Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark one)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from       to       .

 

Commission file number 001-36017

 


 

Control4 Corporation

(Exact name of registrant as specified in its charter)

 


 

Delaware
(State or other jurisdiction of incorporation or organization)

 

42-1583209
(I.R.S. Employer Identification No.)

 

 

 

11734 S. Election Road
Salt Lake City, Utah
(Address of principal executive offices)

 

84020
(Zip Code)

 

(801) 523-3100
(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes o  No x

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No 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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

On October 25, 2013, 22,772,528 shares of the registrant’s Common Stock, $0.0001 par value, were issued and outstanding.

 

 

 



Table of Contents

 

Control4 Corporation

 

Index

 

Part I — Financial Information

 

2

 

 

 

 

 

Item 1.

 

Condensed Consolidated Financial Statements:

 

2

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of December 31, 2012 and September 30, 2013 (unaudited)

 

2

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2012 and 2013

 

3

 

 

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the Three and Nine Months Ended September 30, 2012 and 2013

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2012 and 2013

 

5

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

6

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

16

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

27

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

27

 

 

 

 

 

Part II — Other Information

 

28

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

28

 

 

 

 

 

Item 1A.

 

Risk Factors

 

28

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

46

 

 

 

 

 

Item 6.

 

Exhibits

 

47

 

 

 

 

 

Signatures

 

 

 

48

 

 

 

 

 

Exhibit Index

 

 

 

 

 



Table of Contents

 

Control4 Corporation

 

PART I — Financial Information

 

ITEM 1. Condensed Consolidated Financial Statements

 

CONTROL4 CORPORATION

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(in thousands, except share data)

 

 

 

December 31,

 

September 30,

 

 

 

2012

 

2013

 

 

 

 

 

(unaudited)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

18,695

 

$

82,485

 

Accounts receivable, net

 

13,078

 

15,941

 

Inventories

 

12,515

 

15,559

 

Prepaid expenses and other current assets

 

1,871

 

1,965

 

Total current assets

 

46,159

 

115,950

 

Property and equipment, net

 

2,666

 

3,640

 

Intangible assets, net

 

926

 

970

 

Other assets

 

887

 

1,130

 

Total assets

 

$

50,638

 

$

121,690

 

Liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

14,435

 

$

16,699

 

Accrued liabilities

 

6,571

 

5,548

 

Deferred revenue

 

542

 

637

 

Current portion of notes payable

 

1,321

 

1,191

 

Total current liabilities

 

22,869

 

24,075

 

Notes payable

 

1,838

 

2,127

 

Warrant liability

 

601

 

 

Other long-term liabilities

 

1,620

 

484

 

Total liabilities

 

26,928

 

26,686

 

Commitments and contingencies

 

 

 

 

 

Redeemable convertible preferred stock, $0.0001 par value; 83,163,408 and no shares authorized; 15,293,960 and no shares issued and outstanding at December 31, 2012 and September 30, 2013 (unaudited), respectively; aggregate liquidation preference of $118,150 and $0 at December 31, 2012 and September 30, 2013 (unaudited), respectively

 

116,313

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

Preferred stock, $0.0001 par value, no and 25,000,000 shares authorized; no shares issued and outstanding at December 31, 2012 and September 30, 2013 (unaudited), respectively

 

 

 

Common stock, $0.0001 par value; 127,836,592 and 500,000,000 shares authorized; 2,490,870 and 22,766,644 shares issued and outstanding at December 31, 2012 and September 30, 2013 (unaudited), respectively

 

 

2

 

Additional paid-in capital

 

12,988

 

199,354

 

Accumulated deficit

 

(105,587

)

(104,354

)

Accumulated other comprehensive income (loss)

 

(4

)

2

 

Total stockholders’ equity (deficit)

 

(92,603

)

95,004

 

Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)

 

$

50,638

 

$

121,690

 

 

See accompanying notes to condensed consolidated financial statements (unaudited).

 

2



Table of Contents

 

CONTROL4 CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(in thousands, except per share data)

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

 

 

(unaudited)

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

28,605

 

$

33,641

 

$

78,847

 

$

92,755

 

Cost of revenue

 

14,918

 

16,592

 

41,710

 

46,129

 

Cost of revenue — inventory purchase commitment

 

1,840

 

 

1,840

 

(180

)

Gross margin

 

11,847

 

17,049

 

35,297

 

46,806

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

5,158

 

6,409

 

15,119

 

18,670

 

Sales and marketing

 

5,333

 

5,596

 

15,479

 

16,597

 

General and administrative

 

2,471

 

2,847

 

7,666

 

8,623

 

Litigation settlement

 

2,869

 

200

 

2,869

 

440

 

Total operating expenses

 

15,831

 

15,052

 

41,133

 

44,330

 

Income (loss) from operations

 

(3,984

)

1,997

 

(5,836

)

2,476

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

2

 

4

 

11

 

8

 

Interest expense

 

(65

)

(209

)

(209

)

(420

)

Other income (expense)

 

(45

)

42

 

(222

)

(699

)

Total other income (expense)

 

(108

)

(163

)

(420

)

(1,111

)

Income (loss) before income taxes

 

(4,092

)

1,834

 

(6,256

)

1,365

 

Income tax expense

 

 

(103

)

 

(132

)

Net income (loss)

 

$

(4,092

)

$

1,731

 

$

(6,256

)

$

1,233

 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(1.73

)

$

0.12

 

$

(2.69

)

$

0.19

 

Diluted

 

$

(1.73

)

$

0.07

 

$

(2.69

)

$

0.06

 

Weighted-average number of shares:

 

 

 

 

 

 

 

 

 

Basic

 

2,363

 

14,389

 

2,324

 

6,511

 

Diluted

 

2,363

 

23,556

 

2,324

 

21,206

 

 

See accompanying notes to condensed consolidated financial statements (unaudited).

 

3



Table of Contents

 

CONTROL4 CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

(in thousands)

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

 

 

(unaudited)

 

(unaudited)

 

Net income (loss)

 

$

(4,092

)

$

1,731

 

$

(6,256

)

$

1,233

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

(7

)

12

 

(37

)

6

 

Total other comprehensive income (loss)

 

(7

)

12

 

(37

)

6

 

Comprehensive income (loss)

 

$

(4,099

)

$

1,743

 

$

(6,293

)

$

1,239

 

 

See accompanying notes to condensed consolidated financial statements (unaudited).

 

4



Table of Contents

 

CONTROL4 CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(in thousands)

 

 

 

Nine Months
Ended
September 30,

 

 

 

2012

 

2013

 

 

 

(unaudited)

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income (loss)

 

$

(6,256

)

$

1,233

 

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

 

 

 

 

 

Depreciation expense

 

1,254

 

1,609

 

Amortization of intangible assets

 

203

 

218

 

Provision for doubtful accounts

 

203

 

112

 

Loss (gain) on inventory purchase commitment

 

1,840

 

(180

)

Stock-based compensation

 

2,094

 

2,648

 

Warrant liability expense

 

222

 

709

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(3,199

)

(2,978

)

Inventories

 

(1,318

)

(2,947

)

Prepaid expenses and other current assets

 

(495

)

(98

)

Other assets

 

(783

)

(243

)

Accounts payable

 

3,964

 

2,150

 

Accrued liabilities

 

2,650

 

(838

)

Deferred revenue

 

46

 

95

 

Other long-term liabilities

 

(450

)

(1,138

)

Net cash (used in) provided by operating activities

 

(25

)

352

 

Investing activities

 

 

 

 

 

Purchases of property and equipment

 

(1,656

)

(2,575

)

Business acquisition

 

 

(88

)

Net cash used in investing activities

 

(1,656

)

(2,663

)

Financing activities

 

 

 

 

 

Proceeds from issuance of common stock, net of issuance costs

 

 

65,556

 

Proceeds from exercise of options for common stock

 

191

 

367

 

Proceeds from notes payable

 

1,376

 

1,145

 

Repayment of notes payable

 

(708

)

(986

)

Net cash provided by financing activities

 

859

 

66,082

 

Effect of exchange rate changes on cash and cash equivalents

 

(37

)

19

 

Net increase (decrease) in cash and cash equivalents

 

(859

)

63,790

 

Cash and cash equivalents at beginning of period

 

18,468

 

18,695

 

Cash and cash equivalents at end of period

 

$

17,609

 

$

82,485

 

Supplemental disclosure of cash flow information

 

 

 

 

 

Cash paid for interest

 

$

208

 

$

419

 

Cash paid for taxes

 

 

131

 

Supplemental schedule of non-cash investing and financing activities

 

 

 

 

 

Options for common stock granted in connection with a business acquisition

 

 

174

 

Elimination of liability upon net exercise of warrants to purchase preferred stock

 

 

1,310

 

Conversion of redeemable convertible preferred stock to common stock

 

 

116,313

 

 

See accompanying notes to condensed consolidated financial statements (unaudited).

 

5



Table of Contents

 

Control4 Corporation

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. Description of Business and Summary of Significant Accounting Policies

 

Control4 Corporation (‘‘Control4’’ or the ‘‘Company’’) is a leading provider of automation and control solutions for the connected home. The Company unlocks the potential of connected devices, making entertainment systems easier to use, homes more comfortable, appliances more energy efficient, and families more secure. The Company was incorporated in the state of Delaware on March 27, 2003.

 

Reclassifications

 

Certain prior-year amounts have been reclassified in order to conform to the current-year presentation. The reclassification is related to gains or losses on inventory purchase commitments from accrued liabilities into the applicable caption on the statements of cash flows. This reclassification had no effect on the previously reported net cash (used in) provided by operating activities.

 

Unaudited Interim Financial Statements

 

The accompanying condensed consolidated balance sheets and the condensed consolidated statements of operations, comprehensive income (loss), and cash flows are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (‘‘GAAP’’) on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting of only normal recurring adjustments, considered necessary to present fairly the Company’s financial position, results of operations and cash flows. The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013, or any other future interim or annual period.

 

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Prospectus filed with the Securities and Exchange Commission (the “SEC”) on August 2, 2013. The December 31, 2012 consolidated balance sheet included herein was derived from the audited financial statements as of that date.

 

Basis of Presentation

 

The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in the unaudited condensed consolidated financial statements.

 

Initial Public Offering

 

On August 7, 2013, the Company completed its initial public offering (“IPO”) of common stock in which the Company sold and issued 4,600,000 shares of common stock at a price of $16.00 per share. As a result of the IPO, the Company raised a total of $73.6 million in gross proceeds, or approximately $65.6 million in net proceeds after deducting underwriting discounts and commissions of $5.2 million and offering expenses of approximately $2.8 million.

 

Stock Split

 

In July 2013, the Company’s board of directors and stockholders approved an amendment to the Company’s amended and restated certificate of incorporation. The amendment provided for a 1-for-5.2 reverse stock split of the outstanding common stock and outstanding convertible preferred stock (collectively, “Capital Stock”), which became effective on July 18, 2013. Accordingly, (i) every 5.2 shares of Capital Stock have been combined into one share of Capital Stock, (ii) the number of shares of Capital Stock into which each outstanding option or warrant to purchase Capital Stock is exercisable, as the case may be, have been proportionately decreased on a 5.2-for-1 basis, and (iii) the exercise price for each such outstanding option or warrant to purchase Capital Stock has been proportionately increased on a 1-for-5.2 basis. All of the share numbers, share prices, and exercise prices have been adjusted within these financial statements, on a retroactive basis, to reflect this 1-for-5.2 reverse stock split.

 

6



Table of Contents

 

Segment Reporting

 

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker, the Chief Executive Officer, in making decisions regarding resource allocation and accessing performance. To date, the Company has viewed its operations and manages its business as one segment.

 

Concentrations of Risk

 

Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents and accounts receivable. The Company deposits cash and cash equivalents with one high-credit-quality financial institution and maintains balances that exceed federally insured amounts. The Company has policies that limit its investments as to types of investments, maturity, liquidity, credit quality, concentration and diversification of issuers.

 

The Company’s accounts receivable are derived from revenue earned from customers primarily located in the United States and Canada. The Company’s sales to customers located outside the United States are generally denominated in United States dollars, except for sales to customers located in the United Kingdom, which are denominated in pounds sterling. There were no individual account balances greater than 10% of total accounts receivable at December 31, 2012 and September 30, 2013.

 

No customer accounted for more than 10% of total revenue for the three- and nine-month periods ended September 30, 2012 and 2013.

 

The Company relies on a limited number of suppliers for its contract manufacturing. A significant disruption in the operations of these manufacturers would impact the production of the Company’s products for a substantial period of time, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

Geographic Information

 

The Company’s revenue includes amounts earned through sales to customers located outside of the United States. With the exception of Canada, no single foreign country accounted for more than 10% of total revenue for the three- and nine-month periods ended September 30, 2012 and 2013. The following table sets forth revenue from the U.S., Canadian and all other international customers combined (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Revenue-United States

 

$

17,845

 

$

22,264

 

$

51,347

 

$

61,430

 

Revenue-Canada

 

3,344

 

3,641

 

9,184

 

10,690

 

Revenue-all other international sources

 

7,416

 

7,736

 

18,316

 

20,635

 

Total revenue

 

$

28,605

 

$

33,641

 

$

78,847

 

$

92,755

 

 

 

 

 

 

 

 

 

 

 

International revenue (excluding Canada) as a percent of total revenue

 

26

%

23

%

23

%

22

%

 

Use of Accounting Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates including those related to revenue recognition, sales returns, provisions for doubtful accounts, product warranty, inventory obsolescence, litigation, determination of fair value of stock options, deferred tax asset valuation allowances and income taxes. Actual results may differ from those estimates.

 

Product Warranty

 

The Company provides its customers a limited product warranty of two years, which requires the Company to repair or replace defective products during the warranty period at no cost to the customer. The Company estimates the costs that may be incurred to replace or repair defective products and records a reserve at the time revenue is recognized. Factors that affect the Company’s warranty liability include the number of installed systems, the Company’s historical experience and management’s judgment regarding anticipated rates of product warranty returns. The Company assesses the adequacy of its recorded warranty liability each period and makes adjustments to the liability as necessary.

 

7



Table of Contents

 

The following table presents the changes in the product warranty liability (in thousands):

 

 

 

Warranty Liability

 

Balance at December 31, 2012

 

$

1,155

 

Warranty costs accrued

 

420

 

Warranty claims

 

(414

)

Balance at September 30, 2013

 

$

1,161

 

 

Fair Value of Financial Instruments

 

The carrying amounts reported in the accompanying condensed consolidated financial statements for cash and cash equivalents, accounts payable and accrued liabilities approximate their fair value because of the short-term nature of the accounts. The fair value of the notes payable approximates its carrying value based on the variable nature of interest rates and current market rates available to the Company.

 

Net Income (Loss) Per Share

 

Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average number of common shares outstanding and potentially dilutive common shares outstanding during the period that have a dilutive effect on net income per share. Potentially dilutive common shares result from the assumed exercise of outstanding stock options and the assumed conversion of outstanding convertible preferred stock and warrants using the if-converted method. In a net loss position, diluted net loss per share is computed using only the weighted-average number of common shares outstanding during the period, as any additional common shares would be anti-dilutive.

 

The following table presents the reconciliation of the numerator and denominator used in the calculation of basic and diluted net income (loss) per share (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(4,092

)

$

1,731

 

$

(6,256

)

$

1,233

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common stock outstanding for basic net income (loss) per common share

 

2,363

 

14,389

 

2,324

 

6,511

 

Effect of dilutive securities—stock options, convertible preferred stock, and warrants to purchase common stock and preferred stock

 

 

9,167

 

 

14,695

 

Weighted average common shares and dilutive securities outstanding

 

2,363

 

23,556

 

2,324

 

21,206

 

 

The following weighted-average common stock equivalents were anti-dilutive and therefore were excluded from the calculation of diluted net income (loss) per share (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Convertible preferred stock

 

15,294

 

 

15,294

 

 

Options to purchase common stock

 

4,366

 

253

 

4,312

 

355

 

Warrants to purchase common stock

 

541

 

 

541

 

 

Warrants to purchase preferred stock

 

194

 

 

194

 

1

 

Total

 

20,395

 

253

 

20,341

 

356

 

 

Recent Accounting Pronouncements

 

In February 2013, the FASB issued ASU 2013-02, ‘‘Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.’’ The amended guidance requires an entity to present the effects on the line items of net income of significant reclassifications out of accumulated other comprehensive income if the amount being reclassified is required under U.S. generally accepted accounting principles to be reclassified in its entirety to net income in the same reporting period. The

 

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Table of Contents

 

guidance is effective prospectively for the reporting periods beginning after December 15, 2012. This new guidance was effective for the Company beginning January 1, 2013. The adoption of this guidance did not have an impact on the Company’s results of operations, financial position, or cash flows as it relates only to financial statement presentation.

 

2. Balance Sheet Components

 

Inventories consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2012

 

2013

 

Finished goods

 

$

12,306

 

$

14,202

 

Component parts

 

209

 

1,357

 

 

 

$

12,515

 

$

15,559

 

 

Property and equipment, net consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2012

 

2013

 

Computer equipment and software

 

$

3,518

 

$

3,817

 

Manufacturing tooling and test equipment

 

2,731

 

2,647

 

Furniture and fixtures

 

1,801

 

1,965

 

Lab and warehouse equipment

 

1,974

 

2,311

 

Marketing equipment

 

419

 

424

 

Leasehold improvements

 

803

 

1,390

 

 

 

11,246

 

12,554

 

Less: accumulated depreciation

 

(8,580

)

(8,914

)

 

 

$

2,666

 

$

3,640

 

 

Intangible assets, net consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2012

 

2013

 

Acquired technology

 

$

1,357

 

$

1,628

 

Less: accumulated amortization

 

(431

)

(658

)

 

 

$

926

 

$

970

 

 

Other assets consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2012

 

2013

 

Prepaid licensing

 

700

 

735

 

Deposits

 

187

 

395

 

 

 

$

887

 

$

1,130

 

 

Accrued liabilities consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2012

 

2013

 

Current portion of settlement obligations (see Note 5)

 

$

2,229

 

$

887

 

Sales returns and warranty accruals

 

2,045

 

2,104

 

Compensation accruals

 

1,495

 

2,118

 

Other accrued liabilities

 

802

 

439

 

 

 

$

6,571

 

$

5,548

 

 

3. Fair Value Measurements

 

The Company’s financial instruments that are measured at fair value on a recurring basis consist of money market funds and redeemable preferred stock warrants. The following three levels of inputs are used to measure the fair value of financial instruments:

 

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Level 1: Quoted prices in active markets for identical assets or liabilities. The Company classifies its money market funds as Level 1 instruments as they are traded in active markets with sufficient volume and frequency of transactions.

 

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data. The Company did not have any Level 2 instruments during the reported periods.

 

Level 3: Unobservable inputs are used when little or no market data is available. The Company utilized a Black-Scholes option-pricing model in order to determine the fair value of the redeemable preferred stock warrant, with such value determined on an as-converted basis. Certain inputs used in the model are unobservable. The fair values could change significantly based on future market conditions.

 

The fair values of these financial assets and the redeemable preferred stock warrant were determined using the following inputs (in thousands):

 

 

 

Fair value measurements at

 

 

 

December 31, 2012 using

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

15,554

 

$

 

$

 

$

15,554

 

Other liabilities:

 

 

 

 

 

 

 

 

 

Redeemable preferred stock warrants

 

 

 

601

 

601

 

 

 

 

Fair value measurements at

 

 

 

September 30, 2013 using

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

79,004

 

$

 

$

 

$

79,004

 

Other liabilities:

 

 

 

 

 

 

 

 

 

Redeemable preferred stock warrants

 

 

 

 

 

 

Upon the closing of the Company’s initial public offering, the warrants to purchase shares of the Company’s redeemable convertible preferred stock were net exercised.  The then-current aggregate fair value of the warrant liability of $1.3 million was reclassified from long-term liabilities to additional paid-in capital, a component of stockholders’ equity, and the Company ceased to record any further periodic fair value adjustments relating to the warrant liability.

 

4. Acquisition

 

On June 21, 2013, the Company acquired 100% of the stock of a technology company. The fair value of the aggregate purchase price was approximately $259,000, which consisted of (1) a cash payment of $10,000, (2) notes payable of approximately $74,000, and (3) options to purchase shares of common stock with an exercise price of $11.28.  The estimated fair value of separately identifiable intangible assets will be amortized over an estimated useful life of two to three years. As a result, future amortization expense related to the acquisition will be $48,000, $96,000, $88,000, and $40,000 for the years ending December 31, 2013, 2014, 2015, and 2016, respectively.

 

5. Long-Term Obligations

 

Loan and Security Agreement

 

In June 2013, the Company entered into an Amended and Restated Loan and Security Agreement with Silicon Valley Bank (the “SVB Agreement”), which consists of a revolving credit facility of $13.0 million (subject to certain borrowing base restrictions) and term borrowings to fund purchases of property and equipment. All borrowings under the SVB Agreement are collateralized by the general assets of the Company. The credit facility has a variable rate of interest of prime (as published in the Wall Street Journal) or LIBOR plus 2.50%, as selected by the Company. The rate was 3.25% at September 30, 2013. In addition, the Company pays an annual commitment fee of $20,000 and a quarterly unused line fee of 0.375% based on the difference between the borrowing commitment of $13.0 million and the then-current balance. The SVB Agreement provides for $2.75 million in term borrowings to fund purchase of property and equipment through May 2014, of which $2.0 million was available at September 30, 2013. Term borrowings are payable in 39 equal monthly payments of principal plus interest and bear interest at prime plus 0.50%, which was 3.75% at September 30, 2013.

 

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Borrowing under the revolving credit facility is subject to certain collateral restrictions relating primarily to our accounts receivable and inventory levels. As of September 30, 2013, our total borrowing capacity was approximately $13.0 million, and no borrowings were outstanding. The revolving credit facility has a maturity date of May 29, 2015.

 

The SVB Agreement contains various restrictive and financial covenants and the Company was in compliance with each of these covenants as of September 30, 2013.

 

Settlement Obligation

 

The Company has entered into various settlement agreements relating to alleged patent infringements, which included future payments under non-interest bearing, unsecured notes payable. The carrying values of the notes payable have been discounted using an implied interest rate of 3.75% and is included in accrued and other long-term liabilities in the accompanying condensed consolidated balance sheets.

 

Upon closing of the Company’s initial public offering, the balance due on one of the settlement obligations was accelerated and became immediately due and payable.  As a result, the Company made a final payment on this obligation of $2.1 million on August 12, 2013.  The difference between the carrying value of the note and the payment was recorded as a $0.2 million charge to interest expense.

 

Future annual payments on the settlement obligations as of September 30, 2013 are shown in the table below (in thousands):

 

2013

 

$

20

 

2014

 

920

 

2015

 

20

 

2016

 

20

 

 

 

980

 

Less amount representing interest

 

(33

)

Present value of settlement obligations

 

947

 

Less current portion of settlement obligations

 

(887

)

Long-term portion of settlement obligations

 

$

60

 

 

6. Income Taxes

 

In order to determine the quarterly provision for income taxes, the Company considers the estimated annual effective tax rate, which is based on expected annual income and statutory tax rates in the various jurisdictions in which the Company operates. Certain significant or unusual items are separately recognized in the quarter during which they occur and can be a source of variability in the effective tax rates from quarter to quarter.

 

Income tax expense was $0 and $0.1 million for the three months ended September 30, 2012 and 2013, respectively, or approximately 0% and 6% of income before income taxes, respectively.  Income tax expense was $0 and $0.1 million for the nine months ended September 30, 2012 and 2013, respectively, or approximately 0% and 10% of income before income taxes, respectively. The effective tax rate for the three and nine months ended September 30, 2013 differs from the U.S. federal statutory rate of 34% primarily due to state income taxes, foreign income taxes, U.S. federal alternative minimum tax, incentive stock options, and the domestic valuation allowance offsetting most of the statutory rate.

 

At September 30, 2012 and 2013, the Company had a full valuation allowance against the deferred tax assets of its domestic operations as it believes it is more likely than not that these benefits will not be realized. At September 30, 2012, the Company also had a full valuation allowance against the deferred tax assets of its operations in the UK; however, the foreign valuation allowance has subsequently been released.  Significant judgment is required in making this assessment, and it is very difficult to predict when, if ever, the assessment may conclude that the remaining portion of the deferred tax assets are realizable.

 

The Company files income tax returns in the United States, including various state and local jurisdictions. The Company’s subsidiaries file income tax returns in the United Kingdom, Hong Kong, China and India. The Company is subject to examination in the United States, the United Kingdom, Hong Kong, China, and India as well as various state jurisdictions. As of September 30, 2013, the Company was not under examination by any tax authorities.

 

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7. Redeemable Convertible Preferred Stock and Stockholders’ Deficit

 

Redeemable Convertible Preferred Stock

 

Upon closing of the Company’s initial public offering, the 15,293,960 shares of issued and outstanding redeemable convertible preferred stock were converted into common stock. Each share of redeemable convertible preferred stock, shown as issued and outstanding in the table below, was converted into one share of common stock.  The carrying value of the redeemable preferred stock at August 7, 2013 of $116.3 million was reclassified to common stock and additional paid-in capital.

 

Redeemable convertible preferred stock consisted of the following at December 31, 2012 and August 7, 2013 (in thousands, except share data):

 

 

 

Shares
Authorized

 

Shares
Issued and
Outstanding

 

Aggregate
Liquidation
Preference

 

Series A

 

8,150,000

 

1,567,306

 

$

4,075

 

Series B

 

18,124,230

 

3,485,425

 

14,735

 

Series C

 

14,215,791

 

2,726,476

 

15,000

 

Series D

 

7,789,215

 

1,497,921

 

15,890

 

Series E

 

5,045,662

 

965,927

 

11,000

 

Series F

 

5,988,024

 

1,151,542

 

20,000

 

Series G

 

8,677,338

 

1,668,707

 

15,450

 

Series G-1

 

2,073,148

 

216,015

 

2,000

 

Series H

 

13,100,000

 

2,014,641

 

20,000

 

 

 

83,163,408

 

15,293,960

 

$

118,150

 

 

Prior to their conversion, the Series A, Series B, Series C, Series D, Series E, Series F, Series G, Series G-1 and Series H redeemable convertible preferred stockholders were entitled to receive, when, as and if declared by the Company’s Board of Directors, dividends at a rate of $0.21, $0.34, $0.44, $0.85, $0.91, $1.39, $0.74, $0.74, and $0.79 per share per year, respectively. To the extent that additional dividends were declared by the Board of Directors, those amounts would have been distributed equally among the Preferred Stockholders and common stockholders. As of September 30, 2013, no dividends had been declared by the Board of Directors.

 

Warrants to Purchase Stock and Preferred Stock Warrant Liability

 

Warrants to purchase common and preferred stock are summarized in the following table:

 

 

 

Number of Shares Subject to Warrant

 

 

 

December 31, 
2012

 

September 30, 
2013

 

Exercise Price

 

Warrants to purchase shares of common stock

 

71,153

 

 

$

7.49

 

Warrants to purchase shares of common stock

 

470,082

 

 

9.93

 

Warrants to purchase Series C redeemable convertible preferred stock (1)

 

7,325

 

 

5.50

 

Warrants to purchase Series E redeemable convertible preferred stock (1)

 

4,390

 

 

11.39

 

Warrants to purchase shares of common stock (1)

 

 

7,325

 

5.50

 

Warrants to purchase shares of common stock (1)

 

 

4,390

 

11.39

 

Warrants to purchase Series G-1 redeemable convertible preferred stock

 

182,666

 

 

9.26

 

 

 

735,616

 

11,715

 

 

 

 


(1)                                 Warrants to purchase Series C and Series E redeemable convertible preferred stock were converted into warrants to purchase shares of common stock upon the closing of the Company’s initial public offering.

 

Upon the closing of the Company’s initial public offering, warrants to purchase 723,901 shares of the Company’s common and preferred stock were net exercised, and the Company issued 293,232 shares of common stock to the holders of the warrants.

 

In 2009, the Series G-1 investors received warrants to purchase 182,666 shares of Series G-1 redeemable convertible preferred stock at a price of $9.26 per share. The warrants became immediately exercisable upon the closing of the Series G-1 financing and the fair value of $0.4 million was recorded as a liability with the offsetting charge to expense. Because the holders of the

 

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preferred stock were able to elect to redeem the shares for cash, the Company’s outstanding preferred stock warrants were classified as liabilities and were revalued at the end of each reporting period using the Black-Scholes option-pricing valuation model. Changes in fair value were reflected in the Company’s statements of operations as other income or expense. The fair market value of the Company’s common stock was used to value the warrant liability using the Black-Scholes option-pricing model. Upon the effective date of the Company’s initial public offering, the Company adjusted the liability based upon the offering price of $16.00 per share. As a result, the Company recognized $29,000 of other income and $0.7 million of other expense during the three- and nine-month periods ended September 30, 2013.

 

As discussed above, upon the closing of the Company’s initial public offering, the warrants to purchase shares of the Company’s redeemable convertible preferred stock were net exercised.  Of the 293,232 shares issued, the Company issued 76,964 shares of common stock to the warrant holder of Series G-1 redeemable convertible preferred stock. The then-current aggregate fair value of the warrant liability of $1.3 million was reclassified from long-term liabilities to additional paid-in capital, a component of stockholders’ equity, and the Company ceased to record any further periodic fair value adjustments relating to the warrant liability.

 

Stock Options

 

In 2003, the Board of Directors adopted the 2003 Equity Incentive Plan (the “2003 Plan”), which provides for the granting of nonqualified and incentive stock options, stock appreciation rights, stock awards and restricted stock. Under the 2003 Plan, the Company may grant nonqualified and incentive stock options to directors, employees and non-employees providing services to the Company. The Board of Directors, on an option-by-option basis, determines the number of shares, terms and exercise period. Options granted generally have a ten-year life and vest over a period of four years. The exercise price of options on the date of grant is equivalent to the estimated fair value of the stock as determined by the Board of Directors based upon information available to it at the time of grant. Because there was no public market for the common stock, prior to the Company’s initial public offering, the Company’s Board of Directors determined the fair value of the Company’s common stock based on a variety of factors, including periodic valuations of the Company’s common stock, arm’s-length sales of the Company’s common stock, the Company’s financial position, historical financial performance, projected financial performance, valuations of publicly traded peer companies and the illiquid nature of the Company’s common stock.

 

On June 11, 2013, the Company’s Board of Directors adopted the 2013 Stock Option and Incentive Plan (the “2013 Plan”), which was subsequently approved by the Company’s stockholders.  The 2013 Plan became effective as of the closing of the Company’s initial public offering. The Company initially reserved 2,390,401 shares of its Common Stock for issuance of awards under the 2013 Plan. To the extent that any awards outstanding under the 2003 Plan are forfeited or lapse unexercised subsequent to August 1, 2013, the shares of common stock subject to such awards will become available for issuance under the 2013 Plan.  As of September 30, 2013, an aggregate of 2,328,805 shares were available for issuance under the 2013 Plan. The 2013 Plan provides for annual increases in the number of reserved shares of up to 5% of the outstanding number of shares of the Company’s Common Stock.

 

A summary of stock option activity for the nine months ended September 30, 2013 is presented below:

 

 

 

Shares
Subject to
Options
Outstanding

 

Weighted
Average
Grant Date
Fair Value

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Life (Years)

 

Balance at December 31, 2012

 

4,649,238

 

$

3.33

 

$

5.56

 

7.2

 

Granted

 

456,098

 

10.28

 

13.63

 

 

 

Exercised

 

(88,582

)

2.39

 

4.14

 

 

 

Expired

 

(31,722

)

3.39

 

5.62

 

 

 

Forfeited

 

(35,467

)

4.60

 

7.33

 

 

 

Balance at September 30, 2013

 

4,949,565

 

3.99

 

6.36

 

6.7

 

 

 

 

 

 

 

 

 

 

 

Exercisable options at September 30, 2013

 

3,061,051

 

$

2.79

 

$

4.65

 

5.5

 

Vested and expected to vest at September 30, 2013

 

4,607,844

 

3.85

 

6.19

 

 

 

 

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The following table summarizes information about stock options outstanding and exercisable at September 30, 2013:

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of Exercise Prices

 

Weighted
Average
Exercise
Price

 

Number of
Underlying
Shares

 

Weighted-
Average
Remaining
Contractual
Life (in
years)

 

Number of
Underlying
Shares

 

Weighted-
Average
Remaining
Contractual
Life (in
years)

 

$0.26 - 1.30

 

$

0.56

 

190,939

 

1.2

 

190,939

 

1.2

 

1.35 - 2.60

 

2.18

 

473,347

 

2.7

 

473,347

 

2.7

 

2.65 - 3.90

 

3.23

 

325,523

 

3.8

 

325,523

 

3.8

 

3.95 - 5.20

 

4.87

 

954,522

 

5.5

 

926,448

 

5.5

 

5.25 - 6.50

 

6.19

 

1,734,885

 

8.0

 

933,316

 

7.9

 

6.55 - 7.80

 

7.49

 

118,947

 

6.8

 

95,260

 

6.8

 

7.85 - 9.10

 

8.84

 

239,893

 

8.7

 

81,075

 

8.7

 

9.15 – 22.77

 

11.40

 

911,509

 

8.9

 

35,143

 

9.1

 

 

 

 

 

4,949,565

 

 

 

3,061,051

 

 

 

 

The following table summarizes the aggregate intrinsic-value of options exercised, outstanding and exercisable (in thousands):

 

 

 

For the nine months ended
and as of September 30, 2013

 

Options Exercised

 

$

1,130

 

Options Outstanding

 

55,147

 

Options Exercisable

 

38,783

 

 

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Expected volatility

 

61

%

57

%

61-63

%

56-59

%

Expected dividends

 

0

%

0

%

0

%

0

%

Expected terms (in years)

 

6.0-6.1

 

5.5-6.1

 

5.5-6.1

 

3.3-7.2

 

Risk-free rate

 

0.8

%

1.5-1.7

%

0.8-0.9

%

0.8-1.7

%

Forfeiture rate

 

7.9

%

7.2

%

7.9

%

7.2

%

 

Total stock-based compensation expense has been classified as follows in the accompanying statements of operations (in thousands):

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended

September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Cost of revenue

 

$

18

 

$

15

 

$

53

 

$

46

 

Research and development

 

202

 

419

 

461

 

974

 

Sales and marketing

 

139

 

187

 

421

 

543

 

General and administrative

 

363

 

319

 

1,159

 

1,085

 

Total stock-based compensation expense

 

$

722

 

$

940

 

$

2,094

 

$

2,648

 

 

At September 30, 2013, there was $8.1 million of total unrecognized compensation cost related to non-vested stock option awards that will be recognized over a weighted-average period of 3.1 years.

 

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8. Related Party Transactions

 

The Company has entered into sales agreements with certain of its investors. The following table sets forth revenue from product sales to companies affiliated with these investors (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Company 1

 

$

747

 

$

694

 

$

1,567

 

$

2,059

 

Company 2

 

211

 

 

813

 

128

 

Company 3

 

372

 

262

 

1,139

 

748

 

Company 4

 

368

 

4

 

784

 

423

 

 

 

$

1,698

 

$

960

 

$

4,303

 

$

3,358

 

 

As of December 31, 2012 and September 30, 2013, the Company had accounts receivable from these companies totaling $1.5 million and $0.8 million, respectively.  Purchase and payment terms with these customers are consistent with other non-affiliated companies.

 

9. Commitments and Contingencies

 

Operating Leases

 

The Company leases office and warehouse space under operating leases that expire between 2013 and 2018. The terms of the leases include periods of free rent, options for the Company to extend the leases (three to five years) and increasing rental rates over time. The Company recognizes rental expense under these operating leases on a straight-line basis over the lives of the leases and has accrued for rental expense recorded but not paid.

 

Rental expense was approximately $0.3 million for the three months ended September 30, 2012 and 2013, and $0.7 million and $1.0 million for the nine months ended September 30, 2012 and 2013, respectively.

 

Future minimum rental payments required under non-cancelable operating leases with initial or remaining terms in excess of one year consist of the following as of September 30, 2013 (in thousands):

 

2013

 

$

370

 

2014

 

1,452

 

2015

 

1,451

 

2016

 

1,312

 

2017

 

1,124

 

Thereafter

 

557

 

 

 

$

6,266

 

 

Purchase Commitments

 

The Company had non-cancellable purchase commitments for the purchase of inventory, which extend through May 2014 totaling approximately $23.9 million at September 30, 2013.

 

Indemnification

 

The Company has agreed to indemnify its officers and directors for certain events or occurrences, while the officer or director is or was serving at the Company’s request in such capacity. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer insurance policy that provides corporate reimbursement coverage that limits its exposure and enables it to recover a portion of any future amounts paid. The Company is unable to reasonably estimate the maximum amount that could be payable under these arrangements since these obligations are not capped but are conditional to the unique facts and circumstances involved. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2013.

 

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Table of Contents

 

Employment Agreements

 

The Company has signed employment agreements with certain executive officers who are entitled to receive certain benefits if their employment is terminated by the Company, including severance payments, accelerated vesting of stock options and continuation of certain insurance benefits.

 

Legal Matters

 

The Company is subject to various lawsuits and other claims that arise from time to time in the ordinary course of business. These actions may be based on alleged patent infringement or other matters. The Company intends to defend itself vigorously against any such actions. The Company establishes reserves for specific liabilities in connection with legal actions that it deems to be probable and estimable.

 

In management’s opinion, the Company is not currently involved in any legal proceedings that, individually or in the aggregate, could have a material effect on the Company’s financial condition, operations, or cash flows.

 

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis is intended to provide greater details of our results of operations and financial condition and should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this document.  Certain statements in this Quarterly Report constitute forward-looking statements and as such, involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements.  Such forward-looking statements include any expectation of earnings, revenues or other financial items; any statements of the plans, strategies and objectives of management for future operations; factors that may affect our operating results; statements related to adding employees; statements related to future capital expenditures; statements related to future economic conditions or performance; statements as to industry trends and other matters that do not relate strictly to historical facts or statements of assumptions underlying any of the foregoing.  These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may” or “will,” and similar expressions or variations.  Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to those discussed in the section titled “Risk Factors” included in Item 1A of Part II of this Quarterly Report on Form 10-Q, and the risks discussed in our other SEC filings.

 

We urge you to consider these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q.  These statements are based on the beliefs and assumptions of our management based on information currently available to management.  The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report.  All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements.  We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

 

Overview

 

Control4 is a leading provider of automation and control solutions for the connected home. We unlock the potential of connected devices, making entertainment systems easier to use, homes more comfortable and energy efficient, and families more secure. We provide our consumers with the ability to integrate music, video, lighting, temperature, security, communications and other functionalities into a unified home automation solution that enhances our consumers’ daily lives. At the center of our solution is our advanced software platform, which we provide through our products that interface with a wide variety of connected devices that are developed by us and by third parties.

 

We derive virtually all of our revenue from the sale of products that contain our proprietary software, which functions as the operating system of the home. We derive a smaller portion of our revenue from licensing our MyHome software, which allows consumers to access their home control system from within their home using their smartphone, tablet or laptop.  We recently began bundling the MyHome software licenses with our controller appliances. As a result, we are currently only selling the MyHome software to legacy system owners and anticipate that sales of individual MyHome software licenses will continue to decline and we will eventually discontinue the sale of the unbundled software. We also generate revenue from the sale of annual subscriptions to our 4Sight service, which allows consumers to remotely access and control their home control system, as well as receive alerts regarding activities in their home.  4Sight also allows dealers to perform remote diagnostic services. Although our subscription-based revenue is

 

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currently insignificant, we intend over time to develop additional subscription-based services and increase our subscription-based revenue.

 

We outsource the manufacturing of our hardware products to contract manufacturers. The majority of our hardware products are manufactured by Sanmina and LiteOn at their respective facilities in southern China, with additional manufacturing performed by six other contract manufacturers throughout Asia.

 

Consumers purchase our products from our worldwide network of certified independent dealers, regional and national retailers and distributors. These dealers design and install a solution to fit the specific needs of each consumer, whether it is a one-room home theatre solution or a whole-home automation solution that includes the integration of music, video, lighting, temperature, security and communications devices. Our products are installed in both new and existing residences. In addition, a portion of our revenue is attributable to small commercial installations and multi-dwelling units, including hotels. During the year ended December 31, 2012, we sold our products directly to over 2,800 active direct dealers in the United States, Canada, the United Kingdom and 40 other countries, and partnered with 27 distributors to cover an additional 38 countries where we do not have direct dealer relationships. These distributors sell our solutions through dealers and provide warehousing, training, technical support, billing and service for dealers in each of those countries.

 

We were founded in 2003 and began shipping our products and generating revenue in 2005. Our revenue has increased from $23.0 million for the year ended December 31, 2006 to $109.5 million for the year ended December 31, 2012. Our revenue for the three- and nine-month periods ended September 30, 2013 was $33.6 million and $92.8 million, compared to $28.6 million and $78.8 million for the three- and nine-month periods ended September 30, 2012. Our revenue growth has resulted primarily from a combination of adding new dealers and distributors to our sales channels, as well as increasing revenue from existing dealers and distributors by enhancing and expanding our product offerings and solutions.

 

To date, nearly all of our revenue growth has been organic. We have completed small acquisitions, but those acquisitions have been technology- and distribution-related and have not contributed materially to our revenue. We intend to identify, acquire and integrate strategic technologies, assets and businesses that we believe will enhance the overall strength of our business.

 

We have historically experienced seasonal variations in our revenue as a result of holiday-related factors that are common in our industry. Our revenue is generally highest in the fourth quarter due to consumers’ desires to complete their home installations prior to the Thanksgiving and Christmas holidays. We generally see decreased sales in the first quarter due to the number of installations that were completed in the fourth quarter and the resulting decline in dealer activity in the first quarter. We generally expect these seasonal trends to continue in the future, which may cause quarterly fluctuations in our results of operations and certain financial metrics.

 

Key Operating and Financial Metrics

 

We use the following key operating and financial metrics to evaluate and manage our business.

 

 

 

December 31,
2012

 

September 30,
2013

 

Number of North America dealers

 

2,350

 

2,457

 

Number of direct international dealers

 

501

 

554

 

 

 

 

Three Months
Ended September 30,

 

Nine Months
Ended September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Number of controller appliances sold

 

18,585

 

16,154

 

52,271

 

49,120

 

Core revenue growth

 

21

%

18

%

19

%

19

%

International core revenue as a percentage of total revenue

 

24

%

23

%

21

%

22

%

 

Number of North America and Direct International Dealers

 

Because our dealers promote, sell, install and support our products, a broader dealer network allows us to reach more potential consumers across more geographic regions. We expect our dealer network to continue to grow, both in North America and internationally. While we have historically focused on dealers affiliated with the Custom Electronics Design and Installation Association (“CEDIA”), we believe there is an opportunity to establish relationships with dealers outside of CEDIA, including electrical contractors, heating and cooling specialists, and security system installers. The number of dealers in the above table reflects active direct dealers that have placed an order with us in the trailing 12-month period.

 

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Our international dealer network is growing at a faster rate than our North America dealer network, and we expect this trend to continue as we increase our presence in new and existing international markets. In addition, in some international markets, we plan to establish direct relationships with selected dealers that we previously served through distributors, which we expect will further increase our number of direct international dealers.

 

While we believe we continue to have significant international opportunities, we face challenges in international expansion.  Such challenges may cause our growth rate to be slower than anticipated. During the third quarter of 2013, we opened our technical support and training center in China which we believe will help us expand our presence in China and accelerate our transition from a distributor to direct-to-dealer channel model.  A similar facility is scheduled to open in India during the fourth quarter of 2013. In addition, our efforts are focused on addressing other obstacles to growth including new product introduction as well as promotion and pricing programs in certain markets.

 

Number of Controller Appliances Sold

 

Our controller appliances contain our proprietary software and provide consumers with the essential software technology to enable home control, automation and personalization. The number of controller appliances we sell in a given period provides us with an indication of consumer adoption of our technology. Our sales of controller appliances also create significant opportunity to sell our other products and services. Once a consumer has deployed our controller appliances, we believe that the consumer is more likely to remain committed to our technology platform and purchase more of our products, applications and services in the future.

 

In the first quarter of 2012, we introduced our new HC-800 controllers and in the second quarter of 2012, we introduced our new HC-250 controllers.  These new controllers offer increased capability and performance compared to the controllers that they replaced (i.e. the HC-1000, the HC-300, and the HC-200).  As a result of the increased capability and higher performance of the new controllers, many installations now require fewer controllers per system and we have therefore seen a decrease in the average number of controllers per system in 2013 compared to 2012.  The net result is an increase in revenue and a decrease in the number of controllers sold for the three- and nine-month periods ended September 30, 2013 compared to the same periods of 2012.

 

Core Revenue Growth

 

The majority of our revenue comes from sales of our products through our distribution channels comprised of dealers in the United States and Canada and dealers and distributors located throughout the rest of the world. We refer to revenue attributable to sales through dealers located in the United States and Canada as North America Core revenue, and revenue attributable to sales through dealers and distributors located throughout the rest of the world as International Core revenue. Core revenue does not include revenue from sales to hotels or multi-dwelling units or certification fees paid to us. Our revenue from sales to hotels, multi-dwelling units and other sources is generally project-based and has been significant in some periods and insignificant in other periods. In the future, we expect revenue from these sources to continue to be attributable to large projects and will continue to be significant in some periods and insignificant in other periods. We, therefore, believe that our core revenue growth is a good measure of our market penetration and the growth of our business.

 

International Revenue as a Percentage of Total Revenue

 

We believe that the international market represents a large and underpenetrated opportunity for us. In recent years, we have established offices in England, China, and India, we have formed relationships with international dealers and distributors and we have expanded foreign language support for our solutions. We track International revenue as a percentage of total revenue as a key measure of our success in expanding our business internationally.

 

Non-GAAP Financial Measures

 

In addition to our GAAP operating results, we use certain non-GAAP financial measures to understand and evaluate our operating performance and trends, to prepare and approve our annual budget, and to develop short- and long-term operational plans. These measures, which we refer to as our non-GAAP financial measures, are not prepared in accordance with generally accepted accounting principles in the United States. Non-GAAP adjusted gross margin, non-GAAP adjusted operating income, and non-GAAP net income exclude non-cash expenses related to stock-based compensation as well as gains or losses on inventory purchase commitments. We further exclude litigation settlement expense from non-GAAP operating income and non-GAAP net income.

 

Management believes that it is useful to exclude stock-based compensation expense because the amount of such expense in any specific period may not directly correlate to the underlying performance of our business operations. We believe it is useful to exclude gains or losses on inventory purchase commitments because it is income or expense that arose from our commitment to purchase energy-related products from our contract manufacturing partner that we will not use due to our decision to discontinue our

 

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energy product line for utility customers. We have not recognized that type of income or expense in periods prior to 2012, and we believe that past and future periods are more comparable if we exclude that income or expense. Furthermore, we believe it is useful to exclude litigation settlement expense because of the variable and unpredictable nature of these expenses which are not indicative of past or future operating performance. We believe that past and future periods are more comparable if we exclude that expense.

 

We believe these adjustments provide useful comparative information to investors. Non-GAAP results are presented for supplemental informational purposes only for understanding our operating results. The non-GAAP results should not be considered a substitute for financial information presented in accordance with generally accepted accounting principles, and may be different from non-GAAP measures used by other companies. Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry, as other companies in our industry may calculate non-GAAP financial results differently, particularly related to non-recurring, unusual items. We urge our investors to review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures included below, and not to rely on any single financial measure to evaluate our business.

 

 

 

Three Months

 

Nine Months

 

 

 

Ended

 

Ended

 

 

 

September 30,

 

September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

 

 

(in thousands, except percentages and per share data)

 

Reconciliation of Gross Margin on a GAAP Basis to Adjusted Gross Margin on a Non-GAAP Basis:

 

 

 

 

 

 

 

 

 

Gross margin

 

$

11,847

 

$

17,049

 

$

35,297

 

$

46,806

 

Stock-based compensation expense in cost of revenue

 

18

 

15

 

53

 

46

 

Cost of revenue — inventory purchase commitment

 

1,840

 

 

1,840

 

(180

)

Adjusted gross margin

 

$

13,705

 

$

17,064

 

$

37,190

 

$

46,672

 

Revenue

 

$

28,605

 

$

33,641

 

$

78,847

 

$

92,755

 

Gross margin percentage

 

41.4

%

50.7

%

44.8

%

50.5

%

Adjusted gross margin percentage

 

47.9

%

50.7

%

47.2

%

50.3

%

 

 

 

 

 

 

 

 

 

 

Reconciliation of Operating Income (Loss) on a GAAP Basis to Adjusted Operating Income on a Non-GAAP Basis:

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

$

(3,984

)

$

1,997

 

$

(5,836

)

$

2,476

 

Stock-based compensation expense

 

722

 

940

 

2,094

 

2,648

 

Cost of revenue — inventory purchase commitment

 

1,840

 

 

1,840

 

(180

)

Litigation settlement

 

2,869

 

200

 

2,869

 

440

 

Adjusted operating income from operations

 

$

1,447

 

$

3,137

 

$

967

 

$

5,384

 

Revenue

 

$

28,605

 

$

33,641

 

$

78,847

 

$

92,755

 

Operating margin percentage

 

-13.9

%

5.9

%

-7.4

%

2.7

%

Adjusted operating margin percentage

 

5.1

%

9.3

%

1.2

%

5.8

%

 

 

 

 

 

 

 

 

 

 

Reconciliation of Net Income (Loss) on a GAAP Basis to Adjusted Net Income on a Non-GAAP Basis:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(4,092

)

$

1,731

 

$

(6,256

)

$

1,233

 

Stock-based compensation expense

 

722

 

940

 

2,094

 

2,648

 

Cost of revenue — inventory purchase commitment

 

1,840

 

 

1,840

 

(180

)

Litigation settlement

 

2,869

 

200

 

2,869

 

440

 

Adjusted net income

 

$

1,339

 

$

2,871

 

$

547

 

$

4,141

 

Adjusted net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.57

 

$

0.20

 

$

0.24

 

$

0.64

 

Diluted

 

$

0.07

 

$

0.12

 

$

0.03

 

$

0.20

 

Weighted-average number of shares:

 

 

 

 

 

 

 

 

 

Basic

 

2,363

 

14,389

 

2,324

 

6,511

 

Diluted

 

19,052

 

23,556

 

18,872

 

21,206

 

 

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Table of Contents

 

Recent Developments

 

Net Proceeds from Initial Public Offering

 

On August 7, 2013, we completed our initial public offering (“IPO”) of common stock in which we sold and issued 4,600,000 shares of common stock and received net proceeds of approximately $65.6 million after deducting underwriting discounts and commissions and offering expenses.

 

Effect of Initial Public Offering on Warrant Liability

 

Freestanding warrants that relate to the Company’s redeemable convertible preferred stock are classified as a liability on the balance sheet as of December 31, 2012. The warrant to purchase Series G-1 redeemable convertible preferred stock was subject to re-measurement at each balance sheet date and any change in fair value is recognized as a component of other income or expense. Fair value was measured using the Black-Scholes option-pricing model. Upon the effective date of the Company’s initial public offering, we adjusted the liability to fair value based upon the offering price of $16.00 per share. As a result, we recognized $29,000 of other income and $0.7 million of other expense during the three- and nine-month periods ended September 30, 2013.

 

Upon the closing of our initial public offering, the holders of the Series G-1 warrants net-exercised their warrants in exchange for 76,964 shares of our common stock.  The warrant liability of $1.3 million was reclassified from long-term liabilities to additional paid-in capital, a component of stockholders’ equity, and we ceased to record any further periodic fair value adjustments relating to the warrant liability.

 

Components of Consolidated Statements of Operations

 

Revenue

 

We derive revenue primarily from the sale of products that contain our proprietary software. We generally recognize revenue upon the shipment of our products. We also license software that allows our customers to manage and control their homes from their smartphones, tablets or laptops. We recognize software license revenue at the time the software license is provided to the customer. In addition, we sell a subscription service, 4Sight, which allows consumers to control and monitor their homes remotely from their smartphones, tablets or laptops, and allows our dealers to perform remote diagnostic services. We defer subscription revenue at the time of payment and recognize it ratably over the term the service is provided. We record estimated reductions to revenue for dealer and distributor incentives at the time of the initial sale. We also record estimated reductions to revenue for estimated returns from our dealers and distributors at the time of the initial sale.

 

Cost of Revenue

 

Cost of revenue is comprised primarily of the price we pay our contract manufacturers for the components and products that they produce on our behalf. We closely monitor our product costs and continually work to reduce the cost of our products through negotiation with our contract manufacturers and component vendors and through engineering design changes. Cost of revenue also includes all of the overhead expenses associated with procuring, warehousing and shipping our products (both inbound and outbound). Cost of revenue also includes estimated and actual expenses associated with excess and obsolete inventory, as well as warranty expenses and royalty fees paid to third-party licensors.

 

Gross Margin

 

As a percentage of revenue, our gross margin has been and will continue to be affected by a variety of factors. Our gross margin is relatively consistent across our products. Our gross margin is higher on software licensing and subscription revenue than it is on product sales. Our gross margin is also higher on our sales made directly through dealers than it is on our sales made through distributors. Gross margin may also be negatively affected by price competition in our target markets and associated promotional or volume incentive rebates offered to our customers. Our gross margin on third-party products we sell through our online distribution platform is higher than our gross margin on our other product sales because we only recognize our net profit on these sales as revenue.

 

In the near term, we generally expect our gross margin to increase modestly as a result of our continued efforts to work with our contract manufacturers and component vendors to reduce the cost of components we purchase, engineer product design and cost improvements, manage our supply chain and realize economies of scale as we grow our business. We also expect increased third-party product sales through our online distribution platform to have a positive impact on our gross margin going forward. From time to time, however, we may experience fluctuations in our gross margin as a result of the factors discussed in the preceding paragraph.

 

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Table of Contents

 

Research and Development

 

Research and development expenses consist primarily of compensation for our engineers and product managers. Research and development expenses also include prototyping and field-testing expenses incurred in the development of our products, including products used for testing. We also include fees paid to agencies to obtain regulatory certifications. We expect our research and development expenses to increase in absolute dollars for the foreseeable future as we continue to invest in the development of new solutions; however, we expect those expenses to fluctuate as a percentage of our revenue in future periods based on fluctuations in our revenue and the timing of those expenses.

 

Sales and Marketing

 

Sales and marketing expenses consist primarily of compensation and related travel expenses for our sales and marketing personnel. Sales and marketing expenses also include expenses associated with trade shows, marketing events, advertising and other marketing-related programs. We expect our sales and marketing expenses to increase in absolute dollars for the foreseeable future as we add sales personnel, particularly in our international channel, and continue to invest in advertising and promotions to increase awareness of our products. However, we also expect our sales and marketing expenses to fluctuate as a percentage of our revenue in future periods based on fluctuations in our revenue and the timing of those expenses.

 

General and Administrative

 

General and administrative expenses consist primarily of compensation for our employees in our executive administration, finance, information systems and legal departments. Also included in general and administrative expenses are outside legal fees, audit fees, facilities expenses and insurance costs. We expect our general and administrative expenses to increase in absolute dollars primarily as a result of the increased cost associated with being a public company. However, we also expect our general and administrative expenses to fluctuate as a percentage of our revenue in future periods based on fluctuations in our revenue and the timing of those expenses.

 

Results of Operations

 

Revenue

 

We refer to revenue from sales through our dealer and distributor network in the United States and Canada (“North America”) and outside of North America (“International”) as our Core revenue. Our Core revenue excludes revenue attributable to products we sell to hotels and other multi-dwelling units, and certain other revenue. The following is a breakdown of our revenue between North America and International and a further breakdown between our Core revenue and other revenue:

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

 

 

(in thousands)

 

North America Core Revenue

 

$

21,016

 

$

25,353

 

$

59,604

 

$

70,752

 

Other North America Revenue

 

173

 

552

 

927

 

1,368

 

Total North America Revenue

 

21,189

 

25,905

 

60,531

 

72,120

 

International Core Revenue

 

6,942

 

7,710

 

16,742

 

20,060

 

Other International Revenue

 

474

 

26

 

1,574

 

575

 

Total International Revenue

 

7,416

 

7,736

 

18,316

 

20,635

 

Total Revenue

 

$

28,605

 

$

33,641

 

$

78,847

 

$

92,755

 

North America Core Revenue as a % of Total Revenue

 

73

%

75

%

76

%

76

%

International Core Revenue as a % of Total Revenue

 

24

%

23

%

21

%

22

%

 

North America core revenue was $25.4 million and $70.8 million during the three- and nine-month periods ended September 30, 2013, respectively, increases of $4.3 million or 21% and $11.1 million or 19% compared to the same periods in 2012.  The increase in North America core revenue was due to a combination of a net increase in the number of active direct dealers selling our products and services and an increase in sales from existing direct dealers.

 

International core revenue was $7.7 million and $20.1 million during the three- and nine-month periods ended September 30, 2013, respectively, increases of $0.8 million or 11% and $3.3 million or 20% compared to the same periods in 2012. The increase in

 

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Table of Contents

 

International core revenue was primarily due to an increase in the number of dealers and distributors selling our products and services and the resulting increase in the number of system sales. While we believe we continue to have significant international opportunities, we face challenges in international expansion. Such challenges may cause our growth rate to be slower than anticipated. During the third quarter of 2013, we opened our technical support and training center in China which we believe will help us expand our presence in China and accelerate our transition from a distributor to direct-to-dealer channel model. A similar facility is scheduled to open in India during the fourth quarter of 2013. In addition, our efforts are focused on addressing other obstacles to growth including new product introduction as well as promotion and pricing programs in certain markets.

 

Gross Margin

 

Gross margin for the three- and nine-month periods ended September 30, 2012 and 2013 was as follows (in thousands, except percentages):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Gross margin

 

$

11,847

 

$

17,049

 

$

35,297

 

$

46,806

 

Percentage of revenue

 

41

%

51

%

45

%

50

%

 

Our total cost of revenue for the three- and nine- month periods ended September 30, 2012 included a $1.8 million loss on an inventory purchase commitment resulting from our decision to discontinue our energy product line.

 

As a percentage of revenue, our gross margin increased from 41% during the three month period ended September 30, 2012 to 51% during the same period in 2013.  In addition to the $1.8 million loss on inventory purchase commitment noted above, the year over year increase in our gross margin percentage during the three month period ended September 30, 2013 was due to a variety of factors including higher prices charged for our controller products and associated software, higher sales of third party products sold through our online distribution platform, lower component costs and lower fixed manufacturing overhead expenses as a percent of revenue.

 

As a percentage of revenue, our gross margin increased from 45% during the nine month period ended September 30, 2012, to 50% during the same period in 2013.  During the second quarter of 2013, we reduced our reserve for loss on inventory purchase commitments by approximately $0.2 million, as our proceeds from liquidating the underlying inventory and our ability to consume common components exceeded our original estimates. In addition to the $1.8 million loss on inventory purchase commitment noted above, the year over year increase in our gross margin percentage during the nine month period ended September 30, 2013 was due to a variety of factors, including higher prices charged for our controller products and associated software, higher sales of third party products sold through our online distribution platform and lower component costs as a percent of revenue.

 

We expect the favorable impact on our gross margin percentage related to higher prices for our controller products and associated software to continue in future periods; however, the impact will decline as software sold separately for use with legacy systems will diminish over time.

 

We expect the positive impact on our gross margin percentage resulting from increased sales of third-party products sold through our online distribution platform to continue in future periods; however, the impact will diminish as the growth rate of that revenue slows in future periods.

 

We expect product component cost reductions to continue to have a positive impact on our gross margin as a percentage of revenue as those reductions are the result of negotiated price decreases with our contract manufacturers that are not short-term in nature.

 

The impact of lower manufacturing overhead as a percentage of revenue on our gross margin percentage will vary depending on overhead spending in that period. In the nine months ended September 30, 2013, we received credits for duties paid in previous periods.  We expect to receive duty draw-back credits in future periods, which will have a favorable impact on our gross margin percentages; however, we anticipate that the favorable impact will be less significant in future periods.

 

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Table of Contents

 

Research and Development Expenses

 

Research and development expenses for the three- and nine-month periods ended September 30, 2012 and 2013 were as follows (in thousands, except percentages):

 

 

 

Three Months Ended
 September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Research and development

 

$

5,158

 

$

6,409

 

$

15,119

 

$

18,670

 

Percentage of revenue

 

18

%

19

%

19

%

20

%

 

Research and development expenses increased by $1.3 million, or 24%, and $3.6 million, or 23%, in the three- and nine-month periods ended September 30, 2013 compared to the same periods in 2012. These increases were primarily due to an increase in headcount and related expenses, including non-cash stock compensation expense, to support on-going and expanded product development activities.

 

Sales and Marketing Expenses

 

Sales and marketing expenses for the three- and nine-month periods ended September 30, 2012 and 2013 were as follows (in thousands, except percentages):

 

 

 

Three Months Ended 
September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Sales and marketing

 

$

5,333

 

$

5,596

 

$

15,479

 

$

16,597

 

Percentage of revenue

 

19

%

17

%

20

%

18

%

 

Sales and marketing expenses increased by $0.3 million, or 5%, and $1.1 million, or 7%, in the three- and nine-month periods ended September 30, 2013, respectively, compared to the same periods in 2012. The period over period increases in absolute dollars for sales and marketing expenses was due to headcount increases and the related expenses as well as increased credit card merchant fees, which grew proportionate to our growth in revenue.  In addition, we increased our spending for tradeshow and other marketing related expenses to support new product releases and grow our dealer and distributor networks throughout the world.

 

General and Administrative Expenses

 

General and administrative expenses for the three- and nine-month periods ended September 30, 2012 and 2013 were as follows (in thousands, except percentages):

 

 

 

Three Months Ended 
September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

General and administrative

 

$

2,471

 

$

2,847

 

$

7,666

 

$

8,623

 

Percentage of revenue

 

9

%

8

%

10

%

9

%

 

General and administrative expenses increased by $0.4 million, or 15% and $1.0 million or 12%, in the three- and nine-month periods ended September 30, 2013 compared to the same periods in 2012. The period over period increases in absolute dollars in general and administrative expenses were due primarily to increased headcount and related expenses, professional fees and facilities related costs.

 

Litigation Settlement Expense

 

Litigation settlement expense for the three- and nine-month periods ended September 30, 2012 and 2013 were as follows (in thousands, except percentages):

 

 

 

Three Months Ended 
September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Litigation settlement expense

 

$

2,869

 

$

200

 

$

2,869

 

$

440

 

Percentage of revenue

 

10

%

1

%

4

%

0

%

 

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Table of Contents

 

In the third quarter of 2012, we recorded an expense of $2.9 million in connection with two separate legal settlements. During the first and third quarters of 2013, we expensed $240,000 and $200,000, respectively, to settle certain legal matters.

 

Other Income (Expense)

 

Other income (expense) for the three- and nine-month periods ended September 30, 2012 and 2013 were as follows (in thousands, except percentages):

 

 

 

Three Months Ended 
September 30,

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

2012

 

2013

 

Other income (expense)

 

$

(45

)

$

42

 

$

(222

)

$

(699

)

Percentage of revenue

 

0

%

0

%

0

%

(1

)%

 

Other income (expense) increased by $87,000 and $0.5 million for the three- and nine-month periods ended September 30, 2013 compared to the same periods in 2012. The increase is due to the change in the fair value of the warrant liability.  Upon the effective date of our initial public offering, we adjusted the liability to fair value based upon the offering price of $16.00 per share. As a result, we recognized $29,000 of other income and $0.7 million of other expense during the three- and nine-month periods ended September 30, 2013. Upon the closing of our initial public offering, the holders of the Series G-1 warrants net-exercised their warrants in exchange for 76,964 shares of our common stock.  The warrant liability of $1.3 million was reclassified from long-term liabilities to additional paid-in capital, a component of stockholders’ equity, and we will cease to record any further periodic fair value adjustments relating to the warrant liability.

 

Liquidity and Capital Resources

 

Primary Sources of Liquidity

 

The following table shows selected financial information and statistics as of December 31, 2012 and September 30, 2013 (in thousands):

 

 

 

December 31, 2012

 

September 30, 2013

 

Cash and cash equivalents

 

$

18,695

 

$

82,485

 

Accounts receivable, net

 

13,078

 

15,941

 

Inventories

 

12,515

 

15,559

 

Working capital

 

23,290

 

91,875

 

 

As of September 30, 2013, we had $82.5 million in cash and cash equivalents, an increase of $63.8 million from December 31, 2012.  The increase in cash is primarily the result of the net proceeds received from our initial public offering of common stock of approximately $65.6 million offset by settlement obligation payments made of $3.0 million during the three month period ended September 30, 2013.

 

Cash Flow Analysis

 

A summary of our cash flows for the nine months ended September 30, 2012 and 2013 is set forth below (in thousands):

 

 

 

Nine Months Ended
September 30,

 

 

 

2012

 

2013

 

Cash and cash equivalents at beginning of period

 

$

18,468

 

$

18,695

 

Net cash (used in) provided by operating activities

 

(25

)

352

 

Net cash used in investing activities

 

(1,656

)

(2,663

)

Net cash provided by financing activities

 

859

 

66,082

 

Effect of exchange rate changes on cash and cash equivalents

 

(37

)

19

 

Net change in cash for the period

 

(859

)

63,790

 

Cash and cash equivalents at the end of the period

 

$

17,609

 

$

82,485

 

 

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Table of Contents

 

Operating Activities

 

Our net cash provided by operating activities for the nine months ended September 30, 2013 was $0.4 million and was primarily due to net income of $1.2 million, offset by non-cash expenses of $5.3 million, and a decrease in working capital accounts included in operating activities of $4.6 million. The non-cash expenses included in net income consist primarily of stock-based compensation expense of $2.6 million, depreciation expense of $1.6 million, and warrant liability expense of $0.7 million. The changes in working capital were primarily comprised of increases in accounts receivable of $3.0 million and inventories of $2.9 million, a decrease in accrued liabilities of $0.8 million, offset by an increase in accounts payable of $2.2 million. The changes in working capital resulted primarily from the growth in sales to our customers and the timing of payments to our vendors, primarily for the purchase of inventory. Additionally, there was a decrease in other long-term liabilities of $1.1 million, which was due primarily to a $0.9 million payment against an accrued litigation settlement obligation.

 

Our net cash used in operating activities for the nine months ended September 30, 2012 was $25,000 and was primarily due to a net loss of $6.3 million, offset by non-cash expenses of $4.0 million, a loss on inventory purchase commitments of $1.8 million, and an increase in working capital accounts included in operating activities of $1.6 million.  The non-cash expenses included in the net loss consist primarily of stock-based compensation expense of $2.1 million and depreciation expense of $1.3 million. The changes in working capital were primarily comprised of increases in accounts receivable of $3.2 million and inventories of $1.3 million, offset by increases in accounts payable of $4.0 million and accrued liabilities of $2.7 million. The changes in working capital resulted from the growth in sales to our customers and the timing of payments to our vendors, primarily for the purchase of inventory.

 

Investing Activities

 

Net cash used in investing activities has historically been due primarily to purchases of property and equipment needed to support the growth of our business. Our purchases of property and equipment have been for computer equipment and software used internally, manufacturing tooling and test equipment that we purchase and own, but is located with our manufacturing partners, furniture and fixtures for our facilities, lab and warehouse equipment for our engineering and supply chain organizations, marketing equipment that is primarily used for trade shows and leasehold improvements to our facilities.

 

For the nine months ended September 30, 2012 and 2013, our cash used to purchase property and equipment was $1.7 million and $2.6 million, respectively.

 

Financing Activities

 

Net cash provided by financing activities for the nine months ended September 30, 2013 was $66.1 million.  As a result of our initial public offering, we raised a total of $73.6 million in gross proceeds, or approximately $65.6 million in net proceeds after deducting underwriting discounts and commissions of $5.2 million and offering expenses of approximately $2.8 million.

 

Net cash provided by financing activities for the nine months ended September 30, 2012 was $0.9 million and consisted of net proceeds from borrowings under our equipment loan as well as proceeds from the exercise of options for common stock.

 

Debt Obligations

 

In June 2013, we entered into an Amended and Restated Loan and Security Agreement with Silicon Valley Bank (the “SVB Agreement”), which consists of a revolving credit facility of $13.0 million (subject to certain borrowing base restrictions) and term borrowings to fund purchases of property and equipment. All borrowings under the SVB Agreement are collateralized by our general assets. The credit facility has a variable rate of interest of prime (as published in the Wall Street Journal) or LIBOR plus 2.50%, as selected by us. The rate was 3.25% at September 30, 2013. In addition, we pay an annual commitment fee of $20,000 and a quarterly unused line fee of 0.375% based on the difference between the borrowing commitment of $13.0 million and the then-current balance. The SVB Agreement provides for $2.75 million in term borrowings to fund purchase of property and equipment through May 2014, of which $2.0 million was available at September 30, 2013. Term borrowings are payable in 39 equal monthly payments of principal plus interest and bear interest at prime plus 0.50%, which was 3.75% at September 30, 2013.

 

Borrowing under the revolving credit facility is subject to certain collateral restrictions relating primarily to our accounts receivable and inventory levels. As of September 30, 2013, our total borrowing capacity was approximately $13.0 million, and no borrowings were outstanding. The revolving credit facility has a maturity date of May 29, 2015.

 

We have historically used the term borrowing facility to fund capital purchases on a quarterly basis. During the third quarter of 2013, we did not borrow against the term facility as our capital requirements were addressed from the receipt of proceeds from our initial public offering. We will continue to evaluate on a quarterly basis whether to borrow additional amounts based on our future cash needs.

 

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Table of Contents

 

The SVB Agreement contains various restrictive and financial covenants and we were in compliance with each of these covenants as of September 30, 2013.

 

Future Capital Requirements

 

Historically, we have experienced negative cash flows from operating activities primarily due to our continued investment in research and development and sales and marketing resources needed to design, develop, market and sell our solutions. Ou