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GIMO > SEC Filings for GIMO > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for GIGAMON INC.

Form 10-Q for GIGAMON INC.


8-Aug-2014

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 Annual Report on Form 10-K for the fiscal year ended December 28, 2013, as filed with the Securities and Exchange Commission. 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.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "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, business 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 Part II, Item 1A. "Risk Factors" in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for us to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Unless expressly indicated or the context requires otherwise, the terms "Gigamon," "company," "we," "us" and "our" in this document refer to Gigamon Inc., a Delaware corporation, and, where appropriate, its wholly owned subsidiaries. The term "Gigamon" may also refer to our products, regardless of the manner in which they are accessed.

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 Traffic Visibility 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.

In fiscal 2014, we launched NetFlow Generation, a new GigaSMART application, as well as GigaVUE-HC2, our latest Visibility Fabric platform, which offers increased agility and versatility when combined with our GigaSMART applications.


Our revenue increased from $32.4 million in the three months ended June 29, 2013 to $34.9 million in the three months ended June 28, 2014, representing 8% growth from sales of our products and services to existing and new customers. In the three months ended June 28, 2014, we added 84 new customers as compared to 72 new customers in the three months ended June 29, 2013. In the six months ended June 28, 2014, our revenue increased to $66.6 million from $58.2 million in the six months ended June 29, 2013, representing 14% growth. Net loss attributable to common stockholders was $32.5 million and $40.7 million in the three and six months ended June 28, 2014, compared to $9.8 million and $11.0 million in the six months ended June 29, 2013, respectively. We used cash in operations of $3.7 million in the six months ended June 28, 2014 and generated positive net operating cash flows of $15.1 million in the six months ended June 29, 2013.

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 28,        June 29,        June 28,        June 29,
                                 2014            2013            2014            2013
                                             (As Revised)                    (As Revised)
  Key Performance Indicators:
  Revenue                     $   34,851     $      32,409     $  66,611     $      58,222
  Gross margin                        78 %              72 %          75 %              75 %
  Loss from operations        $    7,838     $      32,345     $  19,776     $      33,510
  Deferred revenue            $   48,043     $      36,301     $  48,043     $      36,301

Revenue. We monitor our 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 from operations. We monitor our operating results 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 distributors who stock inventory until the distributors report to us that they have sold the products to end-user customers. 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.

The financial data presented herein for the three and six months ended June 29, 2013, has been revised to correct immaterial accounting errors as described in Note 2 to the condensed consolidated financial statements.

Financial Overview

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. Our 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 that all other revenue recognition criteria have been met. As a percentage of 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 and seasonal and cyclical factors discussed under the section titled "Results of Operations."


We expect our revenue in the third quarter to remain relatively consistent or slightly increase as compared to the three months ended June 28, 2014.

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; personnel costs for salary, benefits, bonuses and stock-based compensation expense; shipping costs; allocated costs of facilities and information technology; any inventory write-downs; and warranty costs and other related expenses.

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.

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, changes in our product costs including any excess inventory write-downs, new product introductions and upgrades to existing products, changes in customer mix, changes in pricing and the extent of customer rebates and incentive programs. 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 28, 2013 through June 28, 2014, we increased headcount attributable to our operating expenses from 326 to 381. We expect overall operating expenses, excluding stock-based compensation expense, to be relatively consistent in absolute dollars for the third quarter of 2014, as compared to the three months ended June 28, 2014. We expect stock-based compensation expense to increase in absolute dollars for the third quarter of 2014, as compared to the three months ended June 28, 2014. This does not include expenses to be recognized related to employee stock awards that are granted after June 28, 2014. In addition, to the extent forfeiture rates are different from what we have anticipated; stock-based compensation expense related to these awards will be different from our expectations.

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 primarily consist 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.

Sales and marketing. Sales and marketing expenses are the largest component of our operating expenses and primarily consist 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.


General and administrative. General and administrative expenses primarily 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 primarily consist of outside legal and accounting services. We have incurred and expect to continue to incur 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, cash equivalents and short-term investments, which have not been material to date.

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.

Income tax benefit (provision)

On May 31, 2013, we converted from a Delaware limited liability company (a pass through entity not subject to U.S. federal and state income taxes) to a Delaware corporation. Accordingly, following such conversion, we elected to be treated as a corporation under Subchapter C of Chapter 1 of the United States Internal Revenue Code, as amended, and, therefore, have become subject to both federal and state income taxes.

The provision for income taxes for the six months ended June 28, 2014, was primarily related to the establishment of a valuation allowance against the deferred tax assets in the United States and the taxes assessed by foreign jurisdictions. As of June 28, 2014 it was assessed that it is more-likely-than-not that it will not realize its federal and state deferred tax assets based on the absence of sufficient positive objective evidence that it would generate sufficient taxable income in our United States tax jurisdiction to realize the deferred tax assets. Accordingly, a valuation allowance was recorded on the federal and state deferred tax assets for an amount of $24.6 million and was charged to the income tax provision.

The recording of $24.6 million of valuation allowance was primarily due to ongoing losses and the uncertainty regarding future results adjusted for permanent differences which have resulted in a more likely than not determination that the deferred tax assets would not be realized. In making this determination, we considered all available evidence, both positive and negative. Such evidence included, among others, our history of profitability and losses, jurisdictional income recognition trends, pretax losses adjusted for certain extraordinary and other items, and forecasted income by jurisdiction. The benefit from income taxes for six months ended June 29, 2013 was $25.0 million in the initial recognition of deferred tax assets, upon the conversion of the limited liability company to a corporation, partially offset by current foreign taxes.

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 income taxes in the jurisdictions in which it operates.

Stock-based compensation expense and other charges

Prior to our initial public offering (the "IPO"), we granted restricted stock units ("RSUs") and stock option awards (together, the "IPO Awards") that were subject to the completion of our IPO. In addition, upon the completion of our IPO in June 2013, we began offering eligible employees the opportunity to purchase shares under our 2013 Employee Stock Purchase Plan (the "ESPP"). Accordingly, prior to the second quarter of fiscal 2013, we did not record any stock-based compensation associated with the IPO Awards and the ESPP purchase rights. Total stock-based compensation expense, net of estimated forfeitures, in three and six months ended June 28, 2014 and June 29, 2013 was $6.0 million and $13.9 million, respectively, compared to $16.7 million and $18.3 million in the three and six months ended June 28, 2014 and June 29, 2013, respectively. In addition, payroll taxes related to stock-based compensation were $0.8 million in the three and six months ended June 28, 2014. As of June 28, 2014, unrecognized stock-based compensation expense, net of estimated forfeitures, was $32.9 million.


Results of Operations

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



                                             Three Months Ended                   Six Months Ended
                                        June 28,          June 29,          June 28,          June 29,
                                          2014              2013              2014              2013
                                                        (As Revised)                        (As Revised)
Consolidated Statement of Operations
Data:
Revenue:
Product                                $   22,544      $       23,354      $   42,624      $       40,873
Services                                   12,307               9,055          23,987              17,349
Total revenue                              34,851              32,409          66,611              58,222
Cost of revenue:
Product                                     6,281               6,944          13,286              11,668
Services                                    1,544               1,911           3,124               2,564
Total cost of revenue                       7,825               8,855          16,410              14,232
Gross profit                               27,026              23,554          50,201              43,990
Operating expenses:
Research and development                   10,860              17,097          21,798              22,768
Sales and marketing                        19,558              26,114          37,728              38,535
General and administrative                  4,446              12,688          10,451              16,197
Total operating expenses                   34,864              55,899          69,977              77,500
Loss from operations                       (7,838 )           (32,345 )       (19,776 )           (33,510 )
Interest income                                73                   1             134                   3
Other income (expense), net                     6                 (18 )           (35 )               (25 )
Loss before provision for income taxes     (7,759 )           (32,362 )       (19,677 )           (33,532 )
Income tax (provision) benefit            (24,727 )            22,569         (21,027 )            22,540
Net loss                                  (32,486 )            (9,793 )       (40,704 )           (10,992 )

Net loss includes Performance Unit
Plan (PUP) 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                        $      471      $        2,691      $      919      $        2,709
Research and development                    2,054               6,069           4,653               6,378
Sales and marketing                         2,424               5,263           5,198               5,692
General and administrative                  1,090               2,674           3,127               3,511
Total stock-based compensation expense $    6,039      $       16,697      $   13,897      $       18,290

Percentage of Total Revenue:
Revenue:
Product                                        65 %                72 %            64 %                70 %
Services                                       35 %                28 %            36 %                30 %
Total revenue:                                100 %               100 %           100 %               100 %
Cost of revenue                                22 %                27 %            25 %                24 %
Gross margin                                   78 %                73 %            75 %                76 %
Operating expenses:
Research and development                       31 %                53 %            33 %                39 %
Sales and marketing                            56 %                81 %            57 %                66 %
General and administrative                     13 %                39 %            16 %                28 %
Total operating expenses                      100 %               172 %           105 %               133 %
Loss from operations                          (24 %)              (99 %)          (30 %)              (58 %)
Interest income                                 0 %                 0 %             0 %                 0 %
Other expense, net                              0 %                 0 %             0 %                 0 %
Loss before income tax benefit
(provision)                                   (24 %)              (99 %)          (30 %)              (58 %)
Income tax benefit (provision)                (71 %)               70 %           (32 %)               39 %
Net loss                                      (95 %)              (29 %)          (62 %)              (19 %)


We have revised our consolidated financial statements for the three and six months ended June 29, 2013 to correct for insignificant accounting errors which are described in Note 2, Revision of previously issued Financial Statements, included in Part I - Item I - Financial Statements (unaudited).

Comparison of the three and six months ended June 28, 2014 and June 29, 2013

Revenue

                              Three Months Ended                                           Six Months Ended
                            June 28,      June 29,       Increase/      % Increase      June 28,      June 29,       Increase/       % Increase
                              2014          2013        (Decrease)      (Decrease)        2014          2013        (Decrease)       (Decrease)
                                                                          (dollars in thousands)
Revenue:
Product                    $   22,544     $  23,354     $      (810 )        (3%)       $  42,624     $  40,873     $     1,751            4%
Services                       12,307         9,055           3,252          36%           23,987        17,349           6,638           38%
Total revenue              $   34,851     $  32,409     $     2,442           8%        $  66,611     $  58,222     $     8,389           14%

Product revenue decreased $0.8 million in the three months ended June 28, 2014 compared to the three months ended June 29, 2013, primarily due to a decrease in the volume of sales from our G-Series products, partially offset by increased sale of our high density (H-Series) products. Revenue from our H-Series products increased to $18.0 million in the three months ended June 28, 2014, compared to $13.5 million in the three months ended June 29, 2013.

Product revenue increased $1.8 million in the six months ended June 28, 2014 compared to the six months ended June 29, 2013, primarily due to an increase in the volume of sales of our H-Series products by $8.5 million offset in part by lower G-Series products sales, primarily due to lower volume of shipments of such products.

Services revenue increased $3.3 million and $6.6 million in the three and six months ended June 28, 2014 compared to the three and six months ended June 29, 2013, respectively, primarily due to the growth in our installed base at our existing end-user 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 product sales.

Cost of revenue and gross margin

                                                   Three Months Ended                                                Six Months Ended
                               June 28,         June 29,                                       June 28,         June 29,
                                 2014             2013                                           2014             2013
                                              (As Revised)      Decrease       % Decrease                     (As Revised)       Increase       % Increase
                                                                                 (dollars in thousands)
Cost of revenue:
Product                       $    6,281     $        6,944     $    (663 )        (10%)       $  13,286     $        11,668     $   1,618           14%
Services                           1,544              1,911          (367 )        (19%)           3,124               2,564           560           22%
Total cost of revenue         $    7,825     $        8,855     $  (1,030 )        (12%)       $  16,410     $        14,232     $   2,178           15%

Gross margin:
Product                               72 %               70 %                                         69 %                71 %
. . .
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