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 EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

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 x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes 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 24, 2014, 23,880,867 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 (unaudited) as of December 31, 2013 and September 30, 2014

2

 

 

 

 

Condensed Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2013 and 2014

3

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (unaudited) for the Three and Nine Months Ended September 30, 2013 and 2014

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2013 and 2014

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

6

 

 

 

Item 2.

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

17

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

30

 

 

 

Item 4.

Controls and Procedures

30

 

 

 

Part II — Other Information

31

 

 

 

Item 1.

Legal Proceedings

31

 

 

 

Item 1A.

Risk Factors

31

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

48

 

 

 

Item 4.

Mine Safety Disclosures

49

 

 

 

Item 6.

Exhibits

49

 

 

 

Signatures

50

 

 

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,

 

 

 

2013

 

2014

 

 

 

(unaudited)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

84,546

 

$

17,450

 

Restricted cash

 

 

325

 

Short-term investments

 

 

48,730

 

Accounts receivable, net

 

15,064

 

19,215

 

Inventories

 

15,312

 

15,546

 

Prepaid expenses and other current assets

 

1,773

 

2,179

 

Total current assets

 

116,695

 

103,445

 

Property and equipment, net

 

3,943

 

4,208

 

Long-term investments

 

 

23,225

 

Intangible assets, net

 

928

 

1,570

 

Goodwill

 

 

99

 

Other assets

 

1,120

 

1,144

 

Total assets

 

$

122,686

 

$

133,691

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

13,314

 

$

14,217

 

Accrued liabilities

 

6,821

 

4,902

 

Deferred revenue

 

644

 

743

 

Current portion of notes payable

 

1,138

 

1,013

 

Total current liabilities

 

21,917

 

20,875

 

Notes payable

 

1,828

 

1,106

 

Other long-term liabilities

 

467

 

440

 

Total liabilities

 

24,212

 

22,421

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.0001 par value; 500,000,000 shares authorized; 22,785,104 and 23,870,761 shares issued and outstanding at December 31, 2013 and September 30, 2014 (unaudited), respectively

 

2

 

2

 

Additional paid-in capital

 

200,545

 

209,187

 

Accumulated deficit

 

(102,084

)

(97,849

)

Accumulated other comprehensive income (loss)

 

11

 

(70

)

Total stockholders’ equity

 

98,474

 

111,270

 

Total liabilities and stockholders’ equity

 

$

122,686

 

$

133,691

 

 

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

 

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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,

 

 

 

2013

 

2014

 

2013

 

2014

 

 

 

(unaudited)

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

33,641

 

$

39,120

 

$

92,755

 

$

107,636

 

Cost of revenue

 

16,592

 

18,847

 

46,129

 

52,160

 

Cost of revenue — inventory purchase commitment

 

 

 

(180

)

 

Gross margin

 

17,049

 

20,273

 

46,806

 

55,476

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

6,409

 

6,647

 

18,670

 

20,519

 

Sales and marketing

 

5,596

 

6,876

 

16,597

 

19,541

 

General and administrative

 

3,002

 

3,530

 

8,613

 

10,658

 

Litigation settlements

 

200

 

10

 

440

 

45

 

Total operating expenses

 

15,207

 

17,063

 

44,320

 

50,763

 

Income from operations

 

1,842

 

3,210

 

2,486

 

4,713

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest, net

 

(205

)

24

 

(412

)

25

 

Other income (expense), net

 

197

 

(221

)

(709

)

(150

)

Total other income (expense)

 

(8

)

(197

)

(1,121

)

(125

)

Income before income taxes

 

1,834

 

3,013

 

1,365

 

4,588

 

Income tax expense

 

(103

)

(250

)

(132

)

(353

)

Net income

 

$

1,731

 

$

2,763

 

$

1,233

 

$

4,235

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.12

 

$

0.12

 

$

0.19

 

$

0.18

 

Diluted

 

$

0.07

 

$

0.11

 

$

0.06

 

$

0.16

 

Weighted-average number of shares:

 

 

 

 

 

 

 

 

 

Basic

 

14,389

 

23,840

 

6,511

 

23,559

 

Diluted

 

23,556

 

25,590

 

21,206

 

25,671

 

 

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

 

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Table of Contents

 

CONTROL4 CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(in thousands)

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

 

 

(unaudited)

 

(unaudited)

 

Net income

 

$

1,731

 

$

2,763

 

$

1,233

 

$

4,235

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

12

 

(53

)

6

 

(35

)

Net unrealized losses on available-for-sale investments

 

 

(46

)

 

(46

)

Total other comprehensive income (loss)

 

12

 

(99

)

6

 

(81

)

Comprehensive income

 

$

1,743

 

$

2,664

 

$

1,239

 

$

4,154

 

 

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

 

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Table of Contents

 

CONTROL4 CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(in thousands)

 

 

 

Nine Months
Ended
September 30,

 

 

 

2013

 

2014

 

 

 

(unaudited)

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income

 

$

1,233

 

$

4,235

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation expense

 

1,609

 

1,880

 

Amortization of intangible assets

 

218

 

330

 

Provision for doubtful accounts

 

112

 

271

 

Gain on inventory purchase commitment

 

(180

)

 

Stock-based compensation

 

2,648

 

3,994

 

Excess tax benefit from exercise of options for common stock

 

 

(18

)

Warrant liability expense

 

709

 

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(2,978

)

(4,338

)

Inventories

 

(2,947

)

(175

)

Restricted cash

 

 

(334

)

Prepaid expenses and other current assets

 

(98

)

(402

)

Other assets

 

(243

)

(24

)

Accounts payable

 

2,150

 

956

 

Accrued liabilities

 

(838

)

(2,072

)

Deferred revenue

 

95

 

99

 

Other long-term liabilities

 

(1,138

)

(26

)

Net cash provided by operating activities

 

352

 

4,376

 

Investing activities

 

 

 

 

 

Purchases of available-for-sale investments

 

 

(86,765

)

Proceeds from sales of available-for-sale investments

 

 

2,850

 

Proceeds from maturities of available-for-sale investments

 

 

11,915

 

Purchases of property and equipment

 

(2,575

)

(2,148

)

Business acquisitions, net of cash acquired

 

(88

)

(1,116

)

Net cash used in investing activities

 

(2,663

)

(75,264

)

Financing activities

 

 

 

 

 

Proceeds from issuance of common stock, net of issuance costs

 

65,556

 

 

Proceeds from exercise of options for common stock

 

367

 

4,630

 

Excess tax benefit from exercise of options for common stock

 

 

18

 

Proceeds from notes payable

 

1,145

 

 

Repayment of notes payable

 

(986

)

(847

)

Net cash provided by financing activities

 

66,082

 

3,801

 

Effect of exchange rate changes on cash and cash equivalents

 

19

 

(9

)

Net decrease in cash and cash equivalents

 

63,790

 

(67,096

)

Cash and cash equivalents at beginning of period

 

18,695

 

84,546

 

Cash and cash equivalents at end of period

 

$

82,485

 

$

17,450

 

Supplemental disclosure of cash flow information

 

 

 

 

 

Cash paid for interest

 

$

419

 

$

150

 

Cash paid for taxes

 

131

 

227

 

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).

 

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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.

 

Unaudited Interim Financial Statements

 

The accompanying condensed consolidated balance sheets and the condensed consolidated statements of operations, comprehensive income and cash flows are unaudited. These unaudited 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, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014, or any other future interim or annual period.

 

These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on February 21, 2014. The December 31, 2013 consolidated balance sheet included herein was derived from the audited financial statements as of that date.

 

Reclassifications

 

Certain prior-year amounts have been reclassified in order to conform to the current-year presentation. A reclassification was made from general and administrative expenses to other income (expense) related to foreign currency transaction gains (losses). As a result, income from operations is impacted by $0.2 million for the three months ended September 30, 2013, and by $10,000 for the nine months ended September 30, 2013, but this reclassification did not impact previously reported net income, or related per share amounts, for either period. In addition, a reclassification was made related to international hospitality revenue previously disclosed as United States hospitality revenue. The reclassification did not materially impact previous disclosures related to geographic information. Furthermore, this reclassification had no effect on previously reported amounts related to total revenue, income from continuing operations, net income or related per share amounts, and does not impact previous disclosures regarding concentrations of revenue.

 

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.

 

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 operating segment.

 

Concentrations of Risk

 

The Company’s accounts receivable are derived from revenue earned from its worldwide network of dealers and distributors. The Company’s sales to dealers and distributors located outside the United States are generally denominated in United States dollars, except for sales to dealers and distributors located in the United Kingdom and the European Union, which are generally denominated in pounds sterling and the euro, respectively. There were no individual account balances greater than 10% of total accounts receivable at December 31, 2013 and September 30, 2014.

 

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Table of Contents

 

No dealer or distributor accounted for more than 10% of total revenue for the three and nine months ended September 30, 2013 and 2014.

 

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 dealers and distributors 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 months ended September 30, 2013 and 2014. The following table sets forth revenue from the United States, Canada and all other international dealers and distributors combined (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Revenue-United States

 

$

22,140

 

$

25,517

 

$

60,933

 

$

71,211

 

Revenue-Canada

 

3,641

 

4,140

 

10,690

 

10,802

 

Revenue-all other international sources

 

7,860

 

9,463

 

21,132

 

25,623

 

Total revenue

 

$

33,641

 

$

39,120

 

$

92,755

 

$

107,636

 

 

 

 

 

 

 

 

 

 

 

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

 

23

%

24

%

23

%

24

%

 

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, asset impairment, 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 (at its option) 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, net of refurbished products. The Company assesses the adequacy of its recorded warranty liability each period and makes adjustments to the liability as necessary. Warranty costs accrued includes amounts accrued for products at the time of shipment, adjustments for changes in estimated costs for warranties on products shipped in the period, and changes in estimated costs for warranties on products shipped in prior periods. It is not practicable for the Company to determine the amounts applicable to each of these components.

 

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

 

 

 

Warranty Liability

 

Balance at December 31, 2013

 

$

1,213

 

Warranty costs accrued

 

679

 

Warranty claims

 

(778

)

Balance at September 30, 2014

 

$

1,114

 

 

Net Income Per Share

 

Basic net income per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of common shares outstanding and potentially dilutive

 

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Table of Contents

 

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 per share (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

1,731

 

$

2,763

 

$

1,233

 

$

4,235

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common stock outstanding for basic net income per common share

 

14,389

 

23,840

 

6,511

 

23,559

 

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

 

9,167

 

1,750

 

14,695

 

2,112

 

Weighted average common shares and dilutive securities outstanding

 

23,556

 

25,590

 

21,206

 

25,671

 

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Convertible preferred stock

 

 

 

 

 

Options to purchase common stock

 

253

 

1,245

 

355

 

912

 

Warrants to purchase common stock

 

 

 

 

 

Warrants to purchase preferred stock

 

 

 

1

 

 

Total

 

253

 

1,245

 

356

 

912

 

 

Restricted Cash

 

Restricted cash as of September 30, 2014, is composed of a guarantee made by our subsidiary in the United Kingdom to HM Revenue & Customs related to a customs duty deferment account.

 

Recent Accounting Pronouncements

 

In July 2013, the FASB issued ASU 2013-11, ‘‘Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.’’ The amended guidance requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The guidance was effective for the Company beginning January 1, 2014. 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.

 

In May 2014, the FASB issued ASU 2004-09, “Revenue from Contracts with Customers (Topic 606),” which amends the guidance in ASC 605, “Revenue Recognition.” The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted.  The Company is still evaluating the impact of adopting this guidance as well as whether the Company will apply the amendments retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of applying this update at the date of initial application.

 

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Table of Contents

 

In August 2014, the FASB issued ASU 2014-15, ‘‘Presentation of Financial Statements — Going Concern (Subtopic 205-40).’’ The amended guidance requires an entity to prepare financial statements under the liquidation basis of accounting in accordance with Subtopic 205-30, Presentation of Financial Statements—Liquidation Basis of Accounting, if liquidation of the entity becomes imminent. The guidance is effective for the annual period ending on December 31, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The adoption of this guidance will not have an impact on the Company’s results of operations, financial position, or cash flows.

 

2. Balance Sheet Components

 

Inventories consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2013

 

2014

 

Finished goods

 

$

14,061

 

$

14,689

 

Component parts

 

1,251

 

857

 

 

 

$

15,312

 

$

15,546

 

 

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

 

 

 

December 31,

 

September 30,

 

 

 

2013

 

2014

 

Computer equipment and software

 

$

4,152

 

$

4,240

 

Lab and warehouse equipment

 

2,374

 

2,737

 

Manufacturing tooling and test equipment

 

2,652

 

2,655

 

Furniture and fixtures

 

2,046

 

2,587

 

Leasehold improvements

 

1,450

 

1,646

 

Marketing equipment

 

604

 

662

 

 

 

13,278

 

14,527

 

Less: accumulated depreciation

 

(9,335

)

(10,319

)

 

 

$

3,943

 

$

4,208

 

 

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

 

 

 

December 31,

 

September 30,

 

 

 

2013

 

2014

 

Acquired technology

 

$

1,678

 

$

2,650

 

Less: accumulated amortization

 

(750

)

(1,080

)

 

 

$

928

 

$

1,570

 

 

Other assets consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2013

 

2014

 

Prepaid licensing

 

$

716

 

$

653

 

Deposits

 

404

 

491

 

 

 

$

1,120

 

$

1,144

 

 

Accrued liabilities consisted of the following (in thousands):

 

 

 

December 31,

 

September 30,

 

 

 

2013

 

2014

 

Sales returns and warranty accruals

 

$

2,137

 

$

2,075

 

Compensation accruals

 

3,233

 

1,569

 

Other accrued liabilities

 

544

 

1,238

 

Current portion of settlement obligations

 

907

 

20

 

 

 

$

6,821

 

$

4,902

 

 

9



Table of Contents

 

3. Fair Value Measurements

 

Assets Measured and Recorded at Fair Value on a Recurring Basis

 

The Company’s financial assets that are measured at fair value on a recurring basis consist of money market funds and available-for-sale investments. The following three levels of inputs are used to measure the fair value of financial instruments:

 

Level 1: Quoted prices in active markets for identical assets or liabilities.

 

Level 2: Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3: Unobservable inputs are used when little or no market data is available.

 

The fair values for substantially all of the Company’s financial assets are based on quoted prices in active markets or observable inputs. For Level 2 securities, the Company uses a third-party pricing service which provides documentation on an ongoing basis that includes, among other things, pricing information with respect to reference data, methodology, inputs summarized by asset class, pricing application and corroborative information.

 

The Company determines realized gains or losses on the sale of marketable securities on a specific identification method. During the three and nine months ended September 30, 2014, the Company did not record significant realized gains or losses on the sales of available-for-sale investments.  The following tables show the Company’s cash and available-for-sale investments’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category recorded as cash and cash equivalents or short- or long-term investments as of December 31, 2013 and September 30, 2014 (in thousands):

 

 

 

December 31, 2013

 

 

 

Adjusted
Cost

 

Unrealized
Gains

 

Unrealized
Losses

 

Fair Value

 

Cash and
Cash
Equivalents

 

Short-term
Investments

 

Long-term
Investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

5,533

 

$

 

$

 

$

5,533

 

$

5,533

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 1:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

79,013

 

 

 

79,013

 

79,013

 

 

 

Subtotal

 

79,013

 

 

 

79,013

 

79,013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

84,546

 

$

 

$

 

$

84,546

 

$

84,546

 

$

 

$

 

 

 

 

September 30, 2014

 

 

 

Adjusted
Cost

 

Unrealized
Gains

 

Unrealized
Losses

 

Fair Value

 

Cash and
Cash
Equivalents

 

Short-term
Investments

 

Long-term
Investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

8,310

 

$

 

$

 

$

8,310

 

$

8,310

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 1:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

8,440

 

 

 

8,440

 

8,440

 

 

 

Subtotal

 

8,440

 

 

 

8,440

 

8,440

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 2:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset-backed securities

 

4,461

 

 

(3

)

4,458

 

 

 

4,458

 

Corporate bonds

 

54,146

 

4

 

(47

)

54,103

 

 

37,837

 

16,266

 

Commercial paper

 

11,593

 

 

 

11,593

 

700

 

10,893

 

 

U.S. agency securities

 

2,501

 

 

 

2,501

 

 

 

2,501

 

Subtotal

 

72,701

 

4

 

(50

)

72,655

 

700

 

48,730

 

23,225

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

89,451

 

$

4

 

$

(50

)

$

89,405

 

$

17,450

 

$

48,730

 

$

23,225

 

 

10



Table of Contents

 

As of September 30, 2014, the Company considers the declines in market value of its investment portfolio to be temporary in nature and does not consider any of its investments other-than-temporarily impaired. The Company typically invests in highly-rated securities, and its investment policy generally limits the amount of credit exposure to any one issuer. The policy requires investments generally to be investment grade, with the primary objective of minimizing the potential risk of principal loss. Fair values were determined for each individual security in the investment portfolio. The maturities of the Company’s long-term investments range from one to two years. When evaluating an investment for other-than-temporary impairment the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, changes in market interest rates, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell the investment before recovery of the investment’s cost basis. During the three and nine months ended September 30, 2014, the Company did not recognize any significant impairment charges.

 

Fair Value of Other Financial Instruments

 

The carrying amounts reported in the accompanying 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 (see Note 4).  As a result, the balance of the notes payable is categorized within the Level 2 fair value hierarchy.

 

4. 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 revolving 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, 2014. In addition, the Company pays an annual commitment fee of $20,000 and a quarterly unused line of credit fee of 0.375% based on the difference between the borrowing commitment of $13.0 million and the then current balance. In addition, the SVB Agreement provided for term borrowings to fund purchases of property and equipment through May 2014. Term borrowings are payable in 42 equal monthly payments of principal plus interest and bear interest at prime plus 0.50%, which was 3.75% at September 30, 2014.

 

Borrowing under the revolving credit facility is subject to certain collateral restrictions relating primarily to the Company’s accounts receivable and inventory levels. As of September 30, 2014, the 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, 2014.

 

5. 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 taxable 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 $0.1 million and $0.3 million for the three months ended September 30, 2013 and 2014, respectively, or approximately 6% and 8% of income before income taxes, respectively.  Income tax expense was $0.1 million and $0.4 million for the nine months ended September 30, 2013 and 2014, respectively, or approximately 10% and 8% of income before income taxes, respectively.  The effective tax rate for the three and nine months ended September 30, 2014 differs from the U.S. federal statutory rate of 34% primarily due to the domestic valuation allowance offsetting most of the statutory rate, state income taxes, foreign income taxes, U.S. federal alternative minimum tax, and incentive stock options.

 

Significant judgment is required in determining our provision for income taxes, recording valuation allowances against deferred tax assets and evaluating our uncertain tax positions. In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence, including our past operating results, our forecast of future market growth, forecasted earnings, future taxable income and prudent and feasible tax planning strategies. Due to historical net losses incurred and the uncertainty of realizing the deferred tax assets, for all the periods presented, we have a full valuation allowance against our deferred tax assets. To the extent that we generate positive income and expect, with reasonable certainty, to continue to

 

11



Table of Contents

 

generate positive income we may release all or a portion of our valuation allowance in a future period. This release would result in the recognition of certain deferred tax assets, a decrease to income tax expense for the period such release is made. In addition, our effective tax rate in subsequent periods would increase, and more closely approximate the federal statutory rate of 34%, after giving consideration to state income taxes, foreign income taxes and effect of exercising incentive stock options.

 

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, 2014, the Company was not under examination by any tax authorities. Tax years beginning in 2010 are subject to examination by tax authorities in the United States, although net operating loss and credit carryforwards from all years are subject to examinations and adjustments for at least three years following the year in which the attributes are used. Tax years beginning in 2011 are subject to examination by the taxing authorities in Hong Kong. Tax years beginning in 2012 are subject to examination by the taxing authorities in the United Kingdom, China, and India.

 

6. Equity Compensation

 

Stock Options

 

In 2003, the Board of Directors adopted the 2003 Equity Incentive Plan (the “2003 Plan”), which provided for the granting of nonqualified and incentive stock options, stock appreciation rights, stock awards and restricted stock. Under the 2003 Plan, the Company was able to grant nonqualified and incentive stock options to directors, employees and non-employees providing services to the Company. 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. 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. 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 as of the preceding December 31. On January 1, 2014, the number of reserved shares was increased by 1,139,255 shares in accordance with the provisions of the 2013 Plan.

 

A summary of stock option activity for the nine months ended September 30, 2014 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, 2013

 

4,905,214

 

 

 

$

6.31

 

 

 

Granted

 

1,060,278

 

$

10.91

 

19.34

 

 

 

Exercised

 

(1,077,534

)

 

 

4.29

 

 

 

Expired

 

(136

)

 

 

7.40

 

 

 

Forfeited

 

(69,338

)

 

 

15.53

 

 

 

Balance at September 30, 2014

 

4,818,484

 

 

 

9.47

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercisable options at September 30, 2014

 

2,786,424

 

 

 

5.86

 

5.1

 

Vested and expected to vest at September 30, 2014

 

4,627,382

 

 

 

9.21

 

6.5

 

 

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Table of Contents

 

The following table summarizes information about stock options outstanding and exercisable at September 30, 2014:

 

 

 

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)

 

$0.52 - 1.72

 

$

0.98

 

52,095

 

0.8

 

52,095

 

0.8

 

1.97 - 3.38

 

2.41

 

383,489

 

1.6

 

383,489

 

1.6

 

3.58 - 6.14

 

5.54

 

1,855,137

 

5.3

 

1,625,426

 

5.1

 

6.34 - 9.94

 

8.27

 

1,044,732

 

7.5

 

586,174

 

7.3

 

11.28 - 16.97

 

12.77

 

656,299

 

8.4

 

121,117

 

6.3

 

17.66 - 22.92

 

21.01

 

826,732

 

9.4

 

18,123

 

8.9

 

 

 

 

 

4,818,484

 

 

 

2,786,424

 

 

 

 

For the stock option awards vested during the three and nine months ended September 30, 2014, the total fair value was $1.0 million and $3.4 million, respectively. The following table summarizes the aggregate intrinsic-value of options exercised, exercisable and vested and expected to vest (in thousands):

 

 

 

For the nine months ended
and as of September 30, 2014

 

Options Exercised

 

$

17,856

 

Options Exercisable

 

19,883

 

Options Vested and Expected to Vest

 

23,644

 

 

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,

 

 

 

2013

 

2014

 

2013

 

2014

 

Expected volatility

 

57

%

57-58

%

56-59

%

56-60

%

Expected dividends

 

0

%

0

%

0

%

0

%

Expected terms (in years)

 

5.5-6.1

 

6.1

 

3.3-7.2

 

3.8-6.1

 

Risk-free rate

 

1.5-1.7

%

1.8-1.9

%

0.8-1.7

%

1.1-2.0

%

 

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,

 

 

 

2013

 

2014

 

2013

 

2014

 

Cost of revenue

 

$

15

 

$

29

 

$

46

 

$

77

 

Research and development

 

419

 

562

 

974

 

1,682

 

Sales and marketing

 

187

 

296

 

543

 

810

 

General and administrative

 

319

 

452

 

1,085

 

1,425

 

Total stock-based compensation expense

 

$

940

 

$

1,339

 

$

2,648

 

$

3,994

 

 

At September 30, 2014, there was $16.1 million of total unrecognized compensation cost related to non-vested stock option awards that will be recognized over a weighted-average period of 3.0 years.

 

13



Table of Contents

 

7. Related Party Transactions

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Company 1

 

$

694

 

$

1,011

 

$

2,059

 

$

2,601

 

Company 2

 

 

139

 

128

 

542

 

Company 3

 

262

 

9

 

748

 

11

 

Company 4

 

4

 

 

423

 

 

 

 

$

960

 

$

1,159

 

$

3,358

 

$

3,154

 

 

As of December 31, 2013 and September 30, 2014, the Company had accounts receivable from these companies totaling $0.6 million and $0.9 million, respectively.  Purchase and payment terms with these related parties are consistent with other non-affiliated companies.

 

8. Commitments and Contingencies

 

Operating Leases

 

The Company leases office and warehouse space under operating leases that expire between 2015 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 and $0.5 million for the three months ended September 30, 2013 and 2014, respectively, and $1.0 million and $1.3 million for the nine months ended September 30, 2013 and 2014, 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, 2014 (in thousands):

 

2014

 

$

466

 

2015

 

1,917

 

2016

 

1,811

 

2017

 

1,578

 

2018

 

835

 

 

 

$

6,607

 

 

Purchase Commitments

 

The Company had non-cancellable purchase commitments for the purchase of inventory, which extend through May 2015 totaling approximately $25.4 million at September 30, 2014.

 

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, 2014.

 

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.

 

14



Table of Contents

 

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. For example, on April 23, 2014, Olivistar, LLC (“Olivistar”), a limited liability company organized under the laws of Texas, filed a Complaint against the Company in the Eastern District of Texas alleging that the Company’s light switches and MyHome App infringe two United States patents that Olivistar owns by assignment. On July 15, 2014, the Company filed an Answer to Olivistar’s Complaint, and on August 8, 2014, the parties entered into a settlement agreement, which resulted in Olivistar dismissing its Complaint with prejudice.

 

On August 12, 2014 and September 16, 2014, respectively, the Company received letters from Nokia Corporation alleging that the Company manufactures or supplies products that practice IEEE 802.11 Standards related to wireless technology, and that Nokia is the owner of a portfolio of patents essential to that standard. The Company is conducting an investigation of the claims made by Nokia regarding its patent portfolio. Nokia has not initiated litigation against the Company, but the Company believes that Nokia may do so. The Company intends to defend itself vigorously with respect to this and any other claims or litigation.

 

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 other than specifically identified above, that individually or in the aggregate, could have a material effect on the Company’s financial condition, operations, or cash flows. Currently, a range of loss associated with any individual material legal proceeding cannot be reasonably estimated.

 

9. Acquisition

 

On September 10, 2014, Control4 Corporation (“Control4”), through its wholly owned subsidiary, Control4 EMEA, LTD (“Control4 EMEA”), completed the acquisition of Extra Vegetables Limited, a company incorporated in England and Wales (“Extra Vegetables”), pursuant to a Stock Purchase Agreement dated August 28, 2014, by and among Control4 EMEA and all of the shareholders of Extra Vegetables (the “Purchase Agreement”). Extra Vegetables developed integration modules and third-party device drivers for Control4 and other third-party home automation systems.

 

Pursuant to the terms of the Purchase Agreement, Control4 EMEA purchased all of the issued and outstanding shares of Extra Vegetables from its shareholders (each a “Selling Shareholder,” and together, the “Selling Shareholders”) and Extra Vegetables became a wholly owned subsidiary of Control4 EMEA. Each Selling Shareholder also agreed to become an employee of Control4 EMEA or Control4. The total consideration transferred was $0.9 million in cash, which included a base purchase price of $0.7 million and $0.2 million as payment for the Company’s net working capital.

 

Total consideration transferred was allocated to tangible and identifiable intangible assets acquired and liabilities assumed based on their preliminary fair values at the acquisition date as set forth below, with such preliminary fair values being subject to final review and analysis and consideration of the tax implications of the fair value allocations. While, from the acquisition date, the Extra Vegetables products will be provided without charge of a separate fee, the Company believes that the acquisition of Extra Vegetables will strengthen the Company’s interoperability development efforts for the connected home, accelerate the development and time-to-market for essential third-party device drivers, offer more comprehensive technical support, deliver better functionality, and provide more integration opportunities, while eliminating complexity for the Company’s dealers and distributors managing multiple vendors, licensing, and permission models. Management estimated the fair values of tangible and intangible asset and liabilities in accordance with the applicable accounting guidance for business combinations. The preliminary amount of consideration transferred is subject to potential adjustments in the event that the accounts receivable becomes uncollectible or preliminary estimates of accrued liabilities, including income taxes payable, are inaccurate. The Company expects the allocation of the consideration transferred to be final within the measurement period (up to one year from the acquisition date).

 

The Company’s preliminary allocation of consideration transferred for Extra Vegetables is as follows (in thousands):

 

 

 

Estimated Fair Value

 

Cash

 

$

265

 

Other assets acquired

 

125

 

Intangible assets

 

596

 

Goodwill

 

79

 

Total assets acquired

 

1,065

 

Taxes payable

 

175

 

Other liabilities assumed

 

8

 

Total net assets acquired

 

$

882

 

 

15



Table of Contents

 

Identifiable Intangible Assets

 

The Company acquired intangible assets that consisted of developed technology and non-compete agreements, which had preliminary estimated fair values of $574,000 and $22,000, respectively. The assets were measured at fair value reflecting the highest and best use of nonfinancial assets in combination with other assets and liabilities using an income approach that discounts expected future cash flows to present value. The estimated net cash flows were discounted using a discount rate of 22%, which is based on the estimated internal rate of return for the acquisition and represents the rate that market participants might use to value the intangible assets. The projected cash flows were determined using key assumptions such as: estimates of revenues and operating profits; the time and resources needed to recreate integration modules and drivers; the life of the product; and associated risks related to viability and product alternatives. The Company will amortize the intangible assets on a straight-line basis over their estimated useful lives of four years for developed technology and two years for non-competition agreements. This amortization is not deductible for income tax purposes.

 

Goodwill

 

The $79,000 of goodwill represents the excess of consideration transferred over the fair value of assets acquired and liabilities assumed and is attributable to Extra Vegetables’ assembled workforce as well as the benefits expected from combining the Company’s research and engineering operations with Extra Vegetables’. This goodwill is not deductible for income tax purposes.

 

Other

 

From the date of acquisition through September 30, 2014, the Company recorded revenue and net income associated with Extra Vegetables of approximately $7,000 and $3,500, respectively. Additionally, the Company incurred, and expects to incur, approximately $95,000 in total acquisition-related costs accounted for in general and administrative expenses.

 

Pro Forma Information

 

The unaudited pro forma information presented below includes the effects of the Extra Vegetables acquisition as if it had been consummated as of January 1, 2013, with adjustments to give effect to pro forma events that are directly attributable to the acquisition, including adjustments related to the amortization of acquired intangible assets. The unaudited pro forma information does not reflect any operating efficiency or potential cost savings, which may result from the consolidation of Extra Vegetables. Accordingly, the unaudited pro forma information is presented for informational purposes only and is not necessarily indicative of what the actual results of the combined company would have been if the acquisition had occurred at the beginning of the period presented, nor is it indicative of the future results of operations. In fact, the Company plans to provide the Extra Vegetables products in Control4’s driver database and make them freely available to Control4 dealers through the Company’s installation software; therefore, the Company will not generate any direct, stand-alone product revenue from the Extra Vegetables technology in future periods.

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

 

 

(in thousands)

 

Revenue

 

$

33,961

 

$

39,443

 

$

93,691

 

$

108,724

 

Income from operations

 

2,046

 

3,433

 

3,095

 

5,460

 

Net income

 

$

1,868

 

$

2,936

 

$

1,661

 

$

4,792

 

Net income per share, basic

 

$

0.13

 

$

0.12

 

$

0.26

 

$

0.20

 

Net income per share, diluted

 

$

0.08

 

$

0.11

 

$

0.08

 

$

0.19

 

 

10. Goodwill and Intangible Assets

 

Goodwill

 

Changes in the carrying amount of goodwill consisted of the following (in thousands):

 

 

 

Amount

 

Balance at December 31, 2013

 

$

 

Current period acquisitions

 

99

 

Balance at September 30, 2014

 

$

99

 

 

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For a discussion of the significant changes in goodwill, see Note 9. The Company’s goodwill is not deductible for income tax purposes.

 

Intangible assets

 

The Company’s intangible assets and related accumulated amortization consisted of the following as of December 31, 2013 and September 30, 2014 (in thousands):

 

 

 

December 31, 2013

 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Developed technology

 

$

1,647

 

$

(742

)

$

905

 

Non-competition agreements

 

31

 

(8

)

23

 

Total intangible assets

 

$

1,678

 

$

(750

)

$

928

 

 

 

 

 

 

 

September 30, 2014

 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Developed technology

 

$

2,597

 

$

(1,060

)

$

1,537

 

Non-competition agreements

 

53

 

(20

)

33

 

Total intangible assets

 

$

2,650

 

$

(1,080

)

$

1,570

 

 

For a discussion of the significant changes in intangible assets, see Note 9. The weighted average amortization period is 4.4 years for developed technology, 2.0 years for non-competition agreements, and 4.3 years in total.

 

The Company recorded amortization expense during the respective periods for these intangible assets as follows: (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Amortization of intangible assets

 

$

83

 

$

134

 

$

218

 

$

330

 

 

Amortization of finite lived intangible assets as of September 30, 2014 is as follows for the next four years (in thousands):

 

 

 

Amount

 

2014

 

$

160

 

2015

 

612

 

2016

 

418

 

2017

 

237

 

2018

 

143

 

 

 

$

1,570

 

 

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 Annual Report on Form 10-K for the year ended December 31, 2013 filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 21, 2014, and 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 or growth; 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 or market opportunities 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

 

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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 and not give undue reliance to these forward-looking statements. 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.

 

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying condensed consolidated financial statements and notes to assist readers in understanding our operations, financial condition and cash flows. MD&A is organized as follows:

 

·                  Overview.  Discussion of our business and overall analysis of financial and other highlights affecting the company in order to provide context for the remainder of MD&A.

·                  Factors and Trends Affecting our Performance.  A summary of certain market factors and trends that we believe are important to our business that we must successfully address in order to continue to grow our business.

·                  Key Operating and Financial Metrics.  Key operating and financial metrics that we use to evaluate and manage our business.

·                  Results of Operations.  An analysis of our financial results comparing 2014 to 2013.

·                  Liquidity and Capital Resources.  An analysis of changes in our balance sheets and cash flows, and a discussion of our financial condition and potential sources of liquidity.

·                  Non-GAAP Financial Measures. A reconciliation of certain non-GAAP financial measures used by management 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.

·                  Contractual Obligations and Off-Balance Sheet Arrangements.  An overview of contractual obligations, contingent liabilities, commitments and off-balance sheet arrangements outstanding as of September 30, 2014, including expected payment schedule.

·                  Critical Accounting Estimates.  Accounting estimates that we believe are most important to understanding the assumptions and judgments incorporated in our reported financial results and forecasts.

 

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. In 2013, we derived 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. In April 2013, we began bundling the MyHome software licenses with our controller appliances. As a result, we began selling MyHome software licenses only to legacy system owners. Sales of individual MyHome software licenses have declined since April 2013 and are insignificant in 2014. We also generate revenue from the sale of annual subscriptions to our 4Sight subscription 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.

 

Consumers purchase our products from our worldwide network of certified independent dealers, regional and national retailers and distributors. These dealers, retailers and distributors 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, multi-dwelling units and small commercial facilities. We refer to revenue from sales of our products through these dealers, retailers and distributors as our Core revenue (“Core revenue”). In addition, a portion of our revenue is attributable to sales in the hospitality industry. Core revenue does not include revenue from sales to hotels or certification fees paid to us. Our revenue from sales to hotels

 

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is generally project-based and has been significant in some periods and insignificant in other periods. During the year ended December 31, 2013, we sold our products directly to over 3,000 active direct dealers in the United States, Canada, the United Kingdom and 43 other countries, and partnered with 29 distributors to cover an additional 41 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 compounded annual growth rate for total revenue between 2006 and 2013 was 28%, as shown in the following table (dollars in millions):

 

 

 

For the Year Ended December 31,

 

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

2012

 

2013

 

Core revenue

 

$

22.4

 

$

35.9

 

$

49.8

 

$

56.2

 

$

70.9

 

$

88.3

 

$

105.6

 

$

126.4

 

Core revenue growth over prior year

 

211

%

61

%

39

%

13

%

26

%

25

%

20

%

20

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other revenue

 

$

0.6

 

$

4.2

 

$

7.3

 

$

11.5

 

$

4.0

 

$

5.1

 

$

3.9

 

$

2.1

 

Other revenue growth over prior year

 

515

%

583

%

75

%

57

%

-65

%

28

%

-24

%

-46

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

23.0

 

$

40.1

 

$

57.1

 

$

67.7

 

$

74.9

 

$

93.4

 

$

109.5

 

$

128.5

 

Total revenue growth over prior year

 

215

%

75

%

42

%

19

%

11

%

25

%

17

%

17

%

 

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 and delivering enhanced dealer installation and marketing tools. For example, during the third quarter of 2014 we announced the release of our new operating system, Control4 OS 2.6 and Composer Express, a mobile configuration tool that enables Control4 Dealers to simplify and accelerate the set-up process for home automation systems.  In addition, during 2014, we announced a new initiative to encourage customers to upgrade legacy Control4 systems with our current primary controllers, so that they can enjoy better system performance, the latest Control4 OS, an improved user experience and enhanced functionality and features.

 

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. For example, during the third quarter of 2014, we acquired the operations of two small technology businesses.  In July 2014, we acquired the home automation products and related intellectual property assets of Card Access, Inc. (“Card Access”), an engineering and technology company based in Utah. We previously sold these products through a distribution agreement with Card Access. We determined the Card Access acquisition to be an immaterial transaction. In September 2014, we acquired Extra Vegetables, Ltd (“Extra Vegetables”), a UK-based company that developed integration modules and third-party drivers for Control4 and other third-party home automation systems. While the acquired drivers will be provided in Control4’s driver database and made freely available to Control4 dealers through our installation software, the acquisition will strengthen the Company’s interoperability strategy. We plan to continue to identify, acquire and integrate strategic technologies, assets and businesses that we believe will enhance the overall strength of our business. The purchase of these products and technologies will allow us to streamline sales, technical support and training, enhancing our dealers’ ability to grow their businesses.

 

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.

 

Factors and Trends Affecting Our Performance

 

A number of industry trends have facilitated our growth over the past several years, including the proliferation of connected devices and the ubiquity and growth of network-enabled homes. From smartphones to smart watches to smart cars, technology is transforming nearly every aspect of our lives, streamlining daily routines and providing quick, easy access to the capabilities and content we want most. Not only are new technologies providing convenience on-the-go, but they are becoming increasingly accessible.

 

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From 2006 through 2008, the majority of our sales were for use in new, single-family homes. During the slowdown in the new housing market beginning in 2008, our dealers redirected their focus to existing homes, and today, we estimate that the majority of our installations are in existing homes. We expect that future increases in either new home construction or existing home renovations will have a positive impact on our revenue. In February 2014, we announced an initiative with Toll Brothers, Inc., a leading home builder in the United States, for Toll Brothers to offer several pre-configured Control4 automation packages to prospective home buyers through on-site product demonstrations, videos, marketing collateral and other materials. Since that time, we have focused our efforts on identifying and training 28 Toll Brothers authorized Control4 dealers, as well as distributing sales and marketing packages and materials to model homes and design studios in seven developments in the key regions. Toll Brothers dealers are now actively selling Control4 solutions to prospective homebuyers for these developments. Additionally, we plan to begin working with other national builders on similar strategic alliance terms. Furthermore, we continue to work regionally, throughout the U.S., with our dealers and their local builders to enable hundreds of new housing projects and multi-dwelling communities with Control4 automation for intelligent lighting, aware and efficient heating and cooling, interactive audio & video intercom, and sensors to improve safety and security. In many of these markets, dealers and builders are taking advantage of our regional builder program, whereby the developer commits to install an entry-level Control4 base package in every unit as a standard offering, providing our dealers the opportunity to up-sell additional Control4 solutions to the owner before initial move-in.

 

We believe that the growth of our business and our future success are dependent upon many factors, including the rates at which consumers adopt our products and services, our ability to strengthen and expand our dealer and distributor network, our ability to expand internationally and our ability to meet competitive challenges. While each of these areas presents significant opportunities for us, they also pose important challenges that we must successfully address in order to sustain or expand the growth of our business and improve our results of operations. These challenges include:

 

·                  Increasing Adoption Rates of Our Products and Services.  We are focused on increasing adoption rates of our products and services through enhancements to our software platform and product offerings. We intend to accomplish these enhancements through both continued investment in research and development activities and acquisitions of complementary businesses and technologies.

·                  Increasing Our Brand Awareness.  Our historical marketing efforts have been focused on attracting and retaining qualified dealers and distributors and providing them with consumer-facing materials and tools to market to prospects on their own. We recently expanded activities to drive online awareness and sales leads in their local markets. As a result, traffic to our dealers’ sites has increased over 75% since the launch of these initiatives in late 2013. As we begin the planning process for 2015, we look to expand our consumer marketing activities more aggressively to further accelerate lead generation and drive brand awareness in targeted local markets. In September 2014, we hired an advertising agency and are now developing our end-user marketing strategy.

·                  Optimizing Our North America Dealer Network.  We intend to continue to optimize the performance of and expand our network of dealers in North America to ensure that we have geographic coverage and technical expertise to address our existing markets and new markets into which we plan to expand. We have added, and expect to continue to add, field sales and service personnel to assist in the optimization of our North America channel.

·                  Expanding our International Dealer and Distributor Network.  We believe that our future growth will be significantly impacted by our ability to expand our dealer and distributor network outside of North America, adapt our products and services to foreign markets and increase our brand awareness internationally. In particular, we believe that we will have significant opportunities to expand our business in emerging markets such as China and India. We have added, and expect to continue to add, field sales and service personnel to assist in the optimization of our international channels.

·                  Managing Competition.  The market for home automation is fragmented, highly competitive and continually evolving. A number of large technology companies such as Apple, Google, Microsoft and Samsung offer device control capabilities among some of their own products, applications and services and could be engaged in ongoing development efforts to address the broader home automation market. For example, during 2014, Google acquired Nest Labs, Inc. which manufactures thermostats and smoke detectors; Nest Labs, Inc. acquired Dropcam, a home-monitoring camera company; Apple introduced HomeKit, a new framework for communicating with and controlling connected devices in a user’s home; and Samsung acquired home automation startup SmartThings. Our ability to gain significant market share in the home automation market and interoperate with the new technologies developed by other large technology companies over the next several years will be key factors in our ability to continue to grow our business and meet or exceed our future expectations.

 

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Key Operating and Financial Metrics

 

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

 

North America Direct Dealers

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Authorized dealers at the beginning of the period

 

2,476

 

2,605

 

2,388

 

2,544

 

Additions

 

67

 

69

 

219

 

238

 

Terminations

 

(20

)

(36

)

(84

)

(144

)

Authorized dealers at the end of the period

 

2,523

 

2,638

 

2,523

 

2,638

 

Number of active, authorized dealers

 

2,457

 

2,566

 

2,457

 

2,566

 

% of active, authorized dealers

 

97

%

97

%

97

%

97

%

 

International Direct Dealers

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Authorized dealers at the beginning of the period

 

701

 

732

 

629

 

635

 

Additions

 

36

 

40

 

113

 

142

 

Terminations

 

(137

)

(12

)

(142

)

(17

)

Authorized dealers at the end of the period

 

600

 

760

 

600

 

760

 

Number of active, authorized dealers

 

554

 

670

 

554

 

670

 

% of active, authorized dealers

 

92

%

88

%

92

%

88

%

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Number of controller appliances sold

 

16,154

 

20,230

 

49,120

 

53,970

 

 

 

 

 

 

 

 

 

 

 

Core revenue growth

 

18

%

15

%

19

%

16

%

International Core revenue as a percentage of total revenue

 

23

%

23

%

22

%

22

%

 

Number of North America and International Direct 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. We define an active, authorized dealer (“active dealer”) as one that has placed an order with us in the trailing 12-month period.

 

Our active international direct dealer network is generally growing at a faster rate than our active 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. The number of active international dealers increased 21% between the nine months ended September 30, 2013 and 2014, compared to an increase of 4% in the number of active North American direct dealers during the same period.

 

While we believe that we continue to have significant international opportunities, it is difficult to anticipate the exact timing and amount of growth, particularly in new and emerging markets. During the nine months ended September 30, 2014, we experienced 20% year-over-year growth in International Core revenue, driven primarily by strong sales in one of our more mature geographies, the United Kingdom. Divergent regional and local economic and political trends, particularly relating to new home construction and strengthening of the U.S. dollar versus certain local currencies are examples of challenges we must address in order to continue our international expansion. Such challenges may cause our growth rate to be slower than anticipated, offsetting our efforts to expand into these emerging geographies. That said, we are starting to see increasing revenue growth in China and India, suggesting that our

 

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investments in those markets, including the opening of technical support and training centers in the third quarter of 2013, are contributing to increased contribution margin and profitability.

 

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.

 

During the three and nine months ended September 30, 2014, we sold 20,230 and 53,970 controllers, respectively, compared to 16,154 and 49,120 controllers sold in the same periods in 2013. Controller sales grew 25% during the three months ended September 30, 2014 compared to 2013. This compares to our overall growth in revenue of 16% during the same period. The higher growth rate in controller sales during the three months ended September 30, 2014 is due primarily to sales promotions on our HC-250 and HC-800 controllers during the month of September. Year to date controller sales are up only 10% as a result of a reduction in the total number of controllers sold during the first quarter of 2014 compared to the same period in 2013. The year over year reduction in the first quarter of 2014 was due primarily to the increase in controller pricing implemented in the second quarter of 2013.  In the first quarter of 2013, we announced a price increase on our HC-250 and HC-800 controllers to be effective on April 1, 2013. That pricing announcement resulted in a significant number of controllers sold late in the first quarter of 2013, in advance of the price change. Our total revenue for controller sales was higher in the first quarter of 2014 compared to the first quarter of 2013 as our average selling price per controller sold increased by 21%.

 

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 certification fees paid to us. Our revenue from sales to hotels is generally project-based and has been significant in some periods and insignificant in other periods. In the future, we expect revenue from hospitality to continue to be attributable to large projects and will continue to be uneven from period to period. We therefore believe that our Core revenue growth is a good measure of our market penetration and the growth of our business.

 

International Core 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 the U.K., 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.

 

Results of Operations

 

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,

 

 

 

2013

 

2014

 

2013

 

2014

 

 

 

(in thousands)

 

North America Core Revenue

 

$

25,353

 

$

29,098

 

$

70,752

 

$

81,081

 

International Core Revenue

 

7,710

 

8,916

 

20,060

 

24,125

 

Other Revenue

 

578

 

1,106

 

1,943

 

2,430

 

Total Revenue

 

$

33,641

 

$

39,120

 

$

92,755

 

$

107,636

 

North America Core Revenue as a % of Total Revenue

 

75

%

74

%

76

%

75

%

International Core Revenue as a % of Total Revenue

 

23

%

23

%

22

%

22

%

 

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North America Core revenue increased by $3.7 million, or 15%, and $10.3 million, or 15%, in the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013, primarily as a result 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. During the second quarter of 2014, we experienced slower than anticipated sales in Canada, which impeded our year over year growth in North America. The revenue decline in Canada was due primarily to the timing of sales to several large dealers, turnover in our field sales team in Canada and general softness in the Canadian housing market. We saw a reversal of this trend in the third quarter. Core revenue in Canada increased by $0.5 million, or 14%, and $0.1 million, or 1%, respectively, in the three and nine months ended September 30, 2014, respectively. Revenue in Canada was approximately 12% and 10% of our total revenue for the nine months ended September 30, 2013 and 2014, respectively.

 

International Core revenue increased by $1.2 million, or 16%, and $4.1 million, or 20%, respectively, in the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013, primarily due to an increase in both the total number of dealers and distributors and the percentage of those dealers actively selling our products and services.

 

The growth in International Core revenue was due primarily to increased sales in the United Kingdom. During the third quarter of 2013, we opened our technical support and training centers in China and India. In addition, in early 2014 and again recently, we increased the number of field sales personnel in Asia to broaden our sales reach, particularly in China. Revenue growth in these countries suggests that our investments in these markets are contributing to increased gross margin and profitability. For example, revenue has increased 44% and 16% in China for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013.

 

Other revenue, which consists primarily of sales in the hospitality industry, increased by $0.5 million, or 91%, and $0.5 million, or 25%, in the three and nine months ended September 30, 2014, respectively. Hospitality revenue is generally project-based, and, as a result, fluctuates from period to period.

 

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 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. 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 be negatively affected by price competition in our target markets and associated promotional or volume incentive rebates offered to our dealers and distributors. For example, in 2014, we announced a new initiative to encourage customers to upgrade legacy Control4 systems with our current primary controllers, and the products sold under this program included discounted pricing.

 

Gross margin for the three and nine months ended September 30, 2013 and 2014 was as follows (in thousands, except percentages):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Gross margin

 

$

17,049

 

$

20,273

 

$

46,806

 

$

55,476

 

Percentage of revenue

 

51

%

52

%

50

%

52

%

 

As a percentage of revenue, our gross margin increased from 51% and 50%, respectively, in the three and nine months ended September 30, 2013, to 52% and 52%, respectively, during the same periods in 2014. The increase was due to a variety of factors, including component cost reductions, lower manufacturing overhead expenses as a percentage of revenue and favorable channel sales mix.

 

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 long 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 a given period. For the three and nine months ended September 30, 2014, we received credits for duties paid in previous periods of $32,000 and $183,000, respectively. 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 as we are now current on our claims relating to prior periods.

 

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Table of Contents

 

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 be less significant if the growth rate of that revenue slows in future periods.

 

Research and Development Expenses

 

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. We also include fees paid to agencies to obtain regulatory certifications.

 

Research and development expenses for the three and nine months ended September 30, 2013 and 2014, respectively, were as follows (in thousands, except percentages):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2013

 

2014

 

2013

 

2014

 

Research and development

 

$

6,409

 

$

6,647

 

$

18,670

 

$

20,519

 

Percentage of revenue

 

19

%

17

%

20

%

19

%

 

Research and development expenses increased by $0.2 million, or 4%, and $1.8 million, or 10%, in the three and nine months ended September 30, 2014 respectively, compared to the same periods in 2013. These increases were primarily due to an increase in headcount and related expenses, including non-cash stock based compensation expense, to support ongoing and expanded product development activities.

 

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 Expenses

 

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.

 

Sales and marketing expenses for the three and nine months ended September 30, 2013 and 2014 were as follows (in thousands, except percentages):