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FIO > SEC Filings for FIO > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for FUSION-IO, INC.


8-Nov-2013

Quarterly Report

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

Forward-Looking Statements

In addition to historical information, this Annual Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. These forward-looking statements include, but are not limited to, statements concerning our possible or assumed future results of operations, business strategies, financing plans, technological leadership, market opportunity, expectations regarding product acceptance, ability to innovate new products and bring them to market in a timely manner, ability to successfully increase sales of our software offerings as part of our overall sales strategy, expectations concerning our technologies, products and solutions, including our current ioDrive, ioScale, and ioFX product lines, our ION Data Accelerator software, our virtualization acceleration software, and our ioControl hybrid storage system, competitive position and the effects of competition, industry environment, the impact of recent management changes, potential growth opportunities, ability to expand internationally, ability to expand in adjacent markets, the impact of quarterly fluctuations of revenue and operating results, changes to and expectations concerning gross margin, expectations concerning relationships with third parties, including channel partners, key customers and original equipment manufacturers, or OEMs, expectations regarding future revenues from our customers, levels of capital expenditures, future capital requirements and availability to fund operations and growth, the adequacy of facilities, impact and expectations concerning our acquisitions of the ID7 Ltd. and SCST Limited, or ID7 Entities, and NexGen Storage, Inc., or

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NexGen, the adequacy of our intellectual property rights, expectations concerning pending legal proceedings and related costs, the sufficiency of our issued patents and patent applications to protect our intellectual property rights, the effects of a natural disaster on us or our suppliers, our ability to resell inventory that we cannot use in our products due to obsolescence, our ability to maintain or grow our sales through OEMs and other channel partners and to maintain our relationships with those channel partners, including the timely qualification of our products for promotion and sale through those channels, particularly OEMs, OEMs continuing to design our products into their products, the importance of software innovation, and volatility regarding our provision for income taxes. Forward-looking statements include statements that are not historical facts and can be identified by terms such as "anticipates," "believes," "could," "seeks," "estimates," "expects," "intends," "may," "plans," "potential," "predicts, "projects," "should," "will," "would," or similar expressions and the negatives of those terms.

These forward-looking statements are inherently subject to uncertainties, risks, and changes in circumstances that are difficult to predict. Actual results could differ materially from those contained in these forward-looking statements for a variety of reasons, including, but not limited to, those discussed in the section entitled "Risk Factors" in Part II, Item 1A and elsewhere in this report. Other unknown or unpredictable factors also could have a material adverse effect on our business, financial condition, and results of operations. Accordingly, readers should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management's beliefs and assumptions only as of the date of this Form 10-Q.

We are not under any obligation to, and do not intend to, publicly update or review any of these forward-looking statements, whether as a result of new information, future events, or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized, except to the extent required by applicable securities laws. Please carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission, or SEC, that attempt to advise interested parties of the risks and factors that may affect our business, prospects, and results of operations.

The information included in this management's discussion and analysis of financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes included in this report, and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 30, 2013.

Overview

We provide solutions for enterprises, hyperscale datacenters, and small to medium enterprises that accelerate databases, virtualization, cloud computing, big data, information systems, and the applications that help drive business from the smallest e-tailers to some of the world's largest data centers, social media leaders, and Fortune Global 500 businesses. Our integrated hardware and software platforms enable the acceleration of data away from legacy architectures and proprietary hardware. This core technology leverages flash memory to significantly increase datacenter and computer-based information system efficiency, with enterprise grade performance, reliability, availability, and manageability.

We were incorporated in December 2005 and have experienced significant growth since inception. Our growth has included significant increases in end-customers, introduction of new products including those from acquisitions, and investments in our product roadmap and business operations to support this growth. As a result of these factors, our headcount increased from 733 employees as of September 30, 2012 to 911 employees as of September 30, 2013.

We sell our products through our global direct sales force, OEMs, including Cisco, Dell, Fujitsu, HP, and IBM, and other channel partners. Some of our OEMs and channel partners integrate our platform into their own proprietary product offerings. Our primary sales office is located in San Jose, California, and we also have additional sales presence in North America, Europe, and Asia.

Large purchases by a limited number of customers, including OEMs and resellers which sell to end-customers, have accounted for a substantial majority of our revenue, and the composition of the group of our largest customers changes from period to period. Some of our customers make concentrated purchases to complete or upgrade specific large-scale data storage installations. These concentrated purchases are short-term in nature and are typically made on a purchase order basis rather than pursuant to long-term contracts. Customers that accounted for 10% or more of our revenue represented 70% and 57% of revenue for the three months ended September 30, 2012 and 2013, respectively. During the three months ended September 30, 2012 and 2013, revenue from the 10 largest customers in each period, including the applicable OEMs, accounted for approximately 91% and 77% of revenue, respectively. As a result of our revenue concentrations, our quarterly and annual revenue, gross margin, and operating results are likely to fluctuate in the future and will be difficult to estimate. We expect that sales to a limited number of customers will continue to contribute materially to our revenue for the foreseeable future. As our solutions become more broadly deployed in the market place and the number of our end-customers increases, we expect to have a broader customer base to support the continued growth of our business.

We anticipate that sales through OEMs and other channel partners will continue to constitute a substantial portion of our future revenue. In some cases, our products must be designed or qualified into the OEM's products. If that fails to occur for a given product line of an OEM, we would likely be unable to sell our products to that OEM during the life cycle of that product, which would adversely affect our revenue. We expect that as we continue to expand our global presence and business overseas, we will increasingly depend on our OEM relationships in such markets.

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We believe that extending our platform differentiation through software and hardware innovation will be critical to achieving broader market acceptance and to maintaining or increasing our gross margins. In this regard, our ioTurbine virtualization acceleration software, ION Data Accelerator software, ioVDI virtual desktop acceleration, ioControl hybrid storage software, ioSphere management software, and specialized storage memory programming software interface extensions that allow Integrated Software Vendors to develop, integrate, and add significant value to applications using our platforms are important strategic investments that differentiate our products from hardware competitors. We invest in hardware qualification so that we can apply the value of our software to new non-volatile technologies as they become available. We also invest in new hardware controllers to ensure that our products are competitive in performance, reliability, power, and density. If we are unable to successfully develop or acquire hardware or software technology, and then market and sell additional functionality, our ability to increase our revenue and gross margins could be adversely affected.

Our ioMemory technology forms the basis of our ioDrive, ioScale, and ioFX product offerings. Our ioMemory is designed as a portfolio of upgradeable design modules, enabling faster time-to-market and increased extensibility, and it provides server-based storage class memory, low access latency, field upgradeability, deep error correction, self-healing protection, and native PCI-Express connectivity. Our second generation ioMemory technology supports the latest NAND geometries, significantly increases performance and capacity, improves reliability and cost while retaining the ability to build storage systems of varying capacity, performance, and form factors. At the heart of the ioMemory technology is our proprietary field programmable data path controller. It connects a large array of non-volatile memory chips natively to the server's PCI-Express 1.0 or 2.0 peripheral bus, and addresses the reliability issues of non-volatile memory with our Adaptive Flashback Protection advanced chip-level fault tolerance technology, which is capable of restoring, correcting, and resurrecting lost data in the flash-based storage sub-system.

We outsource manufacturing of our ioMemory-based products using a limited number of contract manufacturers. We outsource manufacturing of our shared acceleration products using a limited number of system integrators. We procure a majority of the components used in our products directly from third-party vendors and have them delivered to our contract manufacturers for manufacturing and assembly. Once our contract manufacturers perform sub-assembly and assembly quality tests, our products are assembled to our specified configurations. We then perform final manufacturing assurance tests, labeling, final configuration, including a final firmware installation and shipment to our customers.

As a consequence of the rapidly evolving nature of our business and our limited operating history, we believe that period-to-period comparisons of revenue and other operating results, including gross margin and operating expenses as a percentage of our revenue should not be relied upon as indications of future performance. Although we have historically experienced significant percentage growth in our revenue, we do not believe that our historical growth rates are likely to be sustainable or indicative of future growth.

Components of Condensed Consolidated Statements of Operations

Revenue

We derive revenue primarily from the sale of our storage memory products and support services. We sell our solutions through our global direct sales force, OEMs, and other channel partners. We provide our support services pursuant to support contracts, which involve hardware support, software support, and software upgrades on a when-and-if available basis for a period of one to five years. We recorded services, support, and maintenance revenue of $7.5 million and $8.4 million for the three months ended September 30, 2012 and 2013, respectively. For the periods presented, our software revenue was not significant to our condensed consolidated statements of operations.

Cost of Revenue

Cost of revenue consists primarily of material costs including amounts paid to our suppliers and contract manufacturers for hardware components and assembly of those components into our products. The largest portion of our cost of revenue consists of the cost of non-volatile memory components. Given the commodity nature of memory components, neither we nor our contract manufacturers generally enter into long-term supply contracts for our product components, which can cause our cost of revenue to fluctuate. Cost of revenue is recorded when the related product revenue is recognized. Cost of revenue also includes costs related to carrying value adjustments recorded for excess and obsolete inventory, allocated personnel expenses related to customer support, amortization of intangible assets, manufacturing operations, warranty costs, and costs of shipping.

Operating Expenses

The largest component of our operating expenses is personnel costs, consisting of salaries, benefits, and incentive compensation for our employees, which includes stock-based compensation. Our headcount increased from 733 to 911 from September 30, 2012 to September 30, 2013. As a result, operating expenses have increased significantly over these periods.

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Certain expense amounts previously reported in the condensed consolidated statements of operations for the three months ended September 30, 2012 have been reclassified to reflect an adjustment to the method in which we allocate information technology and facility costs and to conform to fiscal 2014 presentation. As a result of the reclassifications, cost of revenue increased by $0.1 million, sales and marketing expenses increased by $0.6 million, research and development expenses increased by $0.5 million, and general and administrative expenses decreased by $1.2 million for the three months ended September 30, 2012. The net effect of these reclassifications did not impact the amounts previously reported as income from operations and net income.

Sales and Marketing

Sales and marketing expenses consist primarily of personnel costs, including incentive compensation, travel-related costs, allocated facilities and IT costs, product demonstration expenses, depreciation associated with sales and marketing acquired assets, contract labor and consulting expenses associated with sales and marketing activities, and amortization of intangible assets.

Research and Development

Research and development expenses consist primarily of personnel costs, including incentive compensation, allocated facilities and IT costs, depreciation associated with research and development acquired assets, contract labor and consulting services, amortization of intangible assets, travel-related costs, and prototype expenses. We expense research and development costs as incurred.

General and Administrative

General and administrative expenses consist primarily of personnel costs, including incentive compensation, depreciation expense, legal, finance, and accounting expenses, consulting and professional services, allocated facilities and IT costs for our executive, finance, human resources, information technology, and legal organizations, and travel-related costs.

Other Income (Expense), net

Other income (expense), net consists of transactional foreign currency gains and losses, interest expense, and interest income.

Trends in Our Business

Gross Margin

Our gross margin will vary due to product mix, pricing, cost of materials, and product transition. We currently anticipate gross margin to decrease in the near term primarily as a result of our growth strategy.

Operating Expenses

We expect operating expenses to remain relatively flat in absolute dollars in the near term and to increase over time to support growth.

Results of Operations

Revenue

The following table presents our revenue for the periods indicated and related changes as compared to the prior periods (dollars in thousands):

Three Months Ended September 30, Change in 2012 2013 $ % Revenue $ 118,115 $ 86,293 $ (31,822 ) (27 )%

Revenue decreased $31.8 million from the three months ended September 30, 2012 compared to the three months ended September 30, 2013 primarily due to the decrease in the overall volume of our products shipped.

Customers that accounted for 10% or more of our revenue represented 70% and 57% of revenue for the three months ended September 30, 2012 and 2013, respectively. Revenue from the 10 largest customers, including the applicable OEMs, for the periods presented was 91% and 77% of revenue for the three months ended September 30, 2012 and 2013, respectively. Revenue recognized from sales with a ship-to location outside of the United States was 38% and 40% of revenue for the three months ended September 30, 2012 and 2013, respectively.

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Cost of Revenue and Gross Margin

The following table presents our cost of revenue, gross profit, and gross margin
for the periods indicated and related changes as compared to the prior periods
(dollars in thousands):



                                Three Months Ended
                                   September 30,                Change in
                                2012           2013            $            %
            Cost of revenue   $  48,065      $ 36,540      $ (11,525 )      (24 )%
            Gross profit         70,050        49,753        (20,297 )      (29 )%
            Gross margin             59 %          58 %

Cost of revenue decreased $11.5 million and gross profit decreased $20.3 million from the three months ended September 30, 2012 compared to the three months ended September 30, 2013, primarily due to the decrease in the volume of our products shipped. Gross margin decreased period over period due to inventory adjustments primarily from excess and obsolete inventory and amortization of intangible assets acquired in fiscal 2013, partially offset by favorable product mix and material costs.

Operating Expenses

Sales and Marketing

The following table presents our sales and marketing expenses for the periods indicated and related changes as compared to the prior periods (dollars in thousands):

Three Months Ended September 30, Change in 2012 2013 $ % Sales and marketing $ 25,587 $ 34,798 $ 9,211 36 %

Sales and marketing expenses increased $9.2 million from the three months ended September 30, 2012 compared to the three months ended September 30, 2013, primarily due to an increase in sales and marketing personnel, as we hired additional employees to focus on acquiring new customers and expanding our business. This increase in headcount resulted in an $8.1 million increase in personnel-related costs, including a $1.9 million increase in sales commissions. The increase was also due to a $1.6 million increase in travel costs.

Research and Development

The following table presents our research and development expenses for the periods indicated and related changes as compared to the prior periods (dollars in thousands):

Three Months Ended September 30, Change in 2012 2013 $ % Research and development $ 22,173 $ 29,468 $ 7,295 33 %

Research and development expenses increased $7.3 million from the three months ended September 30, 2012 compared to the three months ended September 30, 2013, primarily due to an increase in research and development personnel, resulting in a $7.0 million increase in personnel-related costs.

General and Administrative

The following table presents our general and administrative expenses for the periods indicated and related changes as to the prior periods (dollars in thousands):

Three Months Ended September 30, Change in 2012 2013 $ % General and administrative $ 13,841 $ 13,291 $ (550 ) (4 )%

General and administrative expenses decreased $0.6 million from the three months ended September 30, 2012 compared to the three months ended September 30, 2013, primarily due to lower stock-based compensation expense offset by an increase in other personnel-related costs.

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Other Income (Expense), net

The following table presents our other income (expense), net for the periods indicated and related changes as compared to the prior periods (dollars in thousands):

Three Months Ended September 30, Change in 2012 2013 $ % Other income (expense), net $ 55 $ 170 $ 115 209 %

Other income (expense), net changed by $0.1 million from the three months ended September 30, 2012 compared to the three months ended September 30, 2013, primarily due to an increase in foreign currency exchange rate variances.

Income Tax Expense

The following table presents our income tax expense for the periods indicated and related changes as compared to the prior periods (dollars in thousands):

Three Months Ended September 30, Change in 2012 2013 $ % Income tax expense $ 4,571 $ 262 $ (4,309 ) (94 )%

Income tax expense decreased by $4.3 million from the three months ended September 30, 2012 compared to the three months ended September 30, 2013, primarily due to the current period operating loss. The provision for income taxes for the three months ended September 30, 2013 was comprised primarily of foreign and state income taxes.

Financial Position, Liquidity, and Capital Resources

Primary Sources of Liquidity

As of September 30, 2013, our principal sources of liquidity consisted of cash and cash equivalents of $225.3 million, net accounts receivable of $63.9 million, and amounts available under our revolving line of credit of approximately $21.8 million. We had working capital of $301.4 million as of September 30, 2013.

Historically, our primary sources of liquidity have been from customer payments for our products and services, and the issuance of common stock.

Cash Flow Analysis



                                                  Three Months Ended
                                                     September 30,
                                                  2012          2013
                                                    (In thousands)
              Net cash provided by (used in):
              Operating activities              $ 28,667      $ (17,146 )
              Investing activities                (5,175 )       (3,281 )
              Financing activities                 9,068          7,349

Operating Activities

Our operating cash flow primarily depends on the timing and amount of cash receipts from our customers, inventory purchases, and payments for operating expenses.

Our net cash provided by operating activities for the three months ended September 30, 2012 was $28.7 million. During this period, cash collected from our customers exceeded our operating cash outflows, which consisted primarily of purchases of inventory and personnel-related costs.

Our net cash used in operating activities for the three months ended September 30, 2013 was $17.1 million. During this period, our cash used in operating activities was primarily the result of operating cash outflows, which mainly included payments on certain year-end accrued liabilities and purchases of inventory, exceeding cash collected from our customers as a result of decreased revenue.

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Investing Activities

Cash flows from investing activities primarily relate to purchases of computer equipment, leasehold improvements, and property and equipment to support our growth.

During the three months ended September 30, 2012 and 2013, our net cash used in investing activities was $5.2 million and $3.3 million, respectively, for purchases of property and equipment.

Financing Activities

Cash flows from financing activities primarily include net proceeds from the exercise of stock options and our employee stock purchase plan.

We generated $9.1 million of net cash from financing activities for the three months ended September 30, 2012, primarily due to $5.7 million in net proceeds from the exercise of stock options and our employee stock purchase plan, and $4.4 million from a tax benefit from the exercise of stock options, all offset by the issuance of restricted stock awards and restricted stock units, net of repurchases of $1.1 million.

We generated $7.3 million of net cash from financing activities for the three months ended September 30, 2013, primarily due to $4.8 million in net proceeds from the exercise of stock options and our employee stock purchase plan, and reduced restricted cash of $3.3 million as a result of the majority of our letters of credit being collateralized by our line of credit entered into during the three months ended September 30, 2013.

Revolving Line of Credit

In September 2013, we entered into a credit agreement, or the revolving line of credit, with Silicon Valley Bank. The revolving line of credit allows us to borrow up to a limit of $25.0 million, with a $25.0 million letter of credit sub-facility. The revolving line of credit contains an option to increase the lending commitments, subject to certain requirements, with Silicon Valley Bank and/or new lenders to provide up to an aggregate of $75.0 million in additional lending commitments. Loan proceeds may be used for general corporate purposes, and we may prepay and/or reborrow revolving loans under the revolving line of credit in whole or in part at any time without premium or penalty. As of September 30, 2013, we had no outstanding revolving loans under the credit agreement and an aggregate face amount of $3.2 million in undrawn letters of credit under the revolving line of credit.

The revolving loans bear interest, at our option, at (i) a base rate determined in accordance with the revolving line of credit, minus 0.75%, or (ii) a LIBOR . . .

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