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MERU > SEC Filings for MERU > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for MERU NETWORKS INC

Form 10-Q for MERU NETWORKS INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report. This Periodic Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts contained in this Form 10-Q, including statements regarding our future results of operations and financial position, strategy and plans, and our expectations for future operations, are forward-looking statements. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. The words "believe," "may," "should," "plan," "potential," "project," "will," "estimate," "continue," "anticipate," "design," "intend," "expect" and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in "Risk Factors." In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Form 10-Q may not occur, and actual results and the timing of certain events could differ materially and adversely from those anticipated or implied in the forward-looking statements as a result of many factors.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. In addition, neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. We disclaim any duty to update any of these forward-looking statements after the date of this Form 10-Q to confirm these statements to actual results or revised expectations.

Overview

We provide a virtualized wireless LAN solution that is designed to cost-effectively optimize the enterprise network to deliver the performance, reliability, predictability and operational simplicity of a wired network, with the advantages of mobility. Our solution represents an innovative approach to wireless networking that utilizes virtualization technology to create an intelligent and self-monitoring wireless network. We sell a virtualized wireless LAN solution built around our System Director Operating System, which runs on our controllers and access points. We also offer additional products designed to deliver centralized network management, predictive and proactive diagnostics and enhanced security.

We were founded in January 2002 with the vision of developing a virtualized wireless LAN solution that enables enterprises to deliver business-critical applications over wireless networks, and become what we refer to as All-Wireless Enterprises. From our inception through 2003, we were principally engaged in the design and development of our virtualized wireless LAN solution. We focused on developing technology that could reliably and predictably deliver business-critical applications using voice, video and data over wireless networks in dense environments. We began commercial shipments of our products in December 2003, and initially targeted markets where the wireless delivery of applications in dense environments is critical, such as healthcare and education. Since that time, we have broadened our focus to include organizations in more markets, and have significantly expanded our geographic reach. To date, our products have been deployed by approximately 7,000 customers worldwide in many markets, including education, healthcare, hospitality, manufacturing, retail, technology, finance, government, telecom, transportation and utilities.

We outsource the manufacturing of our hardware products, including all of our access points and controllers, to original design manufacturers and contract manufacturers. We also outsource the warehousing and delivery of our products to a third-party logistics provider in the United States for worldwide fulfillment.


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Our products and support services are sold worldwide, primarily through value-added resellers, or VARs, and distributors, which serve as our channel partners. We employ a sales force that is responsible for managing sales within each geographic territory in which we market and sell our products.

Since inception, we have expended significant resources on our research and development operations. Our research and development activities were primarily conducted at our headquarters in Sunnyvale, California until 2005, when we significantly expanded our research and development operations in Bangalore, India. In 2006, we began developing products specifically to leverage the capabilities of a new wireless communication standard promulgated by the Institute of Electrical and Electronics Engineers, or IEEE, the 802.11n standard, and began commercial shipments of our 802.11n products in the second half of 2007.

We believe several emerging trends and developments will be integral to the future growth of our business. The growing number of wireless devices and the increased expectations of the users of these devices are driving demand for better performing wireless networks. Enterprises increasingly view wireless networks as a means to deliver better service to their customers and increase the productivity of their workforce, and as a result, they are shifting from the casual use of wireless networks to the strategic use of wireless networks for business-critical applications. Further, enterprises are increasingly realizing that wireless networks designed to optimize the 802.11n standard and the planned 802.11ac standard can deliver the capacity and performance to support their business-critical applications.

Our ability to capitalize on emerging trends and developments will depend, in part, on our ability to execute our growth strategy of increasing the recognition of our brand and the effectiveness of our solution, expanding the adoption of our solution across markets, and expanding and leveraging our relationships with the channel partners. We continue to evolve our entire organization to further capitalize on growth opportunities.

On March 18, 2012, our Board of Directors appointed Dr. Bami Bastani, who previously served as the president, chief executive officer, and board member of companies in the mobility, consumer, and broadband markets, as our president and chief executive officer, or CEO, and a member of our Board of Directors. Our ability to achieve and maintain profitability as well as our other goals in the future will be affected by, among other things, our ability to integrate our current CEO, the continued acceptance of our products, the timing and size of our orders, the average selling prices for our products and services, the costs of our products, and the extent to which we invest in our sales and marketing, research and development, and general and administrative resources.

Our revenues have grown from $1.1 million in 2005 to $90.5 million in 2011 and were $69.3 million during the nine months ended September 30, 2012. It is difficult to predict our revenues in the near term. Our revenues have in the past fluctuated significantly, and may continue to fluctuate in the future. Further, our revenues during any given quarter depend on multiple factors, including, but not limited to, the amount of orders booked in a prior quarter but not shipped until the given quarter, new orders received and shipped in the given quarter, the amount of deferred revenue recognized in the given quarter and the amount of revenues that meet the accounting standards for revenue recognition. These factors could impact our revenues significantly in any given quarter.

In addition, we believe that there can be significant seasonal factors that may cause the first and third quarters of our fiscal year to have relatively weaker products revenues than the second and fourth fiscal quarters. We believe that this seasonality results from a number of factors, including:

customers with a December 31 fiscal year end may choose to spend remaining budgets before their year end resulting in a positive impact on our products revenues in the fourth quarter of our fiscal year;

the structure of our direct sales compensation program may provide additional financial incentives to our sales personnel for exceeding their annual goals;

the timing of our annual training for the entire sales force in our first fiscal quarter combined with the above fourth quarter factors can potentially cause our first fiscal quarter to be seasonally weak;

many of our education customers have procurement and deployment cycles that can result in stronger order flow in our second fiscal quarter than other quarters assuming the continued availability of traditional funding sources, such as the E-Rate program in the United States; and

seasonal reductions in business activity during the summer months in the United States, Europe and certain other regions may have a negative impact on our third quarter revenues.


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We believe that our historical growth, variations in the number of orders booked in a prior quarter but not shipped until a later quarter and other variations in the amount of deferred revenues may have overshadowed the nature or magnitude of seasonal or cyclical factors that might have influenced our business to date. In addition, the timing of one or more large transactions may overshadow seasonal factors in any particular quarterly period. Seasonal or cyclical variations in our operations may become more pronounced over time and may materially affect our results of operations in the future.

We have incurred losses since inception as we grew our business and invested in research and development, sales and marketing, and administrative functions. As of September 30, 2012, we had an accumulated deficit of $248.7 million.

Vendor Specific Objective Evidence

Our recognition of revenues in a particular period depends on the satisfaction of specific revenue recognition criteria, which we describe in more detail below. We adopted two new accounting standards for certain revenue arrangements at the beginning of fiscal year 2011 that include software elements and multiple deliverable revenue arrangements. The manner in which we recognize our revenues has changed significantly over time, particularly in 2008 and 2009, when we established vendor specific objective evidence of fair value, or VSOE, for our support services. These changes have had a significant impact on the timing of when we recognize revenues from sales of our products and services. Generally, upon establishing VSOE for support services for a customer or class of customers, our total recognized revenues from sales to these customers increased in subsequent periods because we were able to recognize all of the products revenues from these sales in these periods once all revenue recognition criteria were satisfied, and we were no longer required to defer the recognition of products revenues over the support period. We also continued to recognize ratable products and services revenues from sales to customers made prior to establishing VSOE for support services. This impact will decrease over time as our deferred revenue balance declines from the time we established VSOE for support services. We recognize the costs of revenues in the same period in which we recognize the associated revenues. When reviewing our financial performance and making period-to-period comparisons, you should consider the impact that the timing of the adoption of the two new accounting standards and the establishment of VSOE had on our financial results, including the amount of our revenues and costs of revenues.

Components of Revenues, Costs of Revenues and Operating Expenses

Revenues. We derive our revenues from sales of our products, and support and services. Our total revenues are comprised of the following:

Products Revenues - We generate products revenues from sales of our software and hardware products, which primarily consist of our System Director Operating System running our access points and controllers, as well as additional software applications.

Support and Services Revenues - We generate support and services revenues primarily from service contracts for our Meru Assure customer support program, which includes software updates, maintenance releases and patches, telephone and internet access to our technical support personnel and hardware support. We also generate support and services revenues from the professional and training services that we provide to our VARs, distributors and customers.

Ratable Products and Services Revenues - Prior to January 1, 2009, we recognized ratable products and services revenues from sales of our products and services in circumstances where VSOE for support services being provided could not be segregated from the value of the entire sales arrangement, or where we provided technical support or unspecified software upgrades outside of contractual terms. In these cases, revenues were deferred and recognized ratably over either the economic life of the product or the contractual period. As of January 1, 2009, we established VSOE for support services for all our channel partners and customers, and we no longer offer support outside of contractual terms, and therefore, we are able to recognize products revenues and support and services revenues separately.


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Deferred Revenue. Prior to establishing VSOE for our support services provided to VARs, distributors and customers, we recognized the revenues from such sales over either the economic life of the related products or the contractual support period, depending on the party and the time at which the sale occurred. As such, prior to establishing VSOE for support services sold to VARs, distributors and customers, only a small amount of our invoiced products and services within a quarter were recognized as revenues in such quarter, with the majority recorded as deferred revenue. We established VSOE for support services sold to our channel partners, including VARs, distributors and customers, at different times during 2007, 2008 and 2009. The decreases in deferred revenue due to the related recognition of ratable revenue are partially offset by the sale of support services that will be recognized over the term of the support agreements. The total deferred revenue as of September 30, 2012 and December 31, 2011 were $17.5 million and $16.2 million.

Costs of Revenues. Our total costs of revenues is comprised of the following:

Costs of Products Revenues - A substantial majority of the costs of products revenues consists of third-party manufacturing costs and component costs. Our costs of products revenues also include shipping costs, third-party logistics costs, write-offs for excess and obsolete inventory and warranty costs.

Costs of Support and Services Revenues - Costs of support and services revenues is primarily comprised of personnel costs associated with our technical support, professional services and training teams.

Costs of Ratable Products and Services Revenues - Costs of ratable products and services revenues is comprised primarily of deferred costs of products revenues and an allocation of costs of services revenues.

Operating Expenses. Our operating expenses consist of research and development, sales and marketing, general and administrative expenses and litigation reserve expense. The largest component of our operating expenses is personnel costs. Personnel costs consist of salaries, commissions, bonuses and benefits for our employees. We grant our employees and members of our board of directors equity awards and recognize stock-based compensation cost as part of operating expenses. We expect to continue to incur significant stock-based compensation expense as our employee base grows. Professional services consist of outside legal and accounting services and information technology and other consulting costs.

Research and Development Expenses. Research and development expenses primarily consist of personnel, engineering, testing and compliance, facilities and professional services costs. We expense research and development costs as incurred. We are devoting substantial resources to the continued development of additional functionality for our existing products and the development of new products.

Sales and Marketing Expenses. Sales and marketing expenses represent the largest component of our operating expenses and primarily consist of personnel costs, sales commissions, travel costs, cost for marketing programs and facilities costs.


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General and Administrative Expenses. General and administrative expenses primarily consist of personnel, professional services and facilities costs related to our executive, finance, human resource and information technology functions. Professional services consist of outside legal and accounting services and information technology consulting costs. We have incurred additional accounting and legal costs related to compliance with rules and regulations enacted by the SEC, including the additional costs of complying with
Section 404 of the Sarbanes-Oxley Act, as well as additional insurance, investor relations and other costs associated with being a public company.

Litigation Reserve Expense. Litigation reserve expense consists of settlements or anticipated settlements of litigation. During the nine months ended September 30, 2012, the litigation reserve expense was related to the settlement, license and release agreement with Extricom Ltd., or Extricom. As part of this agreement, we paid Extricom $2.4 million. The payment was made in April 2012. During the nine months ended September 30, 2011, we entered into a license agreement with Motorola. As part of the license agreement, we agreed to pay Motorola $7.3 million and expensed the full amount in the nine months ended September 30, 2011.

Interest Expense, Net. Interest expense, net consists primarily of interest expense on debt, customer prompt payment discounts for the nine months ended September 30, 2012. Interest expense, net consists primarily of interest expense on debt, prompt payment discounts and interest income on cash and cash equivalents and short-term investments balances. As of September 30, 2012, we had $10.9 million of outstanding debt before debt discounts.

Critical Accounting Policies

Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations, comprehensive income and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgments and estimates.

We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, could potentially have a significant impact on our condensed consolidated financial statements: revenue recognition; stock-based compensation; fair value of financial instruments; inventory valuation; allowance for doubtful accounts; and income taxes.

There have been no significant changes in our accounting policies during the nine months ended September 30, 2012, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2011.


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Results of Operations

Three months ended September 30, 2012 compared to three months ended September 30, 2011

The following table presents our historical operating results in dollars (in thousands) and as a percentage of revenues for the periods presented:

                                             Three Months Ended September 30,
                                                 2012                  2011
REVENUES:
Products                                 $   20,910      82.4 %  $ 20,096    84.6 %
Support and services                          4,432      17.4       3,155    13.3
Ratable products and services                    44       0.2         507     2.1
Total revenues                               25,386     100.0      23,758   100.0
COSTS OF REVENUES:
Products                                      7,191      28.3       7,239    30.5
Support and services                          1,764       7.0       1,191     5.0
Ratable products and services                    24       0.1         333     1.4
Total costs of revenues                       8,979      35.4       8,763    36.9
Gross margin                                 16,407      64.6      14,995    63.1
OPERATING EXPENSES:
Research and development                      4,072      16.0       3,718    15.6
Sales and marketing                          13,830      54.5      12,869    54.2
General and administrative                    3,496      13.8       3,655    15.4
Total operating expenses                     21,398      84.3      20,242    85.2
Loss from operations                         (4,991 )   (19.7 )    (5,247 ) (22.1 )
Interest expense, net                          (721 )    (2.8 )       (45 )  (0.2 )
Other income, net                                35       0.1          18     0.1
Loss before provision for income taxes       (5,677 )   (22.4 )    (5,274 ) (22.2 )
Provision for income taxes                      119       0.4          98     0.4
Net loss                                 $   (5,796 )   (22.8 )% $ (5,372 ) (22.6 )%

Revenues

Our total revenues increased by $1.6 million, or 6.9%, to $25.4 million during the three months ended September 30, 2012 from $23.8 million during the three months ended September 30, 2011. Our products and support and services revenues, or total revenues excluding ratable revenues, increased by $2.1 million, or 9.0%, to $25.3 million during the three months ended September 30, 2012 from $23.3 million during the three months ended September 30, 2011. This increase was primarily the result of increased demand for our products particularly in the United States and the EMEA regions during the three months ended September 30, 2012.

Products revenues increased by $0.8 million, or 4.1%, to $20.9 million during the three months ended September 30, 2012 from $20.1 million during the three months ended September 30, 2011. The increase was primarily a result of an increase in unit shipments particularly in the United States and the EMEA regions during the three months ended September 30, 2012.

Support and services revenues increased by $1.3 million, or 40.5%, to $4.4 million during the three months ended September 30, 2012 from $3.2 million during the three months ended September 30, 2011. The increase in support and services revenues is a result of increased product sales particularly in the United States and the EMEA regions, resulting in first-year support sales, and the renewal of support contracts by existing customers. As our customer base grows over time, we expect our support revenues will continue to increase.

Ratable products and services revenues decreased by $0.5 million, or 91.3%, to $44,000 during the three months ended September 30, 2012 from $0.5 million during the three months ended September 30, 2011. This ratable revenue is being amortized from transactions initiated prior to 2009 and is expected to continue to decline over time as the related deferred revenue balance is depleted during 2013.


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Costs of Revenue and Gross Margin

Total costs of revenues increased by $0.2 million, or 2.5%, to $9.0 million during the three months ended September 30, 2012 from $8.8 million during the three months ended September 30, 2011. Overall gross margins, as a percentage of total revenues, increased to 64.6% during the three months ended September 30, 2012 from 63.1% during the three months ended September 30, 2011. Our product gross margins increased to 65.6% during the three months ended September 30, 2012 from 64.0% during the three months ended September 30, 2011. This increase in the product gross margin was primarily the result of a product mix consisting of higher margin items, particularly increased sales in software products. Our support and services gross margins decreased to 60.2% during the three months ended September 30, 2012 from 62.3% during the three months ended September 30, 2011. This decrease in the support and services gross margin was primarily the result of our continued investment in headcount related to customer support and professional services and a reduction in the amount of support costs allocated to ratable revenues. Our ratable gross margins increased to 45.5% during the three months ended September 30, 2012 from 34.3% during the three months ended September 30, 2011.

Operating Expenses

Our operating expenses increased by $1.2 million, or 5.7%, to $21.4 million during the three months ended September 30, 2012 from $20.2 million during the three months ended September 30, 2011, and decreased as a percentage of revenue from 85.2% during the three months ended September 30, 2011 to 84.3% during the three months ended September 30, 2012.

Research and Development Expenses

Research and development expenses increased by $0.4 million, or 9.5%, to $4.1 million during the three months ended September 30, 2012 from $3.7 million during the three months ended September 30, 2011. This increase is primarily the result of an increase of $0.6 million in research and development personnel costs and an increase of $0.1 million in facility expenses related to our expansion in India partially offset by a decrease of $0.4 million in other related engineering expenses as compared to the same period of last year.

Sales and Marketing Expenses

Sales and marketing expenses increased by $1.0 million, or 7.5%, to $13.8 million during the three months ended September 30, 2012 from $12.9 million . . .

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