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MERU > SEC Filings for MERU > Form 10-Q on 14-May-2013All Recent SEC Filings

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Form 10-Q for MERU NETWORKS INC


14-May-2013

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 "Item 1A. 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 local area network, or 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 7,600 customers worldwide in many markets, including education, healthcare, hospitality, manufacturing, retail, technology, finance, government, telecom, transportation and utilities. However, at the present time, we are focusing the majority of our sales and marketing efforts on the three key vertical markets of education, healthcare and hospitality.

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 our channel partners. We continue to evolve our entire organization, including our sales and marketing programs, 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 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, 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 $97.5 million in 2012 and were $24.7 million during the three months ended March 31, 2013. However, 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.

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. Those factors include year-end spending, end of year sales incentives, the timing of our annual sales training in the first quarter, the procurement and deployment cycles of our education customers and seasonal reductions in business activities during the summer. The magnitude of this seasonality may be overshadowed by overall growth in product sales, variation in deferred revenue, and the timing of large transactions. 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, and we anticipate that we will continue to suffer operating losses through the remainder of fiscal year 2013. As of March 31, 2013, we had an accumulated deficit of


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$256.6 million. We believe that a strong balance sheet, with sufficient cash and cash equivalents to grow our business and instill customer confidence, is important to our continued success. Therefore, during the first quarter of 2013, we engaged in a secondary offering of our Common Stock which generated $12.6 million, net of underwriting discounts, commissions and offering expenses. As of March 31, 2013, we had cash and cash equivalents of $35.6 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. 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, or VSOE, for our support services. These changes have had a significant impact on the timing of our recognition of 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.

Key Metrics

We monitor the key financial metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies. We discuss product revenues, support and services revenues and the components of operating income below under "Components of Revenues, Cost of Revenues and Operating Expenses" and we discuss our cash and cash equivalents under "Liquidity and Capital Resources."

                                                          Three Months Ended March 31,
                                                            2013               2012
                                                             (dollars in thousands)
Products revenues                                      $       20,590    $         15,803
Support and services revenues                                   4,103               3,558
Gross margin-products and support and services                     63 %                64 %
Loss from operations (1)                               $       (2,773 )  $        (14,357 )
Cash and cash equivalents                                      35,620              22,855
Net cash provided by (used in) operating activities             1,036             (10,115 )



(1) Includes stock-based compensation expense of: $ 1,454 $ 2,232

Gross margin-products and support and services. We monitor gross margin to measure our cost efficiencies, including primarily whether our manufacturing costs and component costs are in line with our product revenues and whether our personnel costs associated with our technical support, professional services and training teams are in line with our support and services revenues.

Net cash provided by (used in) operating activities. We monitor cash flow from operations as a measure of our overall business performance. Our primary use of cash from operating activities has been related to personnel and other operating expenditures as well as purchases of inventory. Monitoring cash flow from operations enables us to analyze our financial performance without the non-cash effects of certain items such as depreciation and amortization, stock-based compensation expenses, accrued interest on long-term debt, amortization of issuance costs and warrant expense, thereby allowing us to better understand and manage the cash needs of our business.


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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 MeruAssure customer support program, which includes the provision of 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 those 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.

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. As well, 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.

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 a substantial amount of our 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, legal and information technology functions. Professional services consist of outside legal and accounting services and information technology consulting costs, and include the costs of litigation defense. 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. In 2012, the litigation reserve expense was related to the settlement, license and release agreement with Extricom. As part of this agreement, we paid Extricom $2.4 million and expensed the full amount in 2012. For potential losses for which there is a reasonable possibility (meaning the likelihood is more than remote but less than probable) that a loss exists, we will disclose an estimate of the potential loss or range of such potential loss or include a statement that an estimate of the potential loss cannot be made.

Interest Expense, Net. During the three months ended March 31, 2013 and 2012, interest expense, net consists primarily of interest expense on debt and customer prompt payment discounts. As of March 31, 2013, we had $9.3 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 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; income taxes and loss contingencies.

There have been no significant changes in our accounting policies during the three months ended March 31, 2013, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2012.


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Results of Operations

Three months ended March 31, 2013 compared to three months ended March 31, 2012

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 March 31,
                                               2013                2012
REVENUES:
Products                                 $ 20,590    83.2 %  $  15,803    81.4 %
Support and services                        4,103    16.6        3,558    18.3
Ratable products and services                  42     0.2           50     0.3
Total revenues                             24,735   100.0       19,411   100.0
COSTS OF REVENUES:
Products                                    7,317    29.6        5,454    28.1
Support and services                        1,776     7.2        1,455     7.5
Ratable products and services                  22     0.1           31     0.2
Total costs of revenues                     9,115    36.9        6,940    35.8
Gross margin                               15,620    63.1       12,471    64.2
OPERATING EXPENSES:
Research and development                    3,688    14.9        3,871    19.9
Sales and marketing                        11,420    46.1       15,574    80.2
General and administrative                  3,285    13.3        5,033    25.9
Litigation reserve                              -       -        2,350    12.1
Total operating expenses                   18,393    74.3       26,828   138.2
Loss from operations                       (2,773 ) (11.2 )    (14,357 ) (74.0 )
Interest expense, net                        (610 )  (2.4 )        (29 )  (0.1 )
Other income (expense), net                   (62 )  (0.3 )         28     0.1
Loss before provision for income taxes     (3,445 ) (13.9 )    (14,358 ) (74.0 )
Provision for income taxes                    138     0.6          129     0.3
Net loss                                 $ (3,583 ) (14.5 )% $ (14,487 ) (74.6 )%

Our total revenues increased by $5.3 million, or 27.4%, to $24.7 million during the three months ended March 31, 2013 from $19.4 million during the three months ended March 31, 2012. This increase was primarily the result of increased demand for our products particularly in the United States and United Kingdom during the three months ended March 31, 2013. Our ratable revenues for the three months ended March 31, 2013 and March 31, 2012 were immaterial.

Products revenues increased by $4.8 million, or 30.3%, to $20.6 million during the three months ended March 31, 2013 from $15.8 million during the three months ended March 31, 2012. The increase was primarily a result of an increase in unit shipments particularly in the United States and United Kingdom during the three months ended March 31, 2013.

Support and services revenues increased by $0.5 million, or 15.3%, to $4.1 million during the three months ended March 31, 2013 from $3.6 million during the three months ended March 31, 2012. This increase in support and services revenues is a result of increased product 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 $8,000, or 16.0%, to $42,000 during the three months ended March 31, 2013 from $50,000 during the three months ended March 31, 2012. This ratable revenue is being amortized from transactions initiated prior to 2009 and is expected to continue to decrease 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 $2.2 million, or 31.3%, to $9.1 million during the three months ended March 31, 2013 from $6.9 million during the three months ended March 31, 2012. Overall gross margins, as a percentage of total revenues, decreased to 63.1% during the three months ended March 31, 2013 from 64.2% during the three months ended March 31, 2012. Our product gross margins decreased to 64.5% during the three months ended March 31, 2013 from 65.5% during the three months ended March 31, 2012. This decrease in the product gross margin during the three months ended March 31, 2013 was primarily the result of product mix. Our support and services gross margins decreased to 56.7% during the three months ended March 31, 2013 from 59.1% during the three months ended March 31, 2012. This decrease was primarily the result of increased costs due to our continued investment in headcount related to customer support as well as timing in providing professional services.

Operating Expenses

Our operating expenses decreased by $8.4 million, or 31.4%, to $18.4 million during the three months ended March 31, 2013 from $26.8 million during the three months ended March 31, 2012, and decreased as a percentage of revenue from 138.2% during the three months ended March 31, 2012 to 74.3% during the three months ended March 31, 2013.

Research and Development Expenses

Research and development expenses decreased by $0.2 million, or 4.7%, to $3.7 million during the three months ended March 31, 2013 from $3.9 million during the three months ended March 31, 2012. This decrease is primarily the result of a decrease of $0.2 million in stock-based compensation as compared to the same period of last year.

Sales and Marketing Expenses

Sales and marketing expenses decreased by $4.2 million, or 26.7%, to $11.4 million during the three months ended March 31, 2013 from $15.6 million during the three months ended March 31, 2012. Beginning in the second quarter of 2012, we took steps to bring our sales and marketing expenses in line with our revenue expectations. This resulted in a decrease of $2.2 million in sales and marketing personnel costs as a result of lower headcount, a decrease of $1.0 million in sales and marketing program expenses, a decrease of $0.4 million in travel expenses and a decrease of $0.3 million in stock-based compensation expense as compared to the same period of last year.

General and Administrative Expenses

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