our internal controls over financial reporting for the fiscal
year ended December 31, 2009 as required by the Sarbanes-Oxley Act of 2002. Although our
assessment, testing and evaluation resulted in our conclusion that as of December 31, 2009, our
internal controls over financial reporting were effective, we cannot predict the outcome of our
testing in future periods. If our internal controls are ineffective in future periods, our business
and reputation could be harmed. We may incur additional expenses and commitment of managements
time in connection with further evaluations, either of which could materially increase our
operating expenses.
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Because new and modified laws, regulations and standards are subject to varying
interpretations in many cases due to their lack of specificity, their application in practice may
evolve over time as new guidance is provided by regulatory and governing bodies. This evolution may
result in continuing uncertainty regarding compliance matters and additional costs necessitated by
ongoing revisions to our disclosure and governance practices.
Any material disruption or problem with the operation of our information systems may adversely
impact our business, operating processes and internal controls.
The efficient operation of our business is dependent on the successful operation of our
information systems. In particular, we rely on our information systems to process financial
information, manage inventory and administer our sales transactions. In recent years, we have
experienced a considerable growth in transaction volume and headcount, and we are increasingly
relying upon international resources in our operations. Our information systems need to be
sufficiently scalable to support the continued growth of our operations and the efficient
management of our business. In an effort to improve the efficiency of our operations, achieve
greater automation and support the growth of our business, we have implemented an enterprise
resource planning, or ERP, system and a customer resource management, or CRM, system.
These information systems may not work as we currently intend. Any material disruption or
similar problems with the operation of our information systems could have a material negative
effect on our business and results of operations. In addition, if our information system resources
are inadequate, we may be required to undertake costly modifications and the growth of our business
could be harmed.
Potential uncertainty resulting from unsolicited acquisition proposals and related matters may
adversely affect our business.
In the past we have received, and in the future we may receive, unsolicited proposals to
acquire our company or our assets. The review and consideration of acquisition proposals and
related matters could require the expenditure of significant management time and personnel
resources. Such proposals may also create uncertainty for our employees, customers and business
partners. Any such uncertainty could make it more difficult for us to retain key employees and hire
new talent, and could cause our customers and business partners to not enter into new arrangements
with us or to terminate existing arrangements. Additionally, we and members of our board of
directors could be subject to future lawsuits related to unsolicited proposals to acquire us. Any
such future lawsuits could become time consuming and expensive. These matters, alone or in
combination, may harm our business.
Risks Relating to Our Intellectual Property and Litigation
Our products contain open source software, and failure to comply with the terms of the underlying
open source software licenses could restrict our ability to sell our products.
Like many other software companies, we use and distribute open source software in order to
expedite development of new products and features. Open source software is generally licensed by
its authors or other third parties under open source licenses, including, for example, the GNU
General Public License, or GPL, the GNU Lesser Public License, or LGPL, the BSD License and the
Apache License. This open source software includes, without limitation, Snort, ClamAV, Linux,
Apache, OpenSSL, Etheral, IPTables, Tcpdump and Tripwire. These license terms may be ambiguous, in
many instances have not been interpreted by the courts and could be interpreted in a manner that
results in unanticipated obligations regarding our products. Depending upon how the open source
software is deployed by our developers and the underlying licenses are interpreted by the courts,
we could be required to offer our products that use the open source software for no cost, make
available the source code for modifications or derivative works, or secure an additional license to
the underlying patent rights. Any of these obligations could have an adverse impact on our
intellectual property rights and revenue from products incorporating the open source software.
Our use of open source code could also result in us developing and selling products that
infringe third-party intellectual property rights. It may be difficult for us to accurately
determine the developers of the open source code and whether the code incorporates proprietary
software or otherwise infringes another partys intellectual property rights (including patent
rights). We have processes and controls in place that are designed to address these risks and
concerns, including a review process for screening requests from our development organizations for
the use of open source. However, we cannot be sure that all open source is submitted for approval
prior to use in our products.
41
We also have processes and controls in place to review the use of open source in the products
developed by companies that we may acquire. Even if we conduct due diligence prior to completing an
acquisition, the acquired products or technologies may nonetheless include open source software
that was not identified during the initial due diligence. Our ability to commercialize products or
technologies of any companies we may acquire that incorporate open source software or to otherwise
fully realize the anticipated benefits of any such acquisition may be restricted in the same manner
as if the open source software had been incorporated into our own software.
Our intellectual property rights may be difficult to enforce, which could enable others to
compete with us or to copy or use aspects of our products without compensating us.
We rely primarily on a combination of copyright, trademark, patent and trade secret laws,
confidentiality procedures and contractual provisions to establish and protect our proprietary
rights in our technology. However, the steps we have taken to protect our proprietary rights and
technology may not deter its misuse, theft or misappropriation. Competitors may independently
develop technologies or products that are substantially equivalent or superior to our products or
that inappropriately incorporate our proprietary technology into their products. Our products
incorporate open source Snort software, which is readily available to the public. To the extent
that our proprietary software is included by others in what are purported to be open source
products, it may be difficult and expensive to enforce our intellectual property rights in such
software. Competitors also may hire our former employees who may misappropriate our proprietary
technology.
In addition, from time to time, we become aware that users of our security products may not
have paid adequate license, technical support, or subscription fees to us. However, some
jurisdictions may not provide an adequate legal infrastructure for effective protection or
enforcement of our intellectual property rights. Furthermore, changing legal interpretations of
liability for unauthorized use of our software or lessened sensitivity by corporate, government or
institutional users to refraining from intellectual property piracy or other infringements of
intellectual property could also harm our business.
In limited instances we have agreed to place, and in the future may agree to place, source
code for our proprietary software in escrow. In most cases, the escrowed source code may be made
available to certain of our customers and partners in the event that we were to file for bankruptcy
or materially fail to support our products in the future. Release of our source code upon any such
event would increase the likelihood of misappropriation or other misuse of our software. We have
rarely agreed to source code escrow arrangements in the past and usually only in connection with
prospective customers considering a significant purchase of our products and services.
If we acquire technology to include in our products from third parties, our exposure to
infringement actions may increase because we must rely upon these third parties to verify the
origin and ownership of such technology. Similarly, we face exposure to infringement actions if we
hire software engineers who were previously employed by competitors and those employees
inadvertently or deliberately incorporate proprietary technology of our competitors into our
products despite efforts by our competitors and us to prevent such infringement.
Efforts to assert intellectual property ownership rights in our products could impact our
standing in the open source community, which could limit our product innovation capabilities.
If we were to undertake actions to protect and maintain ownership and control over our
intellectual property rights, our standing in the open source community could be diminished. This
could in turn limit our ability to rely on this community as a resource to identify and defend
against new viruses, threats and techniques to attack secure networks, explore new ideas and
concepts and further our research and development efforts.
Claims that our products infringe the proprietary rights of others could harm our business and
cause us to incur significant costs.
If we are unable to protect our intellectual property rights in our technologies, we may find
ourselves at a competitive disadvantage to others who need not incur the additional expense, time
and effort required to create competitive technologies. As a result, litigation may be necessary to
enforce and protect our intellectual property rights.
Similarly, the security technology industry has increasingly been subject to patent and other
intellectual property rights litigation, particularly from special purpose entities that seek to
monetize their intellectual property rights by asserting claims
42
against others. We expect this trend to continue and accelerate and expect that we may from
time to time be required to defend against this type of litigation. For example, as described under
Legal Proceedings below, we and nine other network security companies have been named as
defendants in a patent infringement lawsuit. Third party asserted claims or initiated litigation
can include claims against us or our customers, end-users, manufacturers, suppliers, partners or
distributors, alleging infringement of intellectual property rights with respect to our existing or
future products or components of those products. The litigation process can be costly and is
subject to inherent uncertainties, so we may not prevail in litigation matters regardless of the
merits of our position. In addition to the expense and distraction associated with litigation,
adverse determinations could cause us to lose our proprietary rights, prevent us from manufacturing
or selling our products, require us to obtain licenses to patents or other intellectual property
rights that our products are alleged to infringe, which licenses may not be available on reasonable
commercial terms or at all, and subject us to significant liabilities including indemnities to our
customers and others for losses resulting from such claims.
Future litigation could have a material adverse impact on our results of operations, financial
condition and liquidity.
From time to time we have been, and may be in the future, subject to litigation,
including stockholder derivative actions. Risks associated with legal liability are difficult to
assess and quantify, and their existence and magnitude can remain unknown for significant periods
of time. While we maintain director and officer insurance, the amount of insurance coverage may not
be sufficient to cover a claim, and there can be no assurance as to the continued availability of
this insurance. We may in the future be the target of additional proceedings, with or without
merit, and these proceedings may result in substantial costs and divert managements attention and
resources.
Risks Relating to Manufacturing
We primarily utilize a just-in-time contract manufacturing and inventory process and depend on a
limited number of manufacturers of our hardware products, which increases our vulnerability to
supply disruption.
We primarily utilize a just-in-time contract manufacturing and inventory process. Therefore,
our ability to meet our customers demand for our products depends upon obtaining adequate hardware
platforms on a timely basis and integrating them with our software. We purchase hardware platforms
from a limited number of contract manufacturers. The unexpected termination of our relationship
with any of these manufacturers would be disruptive to our business and our reputation, and could
result in a material decline in our revenue as well as shipment delays and possible increased costs
as we seek and implement production with an alternative manufacturer.
In addition, we rely on our contract manufacturers to source the components for our hardware
platforms and they in turn obtain materials from a limited number of suppliers. These suppliers may
extend lead times, limit the supply to our manufacturers or increase prices due to capacity
constraints or other factors. Although we work closely with our manufacturers and suppliers to
avoid shortages, we may encounter these problems in the future. Our results of operations would be
adversely affected if we were unable to obtain adequate supplies of hardware platforms in a timely
manner or if there were significant increases in the costs of hardware platforms or problems with
the quality of those hardware platforms.
In some cases, we purchase products from contract manufacturers and hold them in inventory pending
sale to our customers. If demand for these products does not meet our expectations, or if these
products become obsolete, we could be required to write down the value of our inventory, which
could adversely affect our results of operations.
Although we primarily utilize a just-in-time contract manufacturing and inventory process, in
some cases we purchase products from contract manufacturers based on our expectations of future
demand. We then hold these products in inventory pending sale to our customers. Demand for these
products may not meet our expectations as a result of a number of factors, including weakness in
general economic conditions, reductions in our customers purchasing budgets, discounting of prices
on competitive products, defects or perceived defects in the products or the introduction by us or
our competitors of new or enhanced products. In the past, we have recognized expenses related to
inventory write-offs and, in the future, if we reduce our estimate of future demand for our
products held in inventory, or if our inventory becomes obsolete, we may be required to record
additional inventory write-offs, which could negatively impact our gross margin and results of
operations.
43
Risks Relating to Our Common Stock
The price of our common stock may be subject to wide fluctuations.
Since the time of our initial public offering in March 2007, the market price of our common
stock has been subject to significant fluctuations, and we expect this volatility to continue for
the foreseeable future. For example, during the year ended December 31, 2009, our stock traded
between a high of $27.80 per share and a low of $5.12 per share. Among the factors that could
affect our common stock price are the risks described in this Risk Factors section and other
factors, including:
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quarterly variations in our operating results compared to market expectations; |
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changes in expectations as to our future financial performance, including financial
estimates or reports by securities analysts; |
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changes in market valuations of similar companies or of our competitors; |
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liquidity and activity in the market for our common stock; |
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actual or expected sales of our common stock by our stockholders; |
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strategic moves by us or our competitors, such as acquisitions or restructurings; |
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general market conditions; and |
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domestic and international economic, legal and regulatory factors unrelated to our
performance. |
Stock markets in general, and the stocks of technology companies in particular, have
experienced extreme volatility that has often been unrelated to the operating performance of a
particular company. These broad market fluctuations may adversely affect the trading price of our
common stock, regardless of our operating performance.
Sales of substantial amounts of our common stock in the public markets, or the perception that
they might occur, could reduce the price that our common stock might otherwise attain.
As of April 30, 2010, we had 27,473,833 outstanding shares of common stock. This number
includes shares held by institutional investors who own a significant majority of our common stock.
This number also includes shares held by directors and officers who may sell such shares at their
discretion, subject to volume limitations contained in federal securities laws. Sales of
substantial amounts of our common stock in the public market, or the perception that such sales
could occur, could adversely affect the market price of our common stock and may make it more
difficult for you to sell your common stock at a time and price that you deem appropriate.
Anti-takeover provisions in our charter documents and under Delaware law and our adoption of a
stockholder rights plan could make an acquisition of our company, which may be beneficial to our
stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our
current management.
Our certificate of incorporation and our bylaws contain provisions that may delay or prevent
an acquisition of our company or a change in our management. These provisions include a classified
board of directors, a prohibition on actions by written consent of our stockholders and our ability
to issue preferred stock without stockholder approval. In addition, we have adopted a stockholder
rights plan under which we would issue preferred stock rights upon specified events, which could
substantially dilute the stock ownership of a person or group attempting to take us over without
the approval of our board of directors. Although we believe these provisions of our certificate of
incorporation, bylaws, Delaware corporate law and our stockholder rights plan collectively provide
for an opportunity to receive higher bids by requiring potential acquirers to negotiate with us,
they would apply even if stockholders consider the offer to be beneficial. In addition, these
provisions may frustrate or prevent attempts by our stockholders to replace or remove our current
management by making it more difficult for stockholders to replace members of our board of
directors, which is responsible for appointing the members of our management.
44
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Item 2. |
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UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Use of Proceeds
In March 2007, we completed the initial public offering of shares of our common stock. Our
portion of the net proceeds from the initial public offering was approximately $83.9 million after
deducting underwriting discounts and commissions of $6.5 million and $2.4 million in offering
expenses.
We intend to use the net proceeds from the offering for working capital and other general
corporate purposes, including financing our growth, developing new products and funding capital
expenditures. Pending such usage, we have invested the net proceeds primarily in short-term,
interest-bearing investment grade securities.
Repurchase of Equity Securities During the Period Ended March 31, 2010
The following table provides information about purchases by us during the period ended March
31, 2010 of equity securities that are registered by us pursuant to Section 12 of the Securities
Exchange Act.
Repurchases are made under the terms of our 2007 Equity Incentive Plan. Under this plan,
we may award shares of restricted stock to our employees. These shares of restricted stock
typically are subject to a lapsing right of repurchase by us. We may exercise this right of
repurchase in the event that a restricted stock recipients service to us is terminated. If we
exercise this right, we are required to repay the purchase price paid by or on behalf of the
recipient for the repurchased restricted shares, which typically is the par value per share of
$0.001. Repurchased shares are returned to the 2007 Equity Incentive Plan and are available for
future awards under the terms of that plan.
These were the only repurchases of equity securities made by us during the three months
ended March 31, 2010. We do not currently have a stock repurchase program.
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Maximum |
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Total Number of |
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Number of |
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Shares |
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Shares that May |
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Total |
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Purchased as |
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Yet Be |
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Number of |
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Average |
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Part of Publicly |
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Purchased Under |
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Shares |
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Price Paid |
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Announced Plans |
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the Plans or |
Period |
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Purchased |
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per Share |
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or Programs |
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Programs |
2/1/10 2/28/10 |
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1,749 |
(1) |
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$ |
0.001 |
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3/1/10 3/31/10 |
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624 |
(1) |
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0.001 |
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Reflects the repurchase of restricted stock from employees that was unvested at the time
of termination of employment. The purchase price represents the original price paid for the shares
by the employee, which is equal to the par value of our common stock. |
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Item 3. |
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DEFAULTS UPON SENIOR SECURITIES |
Not applicable.
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Item 5. |
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OTHER INFORMATION |
None.
The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference
as part of this report and such Exhibit Index is incorporated herein by reference.
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on May 6, 2010.
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SOURCEFIRE, INC. |
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By:
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/s/ John C. Burris |
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John C. Burris |
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Chief Executive Officer |
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(duly authorized officer) |
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By:
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/s/ Todd P. Headley |
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Todd P. Headley |
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Chief Financial Officer |
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and Treasurer |
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(principal financial and accounting officer) |
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46
Exhibit Index
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Incorporation by Reference |
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Exhibit |
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File |
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Filed with |
Number |
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Exhibit Description |
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Form |
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Number |
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Exhibit |
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File Date |
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this 10-Q |
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3.1 |
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Sixth Amended and Restated Certificate
of Incorporation
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10-Q
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1-33350
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3.1 |
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5/4/2007 |
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3.2 |
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Fifth Amended and Restated Bylaws
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10-K
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1-33350
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3.2 |
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3/16/2009 |
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3.3 |
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Certificate of Designation of the
Series A Junior Participating Preferred
Stock
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8-A
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1-33350
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3.1 |
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10/30/2008 |
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4.1 |
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Form of stock certificate of common stock
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S-1/A
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333-138199
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4.1 |
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3/6/2007 |
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4.2 |
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Rights Agreement, dated as of
October 30, 2008, by and between the
Company and Continental Stock Transfer &
Trust Co., as rights agent
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8-A
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1-33350
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4.1 |
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10/30/2008 |
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10.1 |
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Non-Employee Director Compensation
Policy, as amended effective May 20,
2010
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X |
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31.1 |
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Certification of Chief Executive Officer
pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
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X |
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31.2 |
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Certification of Chief Financial Officer
pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
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X |
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32.1 |
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Certification of Chief Executive Officer
and Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
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X |