Edgar Filing: A10 Networks, Inc.

ATEN-2014.9.30-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-36343

A10 NETWORKS, INC.

(Exact Name of Registrant as Specified in its Charter)



Delaware		20-1446869
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
3 West Plumeria Drive San Jose, California		95134
(Address of Principal Executive Offices)		(Zip Code)

(408) 325-8668

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	¨		Accelerated filer	¨

Non-accelerated filer	x	(Do not check if a smaller reporting company)	Smaller reporting company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of October 31, 2014 the number of outstanding shares of the registrant’s common stock, par value $0.00001 per share, was 60,715,534.

TABLE OF CONTENTS

Insert Title Here

	Page
PART I. FINANCIAL INFORMATION	2
Item 1. Condensed Consolidated Financial Statements (unaudited):	2
Condensed Consolidated Balance Sheets As of September 30, 2014 and December 31, 2013	2
Condensed Consolidated Statements of Operations For the Three and Nine Months Ended September 30, 2014 and 2013	3
Condensed Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2014 and 2013	4
Notes to Condensed Consolidated Financial Statements	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3. Quantitative and Qualitative Disclosures About Market Risk	29
Item 4. Controls and Procedures	30
PART II. OTHER INFORMATION	31
Item 1. Legal Proceedings	31
Item 1A. Risk Factors	31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 3. Defaults Upon Senior Securities	51
Item 4. Mine Safety Disclosures	51
Item 5. Other Information	51
Item 6. Exhibits	51
Signatures	52
Exhibit Index	53

PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

A10 NETWORKS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands, except par value)



	September 30, 2014			December 31, 2013
ASSETS
Current Assets:
Cash and cash equivalents	$	107,099		$	20,793
Accounts receivable, net of allowances of $2,419 and $2,738 as of September 30, 2014 and December 31, 2013	42,474			37,704
Inventory	19,371			17,166
Prepaid expenses and other current assets	4,940			3,056
Total current assets	173,884			78,719
Property and equipment, net	11,837			9,801
Other long-term assets	4,629			5,274
Total Assets	$	190,350		$	93,794
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Accounts payable	$	11,175		$	9,228
Accrued liabilities	19,994			15,514
Accrued litigation expenses	654			10,407
Deferred revenue, current	34,329			28,448
Total current liabilities	66,152			63,597
Revolving credit facility	—			20,000
Deferred revenue, long-term	16,573			12,784
Other long-term liabilities	1,974			6,118
Total Liabilities	84,699			102,499
Commitments and contingencies (Note 5)
Redeemable convertible preferred stock, no par value—no shares authorized, issued or outstanding as of September 30, 2014; 115 shares authorized, 80 shares issued and outstanding with aggregate liquidation preference of $80,000 as of December 31, 2013	—			81,426
Convertible preferred stock, $0.00001 — 100,000 shares authorized and no shares issued and outstanding as of September 30, 2014; no par value —30,569 shares authorized, issued and outstanding with aggregate liquidation preference of $42,884 as of December 31, 2013	—			44,749
STOCKHOLDERS’ EQUITY (DEFICIT)
Common stock, par value $0.00001 — 500,000 and 65,600 shares authorized as of September 30, 2014 and December 31, 2013; 60,509 and 10,032 shares issued and outstanding as of September 30, 2014 and December 31, 2013	1			—
Additional paid-in capital	271,417			12,185
Accumulated deficit	(165,767		)	(147,065		)
Total Stockholders' Equity (Deficit)	105,651			(134,880		)
Total Liabilities, Redeemable Convertible Preferred Stock, Convertible Preferred Stock And Stockholders' Equity (Deficit)	$	190,350		$	93,794

See accompanying notes to the condensed consolidated financial statements.

A10 NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Revenue:
Products	$	31,601		$	32,263		$	102,140		$	78,596
Services	11,827			7,563			32,165			20,942
Total revenue	43,428			39,826			134,305			99,538
Cost of revenue:
Products	8,818			6,669			23,655			16,469
Services	2,935			2,065			8,491			5,783
Total cost of revenue	11,753			8,734			32,146			22,252
Gross profit	31,675			31,092			102,159			77,286
Operating expenses:
Sales and marketing	24,651			18,276			70,189			49,588
Research and development	12,342			8,517			35,416			24,625
General and administrative	5,141			3,686			16,035			11,213
Litigation expense (benefit)	910			1,683			(3,103		)	9,887
Total operating expenses	43,044			32,162			118,537			95,313
Loss from operations	(11,369		)	(1,070		)	(16,378		)	(18,027		)
Other income (expense), net:
Interest expense	(192		)	(1,399		)	(904		)	(1,445		)
Interest income and other income (expense), net	(510		)	(73		)	(673		)	(1,437		)
Total other income (expense), net	(702		)	(1,472		)	(1,577		)	(2,882		)
Loss before provision for income taxes	(12,071		)	(2,542		)	(17,955		)	(20,909		)
Provision for income taxes	233			207			747			586
Net loss	$	(12,304	)	$	(2,749	)	$	(18,702	)	$	(21,495	)
Accretion of redeemable convertible preferred stock dividend	—			(755		)	(1,150		)	(788		)
Net loss attributable to common stockholders	$	(12,304	)	$	(3,504	)	$	(19,852	)	$	(22,283	)
Net loss per share attributable to common stockholders:
Basic	$	(0.21	)	$	(0.38	)	$	(0.45	)	$	(2.43	)
Diluted	$	(0.21	)	$	(0.38	)	$	(0.45	)	$	(2.43	)
Weighted-average shares used in computing net loss per share attributable to common stockholders
Basic	59,913			9,308			44,538			9,153
Diluted	59,913			9,308			44,538			9,153

See accompanying notes to the condensed consolidated financial statements.

A10 NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)



	Nine Months Ended September 30,
	2014			2013
Cash flows from operating activities:
Net loss	$	(18,702	)	$	(21,495	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	7,337			5,000
Stock-based compensation	8,314			2,880
Gain on settlement of contractual liability (Note 3)	(6,993		)	—
Provision for doubtful accounts and sales returns	52			1,150
Fixed assets disposal loss	128			—
Unrealized foreign exchange gain	(159		)	(230		)
Changes in operating assets and liabilities:
Accounts receivable, net	(4,771		)	(7,898		)
Inventory	(6,276		)	(4,434		)
Prepaid expenses and other assets	(3,303		)	209
Accounts payable	4,109			(523		)
Accrued liabilities	4,102			3,138
Accrued litigation expenses	(6,832		)	(2,993		)
Deferred revenue	9,670			4,531
Other	(197		)	2
Net cash used in operating activities	(13,521		)	(20,663		)
Cash flows from investing activities:
Purchases of property and equipment	(5,380		)	(2,876		)
Net cash used in investing activities	(5,380		)	(2,876		)
Cash flows from financing activities:
Proceeds from initial public offering, net of offering costs	121,037			(35		)
Proceeds from issuance of Series D redeemable convertible preferred stock, net of issuance costs	—			79,441
Principal payments on convertible promissory note in relation to settlement of litigation	—			(70,000		)
Proceeds from revolving credit facility	—			34,002
Principal payments on revolving credit facility	(20,000		)	(15,000		)
Principal payments on term loan	—			(631		)
Proceeds from exercise of convertible preferred stock warrants	—			813
Proceeds from exercise of common stock options, net of repurchases of common stock	4,399			1,664
Other	(229		)	(222		)
Net cash provided by financing activities	105,207			30,032
Net increase in cash and cash equivalents	86,306			6,493
Cash and cash equivalents—beginning of period	20,793			23,867
Cash and cash equivalents—end of period	$	107,099		$	30,360
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
Inventory transfers to property and equipment	$	4,072		$	3,370
Costs related to the initial public offering included in accounts payable and accrued liabilities	$	150		$	146
Accretion of Series D redeemable convertible preferred stock	$	1,150		$	788
Reclassification of the convertible preferred stock warrant liability to additional paid-in capital upon the exercise of the convertible preferred stock warrants	$	—		$	2,199
Purchases of property and equipment included in accounts payable and accrued liabilities	$	366		$	430
Vesting of early exercised stock options	$	556		$	422
Issuance of convertible promissory note in relation to settlement of litigation	$	—		$	70,000

See accompanying notes to the condensed consolidated financial statements.

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. Description of Business and Summary of Significant Accounting Policies

Description of Business

A10 Networks, Inc. (together with our subsidiaries, the “Company”, “we”, “our” or “us”) was incorporated in the State of California in 2004 and subsequently reincorporated in the State of Delaware in March 2014.

Our solutions enable enterprises, service providers, Web giants and government organizations to accelerate, secure and optimize the performance of their data center applications and networks. We currently offer three software based advanced application networking solutions. These are Application Delivery Controllers, or ADCs, to optimize data center performance; Carrier Grade Network Address Translation, or CGN, to provide address and protocol translation services for service provider networks; and a Distributed Denial of Service Threat Protection System, or TPS, for network-wide security protection. We deliver these solutions both on optimized hardware appliances and as virtual appliances across our Thunder Series and AX Series product families.

Initial Public Offering

In March 2014, we completed our initial public offering (“IPO”), whereby 12,500,000 shares of common stock were sold to the public at a price per share of $15.00. We sold 9,000,000 common shares and selling stockholders sold 3,500,000 common shares. In April 2014, our underwriters exercised an overallotment available to them and an additional 345,000 shares were sold by our selling stockholders bringing the total shares sold to 12,845,000 for this offering. The total gross proceeds from the offering were $192.7 million. After deducting underwriting discounts and commissions, offering expenses payable by us, and net proceeds received by the selling stockholders, the estimated aggregate net proceeds was $120.2 million. Upon the closing of the initial public offering, all shares of our outstanding redeemable convertible preferred stock and convertible preferred stock converted into 39,997,114 shares of common stock.

Reverse Stock Split

On March 6, 2014, we effected a 1-for-3.75 reverse stock split of our common stock and convertible preferred stock (collectively referred to as “Capital Stock”). Shares of our Series D redeemable convertible preferred stock were not subject to the split but instead the conversion price of the Series D redeemable convertible preferred stock was adjusted proportionally to reflect the split of the common stock issued upon conversion of the Series D redeemable convertible preferred stock. On March 6, 2014 (i) each 3.75 shares of outstanding Capital Stock was combined into 1 share of Capital Stock; (ii) the number of shares of Capital Stock for which each outstanding option to purchase Capital Stock is exercisable was proportionately reduced on a 1-for-3.75 basis; (iii) the exercise price of each such outstanding option was proportionately increased on a 1-for-3.75 basis; (iv) each 3.75 shares of authorized Capital Stock was reduced to 1 share of Capital Stock; and (v) the conversion price of the Series D redeemable convertible preferred stock was adjusted from $2.2628 to $8.4855. All of the share and per share amounts have been adjusted, on a retroactive basis, to reflect this 1-for-3.75 reverse stock split.

Basis of Presentation and Consolidation

The accompanying unaudited condensed consolidated financial statements include the accounts of A10 Networks, Inc., and our wholly owned subsidiaries. All inter-company balances and transactions have been eliminated in consolidation.

We had no comprehensive income (loss) other than our net income (loss), hence our comprehensive income (loss) is the same as the net income (loss) for all periods presented. Pursuant to the accounting guidance provided by Accounting Standard Codification ("ASC") 220 Comprehensive Income, we did not present statements of comprehensive income (loss) for the periods presented.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and following the requirements of the Securities and Exchange Commission (“SEC”), for interim reporting. As permitted under those rules, certain notes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These financial statements have been prepared on the same basis as our annual financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments that are necessary for a fair statement of our financial information. The results of operations for the three months and nine months ended September 30, 2014 are not necessarily indicative of the results to be expected for the year ending December 31, 2014 or for any other interim period or for any other future year. The balance sheet

as of December 31, 2013 has been derived from audited financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements.

The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto for the year ended December 31, 2013 included in our prospectus filed with the SEC on March 21, 2014 pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”).

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Those estimates and assumptions affect revenue recognition and deferred revenue, allowance for doubtful accounts, sales return reserve, valuation of inventory, contingencies and litigation, and determination of fair value of stock-based compensation. These estimates are based on information available as of the date of the condensed consolidated financial statements; therefore, actual results could differ from management’s estimates.

Summary of Significant Accounting Policies

There have been no changes to the significant accounting policies described in the prospectus that have had a material impact on our condensed consolidated financial statements and related notes.

Concentration of Credit Risk and Significant Customers

Financial instruments that potentially subject us to concentrations of credit risk consist of cash, cash equivalents and accounts receivable. Our cash and cash equivalents are invested in high-credit quality financial instruments with banks and financial institutions. Management believes that the financial institutions that hold our cash and cash equivalents are financially sound and, accordingly, are subject to minimal credit risk. Such deposits may be in excess of insured limits provided on such deposits.

Our accounts receivable are unsecured and represent amounts due to us based on contractual obligations of our customers. We mitigate credit risk in respect to accounts receivable by performing periodic credit evaluations of our customers to assess the probability of accounts receivable collection based on a number of factors, including past transaction experience with the customer, evaluation of their credit history, limiting the credit extended and review of the invoicing terms of the contract. We generally do not require our customers to provide collateral to support accounts receivable. We have recorded an allowance for doubtful accounts for those receivables that we have determined not to be collectible.

Significant customers, including distribution channel partners and direct customers, are those which represent more than 10% of our total revenue for each period presented, or our gross accounts receivable balance as of each respective balance sheet date. Revenue from our significant customers as a percentage of our total revenue for the three and nine months ended September 30, 2014 and 2013 are as follows:



	Three Months Ended September 30,		Nine Months Ended September 30,
Customers	2014	2013	2014	2013
Customer A	13%	*	14%	*
Customer B	*	*	*	19%
Customer C	*	21%	*	11%

* represents less than 10% of total revenue

As of September 30, 2014, one customer (Customer A) represented 12% of our total gross accounts receivable. No other customers accounted for 10% or more of our total gross accounts receivable for the periods presented.

Recent Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update (“ASU”) No. 2013-11, Income Taxes (Topic 740), Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. This new standard requires the netting of unrecognized tax benefits (“UTBs”) against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. UTBs will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the UTBs. We adopted ASU-2013-11 on January 1, 2014, and the adoption did not have a material impact on our consolidated financial statements since ASU-2013-11 only impacts financial statement disclosure requirements for unrecognized tax benefits.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which provides new guidance on the recognition of revenue and states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This standard will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. We are currently evaluating the impact of the adoption of this accounting standard update on our consolidated financial position or results of operations.

There have been no other recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2014, as compared to the recent accounting pronouncements described in our prospectus filed with SEC on March 21, 2014, that are of significance or potential significance to us.

2. Fair Value Measurements

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and debt. Cash equivalents are stated at amortized cost, which approximates fair value as of the balance sheet dates, due to the short period of time to maturity. Accounts receivable, accounts payable and accrued expenses are stated at their carrying value, which approximates fair value due to the short time to the expected receipt or payment. The carrying amount of our revolving credit facility approximates the fair value as the stated interest rate approximates market rates currently available to us.

As of September 30, 2014 and December 31, 2013, our financial assets consist of highly liquid money market funds which are classified as Level I assets in the fair value hierarchy as these instruments are valued using quoted market prices for identical assets in an active market. We had no assets or liabilities classified within Level 2 or Level 3 as of September 30, 2014 and December 31, 2013 and there were no transfers of instruments between Level 1, Level 2 and Level 3 regarding fair value measurement during the nine months ended September 30, 2014.

The following table sets forth the fair value of our financial assets measured on a recurring basis by level within the fair value hierarchy (in thousands):



	September 30, 2014				December 31, 2013
	Level 1		Total		Level 1		Total
Financial Assets
Money market funds	$	91,066	$	91,066	$	14,029	$	14,029

We did not have realized gains or losses for the three and nine months ended September 30, 2014 or 2013 related to our financial assets.

3. Balance Sheets and Statement of Operations Components

Inventory

Components of inventory as of September 30, 2014 and December 31, 2013 are shown below (in thousands):



	September 30, 2014		December 31, 2013
Raw materials	$	9,565	$	10,625
Finished goods	9,806		6,541
Total inventory	$	19,371	$	17,166

Property and Equipment, Net

Components of property and equipment, net as of September 30, 2014 and December 31, 2013 are shown below (in thousands):



	September 30, 2014			December 31, 2013
Equipment	$	28,868		$	21,188
Software	2,866			2,479
Leasehold improvements	1,785			1,325
Furniture and fixtures	858			777
Construction in progress	473			123
Property and equipment, gross	34,850			25,892
Less: accumulated depreciation and amortization	(23,013		)	(16,091		)
Total property and equipment, net	$	11,837		$	9,801

Depreciation and amortization on our property and equipment for the three and nine months ended September 30, 2014 was $2.6 million and $7.2 million. Depreciation and amortization on our property and equipment for the three and nine months ended September 30, 2013 was $1.8 million and $4.9 million.

Deferred Revenue

Deferred revenue as of September 30, 2014 and December 31, 2013 consists of the following (in thousands):



	September 30, 2014			December 31, 2013
Deferred revenue:
Products	$	3,219		$	3,170
Services	47,683			38,062
Total deferred revenue	50,902			41,232
Less: current portion	(34,329		)	(28,448		)
Long-term portion	$	16,573		$	12,784

Accrued Liabilities

Accrued liabilities as of September 30, 2014 and December 31, 2013 consists of the following (in thousands):



	September 30, 2014		December 31, 2013
Accrued compensation and benefits	$	12,990	$	9,015
Accrued tax liabilities	2,798		2,156
Other	4,206		4,343
Total accrued liabilities	$	19,994	$	15,514

Foreign Currency Exchange Losses

We recorded $0.5 million and $0.7 million foreign exchange loss during the three and nine months ended September 30, 2014. We recorded $0.1 million and $1.4 million foreign exchange loss during the three and nine months ended September 30, 2013.

Settlement of Contractual Liability

In May 2014, we reached a settlement agreement with one of our legal service providers which resulted in the reduction of a previously accrued contractual liability that totaled $12.0 million. We made a payment of $5.0 million in accordance with the terms of the settlement agreement in June 2014 and recorded a $7.0 million benefit to litigation expense (benefit) during the three months ended June 30, 2014.

4. Credit Facility

In September 2013, we entered into a credit agreement with Royal Bank of Canada, JPMorgan Chase Bank, N.A. and Bank of America, N.A. as lenders. The credit agreement provides a three-year $35.0 million revolving credit facility, which includes a maximum $10.0 million letter of credit facility. In March 2014, we repaid the $20.0 million outstanding borrowing under this credit facility. As of September 30, 2014, we have no outstanding borrowings under this credit facility.

Our obligations under the credit agreement are secured by a security interest on substantially all of our assets, including our intellectual property. The credit agreement contains customary financial and non-financial covenants, and are described in Note 5, Debt, in the Notes to Consolidated Financial Statements of our final prospectus filed with the SEC on March 21, 2014. We were in compliance with all financial and nonfinancial covenants under the revolving credit facility as of September 30, 2014.

At our option, the revolving credit facility bears interest at a rate per annum based on either (i) an alternate base rate plus a margin ranging from 1.75% to 2.50% depending on our total leverage ratio, or (ii) the London interbank offered rate, or LIBOR, based on one, two, three or six month interest periods plus a margin ranging from 2.75% to 3.50% depending on our total leverage ratio. The alternate base rate is equal to the greatest of (i) the Royal Bank of Canada’s prime rate, (ii) the federal funds rate plus a margin equal to 0.50% and (iii) the Eurodollar rate for a one month interest period plus a margin equal to 1.00%.

In addition, we incurred $1.0 million of debt issuance costs that were directly attributable to the issuance of this revolving credit facility which will be amortized to interest expense over the three-year term of this credit facility. As of September 30, 2014, the unamortized debt issuance costs of $0.6 million were included within other long-term assets in our Condensed Consolidated Balance Sheets. We are also required to pay quarterly facility fees of 0.45% per annum on the average daily unused portion of the revolving credit facility.

5. Commitments and Contingencies

Legal Proceedings

From time to time, we may be party or subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business, including proceedings and claims that relate to intellectual property matters. Some of these proceedings involve claims that are subject to substantial uncertainties and unascertainable damages. Accordingly, except as disclosed, we have not established reserves or ranges of possible loss related to these proceedings, as at this time in the proceedings, if any, the matters do not relate to a probable loss and/or amounts can not be reasonably estimated.

Although we believe that we have a strong defense for the litigation proceeding described below, there are many uncertainties associated with any litigation and this action or other third-party claims against us may cause us to incur costly litigation and/or substantial settlement charges that could have a material adverse effect on our results of operations, financial position, or cash flows. In addition, the resolution of any future intellectual property litigation may require us to make royalty payments and/or settlement payments, which could adversely affect gross margin and operating expenses in future periods.

Radware v. A10

In May 2013, Radware, Ltd., and Radware, Inc. (collectively, “Radware”) filed suit against us in the United States District Court for the Northern District of California (the "Court"), asserting that our AX Series and EX Series products infringe three of Radware’s U.S. patents. In August 2014, we entered into a settlement agreement with Radware that includes the dismissal of the lawsuit. The terms of the agreement are confidential, but we do not believe the settlement will have a material effect on our business, other than a reduction in our future legal expenses related to this litigation.

Parallel v. A10

In November 2013, Parallel Networks, LLC (“Parallel Networks”), which we believe is a non-practicing patent holding company, filed a lawsuit against us in the United States District Court for the District of Delaware. In the lawsuit, Parallel Networks alleges that our AX and Thunder series products infringe two of their U.S. patents. Parallel Networks is seeking injunctive relief, damages and attorneys’ fees and costs. Parallel Networks has asserted similar claims against other companies, including Array Networks, Inc., Barracuda Networks, Inc., Brocade Communications Systems, Inc., Cisco Systems, Inc., Citrix Systems, Inc., F5, Riverbed Technology, Inc. and SAP AG. The separate trials for each defendant in these related actions are set to commence in June 2016 in accordance with an order to be set forth in a trial sequencing conference. This matter is in the early stages, but we intend to vigorously defend the lawsuit. We are unable to reasonably estimate a possible loss or range of possible loss if any, in regards to this matter; therefore, no litigation reserve has been recorded in the accompanying Condensed Consolidated Balance Sheets.

Lease Obligations and Other Commitments

We lease various operating spaces in California, Asia, and Europe under noncancelable operating lease arrangements that expire on various dates through February 2020. These arrangements require us to pay certain operating expenses, such as taxes, repairs, and insurance and contain renewal and escalation clauses.

We have entered into agreements with some of our customers and channel partners that contain indemnification provisions in the event of claims alleging that our products infringe the intellectual property rights of a third party. Other guarantees or indemnification arrangements include guarantees of product and service performance and standby letters of credit for lease facilities and corporate credit cards. We have not recorded a liability related to these indemnification and guarantee provisions and our guarantees and indemnification arrangements have not had any significant impact on our consolidated financial statements to date.

6. Equity Award Plans

Equity Incentive Plans

2008 Plans

We adopted the 2008 Stock Option Plan (the "2008 Plan") for the purpose of granting stock-based awards to eligible service providers, which included our employees, directors, and consultants as well as employees and consultants of our subsidiaries. Stock options granted under the 2008 Plan were either incentive stock options (“ISOs”) or nonstatutory stock options (“NSOs”). With the establishment of the 2014 Equity Incentive Plan (the "2014 Plan") in March 2014, we terminated the 2008 Plan. Upon such termination, we ceased granting any awards under the 2008 Plan.

2014 Equity Incentive Plan

The 2014 Plan was adopted by our board of directors and approved by our stockholders in March 2014. The 2014 Plan was effective as of the business day immediately prior to the effectiveness of our registration statement for our initial public offering. The 2014 Plan replaced the 2008 Plan. Our 2014 Plan provides for the granting of stock options, restricted stock awards ("RSAs"), restricted stock units ("RSUs"), stock appreciation rights, performance units and performance shares to our employees, directors and consultants, and our subsidiary corporations’ employees and consultants.

A total of 7,700,000 shares of our common stock are reserved for issuance pursuant to the 2014 Plan. On the first day of each fiscal year, starting with January 1, 2015, the number of shares in the reserve will increase by the lesser of (i) 8,000,000 shares, (ii) 5% of the outstanding shares of common stock on the last day of our immediately preceding fiscal year, or (iii) such other amount as determined by our board of directors. As of September 30, 2014, we have granted 553,123 stock options and 1,570,428 RSUs under the 2014 Plan to our employees and consultants, we have 5,670,240 shares available for future grant.

Vesting periods of awards granted under the 2014 Plan are determined by the board of directors or other committees responsible for administering the 2014 Plan (the "Plan Administrators"). The Plan Administrators determine the contractual terms of awards granted under the 2014 Plan, provided that incentive stock options and stock appreciation rights granted expire no more than ten years from the grant date. In the case of an incentive stock option granted to an employee, who at the time of grant, owns stock representing more than 10% of the total combined voting power of all classes of stock, the exercise price shall be no less than 110% of the fair value per share on the date of grant, and expire five years from the date of grant, and for incentive stock options granted to any other employee, and nonstatutory stock options and stock appreciation rights granted to employees, directors or consultants, the per share exercise price shall be no less than 100% of the fair value per share on the date of grant.

Recipients of RSAs generally will have voting and dividend rights with respect to such shares upon grant without regard to vesting, unless the Plan Administrators provide otherwise.

RSUs granted under the 2014 Plan may be subject to vesting criteria which may be based on achievement of corporate or individual goals, including but not limited to continued services, applicable laws or any other basis that the Plan Administrators determine.

Performance units have an initial dollar value established by the Plan Administrators on or before the grant date. Performance shares will have an initial value equal to the fair market value of a share on the date of grant. The Plan Administrators will establish, at their discretion, (and may subsequently reduce or waive) performance goals or other vesting provisions, which depending on the extent to which they are met, will determine the number and/or the value of performance units and performance shares to be paid out to participants.

2014 Employee Stock Purchase Plan

The 2014 Employee Stock Purchase Plan (the "2014 ESPP") was adopted by our board of directors and approved by our stockholders in March 2014 and was effective as of the business day immediately prior to the effectiveness of our registration statement for our initial public offering.

As of September 30, 2014, a total of 1,600,000 shares of our common stock are available for purchase under the 2014 ESPP. On the first day of each fiscal year, starting with January 1, 2015, the number of shares in the reserve will increase by the least of (i) 3,500,000 shares, (ii) 1% of the outstanding shares of our common stock on the last day of the immediately preceding fiscal year, or (iii) such other amount as determined by our board of directors or other committee administering the 2014 ESPP.

The 2014 ESPP permits eligible employees to acquire shares of our common stock at 85% of the lower of the fair market value of our common stock on the first trading day of each offering period or on the exercise date that occurs at the end of a purchase period. Each offering period will be approximately twenty-four months in duration, starting on the first trading day on or after May 21 and November 21 of each year, except for the first offering period, which commenced on March 21, 2014 and will end on the last trading day on or before May 20, 2016. Each offering period generally consists of four purchase periods and each purchase period will begin after one exercise date and end with the next exercise date approximately six months later, except that the first purchase period of an offering period will begin on the enrollment date of each offering period and end on the next exercise date. If the fair market value of our common stock on the exercise date is less than the fair market value on the first trading day of the offering period, participants will be withdrawn from the then‑current offering period following their purchase of shares on the purchase date and automatically will be enrolled in the immediately following offering period. Participants may purchase shares of common stock through payroll deductions of up to 15% of their eligible

compensation, subject to purchase limits of 1,500 shares during each six month purchase period or $25,000 worth of stock for each calendar year.

Stock Option Activity

The following table summarizes our stock option activity and related information as of and for the nine months ended September 30, 2014 (in thousands, except for years and per share amounts):



	Number of Shares Underlying Outstanding Options		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding as of December 31, 2013	9,971		$	4.14	7.9	$	58,515
Granted	1,264		$	13.36
Exercised	(1,725	)	$	2.55
Canceled	(806	)	$	6.87
Outstanding as of September 30, 2014	8,704		$	5.55	7.4	$	35,753
Vested and expected to vest as of September 30, 2014	8,355		$	5.40	7.4	$	35,174
Vested and exercisable as of September 30, 2014	4,548		$	3.14	6.4	$	27,229

The following table provides information pertaining to our stock options for the nine months ended September 30, 2014 and 2013 (in thousands, except weighted-average fair values):



	Nine Months Ended September 30,
	2014		2013
Total fair value of options granted	$	7,536	$	7,600
Weighted average fair value of options granted	$	5.96	$	2.74
Intrinsic value of options exercised	$	13,900	$	1,500

The aggregate intrinsic value represents the difference between our estimated fair value of our common stock, prior to the IPO, or the closing stock price of our common stock, following the IPO, compared to the exercise price of the outstanding, in-the-money options.

Restricted Stock Units Activity

The following table summarizes restricted stock units activity under all of our equity incentive plans for the nine months ended September 30, 2014 (in thousands, except for weighted average grant date fair value):



	Number of Shares		Weighted Average Grant Date Fair Value
Outstanding as of December 31, 2013	—		$	—
Granted	1,570		11.42
Released	—		—
Canceled	(42	)	11.71
Outstanding as of September 30, 2014	1,528		$	11.41

Valuation Assumptions

We use the Black-Scholes valuation model to determine the fair value of stock options and ESPP. The Black-Scholes model requires the input of highly subjective assumptions, which are summarized in the table below for the three and nine months ended September 30, 2014 and 2013:



	Three Months Ended September 30,		Nine Months Ended September 30,
	2014	2013	2014	2013
Stock Options: *
Expected term (in years)	n/a	6.08	5.50	6.08
Risk-free interest rate	n/a	1.65%	1.73%	1.59%
Expected volatility	n/a	46%	47%	45%
Dividend rate	n/a	—%	—%	—%
ESPP: **
Expected term (in years)	1.4	n/a	1.4	n/a
Risk-free interest rate	0.24%	n/a	0.24%	n/a
Expected volatility	31%	n/a	31%	n/a
Dividend rate	—%	n/a	—%	n/a

* We did not grant stock options during the three months ended September 30, 2014.

** We did not have an ESPP plan prior to the adoption of our 2014 ESPP plan in March 2014.

Stock-based Compensation

The total stock-based compensation recognized for stock-based awards granted under the 2014 Plan, the 2008 Plan, the 2004 Plan and the 2014 ESPP for the three and nine months ended September 30, 2014 and 2013 are as follows (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
Cost of revenue	$	277	$	47	$	578	$	111
Sales and marketing	1,700		597		4,041		1,542
Research and development	1,139		374		2,546		903
General and administrative	422		135		1,149		324
Total stock-based compensation	$	3,538	$	1,153	$	8,314	$	2,880

At September 30, 2014, total compensation expense related to unvested share-based awards granted to employees under our stock plans but not yet recognized was $28.7 million, net of estimated forfeitures. This expense is expected to be amortized on a straight-line basis over a weighted-average period of 2.7 years.

7. Earnings Per Share

For periods presented prior to the IPO, basic and diluted net loss per common share is computed using the two-class method required for participating securities. Concurrent with the closing of the IPO in March 2014, all shares of outstanding preferred stock converted into shares of our common stock. Following the date of the IPO, the two-class method was no longer required. As of September 30, 2014, we have one outstanding class of securities.

The following table sets forth the computation of our basic and diluted net loss per share (in thousands, except per share data):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Net loss attributable to common stockholders	$	(12,304	)	$	(3,504	)	$	(19,852	)	$	(22,283	)
Weighted-average shares outstanding used in computing basic and diluted net loss per share	59,913			9,308			44,538			9,153
Net loss per share attributable to common stockholders, basic and diluted	$	(0.21	)	$	(0.38	)	$	(0.45	)	$	(2.43	)

The following weighted average outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share for the periods presented because including them would have been antidilutive (in thousands):



	Three Months Ended September 30,		Nine Months Ended September 30,
	2014	2013	2014	2013
Convertible preferred stock (on an as if converted basis)	—	36,500	—	32,596
Stock options, restricted stock units and employee stock purchase plan	10,435	8,842	10,241	8,077
Common stock subject to repurchase	244	292	244	348
Convertible preferred stock warrants	—	—	—	59
	10,679	45,634	10,485	41,080

8. Income Taxes

We recorded income tax expense of $0.2 million and $0.7 million for the three and nine months ended September 30, 2014, which was primarily comprised of foreign and state taxes. We recorded income tax expense of $0.2 million and $0.6 million for the three and nine months ended September 30, 2013, which was primarily comprised of state and foreign taxes. The provision for income taxes for these periods was determined using the annual effective tax rate method by excluding the entities that are not expected to realize tax benefit from the operating losses. As a result, and excluding the impact of discrete tax events during the quarter, the provision for income taxes was at a higher consolidated effective rate than would have resulted if all entities were profitable or if losses produced tax benefits.

We believe it is more likely than not that our federal and state net deferred tax assets will not be fully realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of a deferred tax asset will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. A valuation allowance is recorded for loss carryforwards and other deferred tax assets where it is more likely than not that such deferred tax assets will not be realized. Accordingly, we maintain a valuation allowance against all of our net deferred tax assets as of September 30, 2014. Due to historic losses in the U.S., we have a full valuation allowance on the U.S. federal and state deferred tax assets. We will continue to maintain a full valuation allowance against our net federal, state and certain foreign deferred tax assets until there is sufficient evidence to support recoverability of our deferred tax assets.

We had $2.3 million and $1.8 million of unrecognized tax benefits as of September 30, 2014 and December 31, 2013. We do not anticipate a material change to our unrecognized tax benefits over the next twelve months. Unrecognized tax benefits may change during the next twelve months for items that arise in the ordinary course of business.

Accrued interest and penalties related to unrecognized tax benefits are recognized as part of our income tax provision in the Condensed Consolidated Statements of Operations. All tax years remain open and are subject to future examinations by federal, state and foreign tax authorities. We are not under examination in any jurisdiction.

9. Segment Information

Our chief operating decision maker is our Chief Executive Officer who reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. Accordingly, we have a single reportable segment and operating segment structure.

The following table represents revenue by geographic areas based on customers' location, as determined by their ship to addresses (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
United States	$	20,445	$	26,636	$	64,873	$	47,512
Japan	9,893		7,029		35,668		31,071
Asia Pacific, excluding Japan	6,285		2,956		14,960		9,024
EMEA	4,940		1,669		13,005		6,598
Other	1,865		1,536		5,799		5,333
Total revenue	$	43,428	$	39,826	$	134,305	$	99,538

No other country outside of the United States and Japan comprised 10% or greater of our revenue for the three and nine months ended September 30, 2014 and 2013.

Geographical information relating to our long-lived assets which include property and equipment, net and intangible assets, net as of September 30, 2014 and December 31, 2013 was as follows (in thousands):



	September 30, 2014		December 31, 2013
United States	$	10,625	$	8,599
Japan	300		572
Asia Pacific, excluding Japan	1,839		1,657
EMEA	106		34
Total property and equipment, net and intangible assets, net	$	12,870	$	10,862

10. Related-Party Transactions

An affiliate of one of our significant stockholders is also acting as a reseller of our products. During the three and nine months ended September 30, 2014, we recognized $0.8 million and $2.0 million total revenue from this reseller. During the three and nine months ended September 30, 2013, we recognized $1.0 million and $3.6 million total revenue from this reseller.

We had gross accounts receivable of $0.2 million and $0.1 million from this reseller as of September 30, 2014 and December 31, 2013.


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 appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan” “expect,” and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements.

These forward-looking statements include, but are not limited to, statements concerning the following:


•	our ability to maintain an adequate rate of revenue growth;


•	our business plan and our ability to effectively manage our growth;


•	costs associated with defending intellectual property infringement and other claims;


•	our ability to attract and retain end-customers;


•	our ability to further penetrate our existing customer base;


•	our ability to displace existing products in established markets;


•	our ability to expand our leadership position in next-generation application delivery and server load balancing solutions;


•	our ability to timely and effectively scale and adapt our existing technology;


•	our ability to innovate new products and bring them to market in a timely manner;


•	our ability to expand internationally;


•	the effects of increased competition in our market and our ability to compete effectively;


•	the effects of seasonal trends on our results of operations;


•	our expectations concerning relationships with third parties;


•	the attraction and retention of qualified employees and key personnel;


•	our ability to maintain, protect, and enhance our brand and intellectual property; and


•	future acquisitions of or investments in complementary companies, products, services or technologies.

These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including those described in “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for our management 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 forward-looking events and circumstances 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.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations, except as required by law.

Overview

We are a leading provider of application networking technologies. Our solutions enable service providers, enterprises, Web giants and government organizations to accelerate, secure and optimize the performance of their data center applications and networks. Our products are built on our Advanced Core Operating System (" ACOS") platform of advanced network technologies, which is designed to enable our products to deliver substantially greater performance and security relative to prior generation application networking products. Our software based ACOS architecture also provides the flexibility that enables us to expand our business to offer additional products to solve a growing array of networking and security challenges arising from increased Internet cloud and mobile computing.

We currently offer three software based advanced application networking solutions. These are Application Delivery Controllers ("ADCs") to optimize data center performance, Carrier Grade Network Address Translation ("CGN") to provide address and protocol translation services for service provider networks, and a Distributed Denial of Service Threat Protection System ("TPS") for network-wide security protection. We deliver these solutions both on optimized hardware appliances and as virtual appliances across our Thunder Series and AX Series product families.

We derive revenue from sales of products and related support services. Products revenue are generated primarily by sales of hardware appliances with perpetual licenses to our embedded software solutions. We generate services revenue primarily from sales of maintenance and support. Our end-customers predominantly purchase maintenance and support in conjunction with purchases of our products.

We sell our products globally to service providers and enterprises that depend on data center applications and networks to generate revenue and manage operations efficiently. Our end-customers operate in a variety of industries, including telecommunications, technology, industrial, retail, financial and education. Since inception, our customer base has grown rapidly. As of September 30, 2014, we had sold products to more than 3,600 customers across 68 countries, including three of the top four United States wireless carriers, seven of the top ten United States cable service providers, and the top three wireless carriers in Japan, in addition to other global enterprises, Web giants and governmental organizations.

We sell substantially all of our solutions through our high-touch sales organization as well as distribution channel partners, including distributors, value added resellers and system integrators, and fulfill nearly all orders globally through such partners. We believe this sales approach allows us to obtain the benefits of channel distribution, such as expanding our market coverage, while still maintaining face-to-face relationships with our end-customers. We outsource the manufacturing of our hardware products to original design manufacturers. We perform quality assurance and testing at our San Jose, California facilities, as well as at our manufacturers’ locations. We warehouse and deliver the majority of our products out of our San Jose warehouse. We also outsource warehousing and delivery to a third-party logistics provider in some regions.

During the nine months ended September 30, 2014, 48% of our total revenue was generated from the United States, 27% from Japan, and 25% from other geographical regions. During the year ended December 31, 2013, 48% of our total revenue was generated from the United States, 28% from Japan and 24% from other geographical regions.

As a result of the nature of our target market and the current stage of our development, a substantial portion of our revenue comes from a limited number of large end-customers, including service providers, in any period. During the nine months ended September 30, 2014 and years ended December 31, 2013 and 2012, purchases from our ten largest end-customers accounted for approximately 41%, 43% and 49% of our total revenue. The composition of the group of these ten largest end-customers changes from period to period, but often includes service providers, who accounted for approximately 45%, 47% and 53% of our total revenue during the nine months ended September 30, 2014 and years ended December 31, 2013 and 2012. Sales to these large end-customers have typically been characterized by large but irregular purchases with long sales cycles. The timing of these purchases and the delivery of the purchased products is difficult to predict. As a consequence, any acceleration or delay in anticipated product purchases by or deliveries to our largest end-customers could materially impact our revenue and operating results in any quarterly period and cause our quarterly revenue and operating results to fluctuate from quarter to quarter and also be difficult to predict.

We believe our revenue during the nine months ended September 30, 2013 was affected by the issuance of injunctions related to our now settled litigation with Brocade Communications Systems, Inc. Although such injunctions did not prevent us from selling our redesigned products, certain customers informed us that they would not purchase any of our products until we settled the dispute. Total revenue for the nine months ended September 30, 2014 was $134.3 million, a 35% increase from the same period in the prior year. During the three months ended September 30, 2014, revenue from the United States and Canada, collectively referred to herein as the North America region ("North America"), was below our expectation primarily driven by longer than expected close or sales cycles for certain large deals and lower service provider spending as compared to the same period in 2013. Further, we anticipate a possible slowdown in spending from North America service providers, which may lead to continued near term fluctuation in our products revenue and total revenue.

We intend to continue to invest for long-term growth. We have invested and expect to continue to invest heavily in our product development efforts to deliver new products and additional features in our current products to address customer needs. In addition, we expect to continue to expand our global sales and marketing organizations, expand our distribution channel partner programs and increase awareness of our solutions on a global basis. Additionally we will be investing in general and administration resources to meet the requirements to operate as a public company. Our investments in growth in these areas may affect short-term profitability.

Key Components of Our Results of Operations and Financial Condition

Revenue

Our products revenue consists of revenue from sales of our hardware appliances upon which our software is installed. Such software includes our ACOS software platform plus one of our ADC, CGN or TPS solutions. Purchase of a hardware appliance includes a perpetual license to the included software. We recognize products revenue at the time of shipment, provided that all other revenue recognition criteria have been met. As a percentage of revenue, our products revenue may vary from quarter to quarter based on, among other things, the timing of orders and delivery of products, cyclicality and seasonality, changes in currency exchange rates and the impact of significant transactions with unique terms and conditions. During the three months ended September 30, 2014, our revenue from North America was below our expectation primarily driven by longer than expected close or sales cycles for certain large deals and lower service provider spending as compared to the same period in 2013. We anticipate a possible slowdown in spending from North America service providers, which may lead to continued near term fluctuation in our products revenue and total revenue.

We generate services revenue from sales of post contract support, or PCS, which is bundled with sales of products and professional services. We offer tiered PCS services under renewable, fee-based PCS contracts, primarily including technical support, hardware repair and replacement parts, and software upgrades on a when-and-if-released basis. We recognize services revenue ratably over the term of the PCS contract, which is typically one year, but can be up to five years. We expect our services revenue to increase in absolute dollars as we expand our installed base.

Cost of Revenue

Cost of products revenue is primarily comprised of cost of third-party manufacturing services and cost of component inventory for the hardware component of our products. Cost of products revenue also includes warehouse personnel costs, shipping costs, inventory write-downs, certain allocated facilities and information technology infrastructure costs, and expenses associated with logistics and quality control.

Cost of services revenue is primarily comprised of personnel costs for our technical support, training and professional service teams. Cost of services revenue also includes the costs of inventory used to provide hardware replacements to end-customers under PCS contracts and certain allocated facilities and information technology infrastructure costs.

Gross Margin

Gross margin may vary and be unpredictable from quarter to quarter due to a variety of factors. These may include the mix of revenue from each of our regions, the mix of our products sold within a period, discounts provided to customers, discounts on early sales of new products to gain market penetration, inventory write-downs and international currency exchange rates. As to currency, our sales are generally denominated in U.S. dollars, however, in Japan they are denominated in the Japanese yen. Changes in the exchange rates between the U.S. dollar and Japanese yen will therefore affect our revenue and gross margin. For example, in the third quarter of 2014, gross margin was adversely impacted by an increase in our inventory reserve primarily due to obsolete inventory on hand and unfavorable exchange rate fluctuations between the U.S. dollar and the Japanese yen. Any of the factors noted above can generate either a positive or negative impact on gross margin as compared to another period. Although our third quarter ending September 30, 2014 gross margin was lower than anticipated, we expect our gross margin to be consistent with our historical average.

Operating Expenses

Our operating expenses consist of sales and marketing, research and development, general and administrative and litigation. The largest component of our operating expenses is personnel costs which consist of wages, benefits, bonuses, and, with respect to sales and marketing expenses, sales commissions. Personnel costs also include stock-based compensation and travel expenses. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business.

Sales and Marketing

Sales and marketing expenses are our largest functional category of total operating expense. These expenses primarily consist of personnel costs related to our employees engaged in sales and marketing activities. Sales and marketing expenses also include the cost of marketing programs, trade shows, consulting services, promotional materials, demonstration equipment, depreciation and certain allocated facilities and information technology infrastructure costs. We expect our sales and marketing expenses to continue to increase in absolute dollars as we increase the size of our sales and marketing organization and expand into new countries.

Research and Development

Research and development efforts are focused on new product development and on developing additional functionality for our existing products. These expenses consist of personnel costs, and to a lesser extent, prototype materials, depreciation and certain allocated facilities and information technology infrastructure costs. 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.

General and Administrative

General and administrative expenses consist primarily of personnel costs, professional fees and facility costs. General and administrative personnel costs include executive, finance, human resources, information technology, facility and legal (excluding litigation) related expenses. Professional fees consist primarily of fees for outside accounting, tax, legal, recruiting and other administrative services. We expect our general and administrative expenses to increase in absolute dollars due to the additional legal, accounting, insurance, investor relations and other costs that we will incur as a public company, as well as other costs associated with growing our business.

Litigation Expense (Benefit)

Litigation expense (benefit) is comprised of legal expenses incurred related to litigation and, if applicable, charges for litigation reserves. Legal expenses consist of professional fees incurred in defending ourselves against litigation matters and are expensed as incurred when professional services are provided. The litigation reserve, if any, consists of accruals we make related to estimated losses in pending legal proceedings. Litigation reserves, if any, are adjusted as we change our estimates or make payments in damages or settlements.

Other Income (Expense), Net

Interest Expense

Interest expense consists primarily of interest expense on our debt obligations. At September 30, 2014, we have no outstanding balances on our credit facility. We expect to continue to incur commitment fees associated with the undrawn balance of our credit facility. At such time we choose to draw down on the credit facility we would reduce the commitment fees accrued and increase the interest on outstanding balances.

Interest Income and Other Income (Expense), Net

Interest income consists primarily of interest income earned on our cash and cash equivalents balances. Other income (expense) consists primarily of foreign currency exchange gains and losses and, through February 2013, fair value adjustments related to then-outstanding warrants to purchase our convertible preferred stock. Foreign currency exchange gains and losses relate to transactions and asset and liability balances denominated in currencies other than the U.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.

Provision for Income Taxes

Provision for income taxes currently consists of taxes from state and foreign jurisdictions. For federal and state tax purposes, we maintain a valuation allowance against all of our net deferred tax assets. We will continue to maintain a full valuation allowance against our net federal and state deferred tax assets until there is sufficient evidence to support recoverability of our deferred tax assets. As a result, the provision for income taxes primarily relates to foreign and state taxes.

Results of Operations

The following tables provide a summary of our Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013 as derived from our condensed consolidated financial statements included in Part I Financial Information in this Quarterly Report on Form 10-Q (in thousands, except for percentages).



	Three Months Ended September 30,
	2014					2013					Increase (Decrease)
	Amount			Percent of Total Revenue		Amount			Percent of Total Revenue		Amount			Percent
Revenue:
Products	$	31,601		72.8	%	$	32,263		81.0	%	$	(662	)	(2.1	)%
Services	11,827			27.2		7,563			19.0		4,264			56.4
Total revenue	43,428			100.0		39,826			100.0		3,602			9.0
Cost of revenue:
Products	8,818			20.3		6,669			16.7		2,149			32.2
Services	2,935			6.8		2,065			5.2		870			42.1
Total cost of revenue	11,753			27.1		8,734			21.9		3,019			34.6
Gross profit	31,675			72.9		31,092			78.1		583			1.9
Operating expenses:
Sales and marketing	24,651			56.8		18,276			45.9		6,375			34.9
Research and development	12,342			28.4		8,517			21.4		3,825			44.9
General and administrative	5,141			11.8		3,686			9.3		1,455			39.5
Litigation expense (benefit)	910			2.1		1,683			4.2		(773		)	(45.9	)
Total operating expenses	43,044			99.1		32,162			80.8		10,882			33.8
Loss from operations	(11,369		)	(26.2	)	(1,070		)	(2.7	)	(10,299		)	(962.5	)
Other income (expense), net:
Interest expense	(192		)	(0.4	)	(1,399		)	(3.5	)	1,207			86.3
Interest income and other income (expense), net	(510		)	(1.2	)	(73		)	(0.2	)	(437		)	(598.6	)
Total other income (expense), net	(702		)	(1.6	)	(1,472		)	(3.7	)	770			52.3
Loss before provision for income taxes	(12,071		)	(27.8	)	(2,542		)	(6.4	)	(9,529		)	(374.9	)
Provision for income taxes	233			0.5		207			0.5		26			12.6
Net loss	$	(12,304	)	(28.3	)%	$	(2,749	)	(6.9	)%	$	(9,555	)	(347.6	)%



	Nine Months Ended September 30,
	2014					2013					Increase (Decrease)
	Amount			Percent of Total Revenue		Amount			Percent of Total Revenue		Amount			Percent
Revenue:
Products	$	102,140		76.1	%	$	78,596		79.0	%	$	23,544		30.0	%
Services	32,165			23.9		20,942			21.0		11,223			53.6
Total revenue	134,305			100.0		99,538			100.0		34,767			34.9
Cost of revenue:
Products	23,655			17.6		16,469			16.6		7,186			43.6
Services	8,491			6.3		5,783			5.8		2,708			46.8
Total cost of revenue	32,146			23.9		22,252			22.4		9,894			44.5
Gross profit	102,159			76.1		77,286			77.6		24,873			32.2
Operating expenses:
Sales and marketing	70,189			52.3		49,588			49.8		20,601			41.5
Research and development	35,416			26.4		24,625			24.7		10,791			43.8
General and administrative	16,035			11.9		11,213			11.3		4,822			43.0
Litigation expense (benefit)	(3,103		)	(2.3	)	9,887			9.9		(12,990		)	(131.4	)
Total operating expenses	118,537			88.3		95,313			95.7		23,224			24.4
Loss from operations	(16,378		)	(12.2	)	(18,027		)	(18.1	)	1,649			9.1
Other income (expense), net:
Interest expense	(904		)	(0.7	)	(1,445		)	(1.5	)	541			37.4
Interest income and other income (expense), net	(673		)	(0.5	)	(1,437		)	(1.4	)	764			53.2
Total other income (expense), net	(1,577		)	(1.2	)	(2,882		)	(2.9	)	1,305			45.3
Loss before provision for income taxes	(17,955		)	(13.4	)	(20,909		)	(21.0	)	2,954			14.1
Provision for income taxes	747			0.5		586			0.6		161			27.5
Net loss	$	(18,702	)	(13.9	)%	$	(21,495	)	(21.6	)%	$	2,793		13.0	%

Comparison of the Three and Nine Months Ended September 30, 2014 and 2013

Revenue

A summary of our total revenue for the three and nine months ended September 30, 2014 and 2013 is as follows (in thousands, except for percentages):



	Three Months Ended September 30,				Increase (Decrease)
	2014		2013		Amount			Percent
Revenue:
Products	$	31,601	$	32,263	$	(662	)	(2.1	)%
Services	11,827		7,563		4,264			56.4
Total revenue	$	43,428	$	39,826	$	3,602		9.0	%



	Nine Months Ended September 30,				Increase (Decrease)
	2014		2013		Amount		Percent
Revenue:
Products	$	102,140	$	78,596	$	23,544	30.0	%
Services	32,165		20,942		11,223		53.6
Total revenue	$	134,305	$	99,538	$	34,767	34.9	%

Total revenue increased $3.6 million in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 which consisted of a $4.3 million increase in services revenue partially offset by $0.7 million decrease in products revenue. We had lower than expected products revenue from our North America market during the three months ended September 30, 2014 primarily due to longer than expected close or sales cycles for certain large deals and lower North America service provider spending. Total revenue from North America service providers decreased by 62% in the three months ended September 30, 2014 as compared to the same period in 2013. Total revenue increased $34.8 million in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 which consisted of a $23.5 million increase in products revenue and an $11.2 million increase in services revenue. These increases were primarily a result of the positive effects of the now settled Brocade litigation and acceptance of our new Thunder series of products introduced in the third quarter of 2013.

Products revenue decreased $0.7 million during the three months ended September 30, 2014 compared to the three months ended September 30, 2013 as a result of the factors discussed above. Products revenue from North America service providers decreased 78% in the three months ended September 30, 2014 compared to the same period in 2013. The decrease in North America products revenue was offset by increases in revenue from international regions including EMEA and Asia Pacific, excluding Japan, primarily attributable to our efforts in expanding our international sales presence.

Products revenue increased $23.5 million nine months ended September 30, 2014 primarily driven by a rise in sales of our products largely attributable to greater adoption of our solutions to new and existing customers which we believe resulted from the absence of the negative effect of the injunction issued in January 2013 related to the now settled Brocade litigation. The injunction did not prevent us from shipping our redesigned products in January 2013, but at that time, some customers informed us they would not purchase our products until after settlement of the litigation, which occurred in May 2013. In addition, there has been a rapid adoption of our Thunder Series products introduced in the third quarter of 2013 which accounted for the majority of products revenue in the three and nine months ended September 30, 2014. Our Thunder Series of products include our ADC, CGN and TPS product lines.

Services revenue increased $4.3 million and $11.2 million in the three and nine months ended September 30, 2014 compared to the same periods in 2013 primarily attributable to the increase in PCS sales in connection with our increasing installed customer base as well as increases in our professional services revenue. Over 95% of our end-customers purchase one of our maintenance service products when purchasing our hardware products. During the three and nine months ended September 30, 2014, services revenue recognized from our installed base with existing contracts prior to the start of these reporting periods grew by 57% and 54% as compared to revenue generated during the same reporting periods in 2013.

During the three months ended September 30, 2014, 47%, or $20.4 million of total revenue was generated from the United States. Total revenue from the U.S. decreased by 23% in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 primarily as a result of longer than expected close or sales cycles for certain large deals and lower North America service provider revenue partially offset by an increase in services revenue that resulted from our increasing installed customer base.

Total revenue from Japan increased 41%, or $2.9 million, in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 primarily due to increased revenue from service providers by 58% partially offset by unfavorable fluctuations in the U.S dollar exchange rate against the Japanese yen. We continue to see growth in our Asia Pacific, excluding Japan and EMEA regions with revenue increasing by 113% to $6.3 million and 196% to $4.9 million during the three months ended September 30, 2014 as compared to the same period in the prior year. These increases are primarily a result of our efforts to expand our sales presence into these markets.

During the nine months ended September 30, 2014, 48%, or $64.9 million of total revenue was generated from the United States and 27%, or $35.7 million of total revenue was generated from Japan. Total U.S. revenue grew by 37%, or $17.4 million, in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, as the negative

effects of the now settled Brocade litigation during the prior period have subsided. Total revenue from Japan increased by 15% to $35.7 million for the nine months ended September 30, 2014 compared to the same period in the prior year. We continue to see growth in our EMEA and Asia Pacific, excluding Japan regions with total revenue increasing by 97% to $13.0 million and 66% to $15.0 million during the nine months ended September 30, 2014 as compared to the same period in the prior year primarily due to our efforts to expand our presence in regions outside the United States.

We anticipate a possible slowdown in spending from North America service providers, which may lead to continued near term fluctuation in our products revenue and total revenue. We expect services revenue to increase sequentially into the foreseeable future as we increase our installed base.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue

A summary of our cost of revenue for the three and nine months ended September 30, 2014 and 2013 is as follows (in thousands, except for percentages):



	Three Months Ended September 30,				Increase (Decrease)
	2014		2013		Amount		Percent
Cost of revenue:
Products	$	8,818	$	6,669	$	2,149	32.2	%
Services	2,935		2,065		870		42.1
Total cost of revenue	$	11,753	$	8,734	$	3,019	34.6	%



	Nine Months Ended September 30,				Increase (Decrease)
	2014		2013		Amount		Percent
Cost of revenue:
Products	$	23,655	$	16,469	$	7,186	43.6	%
Services	8,491		5,783		2,708		46.8
Total cost of revenue	$	32,146	$	22,252	$	9,894	44.5	%

Gross Margin

A summary of gross profit and gross margin for the three and nine months ended September 30, 2014 and 2013 is as follows (in thousands, except for gross margins):



	Three Months Ended September 30,
	2014				2013				Increase (Decrease)
	Amount		Gross Margin		Amount		Gross Margin		Amount			Gross Margin
Gross profit:
Products	$	22,783	72.1	%	$	25,594	79.3	%	$	(2,811	)	(7.2	)%
Services	8,892		75.2		5,498		72.7		3,394			2.5
Total gross profit	$	31,675	72.9	%	$	31,092	78.1	%	$	583		(5.2	)%



	Nine Months Ended September 30,
	2014				2013				Increase (Decrease)
	Amount		Gross Margin		Amount		Gross Margin		Amount		Gross Margin
Gross profit:
Products	$	78,485	76.8	%	$	62,127	79.0	%	$	16,358	(2.2	)%
Services	23,674		73.6		15,159		72.4		8,515		1.2
Total gross profit	$	102,159	76.1	%	$	77,286	77.6	%	$	24,873	(1.5	)%

Products gross margin decreased 7.2 percentage points and 2.2 percentage points in the three and nine months ended September 30, 2014 compared to the same periods in 2013 primarily due to an unfavorable shift in our geographical sales mix and a devaluation of the Japanese yen to the U.S. Dollar. During the three and nine months ended September 30, 2013 higher sales volumes were from geographic regions with generally higher gross margins compared to the same periods in 2014. In addition, during the three months ended September 30, 2014 our inventory reserve increased compared to the same period in 2013 as a result of our end-customers adopting our new Thunder Series.

Services gross margin increased 2.5 percentage points and 1.2 percentage points in the three and nine months ended September 30, 2014 compared to the same period in 2013, as a result of growth in services revenue and partially offset by the impact of increases in cost of services. Our services revenue recognized from our installed base with existing contracts prior to the start of these reporting periods grew by 57% and 54% as compared to revenue generated during the same reporting periods in 2013. The increase in cost of services was primarily as a result of our investment to expand our service and support group in anticipation of future growth in our installed base. We increased our average support, training and professional services headcount by 59% during the nine months ended September 30, 2014 compared to the same period in 2013.

Operating Expenses

A summary of our operating expenses for the three and nine months ended September 30, 2014 and 2013 is as follows (in thousands, except for percentages):



	Three Months Ended September 30,				Increase (Decrease)
	2014		2013		Amount			Percent
Operating expenses:
Sales and marketing	$	24,651	$	18,276	$	6,375		34.9	%
Research and development	12,342		8,517		3,825			44.9
General and administrative	5,141		3,686		1,455			39.5
Litigation expense (benefit)	910		1,683		(773		)	(45.9	)
Total operating expenses	$	43,044	$	32,162	$	10,882		33.8	%



	Nine Months Ended September 30,					Increase (Decrease)
	2014			2013		Amount			Percent
Operating expenses:
Sales and marketing	$	70,189		$	49,588	$	20,601		41.5	%
Research and development	35,416			24,625		10,791			43.8
General and administrative	16,035			11,213		4,822			43.0
Litigation expense (benefit)	(3,103		)	9,887		(12,990		)	(131.4	)
Total operating expenses	$	118,537		$	95,313	$	23,224		24.4	%

Sales and Marketing

Sales and marketing expenses increased $6.4 million in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 primarily attributable to $3.5 million increase in personnel and related costs, which

includes a $1.1 million increase in stock-based compensation, as a result of a 24% increase in average sales and marketing headcount during the three months ended September 30, 2014 compared to the same period in 2013. The increase was also attributable to a $0.9 million increase in marketing and promotion costs associated with advertising and trade shows and $0.8 million increase in professional fees as we increased our sales and marketing efforts to grow our revenue and expand our international sales presence. Depreciation expense allocated to sales and marketing departments also increased by $0.5 million as a result of higher headcount and increased depreciation expense on our evaluation equipment.

Sales and marketing expenses increased $20.6 million in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 primarily attributable to $13.9 million increase in personnel and related costs, which includes a $2.5 million increase in stock-based compensation. The increase in personnel related costs was a result of higher sales and marketing headcount as we experienced a 27% increase in average headcount during the nine months ended September 30, 2014 compared to the same period in 2013. The increase was also attributable to a $2.3 million increase in marketing and promotion costs associated with advertising and trade shows, and $1.7 million increase in professional fees, as we increased our sales and marketing efforts to grow our revenue and expand our international sales presence. Depreciation expense allocated to sales and marketing departments also increased by $1.4 million as a result of higher headcount and increased depreciation expense on our evaluation equipment.

Research and Development

Research and development expenses increased $3.8 million in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 primarily attributable to a $3.3 million increase in personnel and related costs, which includes a $0.8 million increase in stock-based compensation. The increases in personnel costs primarily resulted from a 27% increase in average research and development headcount for the three months ended September 30, 2014 compared to the same period in 2013, as we continued our efforts to develop new products and additional functionality for our existing products. The increases in research and development expenses also reflected a $0.4 million increase in depreciation and allocated facilities and information technology infrastructure costs in the three months ended September 30, 2014 compared to the same period in 2013.

Research and development expenses increased $10.8 million in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 primarily attributed to an $8.8 million increase in personnel and related costs, which includes a $1.6 million increase in stock-based compensation. The increase in personnel related costs was a result of higher research and development headcount as we experienced a 26% increase in average headcount during the nine months ended September 30, 2014 compared to the same period in 2013. The increases in research and development expenses also reflected a $1.0 million increase in professional services fees largely attributable to certification fees on our new products and a $1.0 million increase in depreciation and allocated facilities and information technology infrastructure costs in the nine months ended September 30, 2014 compared to the same period in 2013.

General and Administrative

General and administrative expenses increased $1.5 million in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 primarily attributable to a $1.0 million increase in personnel related costs which includes a $0.3 million increase in stock-based compensation. The increase in personnel related costs was a result of an increase in our average general and administrative headcount of 29% for the three months ended September 30, 2014 compared to the same period in 2013. In addition, professional services costs increased by $1.1 million in the three months ended September 30, 2014 compared to the same periods in 2013 primarily related to increased general legal and consultant fees in connection with scaling our organization to support increased business activity and the costs associated with being a public company. These increases were partially offset by a $0.7 million decrease in other expenses primarily due to a decrease in bad debt expense.

General and administrative expenses increased $4.8 million from the nine months ended September 30, 2013 to the nine months ended September 30, 2014 primarily attributed to a $2.5 million increase in personnel related costs which includes a $0.8 million increase in stock-based compensation. The increase in personnel related costs was a result of higher general and administrative headcount as we experienced a 27% increase in average headcount during the nine months ended September 30, 2014 compared to the same period in 2013. In addition, professional services costs increased by $1.7 million in the nine months ended September 30, 2014 compared to the same periods in 2013 primarily related to increased general legal and consultant fees in connection with scaling our organization to support increased business activity and costs associated with being a public company.

Litigation Expense (Benefit)

Litigation expense decreased $0.8 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013 primarily attributable to reduction in litigation costs following the settlement of the litigation with Radware in August 2014.

We recognized $3.1 million of litigation benefit and $9.9 million of litigation expense in the nine months ended September 30, 2014 and 2013. The litigation benefit for the nine months ended September 30, 2014 comprised of a benefit of $7.0 million from a settlement agreement with one of our legal services providers which resulted in the reduction of a previously accrued contractual liability partially offset by other litigation expense of $3.9 million. The $9.9 million litigation expense for the nine months ended September 30, 2013 primarily consisted of $7.3 million costs associated with the Brocade litigation which was settled in May 2013 and additional costs related to litigation with Radware and Parallel Networks.

Interest Expense

Interest expense decreased by $1.2 million in the three months ended September 30, 2014 compared to the three months ended September 30, 2013, primarily due to $1.1 million in interest expense on an unsecured convertible promissory note we issued to Brocade in July 2013 in accordance with the terms of the settlement of the Brocade litigation recorded in the three months ended September 30, 2013. We repaid the note in full in September 2013.

Interest expense decreased $0.5 million in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 due to $1.1 million in interest expense on an unsecured convertible promissory note we issued to Brocade in July 2013 recorded in the nine months ended September 30, 2013 partially offset by a $0.3 million contingent payment due upon completion of the initial public offering to a lender and $0.5 million of interest expense related to our revolving credit facility.

Interest Income and Other Income (Expense), Net

Interest income and other income (expense), net, was $0.5 million expense in the three months ended September 30, 2014 primarily comprised of foreign exchange losses resulting from declining Japanese yen exchange rates against the U.S dollar during the three months ended September 30, 2014.

Interest income and other income (expense), net, was $0.7 million expense in the nine months ended September 30, 2014 primarily comprised of foreign exchange losses resulting from declining Japanese yen and the Euro exchange rates against the U.S dollar during the nine months ended September 30, 2014.

Provision for Income Taxes

We recorded an income tax provision of $0.2 million and $0.7 million for the three and nine months ended September 30, 2014 which is primarily the result of taxes in foreign jurisdictions. We recorded an income tax provision of $0.2 million and $0.6 million for the three and nine months ended September 30, 2013 which is primarily the result of taxes in foreign jurisdictions. We maintain a valuation allowance on federal and state deferred tax assets as we do not believe it is more likely than not that said deferred tax assets will be realized. We will continue to maintain a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of this allowance.

Liquidity and Capital Resources

Prior to our initial public offering in March 2014, we had financed our operations primarily through private placements of our convertible preferred stock, debt financings and cash flows derived from the sale of our products and PCS contracts. In March 2014, we completed our initial public offering, whereby we sold 12,500,000 common shares at $15.00 per share (3,500,000 of which were offered by selling stockholders) and received net cash proceeds of $121.0 million after underwriting discounts and commissions and offering expenses during the nine months ended September 30, 2014. As of September 30, 2014, cash and cash equivalents were $107.1 million, including $2.6 million held outside the United States in our foreign subsidiaries. We currently do not have any plans to repatriate our earnings from our foreign operations. As of September 30, 2014, we had working capital of $107.7 million, an accumulated deficit of $165.8 million and total stockholders' equity of $105.7 million.

We plan to continue to invest for long-term growth and anticipate our investment will continue to increase in absolute dollars. We believe that our existing cash and cash equivalents and our cash inflow from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the expansion of sales and marketing activities, the timing and extent of spending to support development efforts, the introduction of new and enhanced product and service offerings and the continuing market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

As we invest in the growth of our business, we expect to incur an additional $2.7 million in capital expenditures in the remainder of 2014 due to recurring investments in computer hardware and software. In addition, as described in the section "Legal Proceedings" we are currently involved in ongoing litigation. Any adverse settlements or judgments in any litigation could have a material adverse impact on our results of operations, cash balances and cash flows in the period in which such events occur.

Credit Agreement

In September 2013, we entered into a credit agreement with Royal Bank of Canada, acting as administrative agent and lender, and JPMorgan Chase Bank, N.A. and Bank of America, N.A. as lenders. The credit agreement provides a three year $35.0 million revolving credit facility, which includes a maximum $10.0 million letter of credit facility. As of December 31, 2013, we had outstanding borrowings under the revolving credit facility of $20.0 million, which was paid in March 2014. The revolving credit facility matures on September 30, 2016.

Our obligations under the credit agreement are secured by a security interest on substantially all of our assets, including our intellectual property. The credit agreement contains customary non-financial covenants, and also requires us to comply with financial covenants. One financial covenant requires us to maintain a total leverage ratio, which is defined as total consolidated debt divided by adjusted EBITDA (defined as earnings before interest expense, tax expense, depreciation, amortization and stock-based compensation, adjusted for certain other non-cash or non-recurring income or expenses such as specified litigation settlement payments and litigation expenses) for the trailing four quarters. In addition, we must maintain a minimum amount of liquidity based on our unrestricted cash and availability under the revolving credit facility. The covenant requires us to maintain a minimum liquidity of $25.0 million provided that at least $10.0 million of such liquidity comprised of unrestricted cash and cash equivalents. The credit agreement includes customary events of default which, if triggered, could result in the acceleration of our obligations under the revolving credit facility, the termination of any obligation by the lenders to extend further credit and the right of the lenders to exercise their remedies as a secured creditor and foreclose upon the collateral securing our obligation under the credit agreement; however, we also have the ability, in certain instances, to cure non-compliance with the financial covenants through qualified equity contributions by certain holders of our equity. Currently, the agreement for our revolving credit facility contains restrictions on our ability to pay dividends. As of September 30, 2014, we had no outstanding balance on our credit facility and were in compliance with our covenants.

Statements of Cash Flows

The following table summarizes our cash flow related activities for the nine months ended September 30, 2014 and 2013 (in thousands):



	Nine Months Ended September 30,
	2014			2013
Cash provided by (used in):
Operating activities	$	(13,521	)	$	(20,663	)
Investing activities	(5,380		)	(2,876		)
Financing activities	105,207			30,032
Net increase in cash and cash equivalents	$	86,306		$	6,493

Cash Flows from Operating Activities

Our cash used in operating activities is driven primarily by sales of our products and, to a lesser extent, by up-front payments from end-customers under PCS contracts. Our primary uses of cash from operating activities have been for personnel-related expenditures, manufacturing costs, marketing and promotional expenses, costs related to our facilities and litigation expenses. Our cash flows from operating activities will continue to be affected principally by the extent to which we increase spending on personnel and sales and marketing activities, our working capital requirements, and litigation expenses.

During the nine months ended September 30, 2014, cash used in operating activities was $13.5 million, consisting of a net loss of $18.7 million and a $3.5 million increase in net operating assets and liabilities offset by non-cash charges of $8.7 million. Our non-cash charges consisted primarily of stock-based compensation of $8.3 million and depreciation and amortization of $7.3 million, partially offset by a $7.0 million gain on settlement of a contractual liability. The change in our net operating assets and liabilities was primarily due to a $6.8 million decrease in accrued litigation expenses, a $6.3 million increase in inventory, a $4.8 million increase in accounts receivable and a $3.3 million increase in prepaid expenses and other current assets, partially offset by a $9.7 million increase in deferred revenue and an $8.2 million increase in accounts payable and accrued liabilities.

The decrease in accrued litigation costs was primarily due to the $5.0 million payment we made under the terms of a settlement of a contractual liability we reached with one of our legal services providers in May 2014 as well as lower litigation activities in the nine months ended September 30, 2014 compared to the same period in 2013. The increase in inventory and prepaid and other current assets was attributable to our year over year business growth. The increase in accounts receivable was primarily due to increased billing and the timing of billing and cash collection, as a higher portion of the September 30, 2014 outstanding accounts receivable were billed during the latter part of the quarter compared to the December 31, 2013 outstanding accounts receivable. The increase in accounts payable and accrued liabilities was primarily attributable to increases in accrued compensation costs due to higher headcount and increases in accounts payable and other accrued liabilities as a result of increased business activity levels and the timing of vendor invoice payments. The increase in deferred revenue was due to billings of support contracts with service terms that are typically one year.

During the nine months ended September 30, 2013, cash used in operating activities was $20.7 million, consisting of a net loss of $21.5 million and $8.0 million increase in our net operating assets and liabilities partially offset by $8.8 million in non-cash charges. Our non-cash charges primarily consisted of $5.0 million in depreciation and amortization, $2.9 million in stock-based compensation and $1.2 million of provisions for doubtful accounts and sales returns. The decrease in our net operating assets and liabilities primarily consisted of a $7.9 million increase in accounts receivable, a $4.4 million increase in inventory both associated with the growth in our business combined with a $3.0 million decrease in accrued litigation expenses attributable to payments of the legal fees following settling the Brocade litigation. These changes were partially offset by a $4.5 million increase in deferred revenue due to increased sales of our PCS contracts and a $3.1 million increase in accrued liabilities attributable to higher accrued personnel costs due to growth in headcount and accrued tax liabilities.

Cash Flows from Investing Activities

During the nine months ended September 30, 2014 and 2013, cash used in investing activities was $5.4 million and $2.9 million primarily for purchases of property and equipment.

Cash Flows from Financing Activities

During the nine months ended September 30, 2014, cash provided by financing activities was $105.2 million, primarily consisting of $121.0 million in net proceeds from the issuance of our common stock to outside investors in our IPO, and $4.4 million from the exercise of common stock options, net of repurchases of common stock, partially offset by a $20.0 million repayment of our revolving credit facility.

During the nine months ended September 30, 2013, cash provided by financing activities was $30.0 million, primarily consisting of $79.4 million in aggregate net proceeds from the issuance of our Series D redeemable convertible preferred stock to outside investors, a net $19.0 million in borrowings from our revolving credit facility, $1.7 million in proceeds from the exercise of stock options, net of repurchases of common stock and $0.8 million in proceeds from the exercise of our Series C convertible preferred stock warrants. These changes were partially offset by a $70.0 million repayment of a promissory note and $0.6 million repayment of our term loan. In July 2013, in conjunction with our litigation settlement with Brocade, we entered into a convertible promissory note with Brocade for $70.0 million, which we repaid in September 2013. During 2013, we drew down on our revolving credit facility with Silicon Valley Bank periodically for short-term cash needs, repaying within a short period of time. In addition, we entered into a credit agreement with Royal Bank of Canada, JPMorgan Chase Bank, N.A. and Bank of America, N.A. in September 2013 and drew down $25.0 million on the new revolving credit facility.

Contractual Obligations

In September 2013, we entered into a credit agreement with Royal Bank of Canada, JPMorgan Chase Bank, N.A. and Bank of America, N.A. as lenders. The credit agreement provides a three year $35.0 million revolving credit facility, which includes a maximum $10.0 million letter of credit facility. As of December 31, 2013, we had outstanding borrowings under the revolving credit facility of $20.0 million, which was repaid in March 2014. We have no outstanding borrowings under this credit facility as of September 30, 2014.

Off-Balance Sheet Arrangements

As of September 30, 2014, we did not have any relationships with any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

There were no significant changes in our critical accounting policies and estimates during the nine months ended September 30, 2014 as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our final prospectus filed with the SEC on March 21, 2014, except for the determination of fair value of our common stock, which was used in the estimating the fair value of stock-based awards at grant date. Prior to our IPO in March 2014, our stock was not publicly traded, therefore we estimated the fair value of our common stock as discussed in the prospectus. Following our IPO, we established a policy of using the closing sale price per share of our common stock as quoted on the New York Stock Exchange on the grant date for purposes of determining the exercise price per share of our options to purchase common stock.


ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Risk

Our consolidated results of operations, financial position and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. Historically, the majority of our revenue contracts are denominated in U.S. dollars, with the most significant exception being Japan where we invoice primarily in the Japanese yen. Our costs and expenses are generally denominated in the currencies where our operations are located, which is primarily in North America, Japan and to a lesser ext

ent EMEA and the Asia Pacific region. To date, we have not entered into any hedging arrangements with respect to foreign currency risk or other derivative instruments. Revenue resulting from selling in local currencies and costs and expenses incurred in local currencies are exposed to foreign currency exchange rate fluctuations which can affect our revenue and operating income. As exchange rates vary, operating income may differ from expectations.

The functional currency of our foreign subsidiaries is the U.S. dollar. At the end of each reporting period, monetary assets and liabilities are remeasured to the functional currency using exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are remeasured at historical exchange rates. Gains and losses related to remeasurement are recorded in interest income and other income (expense), net in the Consolidated Statements of Operations. A significant fluctuation in the exchange rates between our subsidiaries' local currencies, especially the Japanese yen and the Euro, and the U.S. dollar could have an adverse impact on our condensed consolidated financial position and results of operations.

For the nine months ended September 30, 2014, we recorded a $0.7 million foreign exchange loss as other income (expense), net in our Condensed Consolidated Statements of Operations. The effect of a hypothetical 10% change in our exchange rate for the nine months ended September 30, 2014 would not have a significant impact on our operating loss.

Interest Rate Sensitivity

Our exposure to market risk for changes in interest rates relates primarily to our cash and cash equivalents and our indebtedness. Our cash and cash equivalents are held in cash deposits and money market funds with maturities of less than 90 days from the date of purchase. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of the interest rates in the United States. However, because of the short-term nature of the instruments in our portfolio, a sudden change in market interest rates would not be expected to have a material impact on our consolidated financial statements.

Our exposure to interest rates risk relates to our revolving credit facility with variable interest rates, where an increase in interest rate may result in higher borrowing costs. Since we have no outstanding borrowings under our credit facility as of September 30, 2014, the effect of a hypothetical 10% change in interest rates would not have a significant impact on our interest expense.


ITEM 4.	CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2014. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2014, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Securities and Exchange Act of 1934, as amended, that occurred during the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We have been and may currently be involved in various legal proceedings, the outcomes of which are not within our complete control or may not be known for prolonged periods of time. Management is required to assess the probability of loss and amount of such loss, if any, in preparing our consolidated financial statements. We evaluate the likelihood of a potential loss from legal proceedings to which we are a party. We record a liability for such claims when a loss is deemed probable and the amount can be reasonably estimated. Significant judgment may be required in the determination of both probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. As additional information becomes available, we reassess the potential liability related to pending claims and may revise our estimates. Due to the inherent uncertainties of the legal processes in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes, which could have material adverse effects on our business, financial conditions and results of operations.

Additional information with respect to this Item may be found in Note 5. Commitments and Contingencies, in the Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q, which is incorporated into this Item 1 by reference.

ITEM 1A. RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information contained in this report, and in our other public filings. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that affect us. If any of the following risks occur, our business, financial condition, operating results, and prospects could be materially harmed. In that event, the trading price of our common stock could decline, perhaps significantly.

If we do not successfully anticipate market needs and opportunities or if the market does not continue to adopt our application networking products, our business, financial condition and results of operations could be significantly harmed.

The application networking market is rapidly evolving and difficult to predict. Technologies, customer requirements, security threats and industry standards are constantly changing. As a result, we must anticipate future market needs and opportunities and then develop new products or enhancements to our current products that are designed to address those needs and opportunities, and we may not be successful in doing so.

Even if we are able to anticipate, develop and commercially introduce new products and enhancements that address the market’s needs and opportunities, there can be no assurance that new products or enhancements will achieve widespread market acceptance. For example, organizations that use other conventional or first-generation application networking products for their needs may believe that these products are sufficient. In addition, as we launch new product offerings, organizations may not believe that such new product offerings offer any additional benefits as compared to the existing application networking products that they currently use. Accordingly, organizations may continue allocating their IT budgets for conventional or first-generation application networking products and may not adopt our products, regardless of whether our products can offer superior performance or security.

If we fail to anticipate market needs and opportunities or if the market does not continue to adopt our application networking products, then market acceptance and sales of our current and future application networking products could be substantially decreased or delayed, we could lose customers, and our revenue may not grow or may decline. Any of such events would significantly harm our business, financial condition and results of operations.

Our success depends on our timely development of new products and features to address rapid technological changes and evolving customer requirements. If we are unable to timely develop new products and features that adequately address these changes and requirements, our business and operating results could be adversely affected.

Changes in application software technologies, data center and communications hardware, networking software and operating systems, and industry standards, as well as our end-customers’ continuing business growth, result in evolving application networking needs and requirements. Our continued success depends on our ability to identify and develop in a timely manner new products and new features for our existing products that meet these needs and requirements.

Our future plans include significant investments in research and development and related product opportunities. Developing our products and related enhancements is time-consuming and expensive. We have made significant investments in our research and development team in order to address these product development needs. Our investments in research and development may not result in significant design and performance improvements or marketable products or features, or may result in products that are more expensive than anticipated. We may take longer to generate revenue, or generate less revenue,

than we anticipate from our new products and product enhancements. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position.

If we are unable to develop new products and features to address technological changes and new customer requirements in the application networking market or if our investments in research and development do not yield the expected benefits in a timely manner, our business and operating results could be adversely affected.

We have experienced net losses in recent periods, anticipate increasing our operating expenses in the future and may not achieve or maintain profitability in the future. If we cannot achieve or maintain profitability, our financial performance will be harmed and our business may suffer.

We experienced net losses for the years ended December 31, 2012 and 2013, and nine months ended September 30, 2014. Although we experienced revenue growth over these same periods and had achieved profitability in prior year periods, we may not be able to sustain or increase our revenue growth or achieve profitability in the future or on a consistent basis. During 2013 and nine months ended September 30, 2014, we have invested in our sales, marketing and research and development teams in order to develop, market and sell our products. We expect to continue to invest significantly in these areas in the future. As a result of these increased expenditures, we will have to generate and sustain increased revenue, manage our cost structure and avoid significant liabilities to achieve future profitability. In particular, in 2012 and 2013, we incurred substantial expenses associated with defending ourselves in separate litigation matters involving Brocade Communications Systems, Inc. and Radware Ltd. and in our settlement of the Brocade litigation. As a public company, we will also incur significant accounting, legal and other expenses that we did not incur as a private company.

Revenue growth may slow or decline, and we may incur significant losses in the future for a number of possible reasons, including our inability to develop products that achieve market acceptance, general economic conditions, increasing competition, decreased growth in the markets in which we operate, or our failure for any reason to capitalize on growth opportunities. Additionally, we may encounter unforeseen operating expenses, difficulties, complications, delays and other unknown factors that may result in losses in future periods. If these losses exceed our expectations or our revenue growth expectations are not met in future periods, our financial performance will be harmed and our stock price could be volatile or decline.

Our operating results are likely to vary significantly from period to period and may be unpredictable, which could cause the trading price of our common stock to decline.

Our operating results – in particular, revenue, margins and operating expenses – have fluctuated in the past, and we expect this will continue, which makes it difficult for us to predict our future operating results. The timing and size of sales of our products are highly variable and difficult to predict and can result in significant fluctuations in our revenue from period to period. This is particularly true of sales to our largest end-customers, such as service providers, Web giants and governmental organizations, who typically make large and concentrated purchases and for whom close or sales cycles can be long, as a result of their complex networks and data centers, as well as requests that may be made for customized features. Our quarterly results may vary significantly based on when these large end-customers place orders with us and the content of their orders. For example, during the three months ended September 30, 2014, we experienced a decline in our revenues primarily due to longer than expected close or sales cycles for certain large deals and lower North America service provider spending as compared to the same period in 2013, which may have contributed to a dramatic decline in our stock price. We anticipate a possible slowdown in spending from North America service providers, which may lead to continued near term fluctuation in our products revenue and total revenue.

Our operating results may also fluctuate due to a number of other factors, many of which are outside of our control and may be difficult to predict. In addition to other risks listed in this “Risk Factors” section, factors that may affect our operating results include:


•	fluctuations in and timing of purchases from, or loss of, large customers;


•	the budgeting cycles and purchasing practices of end-customers;


•	our ability to attract and retain new end-customers;


•	changes in demand for our products and services, including seasonal variations in customer spending patterns or cyclical fluctuations in our markets;


•	our reliance on shipments at the end of our quarters;


•	variations in product mix or geographic locations of our sales, which can affect the revenue we realize for those sales;


•	the timing and success of new product and service introductions by us or our competitors;


•	our ability to increase the size of our distribution channel and to maintain relationships with important distribution channel partners;


•	the effect of currency exchange rates on our revenue and expenses;


•	the cost and potential outcomes of existing and future litigation;


•	the effect of discounts negotiated by our largest end-customers for sales or pricing pressure from our competitors;


•	changes in the growth rate of the application networking market or changes in market needs;


•	inventory write downs, which may be necessary for our older products when our new products are launched and adopted by our end-customers; and


•	our third-party manufacturers’ and component suppliers’ capacity to meet our product demand forecasts on a timely basis, or at all.

Any one of the factors above or the cumulative effect of some of these factors may result in significant fluctuations in our financial and other operating results. This variability and unpredictability could result in our failure to meet our or our investors’ or securities analysts’ revenue, margin or other operating results expectations for a particular period, resulting in a decline in the trading price of our common stock.

Reliance on shipments at the end of the quarter could cause our revenue for the applicable period to fall below expected levels.

As a result of end-customer buying patterns and the efforts of our sales force and distribution channel partners to meet or exceed their sales objectives, we have historically received a substantial portion of purchase orders and generated a substantial portion of revenue during the last few weeks of each quarter. We can recognize such revenue in the quarter received, however, only if all of the requirements of revenue recognition, especially shipment, are met by the end of the quarter. In addition, any significant interruption in our information technology systems, which manage critical functions such as order processing, revenue recognition, financial forecasts, inventory and supply chain management, could result in delayed order fulfillment and thus decreased revenue for that quarter. If expected revenue at the end of any quarter is delayed for any reason, including the failure of anticipated purchase orders to materialize, our third-party manufacturers’ inability to manufacture and ship products prior to quarter-end to fulfill purchase orders received near the end of the quarter, our failure to manage inventory to meet demand, our inability to release new products on schedule, any failure of our systems related to order review and processing, or any delays in shipments or achieving specified acceptance criteria, our revenue for that quarter could fall below our, or our investors’ or securities analysts’ expectations, resulting in a decline in the trading price of our common stock.

A limited number of our end-customers, including service providers, make large and concentrated purchases that comprise a significant portion of our revenue. Any loss or delay of expected purchases by our largest end-customers could adversely affect our operating results.

As a result of the nature of our target market and the current stage of our development, a substantial portion of our revenue in any period comes from a limited number of large end-customers, including service providers. For example, NTT DoCoMo, Inc., through a reseller, accounted for approximately 32% of our total revenue during the year ended December 31, 2012, approximately 13% of our total revenue during the year ended December 31, 2013 and 7% of our total revenue during the nine months ended September 30, 2014. In addition, during the years ended December 31, 2012 and 2013, and nine months ended September 30, 2014, purchases from our ten largest end-customers accounted for approximately 49%, 43% and 41% of our total revenue. The composition of the group of these ten largest end-customers changes from period to period, but often includes service providers, who accounted for approximately 53%, 47% and 45% of our total revenue during the years ended December 31, 2012 and 2013, and nine months ended September 30, 2014.

Sales to these large end-customers have typically been characterized by large but irregular purchases with long initial sales cycles. After initial deployment, subsequent purchases of our products typically have a more compressed sales cycle. The timing of these purchases and of the requested delivery of the purchased product is difficult to predict. As a consequence, any acceleration or delay in anticipated product purchases by or requested deliveries to our largest end-customers could materially affect our revenue and operating results in any quarter and cause our quarterly revenue and operating results to fluctuate from quarter to quarter.

We cannot provide any assurance that we will be able to sustain or increase our revenue from our largest end-customers nor that we will be able to offset any absence of significant purchases by our largest end-customers in any particular period with purchases by new or existing end-customers in that or a subsequent period. We expect that sales of our products to a limited number of end-customers will continue to contribute materially to our revenue for the foreseeable future. The loss of, or

a significant delay or reduction in purchases by, a small number of end-customers could have a material adverse effect on our consolidated financial position, results of operations or cash flows.

We have been and are a party to litigation and claims regarding intellectual property rights, resolution of which has been and may in the future be time-consuming, expensive and adverse to us, as well as require a significant amount of resources to prosecute, defend, or make our products non-infringing.

Our industry is characterized by the existence of a large number of patents and by increasingly frequent claims and related litigation based on allegations of infringement or other violations of patent and other intellectual property rights. In the ordinary course of our business, we have been and are involved in disputes and licensing discussions with others regarding their patents and other claimed intellectual property and proprietary rights. Intellectual property infringement and misappropriation lawsuits and other claims are subject to inherent uncertainties due to the complexity of the technical and legal issues involved, and we cannot be certain that we will be successful in defending ourselves against such claims or in concluding licenses on reasonable terms or at all.

We currently have fewer issued patents than some of our major competitors, and therefore may not be able to utilize our patent portfolio effectively to assert defenses or counterclaims in response to patent infringement claims or litigation brought against us by third parties. Further, litigation may involve patent holding companies or other adverse patent owners that have no relevant products revenue and against which our potential patents may provide little or no deterrence. In addition, many potential litigants have the capability to dedicate substantially greater resources than we can to enforce their intellectual property rights and to defend claims that may be brought against them. We expect that infringement claims may increase as the numbers of product types and the number of competitors in our market increases. Also, to the extent we gain greater visibility, market exposure and competitive success, we face a higher risk of being the subject of intellectual property infringement claims.

If we are found in the future to infringe the proprietary rights of others, or if we otherwise settle such claims, we could be compelled to pay damages or royalties and either obtain a license to those intellectual property rights or alter our products such that they no longer infringe. Any license could be very expensive to obtain or may not be available at all. Similarly, changing our products or processes to avoid infringing the rights of others may be costly, time-consuming or impractical. Alternatively, we could also become subject to an injunction or other court order that could prevent us from offering our products. Any of these claims, regardless of their merit, may be time-consuming, result in costly litigation and diversion of technical and management personnel, or require us to cease using infringing technology, develop non-infringing technology or enter into royalty or licensing agreements.

Many of our commercial agreements require us to indemnify our end-customers, distributors and resellers for certain third-party intellectual property infringement actions related to our technology, which may require us to defend or otherwise become involved in such infringement claims, and we could incur liabilities in excess of the amounts we have received for the relevant products and/or services from our end-customers, distributors or resellers. These types of claims could harm our relationships with our end-customers, distributors and resellers, may deter future end-customers from purchasing our products or could expose us to litigation for these claims. Even if we are not a party to any litigation between an end-customer, distributor or reseller, on the one hand, and a third party, on the other hand, an adverse outcome in any such litigation could make it more difficult for us to defend our intellectual property rights in any subsequent litigation in which we are a named party.

We have in the past been involved in two litigation matters with F5 Networks, Inc., a litigation matter with Allegro Software Development, Inc., a litigation matter with Brocade and a litigation matter with Radware, all of which have since settled. As part of the settlement with Brocade, we made a significant cash payment to Brocade, granted a license to Brocade to use all of our issued, pending and future patents, and received and granted certain covenants not to sue. We are currently party to one intellectual property litigation matter. In November 2013, Parallel Networks, LLC, which we believe is a patent holding company, filed a lawsuit against us in the United States District Court for the District of Delaware alleging that our AX and Thunder series products infringe two of their patents. Parallel is seeking injunctive relief, damages and costs. While we intend to defend ourselves vigorously against the allegations in this lawsuit, this litigation matter, regardless of the outcome, could result in significant costs and diversion of our management’s efforts.

We may not be able to adequately protect our intellectual property, and if we are unable to do so, our competitive position could be harmed, or we could be required to incur significant expenses to enforce our rights.

We rely on a combination of patent, copyright, trademark and trade secret laws, and contractual restrictions on disclosure of confidential and proprietary information, to protect our intellectual property. We cannot be certain that the intellectual property we decide to protect will be desirable or necessary to our competitors or will ultimately have commercial value, or that we will be the first to seek protection for the intellectual property we attempt to protect.

We also rely in part on confidentiality and/or assignment agreements with our technology partners, employees, consultants, advisors and others. We did not, however, obtain general employee confidentiality and assignment agreements from certain former employees who worked with us prior to July 2010, although we did receive specific assignments from each of these employees who was an inventor of any technologies that we patented. These protections and agreements may not effectively prevent disclosure of our confidential information and may not provide an adequate remedy in the event of unauthorized disclosure. In addition, others may independently discover our trade secrets and intellectual property information we thought to be proprietary, and in these cases we would not be able to assert any trade secret rights against those parties. Despite our efforts to protect our intellectual property, unauthorized parties may attempt to copy or otherwise obtain and use our intellectual property or technology. Monitoring unauthorized use of our intellectual property is difficult and expensive. We have not made such monitoring a priority to date and will not likely make this a priority in the future. We cannot be certain that the steps we have taken or will take will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

If we fail to protect our intellectual property adequately, our competitors might gain access to our technology, and our business might be harmed. In addition, even if we protect our intellectual property, we may need to license it to competitors, which could also be harmful. For example, we have already licensed all of our issued patents, pending applications, and future patents and patent applications that we may acquire, obtain, apply for or have a right to license to Brocade until May 2025, for the life of each such patent. In addition, we might incur significant expenses in defending our intellectual property rights. Any of our patents, copyrights, trademarks or other intellectual property rights could be challenged by others or invalidated through administrative process or litigation.

We may in the future initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Any litigation, whether or not resolved in our favor, could result in significant expense to us and divert the efforts of our management and technical personnel, as well as cause other claims to be made against us, which might adversely affect our business, operating results and financial condition.

In addition, on March 20, 2014, we received a letter from an attorney on behalf of an individual who claims that he is entitled to between 1.6 and 2.6 million shares of our common stock.

The individual alleges that prior to the incorporation of our company he had been promised founders’ shares in a different corporation. The individual also alleges that our Chief Executive Officer and founder, Lee Chen, who was involved with this different entity for a short period of time in mid-2004 before our founding, was the CEO and controlling stockholder of such other entity and that Mr. Chen breached his fiduciary duty to such entity and its stockholders. The individual further alleges that Mr. Chen misappropriated intellectual property and diverted employees and investors from that entity to us. On the basis of these allegations, this individual claims he is entitled to shares of our common stock. The individual also alleges that we knowingly aided and abetted Mr. Chen in such alleged actions. To our knowledge, this individual had not raised any of these allegations or made any equity ownership claims to us prior to our receipt of the email on March 20, 2014.

Based on our preliminary review of the allegations in the letter, we and Mr. Chen believe that the claims are without merit and are not likely to have a material adverse effect on us. However, there can be no assurances with respect to the outcome of these allegations. No lawsuit has been filed, and if a lawsuit is filed, we and Mr. Chen intend to defend against these claims vigorously.

We face intense competition in our market, especially from larger, well-established companies, and we may lack sufficient financial or other resources to maintain or improve our competitive position.

The application networking market is intensely competitive, and we expect competition to increase in the future. To the extent that we sell our solutions in adjacent markets, we expect to face intense competition in those markets as well. We believe that our main competitors fall into three categories:


•	Companies that sell products in the traditional ADC market. In the ADC market, we compete against other companies that are well established in this market, including F5 Networks, Inc., Brocade, Cisco Systems, Inc., Citrix Systems, Inc., and Radware Ltd.;


•	Companies that sell CGN products. Our purpose-built CGN solution competes primarily against products originally designed for other networking purposes, such as edge routers and security appliances from vendors such as Alcatel-Lucent USA Inc., Cisco Systems, Inc. and Juniper Networks, Inc.; and


•	Companies that sell traditional DDoS mitigation products. We are a new entrant into the DDoS market and first publicly launched our DDoS detection and mitigation solution, TPS, in January 2014. We believe our principal competitors in this market are Arbor Networks, Inc., a subsidiary of Danaher Corporation, and Radware.

Many of our competitors are substantially larger and have greater financial, technical, research and development, sales and marketing, manufacturing, distribution and other resources and greater name recognition. In addition, some of our larger competitors have broader products offerings and could leverage their customer relationships based on their other products. Potential customers who have purchased products from our competitors in the past may also prefer to continue to purchase from these competitors rather than change to a new supplier regardless of the performance, price or features of the respective products. We could also face competition from new market entrants, which may include our current technology partners. As we continue to expand globally, we may also see new competitors in different geographic regions. Such current and potential competitors may also establish cooperative relationships among themselves or with third parties that may further enhance their resources.

Many of our existing and potential competitors enjoy substantial competitive advantages, such as:


•	longer operating histories;


•	the capacity to leverage their sales efforts and marketing expenditures across a broader portfolio of products and services at a greater range of prices;


•	the ability to incorporate functionality into existing products to gain business in a manner that discourages users from purchasing our products, including through selling at zero or negative margins, product bundling or closed technology platforms;


•	broader distribution and established relationships with distribution channel partners in a greater number of worldwide locations;


•	access to larger end-customer bases;


•	the ability to use their greater financial resources to attract our research and development engineers as well as other employees of ours;


•	larger intellectual property portfolios; and


•	the ability to bundle competitive offerings with other products and services.

Our ability to compete will depend upon our ability to provide a better solution than our competitors at a competitive price. We may be required to make substantial additional investments in research and development, marketing and sales in order to respond to competition, and there is no assurance that these investments will achieve any returns for us or that we will be able to compete successfully in the future. We also expect increased competition if our market continues to expand. Moreover, conditions in our market could change rapidly and significantly as a result of technological advancements or other factors.

In addition, current or potential competitors may be acquired by third parties that have greater resources available. As a result of these acquisitions, our current or potential competitors might take advantage of the greater resources of the larger organization to compete more vigorously or broadly with us. In addition, continued industry consolidation might adversely impact end-customers’ perceptions of the viability of smaller and even medium-sized networking companies and, consequently, end-customers’ willingness to purchase from companies like us.

As a result, increased competition could lead to fewer end-customer orders, price reductions, reduced margins and loss of market share.

Some of our large end-customers demand favorable terms and conditions from their vendors and may request price concessions. As we seek to sell more products to these end-customers, we may agree to terms and conditions that may have an adverse effect on our business.

Some of our large end-customers have significant purchasing power and, accordingly, have requested from us and received more favorable terms and conditions, including lower prices than we typically provide. As we seek to sell products to this class of end-customer, we may agree to these terms and conditions, which may include terms that reduce our gross margin and have an adverse effect on our business.

If we are unable to at