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GIMO > SEC Filings for GIMO > Form 10-Q on 12-Aug-2013All Recent SEC Filings

Show all filings for GIGAMON INC.

Form 10-Q for GIGAMON INC.


12-Aug-2013

Quarterly Report


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

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, with the Securities and Exchange Commission on June 12, 2013 ("Prospectus"). In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in Part II. Item 1A. "Risk Factors."

Overview

We have developed an innovative solution that delivers pervasive and dynamic intelligent visibility of traffic across networks. Our solution, which we refer to as our Traffic Visibility Fabric, consists of distributed network appliances that enable an advanced level of visibility, modification and control of network traffic. Our Fabric enables IT organizations to forward traffic from network and server infrastructure to management, analysis, compliance and security tools in a manner that is optimized for specific uses or functions.

We generate product revenue primarily from sales of perpetual software licenses installed on physical appliances for our Traffic Visibility Fabric solutions to channel partners, including distributors and resellers, as well as directly to end-user customers. We market and sell our products through a hybrid sales model, which combines a high-touch sales organization and an overlay channel sales team that actively assists our extensive network of channel partners throughout the sales process. We also provide our channel partners with marketing assistance, technical training and support.

We generate services revenue primarily from the sale of maintenance and support services for our products. A one-year contract for our maintenance and support services is bundled with the initial contract to purchase our products. Following expiration of this one-year contract, our end-user customers typically purchase maintenance and support contracts that generally have one-year terms.

Our net revenue increased from $22.5 million in the three months ended June 29, 2012 to $32.4 million in the three months ended June 29, 2013, representing 44% growth. In the six months ended June 29, 2013, our total net revenue increased to $58.2 million from $39.2 million in the six months ended June 30, 2012, representing 49% growth. Net loss attributable to common stockholders was $7.9 million and $9.1 million in the three and six months ended June 29, 2013, respectively, primarily due to the $20.4 million in expenses related to the settlement of performance units ("PUPs") under our 2009 Performance Unit Plan (the "2009 Plan") and $16.7 million in stock-based compensation expense recorded in the three months ended June 29, 2013. In addition, we recorded an income tax benefit of $24.6 million and $24.5 million, in the three and six months ended June 29, 2013, respectively, primarily due to our conversion from a Delaware limited liability company to a Delaware corporation and upon establishing a deferred tax asset resulting from our net loss incurred in 2013. Net income attributable to common stockholders was $1.3 million and $0.4 million in the three and six months ended June 30, 2012, respectively. We generated positive net operating cash flows of $15.1 million and $14.9 million in the six months ended June 29, 2013 and June 30, 2012, respectively.

Key Performance Indicators of Our Business

We monitor a variety of key performance indicators to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies. These key performance indicators include the following (dollars in thousands):

                        Three Months Ended                           Six Months Ended
              June 29,
                2013              June 30, 2012                June 29, 2013         June 30, 2012
Key
Performance
Indicators:
Net revenue $      32,409        $        22,467              $        58,222        $       39,169
Gross
margin                 72 %                   80 %                         75 %                  79 %
(Loss)
income from
operations  $     (32,499 )      $         2,511              $       (33,664 )      $        1,882
Deferred
revenue     $      36,301        $        24,072              $        36,301        $       24,072

Net revenue. We monitor our net revenue to assess the acceptance of our products by our end-user customers and growth in the markets we serve.


Gross margin. We monitor our gross margin to assess the impact on our current and forecasted financial results from any changes to the pricing and mix of products we are selling to our end-user customers.

(Loss) income from operations. We monitor our (loss) income from operations to assess how effectively we are conducting our operations as well as controlling our operating expenses, which are primarily driven by headcount.

Deferred revenue. Our deferred revenue consists of amounts that have been invoiced but that have not yet been recognized as revenue. The majority of our deferred revenue balance consists of the unamortized portion of services revenue from maintenance and support contracts. We also defer revenue, and the related costs of product revenue, on sales of products to a distributor who stocks inventory until that distributor reports to us that it has sold the product to an end-user customer. We monitor our deferred revenue balance because it represents a significant portion of the revenue that we will recognize in future periods. We assess the change in our deferred revenue balance which, taken together with revenue, is an indication of sales activity in a given period.

Initial Public Offering

On June 17, 2013, we completed our initial public offering (the "IPO"), during which we issued and sold 5,512,500 shares of common stock, inclusive of the 1,012,500 shares of common stock sold in connection with the full exercise of the overallotment option of shares granted to the underwriters, at a public offering price of $19.00 per share. In addition, our selling stockholders sold 2,250,000 shares of common stock at a public offering price of $19.00 per share. We did not receive any proceeds from the sales of shares by the selling stockholders. The net proceeds to us from the offering were $93.4 million, net of underwriting discounts, commissions and offering costs.

Financial Overview

Net Revenue

We generate revenue from the sale of products and related services, including maintenance and support. We present revenue net of discounts, rebates, and sales taxes. Net revenue is comprised of the following:

Product revenue. We generate product revenue primarily from sales of perpetual software licenses installed on physical appliances for our Traffic Visibility Fabric solutions. We generally recognize product revenue at the time of product delivery, provided all other revenue recognition criteria have been met. As a percentage of net revenue, we expect our product revenue to vary from quarter-to-quarter based on, among other things, the timing of orders and delivery of products discussed under the section titled "-Results of Operations." We expect our product revenue to increase in absolute dollars as we continue to add new end-user customers, expand the volume of shipments to our current end-user customers and introduce new products.

We have experienced seasonality in the sale of our products and services. The first quarter of each year is usually our lowest revenue quarter during the year and product revenue typically declines sequentially from the prior fourth quarter. We generally expect an increase in sales in the second half of the year, primarily due to the buying habits of many of our end-user customers as budgets for annual capital purchases are being fully utilized.

Services revenue. We generate service revenue from sales of maintenance and support contracts, which are bundled with sales of products, and from subsequent renewals of those contracts. We offer tiered maintenance and support services under our renewable, fee-based maintenance and support contracts, which includes technical support, hardware repair and replacement parts, bug fixes, patches and unspecified upgrades on a when-and-if-available basis. We recognize services revenue ratably over the duration of the contract, which is typically one year and can be up to five years; as a result, the impact on services revenue will lag any shift in product revenue because product revenue is recognized when a product is sold and revenue criteria are satisfied, whereas services revenue is recognized ratably over the contract term. We expect our services revenue to increase in absolute dollars as we increase our installed base by selling more products and adding more end-user customers.

Cost of revenue

Our cost of revenue is comprised of the following:

Cost of product revenue. Cost of product revenue is comprised primarily of the costs associated with manufacturing our products, including third-party hardware manufacturing costs, as well as personnel costs for salary, benefits, bonuses and stock-based compensation expense, shipping costs, allocated costs of facilities and information


technology, and warranty costs and other related expenses. We expect cost of product revenue to increase in absolute dollars in connection with the anticipated increase in product revenue.

Cost of services revenue. Cost of services revenue is comprised primarily of personnel costs for salary, benefits, bonuses and stock-based compensation expense related to our customer support organization, as well as allocated costs of facilities and information technology. We expect cost of services revenue to increase in absolute dollars in connection with the anticipated increase in services revenue.

Gross profit and gross margin

Gross profit has been and will continue to be affected by a variety of factors including shipment volumes, changes in the mix of products and services sold, new product introductions and upgrades to existing products, changes in customer mix, changes in pricing, the extent of customer rebates and incentive programs and changes in our product costs including any excess inventory write-offs. We expect our gross margin to fluctuate over time depending on a variety of factors, including those described above, and may decrease over the longer-term in the event that we experience additional competitive pricing pressure.

Operating expenses

Operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel costs comprise a significant component of our operating expenses, and consist of salary, benefits, bonuses and stock-based compensation expense; and with respect to our sales organization, personnel costs also include sales commissions. From December 31, 2012 through June 29, 2013, we increased headcount from 246 to 327. We expect to continue to hire new employees, although at a slower rate, to support our anticipated growth, particularly with respect to an anticipated increase in research and development headcount for the remainder of 2013. We expect operating expenses to increase in absolute dollars as we continue to grow.

Research and development. Our research and development efforts are focused on new product development and on developing additional functionality for our existing products. Research and development expenses consist primarily of personnel costs, and to a lesser extent, prototype materials, allocated costs of facilities and information technology and product certification. We expense research and development costs as incurred. We expect our research and development expenses to increase in absolute dollars as we continue to develop new products and enhance our existing products.

Sales and marketing. Sales and marketing expenses are the largest component of our operating expenses and consist primarily of personnel costs, as well as travel expenses, trade shows, marketing and promotional activities, and allocated costs of facilities and information technology. We sell our products through our global sales organization, which is divided into three geographic regions: North America, Europe and Asia Pacific. We expect our sales and marketing expenses to increase in absolute dollars as we expand our sales and marketing efforts domestically and internationally to help drive increased revenue.

General and administrative. General and administrative expenses consist of personnel costs and allocated costs of facilities and information technology related to our executive, finance, human resources and legal functions, as well as professional services costs. Professional services costs consist primarily of outside legal and accounting services. We expect to incur additional expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a national securities exchange and costs related to compliance and reporting obligations.

Interest income and other expense, net

Interest income consists primarily of income earned on our invested cash balances. We expect interest income to increase modestly depending on our average invested balances during the period and market interest rates.

Other expense, net consists primarily of foreign currency exchange losses related to transactions denominated in currencies other than the U.S. dollar, which have not been material to date.

Provision for income taxes

We converted from a Delaware limited liability company (a pass through entity for tax purposes) to a Delaware corporation on May 31, 2013. Accordingly, we have elected to be treated as a corporation under Subchapter C of Chapter 1 of the United States Internal Revenue Code and, therefore, have become subject to both federal and state income


taxes. As a result of this tax election, we recorded a one-time non-cash tax benefit of $14.8 million, in the three and six months ended June 29, 2013, for the deferred tax asset amount recorded upon our change in entity status.

We are also subject to state taxes in certain states that may assess capital taxes or taxes based on gross receipts. We also have a subsidiary in a foreign jurisdiction, which is subject to local income taxes.

Stock-based compensation expense and other compensation charges

Beginning in April 2012, we have granted stock options and beginning in August 2012, we have granted restricted stock units ("RSUs"). For the three and six months ended June 30, 2012 or for the first three months of fiscal 2013, we did not record any stock-based compensation expense associated with stock options and RSUs that were subject to the completion of an IPO (the "IPO Awards"). In the three and six months ended June 29, 2013, we recorded stock-based compensation expense of $5.5 million, net of estimated forfeitures, related to these IPO Awards. Upon the completion of our IPO, we began offering eligible employees the opportunity to purchase shares under our 2013 Employee Stock Purchase Plan (the "ESPP"). Total stock-based compensation expense, net of estimated forfeitures, in the three and six months ended June 29, 2013, was $16.7 million and $18.3 million, respectively. As of June 29, 2013, unrecognized compensation expense, net of estimated forfeitures, was $33.0 million.

In addition, upon the completion of our IPO, we recorded cash-based compensation expenses and related payroll taxes of $20.4 million for our PUPs, based on our IPO price of $19.00 per share, and accrued the liability as cost of revenue and operating expenses in the three and six months ended June 29, 2013.

Change in Reporting Calendar

Effective January 1, 2013, we changed our reporting period from a calendar year ending on December 31 of each year to a 52- or 53-week fiscal year that ends on the last Saturday in December. Fiscal year 2013 will be a 52-week fiscal year ending on December 28, 2013, and each quarter will be a 13-week quarter. The first and second quarters of fiscal 2013 ended on March 30, 2013 and June 29, 2013, respectively.


Results of Operations

The following tables set forth our results of operations in dollars and as a
percentage of our net revenue (in thousands, except percentages):





                                 Three Months Ended                  Six Months Ended
                              June 29,         June 30,          June 29,         June 30,
                                2013             2012              2013             2012
Consolidated Statement of
Operations Data:
Net revenue:
Product                      $   23,354        $  16,213        $   40,873        $  27,106
Services                          9,055            6,254            17,349           12,063
Total net revenue                32,409           22,467            58,222           39,169
Cost of revenue:
Product                           7,098            4,086            11,822            7,451
Services                          1,911              453             2,564              945
Total cost of revenue             9,009            4,539            14,386            8,396
Gross margin                     23,400           17,928            43,836           30,773
Operating expenses:
Research and development         17,097            3,570            22,768            7,515
Sales and marketing              26,114            9,112            38,535           17,335
General and administrative       12,688            2,735            16,197            4,041
Total operating expenses         55,899           15,417            77,500           28,891
(Loss) income from
operations                      (32,499 )          2,511           (33,664 )          1,882
Interest income                       1                3                 3                6
Other expense, net                  (18 )             (7 )             (25 )            (33 )
(Loss) income before income
tax benefit (provision)         (32,516 )          2,507           (33,686 )          1,855
Income tax benefit
(provision)                      24,571              (28 )          24,542              (91 )
Net (loss) income            $   (7,945 )      $   2,479        $   (9,144 )      $   1,764

Net (loss) income includes
PUP expense and stock-based
compensation expense
allocated as follows:
PUP expense:
Cost of revenue              $      353        $      -         $      353        $      -
Research and development          5,188               -              5,188               -
Sales and marketing               7,991               -              7,991               -
General and administrative        6,839               -              6,839               -
Total PUP expense            $   20,371        $      -         $   20,371        $      -

Stock-based compensation
 expense:
Cost of revenue              $    2,691        $       2        $    2,709        $       2
Research and development          6,069               32             6,378               32
Sales and marketing               5,263               86             5,692               86
General and administrative        2,674              516             3,511              516
Total stock-based
compensation expense         $   16,697        $     636        $   18,290        $     636


                               Three Months Ended                   Six Months Ended
                           June 29,          June 30,          June 29,          June 30,
                             2013              2012              2013              2012
Percentage of Net
Revenue:
Net revenue:
Product                           72 %              72 %              70 %              69 %
Services                          28                28                30                31
Total net revenue                100               100               100               100
Cost of revenue:                  28                20                25                21
Gross profit                      72                80                75                79
Operating expenses:
Research and development          53                16                39                19
Sales and marketing               80                41                66                45
General and
administrative                    39                12                28                10
Total operating expenses         172                69               133                74
(Loss) income from
operations                      (100 )              11               (58 )               5
Interest income                   -                 -                 -                 -
Other expense, net                -                 -                 -                 -
(Loss) income before
income tax benefit
(provision)                     (100 )              11               (58 )               5
Income tax benefit
(provision)                       75                -                 42                -
Net (loss) income                (25 )%             11 %             (16 )%              5 %

Comparison of the three and six months ended June 29, 2013 and June 30, 2012

Net Revenue

                         Three Months Ended                                                             Six Months Ended
                     June 29,          June 30,                                                     June 29,          June 30,
                       2013              2012             Increase             % Increase             2013              2012             Increase            % Increase
                                                                                   (dollars in thousands)
Net Revenue:
Product              $   23,354         $ 16,213          $     7,141                    44 %      $    40,873         $ 27,106         $    13,767                    51
Services                  9,055            6,254                2,801                    45             17,349           12,063               5,286                    44
Total net revenue    $   32,409         $ 22,467          $     9,942                    44 %      $    58,222         $ 39,169         $    19,053                    49

Three Months Ended June 29, 2013 Compared to Three Months Ended June 30, 2012

Product revenue increased $7.1 million in the three months ended June 29, 2013 compared to the three months ended June 30, 2012, primarily due to the introduction of our high-density products and to a lesser extent from the sales of our existing product portfolio in 2013. Revenue from our high-density products for the three months ended June 29, 2013 increased to $10.3 million from $4.5 million in the three months ended June 30, 2012 due to an increase in volume of units sold. Additionally, revenue from our existing products increased by $1.4 million primarily due to an increase in the volume of units sold in the three months ended June 29, 2013 compared to the three months ended June 30, 2012.

Services revenue increased $2.8 million in the three months ended June 29, 2013 compared to the three months ended June 30, 2012, primarily due to the growth in our installed base at our existing customers and also due to an increase in the total number of end-user customers under maintenance and support contracts, which was driven by higher sales of our products.

Six Months Ended June 29, 2013 Compared to Six Months Ended June 30, 2012

Product revenue increased $13.8 million in the six months ended June 29, 2013 compared to the six months ended June 30, 2012, primarily due to the introduction of our high-density products and to a lesser extent from the sales of our existing product portfolio. Revenue from our high-density products for the six months ended June 29, 2013 increased to $17.2 million from $6.7 million in the six months ended June 30, 2012 due to an increase in volume of units sold. Additionally, revenue from our existing products increased by $3.3 million primarily due to an increase in the volume of units sold in the six months ended June 29, 2013, compared to the six months ended June 30, 2012.


Services revenue increased $5.3 million in the six months ended June 29, 2013 compared to the six months ended June 30, 2012, primarily due to the growth in our installed base at our existing customers and also due to an increase in the total number of end-user customers under maintenance and support contracts, which was driven by higher sales of our products.

Cost of revenue and gross margin

                Three Months Ended                                                 Six Months Ended
             June 29,        June 30,                                          June 29,        June 30,
               2013            2012          Increase        % Increase          2013            2012          Increase        % Increase
                                                                (dollars in thousands)
Cost of
revenue:
Product       $  7,098         $ 4,086         $ 3,012                74  %     $ 11,822         $ 7,451         $ 4,371                59  %
Services         1,911             453           1,458               322           2,564             945           1,619               171
Total cost
of revenue    $  9,009         $ 4,539         $ 4,470                98  %     $ 14,386         $ 8,396         $ 5,990                71  %
Gross
margin:
Product             70  %           75  %                                             71  %           73  %
Services            79  %           93  %                                             85  %           92  %
Total gross
margin              72  %           80  %                                             75  %           79  %
PUP expense
included in:
Cost of
revenue      $    353        $      -        $     353                 *       $   353         $      -        $     353                 *
Stock-based
compensation
expense
included in:
Cost of
revenue       $ 2,691          $     2         $ 2,689                 *        $ 2,709          $     2         $ 2,707                 *

* Not meaningful

Three Months Ended June 29, 2013 Compared to Three Months Ended June 30, 2012

Total gross margin decreased to 72% in the three months ended June 29, 2013 from 80% in the three months ended June 30, 2012. This decrease in gross margin in the three months ended June 29, 2013 was primarily due to increases in stock-based compensation and PUP expenses of $3.0 million in the three months ended June 29, 2013, while gross margins for the three months ended June 30, 2012 were impacted by $0.4 million of inventory write-downs.

Product gross margin decreased to 70% in the three months ended June 29, 2013 from 75% in three months ended June 30, 2012, primarily due to an increase in . . .

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