S-1 1 d439911ds1.htm FORM S-1 Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on April 4, 2013

 

Registration No. 333-                    

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

CYAN, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   7373   20-5862569
(State or other jurisdiction of incorporation or organization)   (Primary Standard Industrial Classification Code Number)  

(I.R.S. Employer

Identification Number)

1383 N. McDowell Blvd., Suite 300

Petaluma, California 94954

(707) 735-2300

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Mark A. Floyd

Chief Executive Officer

1383 N. McDowell Blvd., Suite 300

Petaluma, California 94954

(707) 735-2300

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

David J. Segre

Robert G. Day

Michael E. Coke

Wilson Sonsini Goodrich & Rosati

Professional Corporation

650 Page Mill Road

Palo Alto, California 94304

(650) 493-9300

 

Kenneth M. Siegel

Vice President and General Counsel

Cyan, Inc.

1383 N. McDowell Blvd., Suite 300

Petaluma, California 94954

(707) 735-2300

 

Eric C. Jensen

Andrew S. Williamson

Cooley LLP

101 California Street, 5th Floor

San Francisco, California 94111

(415) 693-2000

 

 

Approximate date of commencement of proposed sale to the public:    As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box:    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

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   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

 

Title of Each Class of Securities

to be Registered

  Proposed Maximum
Aggregate Offering
Price(1)(2)
    Amount of
Registration Fee
 

Common Stock, par value $0.0001 per share

  $ 75,000,000     $ 10,230  

 

 

 

(1) Includes offering price of any additional shares that the underwriters have the option to purchase.
(2) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended.

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting offers to buy these securities in any state where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

Dated April 4, 2013

 

 

                     Shares

 

LOGO

Common Stock

 

 

This is an initial public offering of shares of common stock of Cyan, Inc.

Prior to this offering, there has been no public market for the common stock. It is currently estimated that the initial public offering price per share will be between $            and $            .   We have applied to list our common stock on the New York Stock Exchange under the symbol “CYNI.”

We are an “emerging growth company” as defined under the federal securities laws and are subject to reduced public company reporting requirements.

Investing in our common stock involves risks. See the section titled “Risk Factors” on page 11 to read about factors you should consider before buying shares of our common stock.

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus.   Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discount(1)

   $                    $                

Proceeds, before expenses, to Cyan

   $                    $                

 

(1) See “Underwriting.”

We have granted the underwriters an option to purchase up to an additional                  shares from us at the initial public offering price, less the underwriting discount.

 

 

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2013.

 

 

 

Goldman, Sachs & Co.    J.P. Morgan
Jefferies
Pacific Crest Securities

 

 

Prospectus dated                     , 2013


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LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

Risk Factors

     11   

Special Note Regarding Forward-Looking Statements

     36   

Industry and Market Data

     38   

Use of Proceeds

     39   

Dividend Policy

     39   

Capitalization

     40   

Dilution

     42   

Selected Consolidated Financial Data

     44   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     46   

Business

     75   

Management

     96   

Executive Compensation

     105   

Certain Relationships, Related Party and Other Transactions

     115   

Principal Stockholders

     118   

Description of Capital Stock

     121   

Shares Eligible for Future Sale

     127   

Material U.S. Federal Income Tax Consequences to Non-U.S. Holders

     130   

Underwriting

     134   

Legal Matters

     139   

Experts

     139   

Where You Can Find Additional Information

     139   

Index to Consolidated Financial Statements

     F-1   

 

 

Through and including                     , 2013 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

Neither we nor the underwriters have authorized anyone to provide you with information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we have prepared. We take no responsibility for, and provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

For investors outside the United States: Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about, and to observe any restrictions relating to, this offering and the distribution of this prospectus.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information that you should consider in making your investment decision. Before investing in our common stock, you should carefully read this entire prospectus, including the information set forth under the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes that are included elsewhere in this prospectus. Unless the context otherwise requires, we use the terms “Cyan,” “company,” “we,” “us” and “our” in this prospectus to refer to Cyan, Inc. and, where appropriate, our consolidated subsidiaries.

Company Overview

We have pioneered innovative, carrier-grade networking solutions that transform disparate and inefficient legacy networks into open, high-performance networks. Our solutions include high-capacity, multi-layer switching and transport platforms, as well as a carrier-grade software-defined networking platform and applications. Our solutions enable network operators to virtualize their networks, accelerate service delivery and increase scalability and performance, while reducing costs. We have designed our solutions to provide a variety of existing and emerging premium applications, including business Ethernet, wireless and broadband support services and cloud connectivity. By deploying our solutions, network operators can transform legacy networks into open, multi-vendor, carrier-grade software-defined networks, or SDNs. Our solutions not only reduce network operators’ ongoing capital and operating expenses, but also enable their networks to more flexibly support rapidly changing service requirements and new business models.

New applications and communications trends are driving tremendous growth in bandwidth demand, resulting in increased service requirements as well as dramatic shifts in overall network traffic patterns. At the same time, competition from traditional vendors as well as new market entrants is limiting service providers’ ability to sustain and grow revenue. As a result, service providers must upgrade their networks to handle the exponential scaling challenges driven by these trends as well as to profitably deliver the growing breadth of premium services demanded by their subscribers. Other network operators are also facing these scalability requirements while seeking to deliver new applications that improve the productivity and efficiency of their businesses. We designed our solutions to enable network operators to address these challenges while scaling their networks and services efficiently.

Fundamental to our solution is our software-defined networking approach that enables an array of Cyan as well as third-party applications to manage and control underlying network infrastructure. In December 2012, we released our Blue Planet platform, a carrier-grade software-defined networking solution purpose-built to address network operator requirements. Blue Planet is the latest implementation of our network virtualization and management software that we first introduced in 2009 to work in combination with our high-capacity, multi-layer switching and transport platforms. Blue Planet is designed to simplify the development, deployment and orchestration of scalable communications and business applications over high-performance networks. Blue Planet enables our customers to make more efficient use of existing network assets, cost-effectively expand network capacity and significantly accelerate the delivery of premium, revenue-generating services to their customers. By deploying Blue Planet, our customers can also provide their end-customers with network-as-a-service, or NaaS, allowing for real-time tailoring and customization of their network architecture and services to meet their end-customers’ specific needs.

 

 

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We also offer high-capacity, multi-layer switching and transport platforms, known as our Cyan Z-Series, that have been designed to support the multiple concurrent technologies used in regional and metro networks including both Ethernet-based services as well as optical services. Our Z-Series platforms have been designed to transport traffic over the most efficient network layer, utilizing both electrical and optical domains, to enable network operators to maximize network capacity at the lowest cost per bit. To date, sales of our Z-Series platforms have accounted for substantially all of our revenue. Standalone sales of Blue Planet have accounted for an immaterial amount of our revenue to date and are expected to increase only modestly as a portion of our revenue in the near term. However, we expect that the portion of our revenue derived from standalone sales of Blue Planet will increase over the longer term.

Our customers range from service providers to high-performance data center and large, private network operators. Our solutions have been deployed primarily across North America as well as in Asia and Europe by over 125 customers, including, among our top ten customers by revenue in 2012, Great Plains Communications Inc., Intelleq Communications LLC, Lynx Network Group, Inc., US Carrier Telecom, LLC, US Signal Company, LLC, Vision Net, Inc. and Windstream Corporation.

Our revenue increased from $23.5 million in 2010 to $40.4 million in 2011, and to $95.9 million in 2012. Our net losses were $16.3 million, $15.9 million and $16.6 million in 2010, 2011 and 2012, respectively.

Industry Background

Network operators, which include service providers as well as others with similar network requirements, are facing immense pressure on their existing networks and business models. Despite growing demand for bandwidth and expanded service offerings, service provider revenue has remained relatively flat, mainly due to competitive pressures. Accordingly, service providers are increasingly challenged to provide their services in a cost-effective manner, and to deliver new services that drive additional revenue streams. In addition, the service provider business model is changing from one of deploying fixed bandwidth to one of dynamically provisioning services. However, due to the proprietary and inflexible nature of existing networks and infrastructure, dynamically provisioning services and managing these networks and infrastructure have become cost-prohibitive. This is especially true in regional and metro networks, which typically utilize legacy network architectures that have been built over decades. Network operators have also historically used a variety of technologies to deliver reliable service at scale, which has added to the complex and disparate nature of these legacy regional and metro networks.

Today’s networks require dramatic transformation to meet the service demands driven by significant technology shifts, including the proliferation of mobile devices, the rapid adoption of bandwidth-intensive applications and the growth in cloud computing. Additionally, network operators are now seeking to offer new premium services such as business Ethernet, cloud connectivity, wireless and broadband backhaul, which use wireless and broadband communications systems, respectively, to transmit data across the network from an end-user to a large proprietary network or the Internet, wholesale transport, and private networks with guaranteed service levels as opposed to traditional best-efforts service delivery models. As a result, network operators are being forced to upgrade their networks to profitably deliver these premium services as well as to handle the increased demands of their end-customers, which include higher throughput and utilization, better performance and increased provisioning speed.

To address these pressures, network operators have increasingly looked to deploy Ethernet-based technologies. Ethernet now supports high-bandwidth, carrier-grade environments with enhanced

 

 

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granularity at a significantly lower price per bit than traditional technologies. As a result, network operators are expected to shift more of their capital budgets towards purchasing Ethernet-based solutions.

We believe that legacy approaches to designing regional and metro networks are inadequate to effectively handle next-generation service demands. These legacy approaches, which include adding dedicated networks, deploying router-based products and modifying existing operations support systems, suffer from multiple challenges, including limitations on scalability, performance, flexibility and the ability to provision new services efficiently and cost-effectively. As a result, we believe that network operators require a new approach to drive network transformation.

As part of this new approach to network transformation, network operators are seeking an open architecture that is conducive to deploying multi-vendor, best-of-breed networks and to supporting future innovations while enhancing network efficiency and performance. Moreover, to remain competitive, network operators need to evolve their networks to support higher-bandwidth requirements, introduce new revenue-generating, premium services, and manage network traffic at the optimal layer in a low-latency, cost-optimized way using either the optical or Ethernet layers. To achieve this network transformation, we believe that network operators require new approaches to both their software and infrastructure.

We believe that network operators would be able to achieve this network architecture transformation with spending typically earmarked for products and markets including: Ethernet services edge routing, which routes traffic on the edge of the network without accessing routers at the network’s core; access aggregation, which aggregates traffic on the edge of the network; metro WDM, or wave-division multiplexing, which allows a single optical fiber to carry multiple optical signals on separate wavelengths; multi-service provisioning platforms, which interconnects with legacy optical equipment and Ethernet local area networks; and packet-optical equipment, which enables the transport of packets on optical network infrastructure. According to ACG Research, markets for these products were forecasted to collectively represent approximately $15.7 billion in worldwide revenue in 2012. We believe that our solutions address a substantial portion of these aggregated markets. In addition, our solutions also address a portion of the operational support systems, or OSS, market, which is not included in the ACG Research forecast above.

Our Solution

Our solutions include high-capacity, multi-layer switching and transport platforms, as well as a carrier-grade software-defined networking platform and applications.

In December 2012, we introduced our Blue Planet platform, which is purpose-built to address network operator requirements and enables the deployment of software applications to manage and control underlying network infrastructure. We also offer high-capacity, multi-layer switching and transport platforms, known as our Cyan Z-Series, designed to support the multiple concurrent technologies used in regional and metro networks, including both Ethernet-based services as well as optical services.

Customers may choose to deploy Blue Planet either on a standalone basis or integrated with our Z-Series platforms. By deploying our solutions, network operators can realize the following benefits:

 

  Ÿ  

Deliver Virtual Networks.    Our solutions enable our customers to activate, control and modify network services through our centralized, software control plane, thereby permitting them to present a custom network to each enterprise customer and rapidly offer services. Additionally,

 

 

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our approach embraces a multi-vendor environment by integrating with third-party network devices and centralizing the visualization and management of disparate network elements.

 

  Ÿ  

Enhance Flexibility and Support Open Architectures.    Our multi-layer solutions give network operators the flexibility to support a changing service mix and the ability to evolve their networks to a packet-based approach at their own pace.

 

  Ÿ  

Increase Capacity and Scalability.    Our solutions are designed to scale in a distributed and highly available manner, increasing network capacity and optimizing cost per bit by tailoring traffic transport to the appropriate network layer, leveraging both electrical and optical domains. Additionally, our Z-Series platforms support high-capacity networks by facilitating backplane and switch fabric interconnect rates in excess of 100G per card slot, enabling an easy migration to future 40G and 100G Ethernet services.

 

  Ÿ  

Accelerate Time to Value.    Our Blue Planet platform includes advanced network and service planning applications, enabling network operators to design multi-layer networks quickly and cost-effectively utilizing our advanced three-dimensional visualization tools. Additionally, our carrier-grade SDN approach enables network operators to access network peripherals and functions remotely, thereby allowing them to rapidly extend the delivery of new services throughout their networks.

 

  Ÿ  

Enhance Performance and Intelligence.    Our Blue Planet platform includes real-time and historical analytics to track network performance and assist in capacity planning. Network operators and their end-customers can use Blue Planet extensively to troubleshoot network performance issues, monitor and report on network service level agreements, or SLAs, and make better business planning decisions.

 

  Ÿ  

Offer a Broad Range of Premium Applications.    Our solutions enable network operators to derive additional sources of revenue through the delivery of differentiated Ethernet services that enhance their end-customers’ experiences. Moreover, Blue Planet allows network operators to either develop their own custom applications, utilize our applications or seamlessly integrate third-party applications.

 

  Ÿ  

Scale Networks Cost Effectively.    Our solutions enable network operators to reduce capital and operating expenses by minimizing the need for disparate legacy networks and related software. The modular design of our solutions further reduces costs by enabling our customers to add services and functionality on a pay-as-you-grow basis as well as by limiting field technician dispatches. Additionally, our multi-layer approach to networks enhances long-term capital efficiency and reduces operating expenses by enabling our customers to migrate to packet-based networks over time.

Our Strategy

Our goal is to establish our position as a leading provider of open, carrier-grade networking solutions. The key elements of our strategy include:

 

  Ÿ  

Extend Our Technology Leadership in High-Performance, Carrier-Grade Networking.    We intend to leverage our technology leadership position by continuing to define the market requirements for carrier-grade SDNs and invest in sales and marketing resources to raise awareness of the full benefits of virtualizing high-performance networks.

 

  Ÿ  

Develop Innovative Products and Technology.    We plan to continue to introduce new software and hardware products that enable our customers to more efficiently offer new services and increase their profitability.

 

 

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  Ÿ  

Expand Our Service Provider Customer Base.    We intend to target new service provider customers by continuing to invest in our sales force, field operations and support functions as well as by deepening our engagement with our current channel partners and establishing relationships with new channel partners.

 

  Ÿ  

Sell Additional Solutions to Existing Customers.    Our solutions are well suited for a pay-as-you-grow approach. We intend to continue investing in our existing customer relationships to drive the adoption of additional products as our customers scale and evolve their network services over time.

 

  Ÿ  

Extend Our Presence in New Geographies.    We are growing our channel partner network to further support our growth and international expansion, and we plan to leverage our relationships with existing customers in Asia, Europe and South America to enhance our brand recognition.

 

  Ÿ  

Expand in Emerging Customer Verticals.    We plan to target emerging customer verticals with use cases well suited to the benefits of our solutions, including large data center networks, governments, cable multiple systems operators, or MSOs, as well as enterprises that build and operate large, private networks.

Risks Affecting Us

Our business is subject to numerous risks and uncertainties, including those highlighted in the section titled “Risk Factors” immediately following this prospectus summary. These risks include, but are not limited to, the following:

 

  Ÿ  

we have a limited operating history, which makes it difficult to evaluate our current business and future prospects;

 

  Ÿ  

our business depends on the capital spending patterns and financial capabilities of our service provider customers, and any decrease or delay in their capital spending may adversely affect us;

 

  Ÿ  

our largest customer, Windstream Corporation, has publicly indicated its intention to reduce its overall capital expenditures in 2013, and, as a result, our operating results may be harmed if we are unable to expand our sales to other existing or new customers;

 

  Ÿ  

we currently generate the majority of our revenue from the sale of our Z-Series platforms, and a decrease in purchases of these platforms may adversely affect us;

 

  Ÿ  

if the software-defined networking market does not develop as we anticipate or if Blue Planet or other new solutions we develop face challenges for market acceptance, demand for our solutions may not grow, and our future results could be adversely affected;

 

  Ÿ  

we operate in highly competitive markets, and competitive pressures from existing vendors and new entrants may adversely affect us;

 

  Ÿ  

our business and operations have experienced rapid growth in recent periods, and if we are unable to effectively manage this growth and expansion, or if our business does not continue to grow as we expect, including with respect to our recruitment of qualified personnel, our business and operating results may suffer; and

 

  Ÿ  

our revenue, gross margin and other operating results may fluctuate significantly and be unpredictable, which makes our future operating results difficult to predict.

 

 

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Corporate Information

We were incorporated in Delaware on October 25, 2006 under the name Cyan Optics, Inc. and we changed our name to Cyan, Inc. on November 9, 2011. Our principal executive offices are located at 1383 N. McDowell Blvd., Suite 300, Petaluma, California 94954, and our telephone number is (707) 735-2300. Our website is www.cyaninc.com. Information contained on, or that can be accessed through, our website is not incorporated by reference into this prospectus, and you should not consider information on our website to be part of this prospectus.

Cyan, the Cyan logo, “Blue Planet,” “Z-Series,” “CyNOC,” “Cyan PRO,” “CySupport,” “CyService,” and other trademarks or service marks of Cyan appearing in this prospectus are the property of Cyan. Trade names, trademarks and service marks of other companies appearing in this prospectus are the property of their respective holders.

We are an emerging growth company as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. We will remain an emerging growth company until the earlier of the last day of the fiscal year following the fifth anniversary of the completion of this offering, the last day of the fiscal year in which we have total annual gross revenue of at least $1.0 billion, the date on which we are deemed to be a large accelerated filer (this means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the end of the second quarter of that fiscal year), or the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period.

 

 

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THE OFFERING

 

Common stock offered by us

                shares

Common stock to be outstanding after this offering

                shares

Option to purchase additional shares

   We have granted the underwriters an option, exercisable for 30 days after the date of this prospectus, to purchase up to an additional              shares from us.

Use of proceeds

   We intend to use the net proceeds from this offering for working capital and other general corporate purposes and potential acquisitions. See the section titled “Use of Proceeds.”

Concentration of ownership

   Upon completion of this offering, the executive officers, directors and 5% stockholders of our company and their affiliates will beneficially own, in the aggregate, approximately     % of our outstanding capital stock.

Proposed NYSE trading symbol

   “CYNI”

The number of shares of common stock that will be outstanding after this offering is based on 36,472,225 shares of common stock (including redeemable convertible preferred stock on an as-converted basis) outstanding as of December 31, 2012, and excludes:

 

  Ÿ  

10,212,760 shares of common stock issuable upon the exercise of options to purchase common stock that were outstanding as of December 31, 2012, with a weighted-average exercise price of $2.49 per share;

 

  Ÿ  

1,009,597 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2012, with a weighted-average exercise price of $2.34 per share (of which warrants to purchase 894,596 shares of redeemable convertible preferred stock will either be exercised or terminated immediately prior to the completion of this offering);

 

  Ÿ  

             additional shares of common stock, subject to increase on an annual basis, reserved for future issuance under our 2013 Equity Incentive Plan, which will become effective in connection with the completion of this offering, consisting of:

 

   

             shares of common stock reserved for future grant or issuance under our 2013 Equity Incentive Plan, which will become effective in connection with the completion of this offering; and

 

   

1,242,353 shares of common stock reserved for future issuance under our 2006 Stock Plan, which shares will be added to the shares of common stock to be reserved under our 2013 Equity Incentive Plan upon its effectiveness.

Except as otherwise indicated, all information in this prospectus reflects and assumes the following:

 

  Ÿ  

the conversion of all outstanding shares of our redeemable convertible preferred stock into an aggregate of 33,897,005 shares of common stock immediately prior to the completion of this offering;

 

 

 

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  Ÿ  

the filing of our amended and restated certificate of incorporation in Delaware and the adoption of our amended and restated bylaws, each of which will occur in connection with the completion of this offering;

 

  Ÿ  

no exercise of outstanding options or outstanding warrants; and

 

  Ÿ  

no exercise by the underwriters of their option to purchase up to an additional              shares of common stock from us in this offering.

 

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

The following tables summarize our consolidated financial data. You should read this summary consolidated financial data together with the sections titled “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes that are included elsewhere in this prospectus.

The consolidated statements of operations data for the years ended December 31, 2010, 2011 and 2012 and the consolidated balance sheet data as of December 31, 2012 are derived from our audited consolidated financial statements that are included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future.

 

     Year Ended December 31,  
             2010                     2011             2012  
     (in thousands, except per share data)  

Consolidated Statements of Operations Data:

      

Revenue

   $ 23,484      $ 40,421      $ 95,872   

Cost of revenue

     18,263        27,074        57,315   
  

 

 

   

 

 

   

 

 

 

Gross profit

     5,221        13,347        38,557   

Operating expenses:

      

Research and development

     10,430        12,986        18,447   

Sales and marketing

     7,919        12,825        25,243   

General and administrative

     2,380        3,310        6,055   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     20,729        29,121        49,745   

Loss from operations

     (15,508     (15,774     (11,188

Interest expense

     (429     (419     (33

Other income (expense), net

     (406     322        (5,340
  

 

 

   

 

 

   

 

 

 

Total other income (expense), net

     (835     (97     (5,373
  

 

 

   

 

 

   

 

 

 

Loss before provision for income taxes

     (16,343     (15,871     (16,561

Provision for income taxes

     1        14        40   
  

 

 

   

 

 

   

 

 

 

Net loss

   $ (16,344   $ (15,885   $ (16,601
  

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share(1)

   $ (7.54   $ (6.63   $ (6.60
  

 

 

   

 

 

   

 

 

 

Weighted-average number of shares used in computing basic and diluted net loss per share(1)

     2,167        2,396        2,515   
  

 

 

   

 

 

   

 

 

 

Pro forma basic and diluted net loss per share(1)

       $ (0.31
      

 

 

 

Weighted-average number of shares used in computing pro forma basic and diluted net loss per share(1)

         36,412   
      

 

 

 

 

(1) See Note 9 to our audited consolidated financial statements for an explanation of the calculations of our basic and diluted net loss per share of common stock and pro forma net loss per share of common stock.

 

 

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     As of December 31, 2012  
     Actual     Pro Forma(1)      Pro Forma
As Adjusted(2)
 
     (in thousands)  

Consolidated Balance Sheet Data:

       

Cash and cash equivalents

   $ 20,221      $ 20,221       $                

Working capital

     13,919        20,173      

Property and equipment, net

     6,485        6,485      

Total assets

     70,789        70,789      

Total debt

     12,563        12,563      

Total deferred revenue

     17,417        17,417      

Preferred stock warrant liability

     6,254        —        

Redeemable convertible preferred stock

     98,133        —        

Total stockholders’ equity (deficit)

     (83,055     21,332      

 

(1) The pro forma column reflects (i) the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into 33,897,005 shares of our common stock immediately prior to the closing of this offering and (ii) the reclassification of the preferred stock warrant liability to additional paid-in capital.
(2) The pro forma as adjusted column gives effect to the pro forma adjustments set forth in footnote 1 above and the sale by us of              shares of our common stock offered by this prospectus at an assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses.

The pro forma as adjusted information presented in the consolidated balance sheet data is illustrative only and will change based on the actual initial public offering price and other terms of this offering determined at pricing. Each $1.00 increase or decrease in the assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease, as applicable, each of cash and cash equivalents, working capital, total assets and total stockholders’ equity on a pro forma as adjusted basis by approximately $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses.

 

 

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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 in this prospectus, before making a decision to invest in our common stock. If any of the risks actually occurs, our business, financial condition, operating results and prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline, and you could lose part or all of your investment.

Risks Related to Our Business

We have a limited operating history, which makes it difficult to evaluate our current business and future prospects and may increase the risk of your investment.

We were incorporated in 2006, and began selling our solutions and generating revenue in 2009. Our limited operating history makes financial forecasting and evaluation of our business difficult. Moreover, we compete in markets characterized by rapid technological change, changing customer needs, evolving industry standards and frequent introductions of new products and services. We have experienced rapid growth since our inception, and we continue to increase the breadth and scope of our solutions and, correspondingly, the breadth and scope of our operations. For example, in December 2012, we released for general availability our Blue Planet carrier-grade software-defined networking platform. We have limited historical data and have had a relatively limited time period in which to implement and evaluate our business strategies as compared to companies with longer operating histories. As a result, it is difficult to forecast our future revenue growth, if any, and to plan our operating expenses appropriately, which in turn makes it difficult to predict our future operating results. In the course of our development efforts, we may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new solutions, services and enhancements. If we are not successful, we could experience lower sales, which would harm our business, operating results and financial condition.

Our business depends on the capital spending patterns and financial capabilities of our service provider customers, and any decrease or delay in their capital spending may adversely affect our business and operating results.

Our revenue to date has been derived primarily from our service provider customers. Demand for our solutions depends on the amount and timing of capital spending by these customers as they construct, expand and upgrade their networks. The global economic downturn and uncertainty has contributed to a slowdown in spending in many industries, including by telecommunications service providers. In response to any future challenging economic conditions and decreased availability of capital, spending for network infrastructure projects could be further delayed or cancelled. In addition, capital spending is cyclical in our industry and sporadic among individual service providers, and can change on short notice. As a result, we may not have visibility into changes in spending behavior until near the end of a given quarter. Further, infrastructure improvements may be further delayed or prevented by a variety of factors, including cost, regulatory obstacles, consolidation in the industry, lack of consumer demand and alternative technologies for service delivery. Any reductions in capital expenditures by service providers could adversely affect our operating results and future growth.

We have experienced in the past, and expect to continue to experience, seasonal fluctuations in our revenue as a result of our customers’ spending patterns. We generally expect an increase in business activity as we approach December, as some of our customers accelerate spending to use remaining capital budget dollars. Similarly, we generally expect a decrease in business activity in our first quarter, as some of our customers finalize their spending budgets and project initiatives become

 

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clarified. In addition, from time to time, customers may place large orders that may significantly affect sequential trends. Furthermore, we may experience lower gross margin in a particular period as a result of large initial deployments by our customers since these deployments typically include a significant proportion of lower margin Z-Series chassis. As a consequence of this seasonality and the effect of large customer purchases, our quarterly revenue and operating results may fluctuate from quarter to quarter and are difficult to estimate.

We currently generate the majority of our revenue from a concentrated base of customers, including Windstream Corporation. Since Windstream has publicly indicated its intent to reduce its overall capital expenditures in 2013, unless we can substantially expand our sales to other existing or new customers, we will not be able to grow our revenue.

Windstream Corporation, or Windstream, accounted for approximately 37% and 45% of our revenue for the years ended December 31, 2011 and 2012, respectively. Windstream has publicly indicated its intention to reduce its overall capital expenditures in 2013. Accordingly, we expect our sales to Windstream to decline in future periods. Nonetheless, we anticipate that a large portion of our revenue will continue to depend on sales to Windstream. In addition, given the episodic nature of capital expenditures associated with network deployments, we may derive a substantial amount of our revenue from a limited number of customers in future periods. As a result, unless we can substantially expand our sales to other existing or new customers, we will not be able to grow our revenue.

As a consequence of our customer concentration and the frequently concentrated nature of our customers’ purchases, our quarterly revenue and operating results may fluctuate from quarter to quarter and are difficult to predict. Sales of our solutions to our customers, including Windstream, are made pursuant to purchase orders, and not pursuant to long-term, committed-volume purchase contracts. As a result, we cannot assure you that we will be able to sustain or increase sales to any current or future customer from period to period, or that we will be able to offset the discontinuation of concentrated purchases by these customers with purchases by new or existing customers. The loss of, or a significant delay or reduction in purchases by, any of our significant customers could adversely affect our business and operating results.

We currently generate the majority of our revenue from the sale of our Z-Series platforms and therefore a decrease in purchases of these platforms would adversely affect our revenue and our operating results.

Historically, our Z-Series platforms have accounted for substantially all of our revenue, and we expect to continue to derive a significant portion of our revenue from sales of these platforms in the near term. As a result, our future growth and financial performance will depend heavily on our ability to continue to sell existing, and to develop and sell enhanced, versions of our Z-Series platforms, both to existing and new customers. If current market demand for these products diminishes, or we fail to deliver product enhancements, new releases or new products that customers want, overall demand for our solutions and related services would decrease, and our operating results would be harmed.

If the software-defined networking market does not develop as we anticipate, and if we are unable to increase market awareness of our company and our solutions within that market, demand for our solutions may not grow, and our future results would be adversely affected.

Fundamental to our solution is our software-defined networking approach that enables an array of third-party applications to manage and control underlying network infrastructure. As a result, our success will depend to a significant extent on potential customers recognizing the benefits of our solutions over legacy systems and products, and the willingness of service providers, high-performance data centers and other network operators to increase their use of software-defined

 

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networking solutions in their networks. The market for SDNs is at an early stage with a small installed base and limited market adoption, and it is difficult to predict important trends, including the potential growth, if any, of this market.

If the market for software-defined networking solutions does not evolve in the way we anticipate or if customers do not recognize the benefits of our solutions, we likely would not be able to increase sales of our hardware and software solutions. In such event, our revenue would not grow, or would decline, and our operating results would be harmed. To date, some network operators have been reluctant to switch to SDNs because they have invested substantial resources to maintain and integrate legacy solutions into their networks. These network operators may continue allocating their network budgets to the maintenance and upgrading of their legacy systems and products and therefore not adopt our SDN solutions in addition to or as a replacement for these legacy systems and products.

Even if the market for SDN solutions develops as we anticipate, market awareness of our SDN solutions will be essential to our continued growth. We cannot assure you that network operators will accept the value proposition that we believe our solutions provide. If we are not successful in creating market awareness of our company and our full suite of SDN solutions, our business, financial condition and operating results would be adversely affected.

We recently launched a new software-defined networking platform, Blue Planet, and if this or other new solutions we develop face challenges for market acceptance, our revenue and operating results would be adversely affected.

We released Blue Planet in December 2012. Currently, our Blue Planet offering has an unproven revenue model and accounts for an immaterial amount of our revenue. If network operators do not perceive the benefits of Blue Planet, the market for Blue Planet may not develop or may develop more slowly than we expect, either of which would adversely affect our revenue growth prospects. The widespread acceptance of Blue Planet will require not only the recognition and adoption of software-defined networking as a whole over legacy systems and products, but also the deployment of Blue Planet as a standard solution for our current and potential customers to manage their SDNs. We also face the risk of having a limited time to market in order to establish Blue Planet over any alternative solutions or technologies that network operators utilize for SDNs and other network management. In addition, we have limited experience in pricing Blue Planet separately from our Z-Series platforms, which could result in underpricing that adversely affects our expected financial performance, or overpricing that inhibits our customers’ acceptance of Blue Planet. Even if the initial development and commercial introduction of Blue Planet is successful, we cannot assure you that it will achieve widespread market acceptance or that any market acceptance will be sustainable over the longer term. If Blue Planet does not gain market acceptance at a sufficient rate of growth, our business and operating results would be adversely affected.

We operate in highly competitive markets, and competitive pressures from existing and new companies may adversely affect our business, operating results and market share.

The markets in which we operate are highly competitive and characterized by rapidly changing customer needs and evolving industry standards. We expect competition to intensify in the future as existing competitors and new market entrants introduce new products or enhance existing products. Our business will be adversely affected if we are unable to compete effectively to meet the demand for existing products as well as innovate to bring new products and solutions to market.

We compete either directly or indirectly with large networking and optical companies, such as Alcatel-Lucent SA, Ciena Corporation, Cisco Systems, Inc., Fujitsu Limited, Huawei Technologies Co. Limited and Juniper Networks, Inc., and specialized technology providers that offer solutions that

 

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address a portion of the issues that we address. In addition, we seek to replace legacy network control tools and processes that network operators have either already purchased or internally developed, and potential customers may be reluctant to adopt a solution that replaces or changes existing systems and processes in which they have made significant investments. In the future, in selling Blue Planet we may also compete with companies that are focused on providing virtualization software solutions for other end-markets as they may try to adapt their solutions to meet the needs of network operators or compete with networking companies that develop or acquire SDN solutions. Some of our competitors have made, or may make, acquisitions of businesses that may allow them to offer solutions that are more directly competitive and comprehensive than those they currently offer.

We expect competition and competitive pressure, from both new and existing competitors, to increase in the future. Additionally, many of our competitors have greater name recognition, longer operating histories, well-established relationships with customers or channel partners in our markets and substantially greater financial, technical, personnel and other resources than we have. Our competitors may be able to anticipate, influence or adapt more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the promotion and sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisitions or other opportunities more readily and develop and expand their product and service offerings more quickly than we can. In addition, competitors with substantially larger installed customer bases may leverage their relationships and incorporate functionality into their existing products in a manner that may discourage customers from purchasing our solutions. These larger competitors may also have more diversified businesses that allow them to better withstand significant reductions in capital spending by customers. Moreover, potential customers may also prefer to purchase from their existing providers rather than a new provider, regardless of product performance or features, because our solutions may require additional investment of time and funds to install the solutions and to train operations personnel. In addition, some of our competitors may offer substantial discounts or rebates to win new or retain existing customers, or may bundle different products and services together in a package to their customers where they include products and services that directly compete with our solutions at very low prices or even for free. If we are unable to win customers, or if we are forced to reduce prices in order to secure customers, our business and operating results may be adversely affected.

Our business and operations have experienced rapid growth in recent periods, and if we are unable to effectively manage this growth and expansion, or if our business does not continue to grow as we expect, including with respect to our recruitment of qualified personnel, our operating results may suffer.

We have experienced rapid growth and have significantly expanded our operations since inception, which has placed a strain on our management, administrative, operational and financial infrastructure. Our success will depend in part upon our ability to manage our growth effectively.

We believe that our future success will depend in large part upon our ability to identify, attract and retain highly qualified and skilled personnel, particularly engineers and sales personnel. Our employee headcount has increased from 39 as of December 31, 2008 to 219 as of December 31, 2012, and we currently plan to substantially increase our headcount across all functions in 2013. To do so, we seek to identify and attract the highly skilled personnel we believe are essential to our success. Competition for skilled personnel is intense, particularly for those specializing in network and software engineering and sales, and those located in the San Francisco Bay Area. In addition, our headquarters location in Petaluma, in the northern part of the San Francisco Bay Area, may make it more difficult to attract qualified personnel that live in other parts of the Bay Area. We must continue to expand our sales force, including hiring additional sales managers, to grow our customer base and increase our sales. However, we cannot be certain that we will be successful in attracting qualified personnel, or that newly hired personnel will function effectively, both individually and as a group. In addition, newly hired sales

 

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personnel do not typically become productive for a significant period following their initial hiring, resulting in increased near-term costs relative to their respective sales contributions.

Our ability to manage our operations and growth will further require us to refine our operational, financial and management controls, human resource policies, and reporting systems and procedures. If we fail to efficiently expand our sales force, engineering, operations, IT or financial systems, or otherwise manage our growth, our costs and expenses may increase more than we plan and we may lose the ability to close customer opportunities, enhance our existing products and services, satisfy customer requirements, respond to competitive pressures or otherwise execute our business plan. These additional investments will increase our operating costs, which will make it more difficult for us to offset any future revenue shortfalls in the short term by reducing expenses. Moreover, if we fail to scale our operations successfully, our business and operating results could be adversely affected.

We have a history of losses, and we may not be able to generate sufficient revenue to achieve or maintain profitability.

Since our inception, we have incurred net losses in each quarterly and annual period, and as of December 31, 2012, we had an accumulated deficit of $86.6 million. Although our revenue has grown rapidly in recent periods, our revenue growth is likely to slow and our revenue may decline in future periods as a result of a number of factors, including uncertain demand for our solutions, increasing competition or our failure to capitalize on potential growth opportunities. Accordingly, you should not rely on our revenue growth in any prior quarterly or annual period as an indicator of our future performance. In addition, we anticipate that our operating expenses will increase substantially for the foreseeable future as we continue to expend substantial financial resources on sales and marketing, including domestic and international expansion efforts, product and feature development, technology infrastructure, additional headcount and general administration. These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenue sufficiently, or at all, to offset these higher expenses. To the extent that funds from this offering, combined with existing cash, cash equivalents and operating cash flows, are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing. If we issue equity securities in order to raise additional funds, substantial dilution to existing stockholders may occur. If we raise cash through the issuance of additional indebtedness, we may be subject to additional contractual restrictions on our business. Additionally, we cannot assure you that we will be able to raise additional funds on favorable terms or at all. If we are unable to maintain adequate revenue growth, improve our gross margin or manage our expenses, we may continue to incur significant losses in the future and may not be able to achieve or maintain profitability.

Our revenue, gross margin and other operating results may fluctuate significantly and be unpredictable, which makes our future operating results difficult to predict and could cause the trading price of our common stock to decline.

Our operating results may fluctuate from period to period due to a variety of factors, many of which are outside of our control, which makes it difficult for us to predict our future operating results. For example, the timing and size of sales of our Z-Series platforms and other solutions have been highly variable and difficult to predict, leading to uncertainty and limiting our ability to accurately forecast revenue, and resulting in significant fluctuations in revenue from period to period. This variability has been compounded by our customer concentration and the frequently concentrated nature of our customers’ purchases, which are made pursuant to purchase orders and not pursuant to long-term committed-volume purchase contracts. In addition to, or as elaborated in, other risks listed in this “Risk Factors” section, factors that may affect our operating results include:

 

  Ÿ  

fluctuations in demand for our solutions, and the timing of orders from our customers and channel partners;

 

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  Ÿ  

the capital spending patterns of network operators and any decrease or delay in capital spending by network operators due to economic, regulatory or other reasons;

 

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the inherent complexity, seasonality, length and associated unpredictability of our sales cycles for our solutions;

 

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changing market conditions, particularly any significant changes in the competitive dynamics of our markets, including new entrants, network operator consolidation and any related discounting of products or services;

 

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our ability to expand our international operations;

 

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our ability to control costs such as the costs of the components for our Z-Series platforms;

 

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the ability of our contract manufacturer and component suppliers to timely meet our manufacturing and supply needs at acceptable prices, or at all;

 

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the timing and execution of product transitions, new product introductions or product upgrades by us or our competitors;

 

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our ability to timely and effectively develop, introduce and gain market acceptance for new solutions, products, technologies and services, such as Blue Planet, and anticipate future market demands that meet our customers’ requirements;

 

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our ability to successfully expand the Z-Series, Blue Planet and professional service solutions we sell to existing customers;

 

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the interoperability of our solutions with service providers’ networks, and technical challenges in network operators’ overall networks, unrelated to our solutions, which could delay adoption and installation of our solutions;

 

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decisions by potential customers to purchase alternative products and services from other providers and their willingness to deploy our solutions;

 

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any decision by us to increase or decrease operating expenses in response to changes in the marketplace or perceived marketplace opportunities;

 

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our ability to derive benefits from our investments in sales, marketing, engineering or other activities;

 

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our ability to build and manage our channel partner and distribution networks, and the effectiveness of any changes we make to our distribution model; and

 

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general economic conditions, both domestically and abroad.

Any one of the factors above or the cumulative effect of the factors above may result in significant fluctuations in our operating results from period to period. This variability and unpredictability could result in our failure to meet our internal operating plan or the expectations of securities analysts or investors for any period. If we fail to meet such expectations for these or any other reasons, the market price of our common stock could fall substantially and we could face costly lawsuits, including securities class action litigation.

We operate in a rapidly evolving market and if we are unable to develop and introduce new solutions or make enhancements to existing solutions that successfully respond to emerging technological trends and achieve market acceptance, our revenue and growth prospects would likely be adversely affected.

Our market is characterized by rapidly changing technology, changing customer needs, evolving industry standards and frequent introductions of new products and services. Our future success will

 

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depend significantly on our ability to effectively anticipate and timely adapt to such changes, and to develop and offer, on a timely and cost-effective basis, hardware and software solutions with features that meet changing customer demands, technology trends and industry standards. Our solutions have been developed to rely upon open standards for integration and functionality with legacy networks and third-party vendor network equipment and applications, and we cannot assure you that these standards will continue to receive market acceptance. Additionally, such open standard design could make it easier for competitors to more quickly and inexpensively develop and offer their own products and services based on the same technology. If our competitors introduce new products and services that compete with ours, we may be required to reposition our solutions or introduce new solutions in response to such competitive pressure. If we fail to develop new products or product enhancements, or our customers or potential customers do not perceive our solutions to have compelling advantages, our business, revenue and growth prospects would be adversely affected.

We intend to continue making significant investments in further developing our Blue Planet and Z-Series platforms and enhancing the functionality of our existing solutions. Developing our solutions is expensive, complex and involves uncertainties. We intend to continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, we may not have sufficient resources to successfully manage these hardware and software development cycles, and these investments may take several years to generate positive returns, if ever.

The future growth of our business depends, in significant part, on increasing our international sales, and even if we are successful in expanding internationally, our business will be susceptible to risks associated with international operations.

We currently generate substantially all of our sales from customers in the United States, and have only recently begun marketing, selling and supporting our solutions internationally, primarily through channel partners. We have limited experience managing the sales, support and administrative aspects of a worldwide operation. The future growth of our business depends, in significant part, on increasing our international sales. We may not be successful in our efforts to expand our international operations, including as a result of not being able to increase or maintain international market demand for our solutions, and entry into additional international markets will require significant management attention and financial resources. Our failure to successfully grow internationally could limit the future growth of our business and, consequently, affect our business, operating results and financial condition.

In the course of expanding our international operations and operating overseas, we will be subject to a variety of risks, directly and indirectly through our channel partners, including:

 

  Ÿ  

international trade costs and restrictions, including trade laws, tariffs, export quotas, custom duties or other trade restrictions, affecting our sales;

 

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treatment of revenue from international sources and changes to tax codes, including being subject to foreign tax laws and responsibility for paying withholding income or other taxes in foreign jurisdictions;

 

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compliance with multiple, conflicting and changing governmental laws and regulations, including employment, tax, privacy, data protection, communications and Internet laws and regulations, and the risks and costs of non-compliance;

 

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compliance with U.S. laws and regulations applicable to foreign operations, including the Foreign Corrupt Practices Act, import and export control laws, tariffs, trade barriers, economic sanctions and other regulatory limitations on our ability to sell our solutions in certain foreign markets, and the risks and costs of non-compliance;

 

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  Ÿ  

challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement appropriate systems, policies, compensation and benefits and compliance programs;

 

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difficulties in and costs of staffing foreign operations;

 

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difficulties in enforcing contracts, longer accounts receivable payment cycles and the potential corresponding adverse impact on our days sales outstanding;

 

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the imperative to upgrade our solutions to meet more stringent performance criteria or adapt our solutions to meet the standards of one or more other countries;

 

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the risk of change in political or economic conditions for foreign countries, and the potential for political unrest, acts of terrorism, hostilities or war;

 

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localization of products and services, including translation into foreign languages and associated expenses;

 

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differing laws and business practices, which may favor local competitors;

 

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foreign currency fluctuations and controls; and

 

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limited or unfavorable intellectual property protection in foreign jurisdictions.

Each of these risks could have an adverse effect on our overall business, operating results and financial condition.

We engage channel partners to promote, sell, install and support our solutions internationally, and we intend to rapidly expand our international channel partner network. Any failure to effectively develop and manage this distribution channel could adversely affect our business, operating results and market share.

We engage channel partners who provide sales and support services for our solutions, and we are relying on the rapid expansion of our channel partner network to pursue our international expansion efforts. If we do not properly train our channel partners to sell, install and service our solutions, or if a new channel partner is not able to execute on our sales strategy, our business, financial condition and operating results may suffer. The loss of a key channel partner or the failure of a channel partner to provide adequate customer service could have a negative effect on customer satisfaction and could cause harm to our business. Our use of channel partners and other third-party support partners, and the associated risks, are likely to increase as we seek to expand our international sales. Generally, our channel partners do not have long-term contractual commitments or exclusivity to us. We also compete with other network systems providers for our channel partners’ business as many of our channel partners market competing products. If a channel partner promotes a competitor’s products to the detriment of our solutions or otherwise fails to market our solutions effectively, we would lose market share.

Our sales cycles can be long and unpredictable, and our sales efforts require considerable investment of time and expense. As a result, our sales and revenue are difficult to predict and may vary substantially from period to period, which may cause our operating results to fluctuate significantly.

Our sales process entails planning discussions with prospective customers, analyzing their existing networks and identifying how these potential customers can leverage our solutions within their networks. The sales cycle for a new customer deployment, from the time of prospect qualification to the completion of the first sale, may span multiple quarters. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales of our

 

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solutions. If we invest substantial resources pursuing unsuccessful sales opportunities, our business, operating results and financial condition would be harmed. In addition, purchases by network operators of our solutions are subject to budget constraints, multiple approvals and unplanned administrative, processing and other delays. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, we may not achieve our revenue expectations.

We do not have long-term, committed-volume purchase contracts with our customers for our Z-Series platforms, and therefore have no guarantee of future revenue from any customer, which may cause our operating results to be adversely affected.

Sales of our Z-Series platforms are made pursuant to purchase orders, and we have not entered into long-term, committed-volume purchase contracts with our customers, including our largest customer, Windstream. As a result, any of our customers may cease to purchase our hardware solutions at any time. In addition, our customers may attempt to renegotiate their terms of purchase, including price and quantity, or may delay or cancel already submitted purchase orders. If any of our customers stop purchasing our hardware solutions for any reason, or purchase fewer solutions, our operating results and financial condition would be harmed.

We currently rely upon a single contract manufacturer to manufacture our hardware solutions, and if we encounter problems with the contract manufacturer, our operations could be disrupted, which would adversely affect our business, operating results, financial condition and customer relationships.

We contract with Flextronics International, Ltd., or Flextronics, as the sole manufacturer of all of our Z-Series platforms. Our reliance on Flextronics makes us vulnerable to possible capacity constraints and reduced control over delivery schedules, manufacturing yields and costs. We have limited direct control over the quality and control systems of Flextronics, and therefore may not be able to ensure levels of quality suitable for our customers. The revenue that Flextronics generates from our orders represents a very small percentage of its revenue. As a result, fulfilling our orders may not be considered a priority by Flextronics. If Flextronics were unable or unwilling to continue manufacturing our Z-Series platforms in required volumes and at high quality levels, or if Flextronics significantly increased our costs to have them manufacture our products, we would have to identify, qualify and select an acceptable alternative contract manufacturer. Such alternatives may not be available to us when needed, may take a significant amount of time to contract with and establish manufacturing or supply relationships, and may not be in a position to timely satisfy our production requirements at commercially reasonable prices and quality. Any significant interruption in manufacturing would require us to reduce the amount of Z-Series platforms available to our customers, which in turn would reduce our revenue and adversely affect our business, operating results, financial condition and customer relationships.

If we fail to accurately forecast our manufacturing requirements or manage our inventory with our contract manufacturer, we could incur additional costs, lose revenue and harm our business, operating results, financial condition and customer relationships.

The suppliers of the components used in our Z-Series platforms deliver the components directly to our contract manufacturer, Flextronics, but we bear the inventory risk under our arrangements with Flextronics. As of December 31, 2011 and 2012, we had commitments to Flextronics totaling $5.6 million and $6.6 million, respectively. Lead times for the materials and components that we order through Flextronics vary significantly and depend on numerous factors, including the specific supplier, contract terms and market demand for a component at a given time. The lead times for certain key materials and components could be lengthy depending on overall market demand, requiring us or Flextronics to order materials and components several months in advance of their use in

 

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manufacturing our products. If we overestimate our production requirements, Flextronics may purchase excess components and build excess inventory. If Flextronics purchases excess components or builds excess products, we could be required to pay for these excess components or products and recognize related inventory write-down costs. We also are required to reimburse Flextronics if our inventory is rendered obsolete for any reason. If we experience inventory write-downs associated with excess or obsolete inventory in any significant amount, this would have an adverse effect on our financial condition and operating results. Conversely, if we underestimate our product requirements, our contract manufacturer may maintain inadequate component inventory and be unable to manufacture our Z-Series platforms in sufficient quantities to timely meet customer demand. Any shortfall in available products could result in delays or cancellation of orders by our customers, which could have an adverse effect on our business, operating results, financial condition and customer relationships.

Certain component parts used in the manufacture of our products are sourced from single or limited source suppliers. If we are unable to source these components on a timely basis, we will not be able to meet our customers’ product delivery requirements, which could adversely affect our business, operating results, financial condition and customer relationships.

We depend on certain sole-source and limited source suppliers for key components that Flextronics, our contract manufacturer, uses in the manufacture of our Z-Series platforms. Any of the sole-source and limited source suppliers upon whom we rely could stop producing our components, cease operations or be acquired by, or enter into exclusive arrangements with, our competitors. In particular, our reliance on Broadcom Corporation for certain key semiconductors used in our hardware solutions makes us vulnerable to shortages or pricing pressure on these important components. Neither we nor Flextronics generally has long-term supply agreements with component suppliers, and our purchase volumes currently may be considered too low for us to be a priority customer by many of such suppliers. As such, we cannot be guaranteed a continuous source of, or favorable pricing for, components from any of these suppliers. Furthermore, patent infringement lawsuits between semiconductor companies could have an adverse effect on our ability to acquire components that are sole sourced and integrated into our family of Z-Series platforms, leading to production delays and additional engineering costs, potentially harming our business and customer relationships. Any such interruption or delay may force us to seek similar components or products from alternative sources, which may not be available on commercially reasonable terms, or at all. Switching suppliers may require that we redesign our Z-Series platforms to accommodate new components, and to re-qualify these solutions, which would be costly and time-consuming. Any interruption in the supply of sole-source or limited source components for our solutions would adversely affect our ability to meet scheduled product deliveries to our customers and could result in lost revenue or higher expenses, any of which would harm our business, operating results, financial condition and customer relationships.

Our future success depends in part on revenue from subscriptions for Blue Planet and our other services, and because we recognize revenue from subscriptions over the term of the relevant service period, downturns or upturns in sales will not likely be reflected in full in our operating results for the period in which such downturns or upturns occur.

Sales of new or renewal subscription, support and maintenance contracts, especially with respect to subscriptions for Blue Planet, may decline and fluctuate as a result of a number of factors, including our customers’ level of satisfaction with our solutions, the prices of our solutions, the prices of products and services offered by our competitors and reductions in our customers’ spending levels. If our sales of new or renewal subscription, support and maintenance contracts decline, our revenue and revenue growth will decline and our business will suffer. In addition, we recognize subscription and service contract revenue ratably over the term of the relevant contractual period, typically one year. As a result, much of the subscription and service revenue that we report each quarter is the recognition of deferred revenue from subscription and service contracts entered into during previous quarters. Accordingly,

 

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any decline in new or renewed subscription or service contracts in any one quarter will not be fully reflected in revenue in that quarter but will negatively affect our revenue in future quarters. In addition, our subscription model for Blue Planet also makes it difficult for us to rapidly increase our subscription revenue through additional sales in any period, as subscription revenue must be recognized over the term of the contract.

Our solutions are highly complex and may contain undetected hardware errors or software bugs, which could harm our reputation and increase our warranty obligations and service costs.

Our solutions are highly technical and, when deployed, are critical to the operation of our customers’ networks. Our solutions have from time to time contained and may in the future contain undetected errors, bugs, defects or security vulnerabilities. Some errors in our solutions may only be discovered after a solution has been deployed and used by customers, and may in some cases only be detected under certain circumstances or after extended use. Any errors, bugs, defects or security vulnerabilities discovered in our solutions after commercial release could result in loss of our revenue or delay in revenue recognition, loss of customer goodwill and customer relationships, harm to our reputation and increased service costs, any of which would adversely affect our business, operating results and financial condition. For example, any errors discovered in Blue Planet could cause customers and potential customers to abandon or never adopt the Blue Planet platform, which could adversely affect our ability to grow our business. In addition, quality or performance problems related to our Z-Series platforms that are covered under warranty could require us to repair or replace defective products at no additional cost to the customer. Moreover, we could face claims for product liability, tort or breach of contract from our customers, or be required to indemnify our customers for damages and third-party claims for a variety of reasons. Any increased costs, liabilities and diversion of resources associated with a warranty or other claim related to errors or alleged errors in our solutions could adversely affect our business, operating results and financial condition.

Our solutions must interoperate with existing legacy and competitor software applications and hardware products found in our customers’ networks. If our solutions do not interoperate properly, future sales of our solutions could be negatively affected, which would harm our business.

Our solutions must interoperate with our customers’ existing and planned networks, which often have varied and complex specifications, utilize multiple protocol standards, software applications and products from multiple vendors and may contain multiple generations of products that have been added over time. Our solutions must communicate, manage and analyze networks and the traffic across these networks, often across differing legacy protocols and technologies. As a result, we must continually ensure that our products interoperate properly with these existing and planned networks and network components, including legacy networks that operate on technology originally designed several decades ago. To meet these interoperability requirements, we continuously engage in development efforts that require substantial resources. If we fail to maintain compatibility with other software or equipment included in our customers’ existing and planned networks, we may incur significant warranty, support and repair costs, cause significant customer relations problems and divert the attention of our engineering personnel from our product development efforts, and our business and operating results would be adversely affected. In addition, if our competitors, whose software or equipment incorporate these protocols and technologies, fail to make available to us on an ongoing basis the interfaces and other information we require to maintain the interoperability of our solutions with their software and equipment, our business and operating results would be adversely affected.

 

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If we fail to comply with evolving network industry technical requirements and standards, sales of our existing and future solutions would be adversely affected, which could adversely affect our operating results and growth prospects.

The markets for our solutions are characterized by a significant number of standards, both domestic and international, which are evolving as new network technologies are deployed. Our solutions must comply with these standards in order to be widely marketable. In some cases, we may be required to obtain certifications or authorizations before our solutions can be introduced, marketed or sold in new markets or to new customers. In addition, our ability to expand our international operations and create international market demand for our solutions may be constrained by regulations or standards adopted by other countries that may require us to redesign our existing solutions or develop new products suitable for sale in those countries. We cannot assure you that we will be able to design our solutions to comply with evolving standards and regulations. The cost of complying with evolving standards and regulations, or our failure to obtain timely domestic or foreign regulatory approvals or certifications, may prevent us from selling our solutions where such standards or regulations apply, which could adversely affect our operating results and growth prospects.

Our ability to sell our solutions is highly dependent on the quality of our support and service offerings, and our failure to offer high quality support and services would have an adverse effect on our business, reputation and operating results.

Once our solutions are deployed within our customers’ networks, they depend on our support organization to quickly resolve any issues relating to those products. A high level of support is critical for the successful marketing and sale of our solutions. If we do not effectively assist our customers in deploying our solutions, succeed in helping them quickly resolve post-deployment issues or provide effective ongoing support, it could adversely affect our ability to sell our solutions to existing customers and harm our reputation with potential new customers, which would have an adverse effect on our business, reputation and operating results.

Weakened global economic conditions may harm our industry, business, operating results and financial condition.

Our overall performance depends in large part on global economic conditions, which may remain challenging for the foreseeable future. Global financial developments seemingly unrelated to us or the network industry may harm our business by negatively affecting the demand for networking equipment. The United States, Europe and other key international economies have been adversely affected in the recent past, and continue to face economic uncertainty. These conditions affect the rate of spending on network services, could adversely affect our customers’ ability or willingness to purchase our solutions and could delay prospective customers’ purchasing decisions. In addition, a prolonged economic downturn could affect the viability of our current business strategy. All of these factors could reduce our revenue and harm our business, operating results and financial condition.

Changes in government-sponsored programs, especially decreases in government funding, could affect the timing and buying patterns of certain of our customers, which would cause reduced sales of our solutions and fluctuations in our operating results.

Over the past several years, some of our customers were Independent Operating Companies, or IOCs, and other telecommunications network providers that benefited from federal and state subsidies. Approximately 6.9%, 12.3% and 9.3% of our revenue for the years ended December 31, 2010, 2011 and 2012, respectively, was attributable to sales of our solutions to IOCs and other service providers that used government-supported loan programs or grants to fund purchases from us, such as those originating from the Rural Utility Service, or RUS, program administered by the U.S. Department of

 

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Agriculture, and broadband stimulus programs under the American Recovery and Reinvestment Act of 2009. For example, award grants under the broadband stimulus programs were issued between November 2009 and September 2010, with all funds that were awarded expected to be expended by September 2013. We expect that changes to or elimination of these programs are likely, especially given the current U.S. federal government fiscal issues, and that these support or stimulus funds will not be available to IOCs in whole or in part, which could reduce the ability of IOCs to access capital and reduce our revenue opportunities for selling our solutions to these IOCs. To the extent that any of our customers have received grants or loans under these RUS and stimulus programs, but no longer have access to such assistance, they may substantially reduce or curtail future purchases of our solutions.

Our business substantially depends on the continued growth in demand for Internet and other network services, and lack of growth or contraction of demand for these services could have an adverse effect on our business, operating results and financial condition.

Our future growth depends in large part on the continued growth in the demand for Internet and other telecommunications and network services, and in particular the demand for services that require greater bandwidth, such as the proliferation of mobile devices, rapid adoption of bandwidth-intensive applications and the growth of cloud computing. Our future growth also depends on the deployment of our solutions by customers who provide those services. To the extent that the growth in the demand for these network services slows or an economic slowdown or economic uncertainty and related reduction in capital spending adversely affects spending on Internet, mobile and other network infrastructure, we could experience substantial harm to our business, operating results and financial condition. Even if the demand for Internet and other network services does experience the forecasted growth, our business may not grow at similar rates, or at all. Our growth is subject to many factors, including our success in implementing our business strategy that, in turn, depends on growth in network services, all of which are subject to many risks and uncertainties. Accordingly, the forecasts of growth of Internet and other network services included in this prospectus should not be taken as indicative of our future growth.

Third parties may assert that we are infringing upon their intellectual property rights, which could harm our business, operating results, financial condition and growth prospects.

There is considerable patent and other intellectual property development activity, and litigation related to intellectual property rights, in the technology industry in general and the networking industry in particular. From time to time, our competitors, other third-party developers of technology or non-practicing entities, commonly referred to as “patent trolls,” may claim that we are infringing upon their intellectual property rights. Regardless of the merit of any such claim, responding to such claims can be time consuming, divert management’s attention and resources and may cause us to incur significant expenses. We cannot assure you that we would be successful in defending against any such claims. In addition, patent applications in the United States and most other countries are confidential for a period of time before being published, so we cannot be certain that we were the first to conceive inventions covered by our patents or patent applications. Moreover, we cannot be certain that we are not infringing third parties’ patent or other intellectual property rights. An adverse outcome with respect to any intellectual property claim could invalidate our proprietary rights and/or force us to, among other things, do one or more of the following:

 

  Ÿ  

obtain from a third party claiming infringement a license to sell or use the relevant technology, which may not be available on reasonable terms, or at all;

 

  Ÿ  

stop manufacturing, selling, or using our solutions that embody the asserted intellectual property and refund to customers all or a portion of the fees related to the purchase or license of such solutions;

 

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pay substantial monetary damages;

 

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  Ÿ  

indemnify our customers and/or commercial partners against third-party claims for intellectual property infringement pursuant to indemnification obligations under our contracts, generally without limit; or

 

  Ÿ  

expend significant resources to redesign our solutions that use the infringing technology and to develop or acquire non-infringing technology.

Additionally, if we offer employment to personnel employed or formerly employed by competitors, we may become subject to claims of unfair hiring practices and/or breaches of confidentiality related to the intellectual property of such competitors, and incur substantial costs in defending ourselves against these claims, regardless of their merits. Any of these actions could adversely affect our business, operating results, financial condition and growth prospects.

If we are unable to successfully manage our use of “open source” software, our ability to sell our products and services could be harmed, which could result in competitive disadvantages, and subject us to possible litigation.

We incorporate open source software code in our proprietary software that is part of both our Z-Series and Blue Planet platforms. Use of open source software can lead to greater risks than the use of proprietary or third-party commercial software since open source licensors generally do not provide warranties or controls with respect to origin, functionality or other features of the software. Some open source software licenses require users who distribute open source software as part of their products to publicly disclose all or part of the source code in their software and make any derivative works of the open source code generally available in source code form for limited fees or at no cost. Although we monitor our use of open source software, open source license terms may be ambiguous, and many of the risks associated with the use of open source software cannot be eliminated. If we were found to have inappropriately used open source software in our solutions, we may be required to release our proprietary source code, re-engineer our software, discontinue the sale of certain solutions in the event re-engineering cannot be accomplished on a timely basis, or take other remedial action. Furthermore, if we fail to comply with applicable open source licenses, we may be subject to costly claims of intellectual property infringement or demands for the public release of proprietary source code. Any of the foregoing could harm our business and put us at a competitive disadvantage.

If we are unable to protect our intellectual property rights, our competitive position, ability to protect our proprietary technology and our brand could be harmed or we could be required to incur significant expense to enforce our rights.

Our success depends to a significant degree on our ability to protect our core technology and intellectual property. We rely on a combination of intellectual property rights, including trade secret laws, copyrights, patents and trademarks, as well as customary contractual provisions. To date we have only two issued U.S. patents and have received a notice of allowance for a third, and do not have any patents issued outside the United States. We have not, to date, emphasized any patent program for our know-how, and the patents that we have filed or are pending may not cover important aspects of our technology, and may not be enforceable. We also license software from third parties for integration into our products, including open source software and other commercially available software. We generally control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including contractual protections with employees, contractors, customers and partners, and our software is protected by U.S. and international copyright laws. We also incorporate certain generally available software programs into Blue Planet and our other software solutions pursuant to license agreements with third parties. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors.

 

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The steps we have taken to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our intellectual property rights. We may initiate claims against third parties that we believe are infringing our intellectual property rights if we are unable to resolve matters satisfactorily through negotiation. If we fail to protect our intellectual property rights adequately, our competitors could offer similar products, potentially harming our business. Our intellectual property rights may be challenged by others or invalidated through administrative process or litigation. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel. Effective trademark, copyright, trade secret and patent protection may not be available to us in every country in which we provide our solutions. The laws of some foreign countries are not be as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights in these jurisdictions may be inadequate. We may be required to spend significant resources to monitor and protect our intellectual property rights, and such monitoring may be insufficient to detect all misappropriation or infringement of our rights. We may initiate claims or litigation against third parties for infringement of our intellectual property rights or to establish the validity of such rights.

If we lose key members of our management or engineering teams or are unable retain executives and employees that we need to support our operations and growth, our business and operating results may be harmed.

Our success depends, in large part, on the continued contributions of our key management, engineering, sales personnel and other employees, many of whom are highly skilled and would be difficult to replace. None of our senior management or key technical or sales personnel is bound by a written employment contract to remain with us for a specified period. Moreover, any of our employees may terminate their employment at any time. Many of our key employees have become, or will soon become, vested in a substantial amount of their shares of common stock or stock options. Employees may be more likely to leave us if the shares they own, or the shares underlying their stock options, have vested. In addition, we do not maintain key man life insurance covering our key personnel. The loss of the services of any of our key personnel may harm our business and operating results.

Our failure to comply with laws and regulations, including regulations affecting the import or export of products and anti-bribery laws, could harm our business.

Our business is subject to regulation by various federal, state, local and foreign governmental agencies, including agencies responsible for monitoring and enforcing employment and labor laws, workplace safety, product safety, environmental laws, consumer protection laws, anti-bribery laws, import/export controls, federal securities laws, and tax laws and regulations. In certain jurisdictions, these regulatory requirements may be more stringent than those in the United States. Noncompliance with applicable regulations or requirements could subject us to investigations, sanctions, product recalls, enforcement actions, disgorgement of profits, fines, damages, civil and criminal penalties or injunctions. If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, operating results, and financial condition could be adversely affected. In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions could harm our business, reputation, operating results and financial condition. Any change in laws, regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could negatively affect our ability to sell our solutions and could adversely affect our business, operating results and financial condition.

 

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Our planned international expansion creates additional regulatory challenges. Future international shipments of our solutions may require export licenses or export license exceptions. In addition, the import laws of other countries may limit our ability to distribute our solutions, or our customers’ ability to buy and use our solutions, in those countries. Changes in our solutions or changes in export and import regulations may create delays in the introduction of our solutions in international markets, prevent our customers with international operations from deploying our solutions or, in some cases, prevent the export or import of our solutions to certain countries altogether. We expect our planned expanding global operations will require us to import and export to and from several countries, resulting in additional compliance obligations.

In particular, the U.S. Foreign Corrupt Practices Act, or the FCPA, the United Kingdom Bribery Act 2010, or the Bribery Act, and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business. Under these laws, companies are required to maintain records that accurately and fairly represent their transactions and have an adequate system of internal accounting controls. We are expanding to operate in areas of the world, including in conjunction with our channel partners, that may experience corruption by government officials to some degree and, in certain circumstances, compliance with anti-bribery laws may conflict with local customs and practices. In addition, network operators in various foreign countries may have influence with government officials and many are owned in whole or in part by foreign governments or instrumentalities. We cannot assure you that our employees, channel partners or other agents will not engage in prohibited conduct and render us responsible under the FCPA, the Bribery Act or any similar anti-bribery laws in another jurisdiction. If we are found to be in violation of the FCPA, the Bribery Act or other anti-bribery laws, either due to our nascent compliance system or the acts or omission of our employees, channel partners or other agents, we could suffer criminal or civil penalties or other sanctions, which could have an adverse effect on our business.

Changes in telecommunications and Internet laws, regulations, rules and tariffs could impede the growth in network activity or otherwise harm our customers, which could have a negative effect on our business and operating results.

Increased regulation of telecommunications and Internet network activity or access in the United States or any country in which we do business, particularly those that have the effect of impeding, or lessening the rate of growth in, network activity, could decrease demand for our solutions. New or increased access charges for telecommunications service providers and tariffs on certain communications services could negatively affect our customers’ businesses. Further, many of our customers are subject to FCC rate regulation of interstate telecommunications services, and are recipients of federal universal service fund payments, which are intended to subsidize telecommunications services in areas that are expensive to serve. In addition, many of our customers are subject to state regulation of intrastate telecommunications services, including rates for such services, and may also receive funding from state universal service funds. Changes in rate regulations or universal service funding rules, either at the federal or state level, could adversely affect such customers’ revenue and capital spending plans. Any adoption of new laws, regulations, rules or tariffs, or changes to existing laws, regulations, rules or tariffs, that negatively affects network activity or growth or otherwise adversely affects the business of our customers could harm our business and operating results.

Industry consolidation may lead to increased competition or a decreased customer base, which could harm our business and operating results.

Consolidation in the network equipment industry has been common. Some of our competitors have made acquisitions or entered into partnerships or other strategic relationships to offer a more

 

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comprehensive solution than they had offered individually. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry are acquired for a variety of strategic reasons or are unable to continue operations. Consolidation in our industry may result in stronger competitors that may create more compelling product offerings, be able to offer greater pricing flexibility, and be better able to compete as sole-source vendors for customers. This would make it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs and breadth of technology or product offerings. In addition, companies with which we have strategic partnerships may acquire or form alliances with our competitors, thereby reducing their business with us. Furthermore, continued industry consolidation may adversely affect customers’ perceptions of the viability of smaller and even medium-sized technology companies such as us and, consequently, customers’ willingness to purchase from such companies.

In addition, consolidation of network operators may lead to a reduction in the number of potential customers, with the effect that the loss of any major customer could have a greater effect on operating results than in a customer marketplace composed of more numerous participants. Consolidation among our customers may also cause delays or reductions in their capital expenditure plans and increased competitive pricing pressures as the number of available customers declines and their relative purchasing power increases in relation to suppliers. Consolidation in the number of potential customers could lead to more variability in our operating results and could have an adverse effect on our business.

We may expand through acquisitions of, or investments in, other companies, business or technologies which may divert our management’s attention and result in additional dilution to our stockholders, and we may be unable to integrate acquired businesses and technologies successfully or achieve the expected benefits of such acquisitions or investments.

While we have not consummated any acquisitions to date, we may evaluate and consider potential strategic transactions, including acquisitions of, or investments in, complementary businesses, technologies, services, products and other assets in the future. We also may enter into relationships with other businesses to expand our product and service offerings, which could involve preferred or exclusive licenses, additional channels of distribution, discount pricing, investments in other companies or strategic or joint venture partnership agreements. Acquisitions may disrupt our business, divert our resources and require significant management attention that would otherwise be available for development of our existing business. The anticipated benefits of any acquisition, investment or business relationship may not be realized, or we may be exposed to risks or liabilities that were unknown at the time of the acquisition or that are different from those that faced our business prior to the acquisition. Negotiating and consummating these transactions can be time-consuming, difficult and expensive, and our ability to close these transactions may often be subject to approvals that are beyond our control. Consequently, these transactions, even if undertaken and announced, may not close. For one or more of those transactions, we may:

 

  Ÿ  

use cash that we may need in the future to operate our business;

 

  Ÿ  

incur debt on terms unfavorable to us or that we are unable to repay;

 

  Ÿ  

issue additional equity securities that would dilute our stockholders;

 

  Ÿ  

increase our working capital requirements;

 

  Ÿ  

incur substantial liabilities or large charges, such as impairment of goodwill or intangible assets, at the time of the transaction or for some period long after the transaction;

 

  Ÿ  

encounter difficulties retaining key employees of the acquired company or integrating diverse solutions or business cultures;

 

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  Ÿ  

acquire companies with inadequate financial or operational reporting or control environments; and

 

  Ÿ  

become subject to adverse tax consequences, substantial depreciation or deferred compensation charges.

We may not be able to address these risks successfully, or at all, without incurring significant costs, delays or other operating problems that could disrupt our business and have an adverse effect on our operating results and financial condition.

Unanticipated changes in effective tax rates or adverse outcomes resulting from examination of our income or other tax returns could adversely affect our operating results and financial condition.

We are subject to income taxes in the United States and various foreign jurisdictions, and our domestic and international tax liabilities will be subject to the allocation of expenses in differing jurisdictions. Our future effective tax rates could be subject to volatility or adversely affected by a number of factors, including:

 

  Ÿ  

changes in the valuation of our deferred tax assets and liabilities;

 

  Ÿ  

expected timing and amount of the release of tax valuation allowances;

 

  Ÿ  

expiration of, or detrimental changes in, research and development tax credit laws;

 

  Ÿ  

expiration or non-utilization of net operating losses;

 

  Ÿ  

tax effects of stock-based compensation;

 

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costs related to intercompany restructurings;

 

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changes in tax laws, regulations, accounting principles or interpretations thereof; or

 

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future earnings being lower than anticipated in countries where we have lower statutory tax rates and higher than anticipated earnings in countries where we have higher statutory tax rates.

In addition, we may be subject to audits of our income and sales taxes by the Internal Revenue Service and other foreign and state tax authorities. Outcomes from these audits could have an adverse effect on our operating results and financial condition.

We may not be able to utilize a significant portion of our net operating loss or research and development tax credit carryforwards, which could adversely affect our operating results and financial condition.

As of December 31, 2012, we had $73.7 million of federal and $74.0 million of state net operating loss carryforwards and $2.4 million of federal and $3.4 million of California research tax credit carryforwards available to reduce future taxable income. These net operating loss carryforwards begin to expire in 2026 for U.S. federal income tax and 2016 for state income tax purposes, and the research tax credit carryforwards begin to expire in 2027 for federal purposes, but do not expire for California purposes. U.S. federal and state income tax laws limit the amount of these carryforwards we can utilize in any given year upon a greater than 50% cumulative shift of stock ownership over a three-year period, including shifts due to the issuance of additional shares of our common stock, or securities convertible into our common stock. To date, we have not undertaken an analysis of whether any limitation would apply at this time. We may experience subsequent shifts in our stock ownership and, accordingly, there is a risk that our ability to use our existing carryforwards in the future could be limited and that existing carryforwards would be unavailable to offset future income tax liabilities, which could adversely affect our operating results and financial condition.

 

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As a result of becoming a public company, we will be obligated to develop and maintain proper and effective internal control over financial reporting. We have not completed, and may not complete, our analysis of our internal control over financial reporting in a timely manner, or these internal controls may not be determined to be effective, which may adversely affect investor confidence in our company and, as a result, the value of our common stock.

Pursuant to Section 404 of the Sarbanes-Oxley Act, at the time we file our second annual report with the SEC, we will be required to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. We are in the very early stages of the costly process of compiling the system and processing documentation necessary to perform the evaluation needed to comply with Section 404. We may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to certify that our internal controls are effective, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our common stock to decline, and we may be subject to investigation or sanctions by the SEC. We will be required to disclose changes made in our internal control and procedures on a quarterly basis. However, our independent registered public accounting firm will not be required to report on the effectiveness of our internal control over financial reporting pursuant to Section 404 until the later of the year following our first annual report required to be filed with the SEC, or the date we are no longer an “emerging growth company” as defined in the JOBS Act, if we take advantage of the exemptions contained in the JOBS Act. At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating. In addition, any remediation efforts we undertake may not be successful or enable us to avoid a material weakness in the future.

Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as network security breaches, computer viruses or terrorism.

Our corporate headquarters, the manufacturing facilities of some of our suppliers, as well as our contract manufacturer’s current manufacturing facility for our Z-Series platforms, are all located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, a fire or a flood, occurring near our headquarters, or near the facilities of our suppliers or contract manufacturer, could have an adverse effect on our business, operating results and financial condition. Despite our implementation of network security measures, our networks and outside data center, by which we provide our Blue Planet platform, also may be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our products. In addition, natural disasters, acts of terrorism or war could cause disruptions in our or our customers’ businesses, our suppliers’ and contract manufacturer’s operations or the economy as a whole. We also rely on information technology systems to communicate among our workforce and with third parties. Any disruption to our communications, whether caused by a natural disaster or by manmade problems, such as power disruptions, could adversely affect our business. To the extent that any such disruptions result in delays or cancellations of customer orders or impede our suppliers’ and contract manufacturer’s ability to timely deliver our solutions and components, the deployment of our solutions and our business, operating results and financial condition would be adversely affected.

 

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Risks Relating to This Offering and Owning Our Common Stock

An active trading market for our common stock may never develop or be sustained, which may make it difficult for you to sell your shares at an attractive price, or at all.

Prior to this offering, there has been no public market for our common stock. We cannot predict the extent to which investor interest in us will lead to the development of an active trading market in our common stock or how liquid that market might become. An active public market for our common stock may not develop or be sustained after the offering. If an active public market for our common stock does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you, or at all. The market price for shares of our common stock may decline below the initial public offering price, and you may not be able to resell your shares of common stock at or above the initial public offering price. If the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition.

Our share price may be volatile, and you may be unable to sell your shares at or above the offering price.

Technology stocks, including those of companies in the network industry, have historically experienced high levels of volatility. The trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control and may not be related to our operating performance. This volatility may be enhanced by the relatively limited number of shares of our stock trading publicly following the offering. These fluctuations could cause you to lose all or part of your investment in our common stock. Factors that may cause the market price of our common stock to fluctuate include:

 

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price and volume fluctuations in the overall stock market from time to time;

 

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significant volatility in the market price and trading volume of technology companies in general, and of companies in the network industry in particular;

 

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actual or anticipated changes in our operating results or fluctuations in our operating results;

 

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actual or anticipated changes in the expectations of investors or securities analysts, and whether our operating results meet these expectations;

 

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new product or service introductions and market demand for these and our existing solutions;

 

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failure to meet investor expectations as a result of the timing of large customer orders;

 

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actual or anticipated developments in our competitors’ businesses or the competitive landscape generally;

 

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litigation involving us, our industry or both;

 

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regulatory developments in the United States, foreign countries or both;

 

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general economic conditions and trends;

 

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major catastrophic events;

 

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sales of large blocks of our stock; or

 

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departures of key personnel.

 

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In addition, if either the market for technology stocks or the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to events that affect other companies in the network industry even if these events do not directly affect us.

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. If our stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business, and this could have an adverse effect on our business, operating results and financial condition.

Sales of outstanding shares of our common stock into the market in the future could cause the market price of our common stock to drop significantly.

If our existing stockholders sell, or indicate an intent to sell, substantial amounts of our common stock in the public market after the contractual lock-up and other legal restrictions on resale lapse, the trading price of our common stock could decline. After this offering, approximately              shares of common stock will be outstanding. Of these shares, the shares of our common stock to be sold in this offering pursuant to this prospectus will be freely tradable, unless such shares are held by “affiliates,” as that term is defined in Rule 144 of the Securities Act of 1933, as amended, or the Securities Act.

Our directors, officers and holders of substantially all of our common stock and securities convertible into our common stock are subject to a 180-day contractual lock-up that prevents them from selling their shares prior to the expiration of this lock-up period. Goldman, Sachs & Co. and J.P. Morgan Securities LLC may, in their sole discretion, permit shares subject to this lock-up to be released from this restriction and sold prior to its expiration. After the expiration (or prior release, if applicable) of the 180-day restricted period, these shares may be sold in the public market in the United States, subject to prior registration in the United States, if required, or reliance upon an exemption from U.S. registration, including, in the case of shares held by affiliates or control persons, compliance with the volume restrictions of Rule 144.

 

Number of Shares
and % of Total
Outstanding

  

Date Available for Sale Into Public Markets

or     %

   Immediately after this offering

or     %

   From time to time after the date 180 days after the date of this prospectus due to contractual obligations and lock-up agreements, upon expiration of their respective holding periods under Rule 144. However, the underwriters can waive the provisions of these lock-up agreements and allow these stockholders to sell their shares at any time, provided their respective holding periods under Rule 144 have expired.

See the section titled “Shares Eligible for Future Sale—Lock-Up Agreements” for additional information.

In addition, as of December 31, 2012, 1,242,353 shares of common stock were reserved for future issuance under our 2006 Stock Plan and upon the consummation of this offering, options to purchase approximately              shares of our common stock will be reserved for future issuance under our 2013 Equity Incentive Plan. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline, potentially significantly. See the section titled “Shares Eligible for Future Sale” for additional information.

 

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If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution.

If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution of $             per share, based on an assumed initial public offering price of $             per share, which is the midpoint of the price range set forth on the cover page of this prospectus, because the price that you pay will be substantially greater than the net tangible book value per share of the common stock that you acquire. This dilution is due in large part to the fact that our founders and earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock. In addition, investors who purchase shares in this offering will contribute approximately     % of the total amount of equity capital raised by us through the date of this offering, but will only own approximately     % of our outstanding shares. We have also issued options to acquire our common stock at prices significantly below the initial public offering price. To the extent outstanding options are ultimately exercised, there will be further dilution to investors in this offering.

If securities analysts do not publish research or reports about our business, or if they downgrade our stock, the price of our stock could decline.

The trading market for our common stock could be influenced by any research and reports that securities or industry analysts publish about us or our business. We do not currently have, and may never obtain, research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock would be negatively affected. In the event securities or industry analysts cover our company and one or more of these analysts downgrade our stock or publish unfavorable research about our business, our stock price could decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

The concentration of ownership among our existing directors, executive officers and principal stockholders will provide them, collectively, with substantial control over us after this offering, which could limit your ability to influence the outcome of key transactions, including a change of control.

Our directors, executive officers and each of our stockholders who own greater than 5% of our outstanding common stock and their affiliates, in the aggregate, will beneficially own approximately     % of the outstanding shares of our common stock after this offering, based on the number of shares outstanding as of December 31, 2012. As a result, these stockholders, if acting together, will be able to influence or control matters requiring approval by our stockholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock.

We have broad discretion in the use of the net proceeds that we receive in this offering.

The principal purposes of this offering are to increase our financial flexibility, improve our visibility in the marketplace, create a public market for our common stock and facilitate our future access to the public equity markets. We have not yet determined the specific allocation of the net proceeds that we receive in this offering, but we expect to use the net proceeds that we will receive from this offering for working capital and other general corporate purposes, including the expansion of our sales

 

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organization, overseas expansion, primarily through channel partners and further development and expansion of our solutions. We may also use a portion of the net proceeds that we receive to acquire or invest in complementary businesses, products, services, technologies or other assets. Our management will have broad discretion over the specific use of the net proceeds that we receive in this offering and might not be able to obtain a significant return, if any, on investment of these net proceeds. Investors in this offering will need to rely upon the judgment of our management with respect to the use of proceeds.

The requirements of being a public company will subject us to increased costs and may strain our resources.

As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of the New York Stock Exchange and other applicable securities rules and regulations. Compliance with these rules and regulations will increase our legal, accounting and financial compliance costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources, particularly after we are no longer an “emerging growth company,” as defined in the JOBS Act. In addition, rules implemented by the SEC and the New York Stock Exchange require changes in corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We expect these rules and regulations to make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage, which may have the effect of making it more difficult for us to attract and retain qualified people to serve on our board of directors or as executive officers.

The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management’s attention may be diverted from other business concerns, which could adversely affect our business and operating results. We will likely need to hire more employees in the future or engage outside consultants to comply with these regulations, which will increase our costs and expenses.

In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. For example, rule making with respect to the Dodd-Frank Act has not yet been completed. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards are unsuccessful or differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be adversely affected.

 

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We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

For as long as we remain an “emerging growth company” under the JOBS Act, we may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We may take advantage of these reporting exemptions until we are no longer an “emerging growth company.” We would cease to be an “emerging growth company” upon the earliest of:

 

  Ÿ  

the first fiscal year following the fifth anniversary of this offering;

 

  Ÿ  

the first fiscal year after our annual gross revenue is $1.0 billion or more;

 

  Ÿ  

the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities; or

 

  Ÿ  

the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year.

We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

In addition, under the JOBS Act, “emerging growth companies” can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not “emerging growth companies.”

We do not intend to pay dividends following the completion of this offering.

We have never declared or paid any dividends on our stock. Following the completion of this offering, we intend to retain any earnings to finance the operation and expansion of our business, and we do not anticipate paying any cash dividends for the foreseeable future. In addition, our loan facility contains restrictions on our ability to declare and pay cash dividends on our capital stock. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases.

Provisions in our certificate of incorporation and bylaws and under Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.

Our amended and restated certificate of incorporation and amended and restated bylaws, each to be in effect upon the completion of this offering, contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:

 

  Ÿ  

establish a classified board of directors so that not all members of our board of directors are elected at one time;

 

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  Ÿ  

authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares to discourage a takeover attempt;

 

  Ÿ  

prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;

 

  Ÿ  

prohibit stockholders from calling a special meeting of our stockholders;

 

  Ÿ  

provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and

 

  Ÿ  

establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.

Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder and which may discourage, delay or prevent a change of control of our company.

Any provision of our amended and restated certificate of incorporation or amended and restated bylaws, to be in effect upon the completion of this offering, or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements within the meaning of the federal securities laws, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this prospectus include, but are not limited to, statements about:

 

  Ÿ  

our future financial performance, including our expectations regarding our revenue, cost of revenue, gross profit or gross margin, operating expenses, ability to generate cash flow, and ability to achieve, and maintain, future profitability;

 

  Ÿ  

anticipated trends, growth rates and challenges in our business and in the markets in which we operate;

 

  Ÿ  

market acceptance of our recently introduced Blue Planet solution and its effect on our product mix and financials;

 

  Ÿ  

the impact of seasonality on our business;

 

  Ÿ  

our anticipated growth and growth strategies and our ability to effectively manage that growth;

 

  Ÿ  

maintaining and expanding our customer base and our relationships with our channel partners;

 

  Ÿ  

our ability to anticipate market needs and develop new and enhanced products and services to meet those needs, and our ability to successfully monetize them;

 

  Ÿ  

our ability to hire necessary qualified employees to expand our operations;

 

  Ÿ  

our reliance on our third-party manufacturers and component suppliers;

 

  Ÿ  

the evolution of technology affecting our products, services and markets;

 

  Ÿ  

our ability to adequately protect our intellectual property;

 

  Ÿ  

our liquidity and working capital requirements;

 

  Ÿ  

our spending of the net proceeds from this offering;

 

  Ÿ  

our ability to stay abreast of new or modified laws and regulations that currently apply or become applicable to our business both in the United States and internationally;

 

  Ÿ  

the estimates and estimate methodologies used in preparing our consolidated financial statements and determining option exercise prices;

 

  Ÿ  

the future trading prices of our common stock and the impact of securities analysts’ reports on these prices; and

 

  Ÿ  

our ability to sell our products and expand internationally.

We caution you that the foregoing list may not contain all of the forward-looking statements made in this prospectus.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this prospectus primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, operating results and growth prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in the

 

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section titled “Risk Factors” and elsewhere in this prospectus. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this prospectus. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this prospectus to reflect events or circumstances after the date of this prospectus or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.

 

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INDUSTRY AND MARKET DATA

This prospectus contains estimates and other statistical data, including those relating to our industry and the market in which we operate, that we have obtained or derived from industry publications and reports, including reports from ACG Research, Gartner, Inc. and International Data Corporation, or IDC. These industry publications and reports generally indicate that they have obtained their information from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. This information involves a number of assumptions, limitations and estimates, and there is no assurance that any of them will be reached. Based on our industry experience, we believe that the publications and reports are reliable and that the conclusions contained in the publications and reports are reasonable. The industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors.” These and other factors could cause our actual results to differ materially from those expressed in the industry publications and reports.

The Gartner Reports described herein represent data, research opinion or viewpoints published as part of a syndicated subscription service, by Gartner, and are not representations of fact. Each Gartner Report speaks as of its original publication date (and not as of the date of this prospectus) and the opinions expressed in the Gartner Reports are subject to change without notice.

In certain instances the sources of the industry and market data contained in this prospectus are identified by superscript notations. The sources of these data are provided below:

 

  (1) ACG Research Forecast, Optical Networking, 2H 2012 Worldwide and ACG Research Forecast, Carrier Routing & Switching, Q4 2011 Worldwide.

 

  (2) Gartner, Market Trends: Mobile Data and Video Traffic, 2012, Market Analysis and Statistics, G00237896, dated August 28, 2012, by Jessica Ekholm.

 

  (3) Gartner, Forecast Analysis: Enterprise Network Services, Worldwide, 2009-2016, 4Q12 Update, Market Analysis and Statistics, G00231698, dated December 14, 2012, by Daniel O’Connell, Nhat Pham, Kenshi Tazaki, Lisa Unden-Farbound, Katja Ruud, To Chee Eng, Lydia Leong, Vincent Fu, Elia San Miguel and Fernando Elizalde.

 

  (4) IDC—Press Release, September 26, 2012: “IDC Expects Smart Connected Device Shipments to Grow by 14% Annually Through 2016, Led by Tablets and Smartphones.”

 

  (5) IDC, Worldwide User-Generated Video Content and Archive 2012-2016 Forecast: The Video Bible, IDC #235421, June 2012.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of shares of our common stock in this offering will be $             million, based on an assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses. If the underwriters’ option to purchase additional shares from us is exercised in full, we estimate that our net proceeds would be $             million, after deducting estimated underwriting discounts and commissions and estimated offering expenses.

Each $1.00 increase or decrease in the assumed initial public offering price of $             per share would increase or decrease the net proceeds that we receive from this offering by $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions. Similarly, each increase or decrease of one million shares in the number of shares of common stock offered by us would increase or decrease the net proceeds that we receive from this offering by $             million, assuming the assumed initial public offering price remains the same and after deducting estimated underwriting discounts and commissions.

The principal purposes of this offering are to increase our financial flexibility, improve brand awareness, create a public market for our common stock and facilitate our future access to the public capital markets. We expect to use the net proceeds that we will receive from this offering for working capital and other general corporate purposes, including the expansion of our sales organization, overseas expansion, primarily through channel partners, and further development and expansion of our solutions. We may also use a portion of the net proceeds that we receive to acquire or invest in complementary businesses, products, services, technologies or other assets. We have not entered into any agreements or commitments with respect to any acquisitions or investments at this time.

We cannot specify with certainty all of the particular uses of the net proceeds that we will receive from this offering. Accordingly, we will have broad discretion in using these proceeds. Furthermore, the amount and timing of our actual expenditures will depend on numerous factors, including the cash used in or generated by our operations, the status of our development, the level of our sales and marketing activities, the pace of our international expansion plans, and our investments and acquisitions. Pending the use of proceeds from this offering as described above, we plan to invest the net proceeds that we receive in this offering in short-term and intermediate-term interest-bearing obligations, investment-grade investments, certificates of deposit or direct or guaranteed obligations of the U.S. government. We cannot predict whether the invested proceeds will yield a favorable return.

DIVIDEND POLICY

We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determination to declare dividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions and other factors that our board of directors may deem relevant. In addition, our loan facility contains restrictions on our ability to declare and pay cash dividends on our capital stock.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of December 31, 2012 on:

 

  Ÿ  

an actual basis;

 

  Ÿ  

a pro forma basis, giving effect to (i) the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into 33,897,005 shares of our common stock immediately prior to the closing of this offering, (ii) the reclassification of the preferred stock warrant liability of $6.3 million as of December 31, 2012 into additional paid-in capital, and (iii) the filing of our amended and restated certificate of incorporation in Delaware, which will occur in connection with the completion of this offering; and

 

  Ÿ  

a pro forma as adjusted basis, giving effect to the pro forma adjustments set forth above and the sale by us of              shares of our common stock offered by this prospectus at an assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses.

You should read the information in this table together with the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of December 31, 2012  
     Actual     Pro Forma     Pro Forma
As
Adjusted(1)
 
     (in thousands, except share and per
share data)
 

Cash and cash equivalents

   $ 20,221      $ 20,221      $                      
  

 

 

   

 

 

   

 

 

 

Total debt

   $ 12,563      $ 12,563     

Redeemable convertible preferred stock, $0.0001 par value, 35,031,602 shares authorized; 33,897,005 shares issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma and pro forma as adjusted

     98,133        —       

Stockholders’ equity:

      

Common stock, $0.0001 par value, 50,000,000 shares authorized, actual, and              shares authorized pro forma and pro forma as adjusted; 2,575,220, 36,472,225 and              shares issued and outstanding, actual, pro forma and pro forma as adjusted

     —          4     

Additional paid-in capital

     3,514        107,897     

Accumulated other comprehensive loss

     (19     (19  

Accumulated deficit

     (86,550     (86,550  
  

 

 

   

 

 

   

 

 

 

Total stockholders’ equity (deficit)

     (83,055     21,332     
  

 

 

   

 

 

   

 

 

 

Total capitalization

   $ 27,641      $ 33,895      $     
  

 

 

   

 

 

   

 

 

 

 

(1)

Each $1.00 increase or decrease in the assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit) and total capitalization by approximately $              million, assuming the number of shares offered by us, as set forth on the cover page of this

 

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prospectus, remains the same, and after deducting estimated underwriting discounts and commissions. Similarly, each increase or decrease of one million shares in the number of shares offered by us would increase or decrease, as applicable, cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit) and total capitalization by approximately $             million, assuming an initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions. The pro forma as adjusted information discussed above is illustrative only and will change based on the actual initial public offering price and other terms of this offering determined at pricing.

The outstanding share information in the table above is based on 36,472,225 shares of common stock (including redeemable convertible preferred stock on an as-converted basis) outstanding as of December 31, 2012, and excludes:

 

  Ÿ  

10,212,760 shares of common stock issuable upon the exercise of options to purchase common stock that were outstanding as of December 31, 2012, with a weighted-average exercise price of $2.49 per share;

 

  Ÿ  

1,009,597 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2012, with a weighted-average exercise price of $2.34 per share (of which warrants to purchase 894,596 shares of redeemable convertible preferred stock will either be exercised or terminated immediately prior to the completion of this offering);

 

  Ÿ  

                 additional shares of common stock, subject to increase on an annual basis, reserved for future issuance under our 2013 Equity Incentive Plan, which will become effective in connection with the completion of this offering, consisting of:

 

   

                shares of common stock reserved for future grant or issuance under our 2013 Equity Incentive Plan, which will become effective in connection with the completion of this offering; and

 

   

1,242,353 shares of common stock reserved for future issuance under our 2006 Stock Plan, which shares will be added to the shares of common stock to be reserved under our 2013 Equity Incentive Plan upon its effectiveness.

 

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DILUTION

If you invest in our common stock in this offering, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock immediately after this offering. Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma as adjusted net tangible book value per share of common stock immediately after completion of this offering.

Net tangible book value per share is determined by dividing our total tangible assets less our total liabilities by the number of shares of common stock outstanding. Our historical net tangible book value as of December 31, 2012 was $(83.1 million), or $(32.25) per share. Our pro forma net tangible book value as of December 31, 2012 was $21.3 million, or $0.58 per share, based on the total number of shares of our common stock outstanding as of December 31, 2012, after giving effect to the conversion of all outstanding shares of redeemable convertible preferred stock into shares of common stock, which will occur upon the completion of this offering and the resulting reclassification of the preferred stock warrant liability to additional paid-in capital.

After giving effect to the sale by us of             shares of our common stock in this offering at the assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses, our pro forma as adjusted net tangible book value as of December 31, 2012 would have been approximately $             million, or $             per share. This represents an immediate increase in pro forma net tangible book value of $             per share to our existing stockholders and an immediate dilution of $             per share to investors purchasing shares of common stock in this offering at the assumed initial public offering price.

The following table illustrates this dilution:

 

Assumed initial public offering price per share

      $                

Pro forma net tangible book value per share as of December 31, 2012

   $     0.58      

Increase in pro forma net tangible book value per share attributable to new investors in this offering

     
  

 

 

    

Pro forma net tangible book value per share immediately after this offering

      $     
     

 

 

 

Dilution in pro forma net tangible book value per share to new investors in this offering

      $     
     

 

 

 

Each $1.00 increase or decrease in the assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease, as applicable, our pro forma as adjusted net tangible book value per share to new investors by $            , and would increase or decrease, as applicable, dilution per share to new investors in this offering by $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions. In addition, to the extent any outstanding options to purchase common stock are exercised, new investors will experience further dilution.

If the underwriters exercise their option to purchase additional shares from us in full, the pro forma as adjusted net tangible book value per share of our common stock immediately after this offering would be $             per share, and the dilution in pro forma net tangible book value per share to new investors in this offering would be $             per share.

 

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The following table presents on a pro forma as adjusted basis as of December 31, 2012, after giving effect to the conversion of all outstanding shares of redeemable convertible preferred stock into shares of common stock in connection with the completion of this offering, the differences between the existing stockholders and the new investors purchasing shares of our common stock in this offering, with respect to the number of shares purchased from us, the total consideration paid or to be paid to us, giving effect to the assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, before deducting estimated underwriting discounts and commissions and estimated offering expenses.

 

     Shares Purchased     Total Consideration     Average
Price
Per Share
 
     Number    Percent     Amount      Percent    

Existing stockholders

               $                  $     

New investors

            
  

 

  

 

 

   

 

 

    

 

 

   

Total

        100.0   $           100.0   $     
  

 

  

 

 

   

 

 

    

 

 

   

Each $1.00 increase or decrease in the assumed initial public offering price of $             per share would increase or decrease the total consideration paid by new investors and total consideration paid by all stockholders by approximately $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions. In addition, to the extent any outstanding options to purchase common stock are exercised, new investors will experience further dilution.

If the underwriters exercise their option to purchase additional shares from us in full, our existing stockholders would own     % and our new investors would own     % of the total number of shares of our common stock outstanding upon the completion of this offering.

The outstanding share information in the table above is based on 36,472,225 shares of common stock (including redeemable convertible preferred stock on an as-converted basis) outstanding as of December 31, 2012, and excludes:

 

  Ÿ  

10,212,760 shares of common stock issuable upon the exercise of options to purchase common stock that were outstanding as of December 31, 2012, with a weighted-average exercise price of $2.49 per share;

 

  Ÿ  

1,009,597 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2012, with a weighted-average exercise price of $2.34 per share (of which warrants to purchase 894,596 shares of redeemable convertible preferred stock will either be exercised or terminated immediately prior to the completion of this offering);

 

  Ÿ  

                 additional shares of common stock, subject to increase on an annual basis, reserved for future issuance under our 2013 Equity Incentive Plan, which will become effective in connection with the completion of this offering, consisting of:

 

  Ÿ  

                shares of common stock reserved for future grant or issuance under our 2013 Equity Incentive Plan, which will become effective in connection with the completion of this offering; and

 

  Ÿ  

1,242,353 shares of common stock reserved for future issuance under our 2006 Stock Plan, which shares will be added to the shares of common stock to be reserved under our 2013 Equity Incentive Plan upon its effectiveness.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes that are included elsewhere in this prospectus.

Our consolidated statements of operations data for the years ended December 31, 2010, 2011 and 2012 and our consolidated balance sheet data as of December 31, 2011 and 2012 are derived from our audited consolidated financial statements included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future.

 

     Year Ended December 31,  
     2010     2011     2012  
     (in thousands, except per share data)  

Consolidated Statements of Operations Data:

      

Revenue

   $ 23,484      $ 40,421      $ 95,872   

Cost of revenue(1)

     18,263        27,074        57,315   
  

 

 

   

 

 

   

 

 

 

Gross profit

     5,221        13,347        38,557   

Operating expenses(1):

      

Research and development

     10,430        12,986        18,447   

Sales and marketing

     7,919        12,825        25,243   

General and administrative

     2,380        3,310        6,055   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     20,729        29,121        49,745   

Loss from operations

     (15,508     (15,774     (11,188

Interest expense

     (429     (419     (33

Other income (expense), net

     (406     322        (5,340
  

 

 

   

 

 

   

 

 

 

Total other income (expense), net

     (835     (97     (5,373
  

 

 

   

 

 

   

 

 

 

Loss before provision for income taxes

     (16,343     (15,871     (16,561

Provision for income taxes

     1        14        40   
  

 

 

   

 

 

   

 

 

 

Net loss

   $ (16,344   $ (15,885   $ (16,601
  

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share(2)

   $ (7.54   $ (6.63   $ (6.60
  

 

 

   

 

 

   

 

 

 

Weighted-average number of shares used in computing basic and diluted net loss per share(2)

     2,167        2,396        2,515   
  

 

 

   

 

 

   

 

 

 

Pro forma basic and diluted net loss per share(2)

       $ (0.31
      

 

 

 

Weighted-average number of shares used in computing pro forma basic and diluted net loss per share(2)

         36,412   
      

 

 

 

 

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(1) Stock-based compensation included in the statements of operations data above was as follows:

 

     Year Ended December 31,  
     2010      2011      2012  
     (in thousands)  

Cost of revenue

   $ —         $ 73       $ 57   

Research and development

     57         338         745   

Sales and marketing

     66         229         656   

General and administrative

     72         125         639   
  

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 195       $ 765       $ 2,097   
  

 

 

    

 

 

    

 

 

 

 

(2) See Note 9 to our audited consolidated financial statements for an explanation of the calculations of our basic and diluted net loss per share of common stock and pro forma net loss per share of common stock.

 

     December 31,  
     2011     2012  
     (in thousands)  

Consolidated Balance Sheet Data:

    

Cash and cash equivalents

   $ 25,740      $ 20,221   

Working capital

     26,703        13,919   

Property and equipment, net

     3,791        6,485   

Total assets

     43,528        70,789   

Total debt

     45        12,563   

Total deferred revenue

     5,219        17,417   

Preferred stock warrant liability

     900        6,254   

Redeemable convertible preferred stock

     98,133        98,133   

Total stockholders’ deficit

   $ (68,675 )   $ (83,055

 

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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 consolidated financial statements and the related notes that are included elsewhere in this prospectus. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Risk Factors” and elsewhere in this prospectus. See “Special Note Regarding Forward-Looking Statements.”

Overview

We have pioneered innovative carrier-grade networking solutions that transform disparate and inefficient legacy networks into open high-performance networks. Our solutions include high-capacity, multi-layer switching and transport platforms, as well as a carrier-grade software-defined networking platform and applications. We designed our Z-Series platforms to support the multiple concurrent technologies used in regional and metro networks, including both Ethernet-based services as well as optical services. In December 2012, we introduced our Blue Planet platform, a carrier-grade software-defined networking solution purpose-built to address network operator requirements. Blue Planet is the latest implementation of our network virtualization and management software that we first introduced in 2009 to work in combination with our high-capacity, multi-layer switching and transport platforms. Customers may choose to deploy Blue Planet either on a standalone basis or integrated with our Z-Series platforms. Our solutions enable network operators to virtualize their networks, accelerate service delivery and increase scalability and performance, while reducing costs.

We were founded in October 2006 to simplify network operations and to accelerate innovation through a centralized, open, multi-vendor, software orchestration model. We launched our first Z-Series platform in September 2009. In April 2010, we launched CyMS, one of the first multi-layer network management solutions. In December 2012, we launched Blue Planet. To date, sales of our Z-Series platforms have accounted for substantially all of our revenue. Standalone sales of Blue Planet have accounted for an immaterial amount of our revenue to date and are expected to increase only modestly as a portion of our revenue in the near term. However, we expect that the portion of our revenue derived from standalone sales of Blue Planet will increase over the longer term.

Our customers range from service providers to high-performance data center and large, private network operators. Our solutions have been deployed primarily across North America, as well as in Asia and Europe, by over 125 customers, including, among our top ten customers by revenue in 2012, Great Plains Communications Inc., Intelleq Communications LLC, Lynx Network Group, Inc., US Carrier Telecom, LLC, US Signal Company, LLC, Vision Net, Inc. and Windstream Corporation.

Historically, our revenue has been derived primarily from customers located in the United States. For the years ended December 31, 2011 and 2012, our largest customer was Windstream Corporation, which accounted for approximately 37% and 45% of our revenue, respectively. No other customer represented greater than 10% of our revenue in either of these periods. Windstream has publically indicated its intention to reduce its overall capital expenditures in 2013. Accordingly, we expect our revenue derived from sales to Windstream to decline in future periods. We also expect our revenue derived from sales to Windstream to decline as a percentage of our revenue in future periods as we expand our customer base both in the United States and internationally.

 

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In addition, approximately 6.9%, 12.3% and 9.3% of our revenue for the years ended December 31, 2010, 2011 and 2012, respectively, was attributable to Independent Operating Companies, or IOCs, and other telecommunications network providers that used government-supported loan programs or grants to fund purchases from us. Changes to or elimination of similar government programs have occurred in the past and are likely to occur in the future, especially given the current U.S. federal government fiscal issues. To the extent that any of our customers have received grants or loans under government stimulus programs, but no longer have access to such assistance, they may substantially reduce or curtail future purchases of our solutions.

Revenue from customers located outside of the United States was approximately 1% and 5% of our revenue for the years ended December 31, 2011 and 2012, respectively. We expect the percentage of our revenue derived from international sales to significantly increase in future periods.

Our customers have historically purchased our solutions using a pay-as-you-grow approach that begins with a targeted product purchase to address specific services or portions of their networks and expands over time to additional product purchases as they experience the benefits of our solutions. The sales cycle for a new customer deployment, from the time of prospect qualification to the completion of the first sale, may span multiple quarters. Typically, after we have completed an initial customer deployment, we experience much shorter sales cycles.

We have historically employed a direct sales model. During 2012, we began to transition to a mixed sales channel approach, complementing our direct sales force with a channel distribution strategy, particularly in international markets. We expect to generate a substantial portion of our international sales through this network of channel partners in future periods.

We intend to continue to invest in our sales force, field operations and support capacity, deepen our engagement with our current channel partners and establish relationships with new channel partners to target our existing core markets. We also intend to target additional customer verticals, including large data center networks, governments, cable MSOs and enterprises that build and operate large, private networks.

We outsource the manufacturing of our Z-Series platforms. Our outsourced manufacturing model allows us to scale our business without the significant capital investment and ongoing expenses required to establish and maintain manufacturing operations. Our Z-Series platforms leverage industry standard components, and we work closely with our contract manufacturer and key suppliers to manage the procurement, quality and cost of these components. We seek to maintain an optimal level of finished goods inventory to meet our forecasted sales and unanticipated shifts in sales volume and mix.

We believe that our technological advantages will continue to support our growth and demand for our solutions. However, our business may be affected by future challenging economic conditions, decreased availability of capital for network infrastructure projects, as well as whether the market for Blue Planet develops. In addition, capital spending in our industry is cyclical and sporadic, can change on short notice, and can fluctuate in response to outside factors, such as the availability of government stimulus assistance. As a result, changes in spending behavior in any given quarter or during any economic downturn can reduce our revenue. Spending on network construction, maintenance, expansion and upgrades is also affected by seasonality, delays in the purchasing cycles and reductions in budgets of network operators. Finally, we may face direct and indirect risks as a result of our planned international expansion, including expenses of doing business in multiple jurisdictions, differing regulatory environments, foreign currency fluctuations and varying collection practices.

 

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How We Generate Revenue

We generate revenue primarily from the sales of our Z-Series platforms, subscriptions and licenses to our Blue Planet software-defined networking solutions and various professional service fees.

Cyan Z-Series

Our Z-Series hardware is a family of high-capacity, multi-layer switching and transport platforms. Each Z-Series platform is comprised of a chassis that supports a variety of interchangeable Z-Series line cards to provide a wide range of network applications. Our customers make an initial purchase of chassis and line cards to address their particular network deployment needs, then typically make subsequent purchases of line cards and/or larger chassis as the capacity and service needs of their networks evolve. The majority of our revenue is generated from sales of our Z-Series platforms. We generally recognize product revenue at the time of shipment, provided that all other revenue recognition criteria have been met.

Cyan Blue Planet

In December 2012, we expanded our network virtualization and management software offerings with the commercial launch of Blue Planet. Blue Planet is the latest implementation of the network virtualization and management software that we first introduced in 2009 to work in combination with our Z-Series platforms. Blue Planet is available to customers regardless of whether they have deployed our Z-Series platforms in their networks. Customers may purchase Blue Planet using standard configurations to address common network needs or may customize their implementations by pairing the Blue Planet orchestration layer with their own selection of applications and element adapters. We intend to offer Blue Planet primarily on a software-as-a-service, or SaaS, subscription basis deployed from the cloud. We invoice Blue Planet SaaS customers for the entire contract amount at the start of the subscription term, which will lead to the majority of these invoiced amounts being treated as deferred revenue that will be recognized ratably over the term. In certain cases, we may offer Blue Planet on a perpetual license basis bundled with maintenance and support. In such circumstances, and until we have established vendor-specific objective evidence, or VSOE, of the maintenance and support element of the arrangement, we will invoice Blue Planet license customers for the entire contract amount at the start of the license term, which will lead to the majority of these invoiced amounts being treated as deferred revenue that will be recognized ratably over the term. Given its recent introduction, Blue Planet revenue has been immaterial to date.

CyNOC Professional Services

Our CyNOC offering is a network operations center service through which we monitor, and, in some cases, manage our customers’ multi-vendor networks. Additionally, a number of our customers which maintain their own internal NOC leverage our services as a backup NOC. These services are typically sold to our customers for a one-year term at the time of the initial product sale and renewed on an annual basis thereafter.

Maintenance, Support and Training Services

We offer Cyan PRO professional services, including our CySupport and CyService offerings, to provide a variety of customer service products and support through our technical support engineers as well as through our growing network of authorized and certified channel partners. These services are sold to our customers at the time of the initial product sale, typically for one-year terms that customers may choose to renew for successive annual or multi-year periods.

 

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CySupport is our integrated software maintenance and technical support services package, which provides all essential software and services in one simple and cost-effective package.

CyService encompasses a range of additional professional services to assist our customers with network deployment and installation services. These services are invoiced separately at the time of the initial product sale. We also provide training and other professional services to our end-customers, including services related to the implementation, use, functionality and ongoing maintenance of our products. These services are invoiced separately when the services are delivered.

Deferred Revenue

Our deferred revenue consists of amounts that have been invoiced but that have not yet been recognized as revenue as of the period end, pending completion of the revenue recognition process. Our deferred revenue was $5.2 million and $17.4 million as of December 31, 2011 and 2012, respectively. The majority of our deferred revenue consists of amounts related to sales of our Z-Series platforms, and relates primarily to shipped and billed hardware awaiting customer acceptance. The remainder consists of subscription and support and maintenance revenue that is recognized ratably over the contractual service period. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods. Over the longer term, we expect that the proportion of our deferred revenue relating to subscriptions under our SaaS model for Blue Planet will increase relative to Z-Series related deferred revenue. In most cases, we expect to invoice our customers for the entire contract amount at the start of the annual term of the Blue Planet subscription, which will lead to the majority of these invoiced amounts being treated as deferred revenue and recognized ratably over the term of the subscription.

Components of Operating Results

Cost of Revenue

Cost of revenue primarily consists of manufacturing costs of our products payable to our contract manufacturer. Our cost of revenue also includes third-party manufacturing and supply chain logistics costs, provisions for excess and obsolete inventory, warranty, hosting costs, certain allocated costs for facilities, depreciation and other expenses associated with logistics and quality control. Additionally, it includes salaries, benefits and stock-based compensation for personnel directly involved with manufacturing, installation, maintenance and support services and the provision of Blue Planet.

Gross Margin

Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors. In the near term, we generally expect gross margin to increase modestly as a result of our continued efforts and those of our contract manufacturer to manage our supply chain and raw materials pricing and scale efficiencies in our production model, as well as shifts in product mix from line cards that are more focused on pure optical transport to line cards with packet handling capabilities. In the longer term, we expect that the market adoption of Blue Planet, and the resulting increase in Blue Planet revenue as a percentage of our revenue, will contribute to increases in gross margin. From time to time, however, we may experience lower gross margin in any particular period as a result of large initial deployments. These deployments typically include a significant proportion of lower-margin Z-Series chassis. As our customers expand their networks after large initial deployments, they typically purchase additional higher-margin line cards.

 

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Operating Expenses

Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of our operating expenses and consist of salaries, benefits, bonuses, stock-based compensation, and with regard to sales and marketing expense, sales commissions.

Research and Development.    Research and development expense consists primarily of personnel and consultant costs. Research and development expense also includes costs for prototypes, product certification, travel, depreciation, recruiting and allocated costs for certain facilities and benefits costs allocated based on headcount. In 2012, we nearly doubled the size of our engineering team, predominantly with software engineers, as we have broadened our focus on Blue Planet. We expect the total dollar amount of research and development expense to increase for the foreseeable future as we continue to invest in our future products and services as described above. Despite the expected increase in our research and development spending, these expenses may fluctuate as a percentage of revenue from period to period based on fluctuations in our revenue and the timing of the significant research and development spending.

Sales and Marketing.    Sales and marketing expense consists primarily of personnel costs including commission costs. We expense commission costs as incurred. Sales and marketing expense also includes the costs of trade shows, marketing programs, promotional materials, demonstration equipment, travel, depreciation, recruiting and allocated costs for certain facilities and benefits costs. In 2012, we nearly doubled the size of our sales force, with substantial growth of our sales presence internationally. We expect sales and marketing expense to continue to increase in dollar amount as we increase the size of our sales and marketing organizations to increase touch points with end-customers and to expand our international presence, although our sales and marketing expense may fluctuate as a percentage of revenue from period to period depending on the timing of those expenses.

General and Administrative.    General and administrative expense consists of personnel costs as well as costs for professional services. General and administrative personnel include our executive, finance, human resources, IT and legal organizations. Professional services consist primarily of legal, auditing, accounting, and other consulting costs. We expect general and administrative expense to continue to increase for the foreseeable future due to expansion of our finance and legal departments to support our public company reporting requirements, as well as additional legal and accounting fees, insurance, investor relations, and other costs associated with being a public company. Our general and administrative expense may fluctuate as a percentage of revenue from period to period depending on the timing of those expenses.

Interest Expense

Interest expense consists of interest on our notes payable and capital leases as well as amortization of loan fees. In December 2012, we established a new loan facility consisting of a revolving loan facility and a term loan facility governed by a Loan and Security Agreement with Silicon Valley Bank, or SVB. Under the revolving loan facility, we may, from time to time, borrow up to $10.0 million due December 2014 at a floating annual interest rate equal to the greater of 3.25% or the prime rate (3.25% as of December 31, 2012). Under the term loan facility we may, from time to time, borrow up to $5.0 million due 48 months following an advance at an annual interest rate equal to the prime rate plus 0.5%, which will float for the first 12 months of the loan and will be fixed thereafter. Borrowings under the loan facility are secured by a first-priority security interest in our assets, excluding our intellectual property and certain other assets. Borrowings under the loan facility are subject to our compliance with certain negative and affirmative covenants, including financial

 

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covenants, covenants relating to our ability to incur other indebtedness, our maintenance of depository accounts with SVB, our selling assets or entering into change of control transactions, liens on our assets and our ability to pay dividends to our stockholders. As of December 31, 2012, we had drawn down $5.0 million as term loans and $7.6 million as revolving loans under the agreement.

Other Income (Expense), net

Other income (expense), net consists primarily of the change in fair value of our preferred stock warrant liability offset in part by interest income. Preferred stock warrants are classified as a liability on our consolidated balance sheets and their estimated fair value is re-measured at each balance sheet date with the corresponding change recorded within other income (expense), net. If the fair value of our common stock increases, the fair value of preferred stock warrant liability will increase, which will also increase the charges recognized through other income (expense), net. We expect the fair value of preferred stock warrant liability to increase in future periods prior to completion of this offering. Immediately prior to the completion of this offering, warrants to purchase 115,001 shares of our redeemable convertible preferred stock will either be exercised or converted into warrants to purchase 115,001 shares of our common stock, and warrants to purchase 894,596 shares of our redeemable convertible preferred stock will either be exercised or terminated, and as a result, we will no longer be required to mark-to-market the fair value of such warrants.

Provision for Income Taxes

Provision for income taxes consists primarily of federal and state income taxes in the United States and income taxes in foreign jurisdictions in which we conduct business. Due to the uncertainty as to the realization of the benefits of our domestic deferred tax assets (including net operating loss carryforwards and research and development and other tax credits), we have a full valuation allowance reserved against such assets. We expect to maintain this full valuation allowance in the near term. We also expect our provision for income taxes to increase in future years.

As of December 31, 2012, we had $73.7 million of federal and $74.0 million of state net operating loss carryforwards available to reduce future taxable income. These net operating loss carryforwards begin to expire in 2026 for U.S. federal income tax and 2016 for state income tax purposes and may fully expire by 2031. Our ability to use our net operating loss carryforwards to offset any future taxable income may currently, or in the future be subject to limitations in the event that we experience a change of ownership as defined by Section 382 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code.

 

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Results of Operations

The following tables set forth our results of operations for the periods presented and as a percentage of our revenue for those periods. The period-to-period comparison of our financial results is not necessarily indicative of our future results.

 

     Year Ended
December 31,
 
     2010     2011     2012  
     (in thousands)  

Revenue

   $ 23,484      $ 40,421      $ 95,872   

Cost of revenue

     18,263        27,074        57,315   
  

 

 

   

 

 

   

 

 

 

Gross profit

     5,221        13,347        38,557   

Operating expenses:

      

Research and development

     10,430        12,986        18,447   

Sales and marketing

     7,919        12,825        25,243   

General and administrative

     2,380        3,310        6,055   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     20,729        29,121        49,745   

Loss from operations

     (15,508     (15,774     (11,188

Interest expense

     (429     (419     (33

Other income (expense), net

     (406     322        (5,340
  

 

 

   

 

 

   

 

 

 

Total other income (expense), net

     (835     (97     (5,373
  

 

 

   

 

 

   

 

 

 

Loss before provision for income taxes

     (16,343     (15,871     (16,561

Provision for income taxes

     1        14        40   
  

 

 

   

 

 

   

 

 

 

Net loss

   $ (16,344   $ (15,885   $ (16,601
  

 

 

   

 

 

   

 

 

 

Stock-based compensation included in the statements of operations data above was as follows:

 

     Year Ended
December 31,
 
     2010      2011      2012  
     (in thousands)  

Cost of revenue

   $ —         $ 73       $ 57   

Research and development

     57         338         745   

Sales and marketing

     66         229         656   

General and administrative

     72         125         639   
  

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 195       $ 765       $ 2,097   
  

 

 

    

 

 

    

 

 

 

 

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     Year Ended
December 31,
 
     2010     2011     2012  

Revenue

     100.0     100.0     100.0

Cost of revenue

     77.8        67.0        59.8   
  

 

 

   

 

 

   

 

 

 

Gross margin

     22.2        33.0        40.2   

Operating expenses:

      

Research and development

     44.4        32.1        19.2   

Sales and marketing

     33.7        31.7        26.3   

General and administrative

     10.1        8.2        6.3   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     88.2        72.0        51.8   

Loss from operations

     (66.0     (39.0     (11.7

Interest expense

     (1.8     (1.0     —     

Other income (expense), net

     (1.7     0.7        (5.6
  

 

 

   

 

 

   

 

 

 

Total other expense, net

     (3.6     (0.3     (17.3
  

 

 

   

 

 

   

 

 

 

Loss before provision for income taxes

     (69.6     (39.3     (17.3

Provision for income taxes

     —          —          —     
  

 

 

   

 

 

   

 

 

 

Net loss

     (69.6 )%      (39.3 )%      (17.3 )% 
  

 

 

   

 

 

   

 

 

 

Comparison of the Years Ended December 31, 2011 and 2012

Revenue

 

     Year Ended
December 31,
        
     2011      2012      Change  
     Amount      Amount      Amount      %  
     (dollars in thousands)  

Revenue

   $ 40,421       $ 95,872       $ 55,451         137.2%   

Revenue increased by $55.5 million, or 137.2%, from the year ended December 31, 2011 to the year ended December 31, 2012. This increase was attributable to increased unit shipments of our Z-Series platforms. Approximately 95% of our revenue for the year ended December 31, 2012 was attributable to customers located in the United States. We believe that an improving economy, continued growth in bandwidth demand and increased acceptance of our software-defined networking technology and our high-capacity, multi-layer switching and transport platforms, as an alternative to router-based architecture, contributed to our revenue growth. To drive and support this growing demand and increase our revenue, we doubled our sales and marketing headcount from December 31, 2011 to December 31, 2012.

Cost of Revenue, Gross Profit and Gross Margin

 

     Year Ended
December 31,
        
     2011      2012      Change  
     Amount      Amount      Amount      %  
     (dollars in thousands)  

Cost of revenue

   $ 27,074       $ 57,315       $ 30,241         111.7%   

Gross profit

   $ 13,347       $ 38,557       $ 25,210         188.9%   

Gross margin

     33.0%         40.2%         7.2%      

Cost of revenue increased by $30.2 million, or 111.7%, from the year ended December 31, 2011 to the year ended December 31, 2012, primarily due to an increase in revenue.

 

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Gross profit increased by $25.2 million and gross margin increased by 7.2% from 33.0% to 40.2% from the year ended December 31, 2011 to the year ended December 31, 2012. Of the 7.2% increase in gross margin, approximately 4% was attributable to improved profitability on sales of our solutions. This improvement was principally due to component and materials cost reductions resulting from a combination of dual sourcing of various components, which enabled us to obtain more favorable component pricing, and volume discounts attributable to the higher volume of component purchases. To a lesser extent, the increase in gross margin was positively affected by a decrease in our manufacturing overhead resulting from scale efficiencies as a result of higher volume production.

Operating Expenses

 

     Year Ended December 31,         
     2011      2012      Change  
     Amount      % of
revenue
     Amount      % of
revenue
     Amount      %  
     (dollars in thousands)  

Research and development

   $ 12,986         32.1%       $ 18,447         19.2%       $ 5,461         42.1%   

Sales and marketing

     12,825         31.7%         25,243         26.3%         12,418         96.8%   

General and administrative

     3,310         8.2%         6,055         6.3%         2,745         82.9%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Total operating expenses

   $ 29,121         72.0%       $ 49,745         51.8%       $ 20,624         70.8%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Research and development expense increased by $5.5 million, or 42.1%, from the year ended December 31, 2011 to the year ended December 31, 2012, primarily due to an increase in personnel-related expenses of $5.0 million (including a $0.4 million increase in stock-based compensation) resulting from an increase in headcount of 37, primarily to support continued investment in Blue Planet and our Z-Series platforms. Additional components of the increase include an increase of $0.3 million in depreciation of property and equipment to support our product development efforts and an increase of $0.8 million in consulting expenses. These increases were offset in part by a $0.8 million decrease in expensed prototypes and supplies.

Sales and marketing expense increased by $12.4 million, or 96.8%, from the year ended December 31, 2011 to the year ended December 31, 2012, primarily due to an increase of $6.4 million (including a $0.4 million increase in stock-based compensation) in personnel-related expenses due to the expansion of our sales force. Sales and marketing headcount increased by 46 from December 31, 2011 to December 31, 2012, representing an increase of 97.9%. As a result of increasing our sales and marketing headcount and international expansion, we also experienced increases in travel and related expenses of $1.8 million and consulting and outside services of $0.9 million for the year ended December 31, 2012 as compared to the year ended December 31, 2011. Commission expenses also increased by $2.1 million for the year ended December 31, 2012 due to the increased revenue for the period.

General and administrative expense increased by $2.7 million, or 82.9%, from the year ended December 31, 2011 to the year ended December 31, 2012, primarily due to an increase in headcount of 11, which resulted in increased personnel-related expenses of $1.8 million (including a $0.5 million increase in stock-based compensation) due to the hiring of additional executive and other administrative employees to support our growth. Additional components included modest increases in accounting related expenses and increased legal costs.

 

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Interest Expense

 

     Year Ended
December 31,
        
     2011      2012      Change  
     Amount      Amount      Amount  
     (in thousands)  

Interest expense

   $ 419       $ 33       $ (386

Interest expense for 2011 related to our capital leases and notes payable. In the second quarter of 2011, we made final payments on our capital lease obligations. In addition, our notes payable matured and were repaid in the first quarter of 2012, and additional 2012 obligations under our revolving loans and term loans were incurred in late December 2012. As a result, we expect our interest expense to increase in future periods.

Other Income (Expense), Net

 

     Year Ended
December 31,
       
     2011     2012     Change  
     Amount     Amount     Amount  
     (in thousands)  

Interest income

   $ 14      $ 33      $ 19   

Interest expense

     (419     (33     386   

Preferred stock warrant liabilities

     313        (5,354     (5,667

Foreign currency

     (6     (20     (14

Other

     1        1        —     
  

 

 

   

 

 

   

 

 

 

Total other income (expense), net

   $ (97   $ (5,373   $ (5,276
  

 

 

   

 

 

   

 

 

 

Other income (expense), net changed from income of $0.1 million for the year ended December 31, 2011 to an expense of $5.4 million for the year ended December 31, 2012, due to the change in value of the preferred stock warrant liabilities of $5.4 million. This change was due to the increase in the underlying valuation of our capital stock, which was partially offset by the decrease in the expected term of the warrant as it comes closer to expiration.

Comparison of the Years Ended December 31, 2010 and 2011

Revenue

 

     Year Ended
December 31,
               
     2010      2011      Change  
     Amount      Amount      Amount      %  
     (dollars in thousands)  

Revenue

   $ 23,484       $ 40,421       $ 16,937         72.1%   

Revenue increased by $16.9 million, or 72.1%, from the year ended December 31, 2010 to the year ended December 31, 2011. This increase was attributable to increased unit shipments of our Z-Series platforms. Approximately 99% of our revenue for the year ended December 31, 2011 was attributable to customers located in the United States. We believe that an improving economy, continued growth in bandwidth demand and increased acceptance of our software-defined networking technology and our high-capacity, multi-layer switching and transport platforms, as an alternative to router-based architecture, contributed to our revenue growth. To drive and support this growing demand and increase our revenue, we doubled our sales and marketing headcount from December 31, 2010 to December 31, 2011.

 

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Cost of Revenue, Gross Profit and Gross Margin

 

     Year Ended
December 31
               
     2010      2011      Change  
     (dollars in thousands)  

Cost of revenue

   $ 18,263       $ 27,074       $ 8,811         48.2%   

Gross profit

   $ 5,221       $ 13,347       $ 8,126         155.6%   

Gross margin

     22.2%         33.0%         10.8%      

Cost of revenue increased by $8.8 million, or 48.2%, from the year ended December 31, 2010 to the year ended December 31, 2011, primarily due to an increase in revenue.

Gross profit increased by $8.1 million and gross margin increased by 10.8% from 22.2% to 33.0% from the year ended December 31, 2010 to the year ended December 31, 2011. Of the 10.8% increase in gross margin, approximately 8% was attributable to improved profitability on sales of our solutions. This improvement was principally due to component and materials cost reductions resulting from a combination of dual sourcing of various components, which enabled us to obtain more favorable component pricing, and volume discounts attributable to the higher volume of component purchases. To a lesser extent, the increase in gross margin was positively affected by a decrease in our manufacturing overhead resulting from scale efficiencies as a result of higher volume production.

Operating Expenses

 

     Year Ended December 31,                
     2010      2011      Change  
     Amount      % of
revenue
     Amount      % of
revenue
     Amount      %  
     (dollars in thousands)  

Research and development

   $ 10,430         44.4%       $ 12,986         32.1%       $ 2,556         24.5%   

Sales and marketing

     7,919         33.7%         12,825         31.7%         4,906         62.0%   

General and administrative

     2,380         10.1%         3,310         8.2%         930         39.1%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Total operating expenses

   $ 20,729         88.2%       $ 29,121         72.0%       $ 8,392         40.5%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Research and development expense increased by $2.6 million, or 24.5%, from the year ended December 31, 2010 to the year ended December 31, 2011, primarily attributable to an increase of $2.9 million in personnel-related expenses due to an increase of research and development headcount of 23 and an increase of $0.4 million in depreciation of equipment to support our product development efforts. These increases were offset in part by a $0.9 million decrease in expensed prototypes and supplies.

Sales and marketing expense increased by $4.9 million, or 62.0%, from the year ended December 31, 2010 to the year ended December 31, 2011, primarily due to an increase of $3.0 million in personnel-related expenses resulting from the sales and marketing headcount increase of 23. As a result of increasing our headcount, we also experienced an increase in travel and related expenses of $0.5 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010. Commission expenses also increased by $0.7 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010 due to increased revenue for the period.

General and administrative expense increased by $0.9 million, or 39.1%, from the year ended December 31, 2010 to the year ended December 31, 2011, primarily due to an increase in headcount as we added personnel in late 2010 and early 2011 to support our growth and infrastructure, which

 

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resulted in increased personnel-related expenses of $0.9 million and $0.2 million for increases in legal and insurance costs. These increases were partially offset by decreases of $0.2 million in the use of outside services as we hired additional support staff to manage administrative functions.

Interest Expense

 

     Year Ended
December 31,
        
     2010      2011      Change  
     Amount      Amount      Amount  
     (in thousands)  

Interest expense

   $ 429       $ 419       $ (10

Interest expense for the years ended December 31, 2010 and 2011 related to our capital leases and notes payable. In the second quarter of 2011, we made final payments on our capital lease obligations.

Other Income (Expense), Net

 

     Year Ended
December 31,
       
     2010     2011     Change  
     Amount     Amount     Amount  
     (in thousands)  

Interest income

   $ 1      $ 14      $ 13   

Preferred stock warrant liabilities

     (411     313        724   

Foreign currency

     —          (6     (6

Other

     4        1        (3
  

 

 

   

 

 

   

 

 

 

Total other income (expense), net

   $ (406   $ 322      $ 728   
  

 

 

   

 

 

   

 

 

 

Total other income (expense), net changed from an expense of $0.4 million for the year ended December 31, 2010 to income of $0.3 million for the year ended December 31, 2011, primarily due to the change in value of preferred stock warrant liabilities of $0.7 million. This change was driven by the increase in the underlying valuation of our capital stock.

 

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Quarterly Results of Operations

The following tables set forth selected unaudited quarterly consolidated statements of operations data for each of the quarters indicated. The consolidated financial statements for each of these quarters have been prepared on the same basis as the audited consolidated financial statements included in this prospectus and, in the opinion of management, include all adjustments necessary for the fair presentation of the consolidated results of operations for these periods. You should read this information together with our consolidated financial statements and related notes included elsewhere in this prospectus. These quarterly operating results are not necessarily indicative of the results for any future period.

 

     Three Months Ended  
     Mar. 31,
2011
    June 30,
2011
    Sept.30,
2011
    Dec. 31,
2011
    Mar. 31,
2012
    June 30,
2012
    Sept. 30,
2012
    Dec. 31,
2012
 
     (in thousands, except per share data)  

Revenue

   $ 9,288      $ 8,419      $ 9,594      $ 13,120      $ 14,187      $ 23,069      $ 28,843      $ 29,773   

Cost of revenue

     6,497        5,885        6,317        8,375        8,467        13,456        17,572        17,820   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     2,791        2,534        3,277        4,745        5,720        9,613        11,271        11,953   

Operating expenses:

                

Research and development

     2,705        3,526        3,256        3,499        3,552        3,864        4,889        6,142   

Sales and marketing

     2,731        3,018        3,148        3,927        4,774        5,607        6,798        8,064   

General and administrative

     789        840        796        886        910        1,236        1,741        2,168   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     6,225        7,384        7,200        8,312        9,236        10,707        13,428        16,374   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (3,434     (4,850     (3,923     (3,567     (3,516     (1,094     (2,157     (4,421
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense), net

     (263     22        (36     180        (376     (374     (1,041     (3,582
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before provision for income taxes

     (3,697     (4,828     (3,959     (3,387     (3,892     (1,468     (3,198     (8,003

Provision for income taxes

     2        4        3        5        8        9        10        13   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (3,699   $ (4,832   $ (3,962   $ (3,392   $ (3,900   $ (1,477   $ (3,208   $ (8,016
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share

   $ (1.59   $ (2.03   $ (1.63   $ (1.39   $ (1.60   $ (0.59   $ (1.26   $ (3.13
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of shares used in computing basic and diluted net loss per share

     2,326        2,379        2,436        2,441        2,441        2,512        2,545        2,563   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Stock-based compensation included in the statements of operations data above was as follows:

 

     Three Months Ended  
     Mar. 31,
2011
     June 30,
2011
     Sept. 30,
2011
     Dec. 31,
2011
     Mar. 31,
2012
     June 30,
2012
     Sept. 30,
2012
     Dec. 31,
2012
 
     (in thousands)  

Cost of revenue

   $ 39       $ 25       $ 4       $ 4       $ 8       $ 8       $ 9       $ 32   

Research and development

     70         81         91         96         105         116         163         361   

Sales and marketing

     49         57         60         63         90         113         169         284   

General and administrative

     17         34         35         40         49         108         225         257   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 175       $ 197       $ 190       $ 203       $ 252       $ 345       $ 566       $ 934   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table sets forth selected unaudited consolidated statements of operations data as a percentage of revenue for each of the periods indicated.

 

    Three Months Ended  
    Mar. 31,
2011
    June 30,
2011
    Sept. 30,
2011
    Dec. 31,
2011
    Mar. 31,
2012
    June 30,
2012
    Sept. 30,
2012
    Dec. 31,
2012
 

Revenue

    100     100     100     100     100     100     100     100

Cost of revenue

    70        70        66        64        60        58        61        60   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

    30        30        34        36        40        42        39        40   

Operating expenses:

               

Research and development

    29        42        34        26        25        17        17        21   

Sales and marketing

    29        35        33        30        34        24        23        27   

General and administrative

    9        10        8        7        6        5        6        7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    67        87        75        63        65        46        46        55   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (37)        (57)        (41)        (27)        (25)        (4)        (7)        (15)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense), net

    (3)        —          —          1        (3)        (2)        (4)        (12)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before provision for income taxes

    (40)        (57)        (41)        (26)        (28)        (6)        (11)        (27)   

Provision for income taxes

    —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (40)     (57)     (41)     (26)     (28)     (6)     (11)     (27)
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Quarterly Revenue Trends

Our quarterly revenue increased year-over-year for all periods presented. We believe that comparisons of our year-over-year quarterly revenue are more meaningful than comparisons of our sequential results due to seasonality in the sale of our products and services to varying degrees. We generally expect an increase in business activity as we approach December, as some of our customers accelerate spending to use remaining capital budget dollars. Similarly, we generally expect a decrease in business activity in our first quarter, as many of our customers develop and finalize their spending budgets for the year. From time to time, however, customers may place large orders that may significantly impact sequential trends. For example, in our quarter ended March 31, 2011, we had a large order with one customer that led to strong growth in our revenue for the quarter. The lack of a similar sized order contributed to a decline in revenue on a sequential basis in the following quarter ended June 30, 2011. While we believe that seasonal trends will continue to affect our quarterly results, our recent rapid growth has largely mitigated the effect of these seasonal trends. Historical patterns in our business may not be a reliable indicator of our future sales activity or performance.

Quarterly Gross Margin Trends

Gross margin has increased year-over-year for all periods presented. This increase was largely driven by our continued efforts and those of our contract manufacturer to manage our supply chain and raw materials pricing, growth in revenue resulting in scale efficiencies and shifts in product mix from line cards that are more focused on pure optical transport to line cards with packet-handling capabilities as customers increasingly address applications formerly handled by routers with our

 

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packet-optical solutions. We expect our gross margin to fluctuate in a similar pattern to the seasonality we observe in our revenue given the relatively fixed nature of our manufacturing overhead. The decrease in gross margin for the quarter ended September 30, 2012 compared to the quarter ended June 30, 2012 reflected price competition associated with a large customer opportunity and an increase in sales of chassis relative to line cards resulting from a significant number of new customer deployments.

Quarterly Operating Expenses Trends

Total operating expenses increased year-over-year for all periods presented primarily due to the addition of personnel in connection with the expansion of our business. The addition of headcount has been the primary cause of increases in operating expenses to date, and we expect this trend to continue.

Liquidity and Capital Resources

We had cash and cash equivalents of $20.2 million at December 31, 2012. Cash and cash equivalents consist of cash and money market funds. We did not have any short-term or long-term investments at December 31, 2012.

Since inception, we have financed our operations and capital expenditures primarily through private sales of redeemable convertible preferred stock for aggregate net proceeds of $98.1 million, as well as through a commercial credit facility and capital leases.

We borrowed approximately $6.0 million under a commercial lender growth capital credit facility and various other promissory note agreements to finance hardware and software product development from 2008 to 2009. These borrowings were repaid at various dates through January 2012. In December 2012, we established a new loan facility consisting of a revolving loan facility and a term loan facility governed by a Loan and Security Agreement with Silicon Valley Bank under which we may borrow up to a combined $15.0 million. As of December 31, 2012, we had drawn down $5.0 million as term loans and $7.6 million as revolving loans under the agreement. Loans drawn under the agreement will be used for working capital and general corporate purposes.

In 2008 and 2010, we entered into four capital leases for financed equipment, which were repaid at various dates through October 2011.

We plan to continue to invest for long-term growth. We believe that our existing cash and cash equivalents, together with our expected cash flow from operations and the net proceeds of this offering, will be sufficient to meet our projected operating and capital expenditure requirements for at least the next 12 months.

The following table summarizes our cash flows:

 

     Year Ended
December 31,
 
     2010     2011     2012  
     (in thousands)  

Net cash used in operations

   $ (14,650   $ (13,423   $ (12,463

Net cash used in investing activities

     (1,289     (2,772     (5,698

Net cash provided by financing activities

     26,645        7,888        12,634   

Effect of exchange rates on cash

     —          (27     8   
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ 10,706      $ (8,334   $ (5,519
  

 

 

   

 

 

   

 

 

 

 

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Operating Activities

We used cash in operations of $12.5 million for the year ended December 31, 2012, primarily as a result of a net loss of $16.6 million which was partially offset by $9.3 million in non-cash depreciation and amortization, stock-based compensation and revaluation of preferred stock warrants. In addition, we experienced increases in a majority of our working capital accounts, primarily due to significant increases in our operations as a result of growth in the business. Accounts receivable increased $12.7 million, primarily due to the significant increase in shipments and billings and inventories increased $8.2 million as we prepared for increases in shipments to customers based on demand for our products. These changes were partially offset by an increase in deferred revenue of $12.2 million, partially offset by an increase in deferred costs of $5.9 million related to such deferred revenue. In addition, accounts payable and accrued liabilities increased approximately $7.6 million, primarily as a result of significant inventory purchases and timing of payments of invoices from our contract manufacturer. Additionally, accrued compensation increased by $2.3 million as we increased total headcount.

We used cash in operations of $13.4 million for the year ended December 31, 2011, primarily as a result of a net loss of $15.9 million, which was partially offset by $1.8 million in non-cash depreciation and amortization, stock-based compensation, revaluation of warrants and non-cash interest charges. In addition, we experienced increases in a majority of our working capital accounts, primarily due to significant increases in our operations as a result of growth in the business. Accounts receivable increased $3.5 million as a result of an increase in sales in the fourth quarter of 2011 and inventory increased $1.9 million as we prepared for increases in shipment to customers based on demand for our products. These changes were partially offset by increase in deferred revenue of $5.0 million, partially offset by an increase in deferred costs of $2.3 million related to such deferred revenue. In addition, accounts payable and accrued liabilities increased approximately $2.9 million, primarily as a result of significant inventory purchases and timing of payments of invoices from our contract manufacturer.

We used cash in operations of $14.7 million for the year ended December 31, 2010, primarily as a result of a net loss of $16.3 million which was offset by $1.7 million in non-cash depreciation and amortization, stock-based compensation, revaluation of warrants and non-cash interest charges. We experienced increases in a majority of our working capital accounts, primarily due to significant increases in our operations as a result of growth in our business. Accounts receivable, prepaid expenses, accounts payable and other current liabilities increased primarily due to significant increases in our operations as a result of growth in the business. Our inventory decreased due to strong sales and shipments in the fourth quarter of 2010 where we were not able to replenish finished goods until the first quarter of 2011. Customer deposits as of December 31, 2009 related to prepayments from customers that had prepaid, but units had not yet been shipped. We shipped these units in 2010.

Investing Activities

We used $5.7 million, $2.8 million and $1.3 million in cash for investing activities for the years ended December 31, 2012, 2011 and 2010, respectively, primarily related to the purchase of lab equipment, tooling and computer hardware to support our growth.

Financing Activities

Cash from financing activities for the year ended December 31, 2012 reflected proceeds of $12.6 million related to a $7.6 million draw on our newly established revolving loan facility, a $5.0 million draw on our newly established term loan facility and $116,000 from the exercise of stock options.

 

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We generated $7.9 million in cash from financing activities for the year ended December 31, 2011 as a result of our issuance of 110,446 and 2,138,535 shares of Series E and F redeemable convertible preferred stock, respectively, for aggregate net proceeds of $10.4 million. This increase was partially offset by $2.6 million in payments on our capital lease and notes payable obligations.

Cash from financing activities for the year ended December 31, 2010 was $26.6 million as a result of our issuance of 6,626,765 shares of Series E redeemable convertible preferred stock for net proceeds of $29.9 million. This increase was partially offset by $3.3 million in payments on our capital lease and notes payable obligations.

Contractual Obligations and Known Future Cash Requirements

Debt and Capital Leases

On December 21, 2012, we entered into a Loan and Security Agreement with SVB. The agreement provides a revolving loan facility of up to $10.0 million and a term loan facility of up to $5.0 million, for a total loan facility of up to $15.0 million. As of December 31, 2012, we had drawn down $5.0 million as term loans and $7.6 million as revolving loans under the agreement. Loans drawn under the Loan and Security Agreement will be used for working capital and general corporate purposes.

Revolving loans bear interest at a floating rate equal to the greater of (i) 3.25% or (ii) the prime rate (3.25% as of December 31, 2012). For the first 12 months following each term loan advance, each term loan advance bears interest at a floating rate equal to the prime rate, plus 0.50%. On the date following such 12 month period and thereafter, each term loan advance bears interest at a fixed rate equal to the prime rate on the date following such 12 month period, plus 0.50%.

Interest on the revolving loans and the term loans is due and payable monthly in arrears. Revolving loans may be borrowed, repaid and reborrowed until December 21, 2014, when all outstanding amounts must be repaid. Principal on each term loan advance is payable in 36 equal monthly installments beginning 12 months after the date on which such term loan advance is made. Prepayments of the revolving loan facility and the term loan facility prior to their respective termination dates will be subject to early termination fees, subject to certain exceptions.

Our obligations under the Loan and Security Agreement are secured by a security interest on substantially all of our assets, excluding our intellectual property and certain other assets. Additionally, our future domestic subsidiaries, if any, may be required to become co-borrowers or guarantors under the agreement. The Loan and Security Agreement contains customary affirmative covenants and customary negative covenants limiting our ability and the ability of our subsidiaries to, among other things, dispose of assets, undergo a change in control, merge or consolidate, make acquisitions, incur debt, incur liens, pay dividends, repurchase stock and make investments, in each case subject to certain exceptions. We must also comply with a minimum adjusted quick ratio financial covenant, which is the ratio of our unrestricted cash and net billed accounts receivable to our current liabilities minus the current portion of our deferred revenue.

The Loan and Security Agreement also contains customary events of default including, among others, payment defaults, breaches of covenants, investor abandonment, bankruptcy and insolvency events, cross defaults with certain material indebtedness, judgment defaults, and breaches of representations and warranties. Upon an event of default, SVB may declare all or a portion of our outstanding obligations to be immediately due and payable and exercise other rights and remedies provided for under the agreement. During the existence of an event of default, interest on the obligations could be increased by 5.0%.

 

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Operating Leases and Purchase Commitments

We lease our headquarters in Petaluma, California and other locations worldwide under non-cancelable operating leases that expire at various dates through 2015. In addition, we subcontract with other companies to manufacture and supply components for our products. During the normal course of business, our contract manufacturer procures components from suppliers based on our forecasts. If we cancel all or part of the orders, we will be liable to our contract manufacturer for the cost of the components purchased by the subcontractors to manufacture our products. We periodically review this potential liability and, as of December 31, 2012, we have no significant related accruals recorded. Our financial position and results of operations could be negatively impacted if we are required to compensate our contract manufacturer for any unrecorded liabilities incurred.

The following table summarizes our fixed and determinable contractual obligations at December 31, 2012, including leases:

 

     Total      Less
Than
1 Year
     1-3 Years      3-5 Years      More
Than
5 Years
 
     (in thousands)  

Operating lease obligations

   $ 1,819       $ 630       $ 1,030       $ 159       $ —     

Revolving loan(1)

     7,563         7,563         —           —           —     

Term loan(2)

     5,477         178         5,299         —           —     

Purchase commitments(3)

     6,571         6,571         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 21,430       $ 14,942       $ 6,329       $ 159       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Accrues interest at a floating rate equal to the greater of (i) 3.25% or (ii) the prime rate (3.25% as of December 31, 2012).
(2) Includes $5.0 million of principal and approximately $477,000 of expected interest.
(3) Consists of minimum purchase commitments with our contract manufacturer.

Future Capital Requirements

We believe that our existing cash and cash equivalents, together with our expected cash flow from operations and the net proceeds of this offering, will be sufficient to meet our projected operating and capital expenditure requirements for at least the next 12 months. To the extent that funds from this offering, combined with existing cash, cash equivalents and operating cash flows are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing. If we issue equity securities in order to raise additional funds, substantial dilution to existing stockholders may occur. If we raise cash through the issuance of indebtedness, we may be subject to additional contractual restrictions on our business. We cannot assure you that we will be able to raise additional funds on favorable terms, or at all.

Guaranties, Warranties and Indemnifications

We generally offer hardware warranties on our products for one to eight years based on a tiered structure as determined by the type of customer. In accordance with the Financial Accounting Standards Board’s, or FASB’s, Accounting Standards Codification, or ASC 450-20, Loss Contingencies, we record an accrual when we believe it is estimable and probable based upon historical experience. We record a provision for estimated future warranty work in cost of goods sold upon recognition of revenue and we review the resulting accrual regularly and periodically adjust it to reflect changes in warranty estimates.

 

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From time to time, we enter into certain types of contracts that contingently require us to indemnify various parties against claims from third parties. These contracts primarily relate to (i) certain real estate leases, under which we may be required to indemnify property owners for environmental and other liabilities, and other claims arising from our use of the applicable premises; (ii) certain agreements with our officers, directors, and employees, under which we be required to indemnify such persons for liabilities arising out of their relationship with us; (iii) contracts under which we may be required to indemnify customers against third-party claims that our product infringes a patent, copyright, or other intellectual property right; and (iv) procurement or license agreements, under which we may be required to indemnify licensors or vendors for certain claims that may be brought against us arising from our acts or omissions with respect to the supplied products or technology.

Generally, a maximum obligation under these contracts is not explicitly stated. Because the obligated amounts associated with these types of agreements are not explicitly stated, the overall maximum amount of the obligation cannot be reasonably estimated. Historically, we have not been required to make any payments under these obligations, and no liabilities have been recorded for these obligations in our consolidated balance sheets.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these 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.

We believe that the assumptions and estimates associated with revenue recognition, inventory, warranty and stock-based compensation have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, please see Note 1 of the accompanying notes to our consolidated financial statements.

We are an “emerging growth company” within the meaning of the rules under the Securities Act, and we will utilize certain exemptions from various reporting requirements that are applicable to public companies that are not “emerging growth companies.” For example, we will not have to provide an auditor’s attestation report on our internal controls in future annual reports on Form 10-K as otherwise required by Section 404(b) of the Sarbanes-Oxley Act. In addition, Section 107 of the JOBS Act provides that an “emerging growth company” can utilize the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Thus, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act. As a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-“emerging growth companies.”

Revenue Recognition

We generate revenue from the sales of our networking and packet-optical solutions. These solutions include our Z-Series high-capacity, multi-layer switching and transport platforms, our Blue Planet platform and applications and support, maintenance and other services. Our solutions are sold primarily through our direct sales force.

 

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Revenue is recognized when all of the following criteria have been met:

 

  Ÿ  

Persuasive evidence of an arrangement exists.    Customer purchase orders are generally used to determine the existence of an arrangement.

 

  Ÿ  

Delivery has occurred.    Shipping documents and customer acceptance, when applicable, are used to verify delivery.

 

  Ÿ  

The price is fixed or determinable.    We assess whether the price is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.

 

  Ÿ  

Collectability is reasonably assured.    We assess collectability based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history.

We recognize product revenue at the time of shipment provided that all other revenue recognition criteria have been met. From time to time, we offer customers sales incentives, including discounts. Revenue is recorded net of these amounts. We recognize services revenue from subscriptions and support and maintenance ratably over the service period, typically one year.

Most of our arrangements, other than renewals of subscriptions and support and maintenance, are multiple-element arrangements with a combination of hardware, software, subscriptions, support and maintenance and other services. Products and services generally qualify as separate units of accounting. When accounting for multiple-element arrangements, U.S. GAAP requires we allocate revenue to individual elements using VSOE of the selling price, third-party evidence, or TPE, of the selling price, or our best estimated selling price, or BESP, of deliverables if VSOE and TPE cannot be determined. Our hardware deliverables typically include proprietary operating system software, which together deliver the essential functionality of our products. When allocating consideration, we first do so on the basis of the deliverables’ relative selling prices, without regard to any contingent consideration, and then subsequently determine whether the revenue that may be recognized is limited based on the amount of non-contingent revenue. To the extent that the stated contractual prices agree to our estimated selling price on a standalone basis, the allocation of the consideration is based on stated contractual prices. However, if the stated contractual price for any deliverable is outside a narrow range of the estimated selling price on a standalone basis, the allocation is adjusted using the “relative-selling-price method.” Because the individual products and services meet the criteria for separate units of accounting, we recognize revenue upon delivery of each element.

To determine the estimated selling price in multiple-element arrangements, we establish VSOE of the selling price using the prices charged for a deliverable when sold separately and, for subscriptions and support and maintenance, based on the renewal rates and discounts offered to customers. If VSOE of the selling price cannot be established for a deliverable, we establish TPE of the selling price by evaluating similar and interchangeable competitor products or services in standalone arrangements with similarly situated customers. However, as our products contain a significant element of unique technology and offer substantially different features and functionality from our competitors, we have historically been unable to obtain comparable pricing of our competitors’ products with similar functionality on a standalone basis. Therefore, we have not been able to obtain reliable evidence of TPE of the selling price. If neither VSOE nor TPE of the selling price can be established for a deliverable, we establish BESP primarily based on historical transaction pricing. Historical transactions are segregated based on our pricing model and our go-to-market strategy, which include factors such as market vertical, type of sales channel (reseller or end-customer), the geographies in which our products and services were sold (domestic or international) and offering type (products or services). In analyzing historical transaction pricing, we evaluate whether a majority of the prices charged for a product, as represented by a percentage of list price, fall within a reasonable range. To further support

 

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the best estimate of selling price as determined by the historical transaction pricing or when such information is unavailable, such as when there are limited sales of a new product, we consider the same factors we have established through our pricing model and go-to-market strategy. The determination of BESP is made through consultation with and approval by our management. In determining BESP, we rely on certain assumptions and apply significant judgment. As our business offerings evolve over time, we may be required to modify our estimated selling prices in subsequent periods, and our revenue could be adversely affected.

In instances where substantive acceptance provisions are specified in the customer agreement, revenue is deferred until all acceptance criteria have been met. Our arrangements generally do not include any provisions for cancellation, termination, or refunds that would materially impact revenue recognition.

We enter into arrangements with certain of our customers who receive government supported loans and grants from the U.S. Department of Agriculture’s Rural Utility Service, or RUS, to finance capital spending. Under the terms of an RUS equipment contract that includes installation services, the customer does not take possession and control and the title does not pass until formal acceptance is obtained from the customer. Under this type of arrangement, we do not recognize revenue until we have received formal acceptance from the customer, and all other revenue recognition criteria have been met.

Inventories

Inventories consisting of finished goods purchased from our contract manufacturer are stated at the lower of cost or market value, with cost being determined using standard cost, which approximates actual cost, on a first-in, first-out basis. We regularly monitor inventory quantities on hand and on order and record write-downs for excess and obsolete inventories based on our estimate of the demand for our products, potential obsolescence of technology, product life cycles, and whether pricing trends or forecasts indicate that the carrying value of inventory exceeds our estimated selling price. These factors are affected by market and economic conditions, technology changes, and new product introductions and require estimates that may include elements that are uncertain. Actual demand may differ from forecasted demand and may have a material effect on gross margin. If inventory is written down, a new cost basis will be established that cannot be increased in future periods. During the years ended December 31, 2010, 2011 and 2012, we recorded a provision of $0.1 million, $0.2 million and $0.3 million, respectively, for excess or obsolete inventory in cost of revenue in the accompanying statements of operations.

Warranty

Our products are covered by a warranty for periods generally ranging from one to eight years. We recognize estimated costs related to warranty activities as a component of cost of revenue upon product shipment. The estimates are based on historical product failure rates and historical costs incurred in correcting product failures. The recorded amount is adjusted from time to time for specifically identified warranty exposure. Actual warranty expenses are charged against our estimated warranty liability when incurred. Factors that affect our warranty liability include the number of installed units and historical and anticipated rates of warranty claims and cost per claim. An increase in warranty claims or the related costs associated with satisfying these warranty obligations could increase our cost of sales and negatively affect our gross margin. As of December 31, 2011 and 2012, our warranty liability was $0.8 million and $1.3 million, respectively.

 

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Stock-Based Compensation

Compensation expense related to stock-based compensation, including employee and non-employee director awards, is measured and recognized in the financial statements based on fair value. The fair value of the common stock underlying our stock options was determined by our board of directors. The valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. The assumptions we use in the valuation model are based on future expectations regarding our business, combined with management judgment. Under the fair value recognition provisions of this guidance, stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense, net of estimated forfeitures, over the requisite service period, which is generally the vesting period of the award.

Determining the fair value of stock-based awards at the grant date represents the board of directors’ best estimates; however, the estimates involve inherent uncertainties and the application of judgment. We use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the grant date fair value of options using an option pricing model is affected by our estimated common stock fair value as well as assumptions regarding a number of other complex and subjective variables. These variables include the fair value of our common stock, our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates and expected dividends, which are estimated as follows:

Fair Value of Our Common Stock.    Because our stock is not publicly traded, we must estimate the fair value of our common stock, as discussed in “Common Stock Valuations” below.

Expected Term.    The expected term represents the period that our share-based awards are expected to be outstanding. The expected term was generally estimated using the simplified method allowed under SEC guidance. The simplified method calculates the expected term as the average of the time-to-vesting and the contractual life of the awards. We intend to continue to utilize the simplified method for all “regular” awards until we have established a reasonable period of representative trading history as a public company, at which time we will determine the expected term based on the historical option exercise behavior of our option holders, expectations about future option exercise behavior and post-vesting cancellation.

Volatility.    As we have been a private company and do not have a trading history for our common stock, we estimated the expected stock price volatility by taking the average historic price volatility for industry peers that we selected based on daily price observations over a period equivalent to the expected term of the stock option grants. We selected the peer group of companies from publicly traded companies in the same or similar lines of business to us, with consideration given to the fact that these companies had longer operating lives and were larger when compared to us, typically both in terms of revenue and net worth. We also selected companies with similar growth rates to us. We did not rely on implied volatilities of traded options in these industry peers’ common stock because the volume of activity was relatively low. We intend to continue to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own common stock share price becomes available, or unless circumstances change such that the identified companies are no longer similar to us, in which case more suitable companies whose share prices are publicly available would be utilized in the calculation. Higher volatility and longer expected lives would result in an increase to stock-based compensation expense determined at the date of grant.

Risk-free Rate.    The risk-free interest rate is based on the yields of zero coupon U.S. Treasury securities with maturities similar to the expected term of the options.

 

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Dividend Yield.    We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future. Consequently, we used an expected dividend yield of zero.

The following table presents the assumptions used to estimate the fair value of options granted during the periods presented:

 

     Year Ended December 31,  
     2010      2011      2012  

Volatility

     56.7%-59.5%         55.0%-56.7%         55.0%   

Expected term (in years)

     6.08         6.08         6.08   

Risk-free rate

     1.4%-2.6%         0.97%-2.25%         0.62%-1.02%   

Dividend yield

     —  %         —  %         —  %   

In addition to assumptions used in the Black-Scholes option pricing model, we must also estimate a forfeiture rate to calculate the stock-based compensation for our awards. Our forfeiture rate is based on an analysis of our actual forfeitures since the beginning of the option plan. We routinely evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover and expectations of future option exercise behavior. Quarterly changes in the estimated forfeiture rate can have a significant impact on our stock-based compensation expense as the cumulative effect of adjusting the forfeiture rate is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the stock-based compensation expense recognized in the financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the stock-based compensation expense recognized in the financial statements.

We will continue to use judgment in evaluating the assumptions related to our stock-based compensation on a prospective basis. If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously.

Common Stock Valuations

We are required to estimate the fair value of the common stock underlying our stock-based compensation awards when performing the fair value calculations with the Black-Scholes option-pricing model. The fair values of the common stock underlying our stock-based compensation awards were determined by our board of directors, with input from management. Our board of directors has been and continues to be comprised of a majority of non-employee directors that we believe have the relevant experience and expertise to determine the fair value of our common stock on each respective grant date.

Given the absence of a public trading market of our common stock, and in accordance with the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, our board of directors exercised reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of the fair value of our common stock including:

 

  Ÿ  

contemporaneous valuations performed by unrelated third-party valuation specialists;

 

  Ÿ  

sales by the company of preferred stock to outside investors in arm’s-length transactions;

 

  Ÿ  

the prices, rights, preferences and privileges of the company preferred stock relative to the common stock;

 

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  Ÿ  

our operating and financial performance and forecasts;

 

  Ÿ  

the market performance of comparable publicly traded technology companies;

 

  Ÿ  

hiring of key personnel;

 

  Ÿ  

the introduction by us and risks related to market acceptance of new products or services;

 

  Ÿ  

the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options, such as an initial public offering or sale of our company, given prevailing market conditions and the nature and history of our business;

 

  Ÿ  

the general lack of private, third-party, secondary transactions in our common and preferred stock;

 

  Ÿ  

adjustments necessary to recognize a lack of marketability for our common stock;

 

  Ÿ  

the U.S. and global capital market conditions; and

 

  Ÿ  

other changes in the company since the last time the board of directors had approved option grants and made a determination of fair value.

In order to determine the fair value of our common stock underlying option grants issued prior to this initial public offering, we estimated the business enterprise value, or BEV, and then allocated the BEV to each element of our capital structure (preferred stock, common stock, warrants and options). For all periods below, our BEV was determined as the average of two generally accepted approaches: the income approach and the market-based approach. We believe an equal weighting under the two valuation approaches was appropriate for all of these periods considering the inherent strengths and weaknesses of each valuation approach. We believe that neither valuation technique was more reflective of our BEV than the other after taking into account our continued progress as an enterprise.

We believe the income approach provided an appropriate indicator of our BEV based on discounted projected cash flows, particularly given our operating history. In the application of the income approach, a discounted cash flow method, or DCF, is utilized. The DCF method estimates enterprise value based on the estimated present value of future net cash flows the business is expected to generate over a forecasted period and an estimate of the present value of cash flows beyond that period, which is referred to as terminal value. The terminal value was estimated by applying a multiple to the terminal year’s debt free net income. This multiple was selected based on market multiples observed as well as long-term market indices. The terminal value was then discounted to its present value and added to the present value of the cash flows from the discrete projection period.

The market approach was applied as we believed that the market multiples of our comparable industry peer companies would be an appropriate measure to determine our BEV while factoring in our inherent strengths and weaknesses relative to comparable public company industry peer companies. The market approach measures the value of a business through an analysis of recent sales or offerings of comparable investments or assets, and in our case, focused on comparing us to the group of peer companies. In applying the market approach, valuation multiples are derived from historical operating data of a peer company group. We selected the peer group of companies from publicly-traded companies in the same or similar lines of business to us, with consideration given to the fact that these companies had longer operating lives and were larger when compared to us, typically both in terms of revenue and net worth. We also selected companies with similar growth rates to us. This same peer group of companies was used for the volatility calculation in our Black-Scholes option pricing model. We then apply multiples to our operating data, with an emphasis on revenue multiples given our lack of profitability, to arrive at a range of indicated values of the company.

 

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Our indicated BEV at each valuation date was allocated to the shares of preferred stock, common stock, warrants and options, using an option pricing method, or OPM. OPM treats preferred stock, common stock, warrants and options as call options on an enterprise value, with exercise prices based on the liquidation preference of the preferred stock. Therefore, the common stock has value only if the funds available for distribution to the stockholders exceed the value of the liquidation preference at the time of a liquidity event such as a merger, sale or initial public offering, assuming the enterprise has funds available to make a liquidation preference meaningful and collectible by the stockholders. The common stock is modeled to be a call option with a claim on the enterprise at an exercise price equal to the remaining value immediately after the preferred stock is liquidated. OPM uses the Black-Scholes option-pricing model to price the call option. In our case, we assumed that the preferred stock would convert to common stock based on the computed BEV for the periods presented. An OPM is appropriate to use when the range of possible future outcomes is so difficult to predict that forecasts would be highly speculative.

Commencing with our valuation for December 2012, we utilized a probability-weighted expected return method, or PWERM, to estimate the fair value of our common stock using the methods discussed above. Preparing for this initial public offering led us to apply the PWERM analysis as we had better visibility into the likelihood of achieving a liquidity event in the next year. Under the PWERM, the value of our common stock is estimated based upon an analysis of values for our common stock assuming the following possible future events for the company: initial public offering; strategic merger or sale; remaining a private company; and liquidation of the company. For each of the possible events, a range of future equity values is estimated, based on the BEV and over a range of possible event dates, all discounted for the time-value of money. The timing of these events is based on management’s estimates. For each future equity value scenario, we determined the appropriate allocation of value to holders of outstanding shares of our common stock. The value of each share of common stock is then multiplied by a discount factor derived from the calculated discount rate and the expected timing of the event. The value per share of common stock is then multiplied by an estimated probability for each of the possible events based on management’s estimates. The calculated value per share of common stock under each scenario is then discounted for a lack of marketability. A probability-weighted value per share of common stock is then determined.

For each valuation, we prepared financial projections to be used in the income approach. The financial projections took into account our historical financial operating results, our business experiences and our future expectations. We factored the risk associated with achieving our forecast into selecting the appropriate exit multiple and discount rate. There is inherent uncertainty in these estimates, as the assumptions we used were highly subjective and subject to change as a result of new operating data and economic and other conditions that affect our business.

For determining the fair value per share of our common stock for financial reporting purposes for the periods from December 31, 2011 to March 31, 2013, we used a straight-line calculation over the period based on our determination of fair value at each quarter end and November 30, 2012. We determined that the straight-line calculation provided the most reasonable basis for the valuations of the shares of common stock underlying the options granted on these interim dates for financial reporting purposes because we did not identify any single event that occurred during this interim period that would have caused a material increase or decrease in fair value. In addition, as discussed in detail below under “October 2012,” we re-evaluated our determination of fair value as of September 30, 2012, and used that updated fair value amount for purposes of our straight-line calculation. A combination of the factors described below in each period led to the changes in the fair value of our common stock.

 

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The following stock options were granted between January 1, 2012 and March 31, 2013 to employees and members of our board of directors with the following fair value per share of our common stock for purposes of calculating share-based compensation:

 

Option Grant Date

   Number of
Shares
Underlying
Options
     Common
Stock Fair
Value Per
Share
 

February 28, 2012

     694,635       $ 2.49   

March 27, 2012

     436,050       $ 2.65   

May 22, 2012

     1,729,934       $ 2.97   

July 10, 2012

     205,330       $ 3.34   

July 24, 2012

     94,820       $ 3.53   

August 28, 2012

     83,634       $ 4.01   

September 6, 2012

     193,550       $ 4.14   

September 25, 2012

     2,263,695       $ 4.40   

October 23, 2012

     138,905       $ 5.49   

December 22, 2012

     362,228       $ 7.98   

January 29, 2013

     106,570         (1

February 26, 2013

     1,208,427         (1

 

(1) Amounts to be determined in connection with preparation of our financial results for the quarter ending March 31, 2013.

As of March 31, 2013, the aggregate intrinsic value of vested and unvested options was $        million and $        million, respectively, based on the estimated fair value for our common stock of $        per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus. As of December 31, 2012, we had $11.7 million of unrecognized stock-based compensation expense, net of estimated forfeitures, that is expected to be recognized over a weighted-average period of 3.22 years. In future periods, we expect our stock-based compensation expense to increase in dollar amount as a result of our existing stock-based compensation to be recognized as these options vest and as we issue additional stock-based awards to attract and retain employees.

The following discussion presents the determination of our board of directors of the fair value per share of our common stock underlying option grants and the exercise price for such option grants, together with our determination of the fair value per share of our common stock for financial reporting purposes for the respective periods as follows:

February and March 2012

We experienced continued sequential revenue growth of 37% in the fourth quarter of 2011, generating $13.1 million for the fourth quarter of 2011, compared to $9.6 million for the third quarter of 2011. However, we also experienced continued losses from operations. In connection with these grants, we obtained a third-party valuation of our common stock as of December 31, 2011. We relied upon an average of the income and market approaches to arrive at the BEV. For this valuation, we used a 20% discount rate for the DCM income calculation, a blended revenue multiple of 1.73 for the market approach and a discount for lack of marketability of 29%. Our board of directors determined the fair value of our common stock to be $2.15, consistent with the third-party valuation report. Our board of directors considered numerous factors related to our business and determined that it would set the exercise price of the options at $2.54 per share, consistent with the exercise price for grants in May through October of 2011. For financial reporting purposes, we determined, based on the straight-line calculation, the fair value per share of our common stock to be $2.49 for February 2012 and $2.65 for March 2012.

 

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May 2012

Despite certain year-end cyclicality in our business, we experienced continued sequential revenue growth of 8% in the first quarter of 2012, generating $14.2 million for the first quarter of 2012, compared to $13.1 million for the fourth quarter of 2011. Our operating losses were relatively flat at $3.5 million for the same quarters, but our revenue forecast for the remainder of 2012 remained positive, despite these continued operating losses. In connection with these grants, we obtained a third-party valuation of our common stock as of March 31, 2012. We continued to apply the average of the income and market approaches to arrive at the BEV. We also continued to use a 20% discount rate for the DCM income calculation, a blended revenue multiple of 1.79 for the market approach and a discount for lack of marketability of 29%. Our board of directors determined the fair value of our common stock to be $2.67, consistent with the third-party valuation report, and granted options with an exercise price of $2.67 per share. For financial reporting purposes, we determined, based on the straight-line calculation, the fair value per share of our common stock to be $2.97.

July, August and September 2012

We experienced strong sequential revenue growth of 62% in the second quarter of 2012, generating $23.1 million for the second quarter of 2012, compared to $14.2 million for the first quarter of 2012. Our operating losses decreased slightly for the same quarters and our revenue forecast for the remainder of 2012 remained positive. In connection with these grants, we obtained a third-party valuation of our common stock as of June 30, 2012. We continued to use an average of the income and market approaches to arrive at the BEV for the periods covered by the July, August and September 2012 option grants. We also utilized a 25% discount rate for the DCM income calculation, increased from the prior period to account for the fact that we aggressively increased our forecast of projected income as a result of our growth in the second quarter of 2012 and, accordingly, the risk of achieving these higher projections increased. We also used a blended revenue multiple of 1.71 for the market approach and a discount for lack of marketability of 25% reflecting slightly better prospects for a liquidity event based upon the expected performance of our business. Our board of directors determined the fair value of our common stock to be $3.20, consistent with the third-party valuation report, and granted options with an exercise price of $3.20 per share. For financial reporting purposes, we determined, based on the straight-line calculation, the fair value per share of our common stock to be $3.34 for July 10, 2012, $3.53 for July 24, 2012, $4.01 for August 28, 2012, $4.14 for September 6, 2012 and $4.40 for September 25, 2012.

October 2012

We experienced sequential revenue growth of 25% in the third quarter of 2012, generating $28.8 million for the third quarter of 2012, compared to $23.1 million for the second quarter of 2012. Our operating losses increased slightly sequentially for the same period and our revenue forecast for the remainder of 2012 remained positive. In connection with these grants, we obtained a third-party valuation of our common stock as of September 30, 2012. We continued to use an average of the income and market approaches to arrive at the BEV for the periods covered by the October 2012 option grants. We also utilized a 25% discount rate for the DCM income calculation, a blended revenue multiple of 1.62 for the market approach and a discount for lack of marketability of 25% reflecting better prospects for a liquidity event based upon the expected performance of our business and the commencement of planning with respect to this initial public offering. Our board of directors determined the fair value of our common stock to be $3.61, consistent with the third-party valuation report, and granted options with an exercise price of $3.61 per share. However, for financial reporting purposes, in light of discussions with underwriters in preparation for the initiation of this offering, we re-evaluated the assumptions used in the third-party valuation as of September 30, 2012, that was used to assist our board of directors in its determination of the fair value for equity awards granted in October 2012. The

 

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reassessed common stock fair value was determined using the same valuation methodologies used previously except that we determined that it would be appropriate to select a blended revenue multiple of 2.37, which was a higher point in the range of our existing comparable companies, to better reflect our outlook at that time given our preparation for this offering. As a result of this, we determined the fair value of our common stock for financial reporting purposes to be $4.47 as of September 30, 2012. We then determined, based on the straight-line calculation between the re-evaluated September 30, 2012 valuation of $4.47 and the November 30, 2012 valuation of $7.18, the fair value per share of our common stock to be $5.49.

December 2012

We continued with sequential revenue growth throughout the fourth quarter of 2012, which was not yet complete at the time of our December 2012 stock option grants. We also had been preparing for a potential initial public offering, with our initial confidential submission of a registration statement being made on December 20, 2012. In addition, we introduced our Blue Planet platform in December 2012 to enhance our offerings with the goal of increasing our revenue and improving our gross margin. In connection with these grants, we obtained a third-party valuation of our common stock as of November 30, 2012. We continued to use an average of the income and market approaches to arrive at the BEV for the periods covered by the December 2012 option grants. We also utilized a 22.5% discount rate for the DCM income calculation, reflecting a slight decrease over our prior discount rate, a blended revenue multiple of 2.83 for the market approach, and a discount for lack of marketability of 21%, reflecting better prospects for a liquidity event based upon the work performed in support of this initial public offering. This valuation was the first application of the PWERM, with the weighting of the probability of an initial public offering at 60%, a sale of the company at 20%, remaining a private company at 17.5% and a liquidation scenario at 2.5%. We also added some public companies in the communications networking industry to our set of comparable companies, and dropped one company that we believed was less relevant, based upon new information regarding which companies the market may consider most comparable to us, including taking into account companies whose business models included significant software content given our goals for growth with our Blue Planet software offering. Our board of directors determined the fair value of our common stock to be $7.18, consistent with the third-party valuation report, and granted options with an exercise price of $7.18 per share. For financial reporting purposes, we determined, based on the straight-line calculation, the fair value per share of our common stock to be $7.98.

January and February 2013

We finalized our 2012 results and had early indications that our growth was continuing in the first quarter of 2013, including continuing market acceptance of our Blue Planet platform. We also were fully engaged in the preparation for our initial public offering. In connection with our January and February 2013 grants, we obtained a third-party valuation of our common stock as of December 31, 2012. We continued to use an average of the income and market approaches to arrive at the BEV for the periods covered by the January and February 2013 option grants. We also utilized a 20% discount rate for the DCM income calculation, reflecting a slight decrease over our prior discount rate, a blended revenue multiple of 3.23 for the market approach, and a discount for lack of marketability of 21%. This valuation also applied the PWERM, with the weighting of the probability of an initial public offering at 70%, a sale of the company at 15%, remaining a private company at 12.5% and a liquidation scenario at 2.5%. We also added an additional public company in the communications networking industry to our set of comparable companies based upon further input from our management influenced by our initial public offering process. Our board of directors determined the fair value of our common stock to be $8.31, consistent with the third-party valuation report, and granted options with an exercise price of $8.31 per share. For financial reporting purposes, we will determine the fair value per share of our common stock as of January and February 2013 based on the straight-line calculation by reference to a third party valuation of our common stock at March 31, 2013.

 

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Off-Balance Sheet Arrangements

We do not engage in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, as part of our ongoing business.

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risks in the ordinary course of our business, primarily related to interest rate, inflation and foreign currency risks. We also are exposed to risks relating to changes in the general economic conditions that affect our business. To reduce certain of these risks, we monitor the financial condition of our customers and manage our contract manufacturer and suppliers. In addition, our investment strategy has been to invest in cash and cash equivalents. To date, we have not used derivative instruments to mitigate any market risk exposures. We have not used, nor do we intend to use, derivatives for trading or speculative purposes. We do not believe that these risks have been material to date.

We are exposed to market risk related to changes in interest rates. Our investments are considered cash equivalents and primarily consist of money market funds. As of December 31, 2012, we had cash and cash equivalents of $20.2 million. The primary objectives of our investment activities are the preservation of capital, the fulfillment of liquidity needs and the fiduciary control of cash and investments. We do not enter into investments for trading or speculative purposes. Our investments are exposed to market risk due to a fluctuation in interest rates, which may affect our interest income and the fair market value of our investments. In addition, as of December 31, 2012, we had drawn down $5.0 million as term loans and $7.6 million as revolving loans under our Loan and Security Agreement with SVB. Due to the short-term nature of our investment portfolio and our outstanding loan amounts, we believe that only dramatic fluctuations in interest rates would have a material effect on us. As a result, we do not expect our operating results or cash flows to be materially affected by a sudden change in market interest rates.

We do not believe that inflation has had a material effect on our business, financial condition or results of operations. However, if our costs, in particular salaries and manufacturing costs, were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, operating results and financial condition.

Historically, as our operations and sales, including all of our manufacturing, have been primarily in the United States, we have not faced any significant foreign currency risk. As our international operations grow, our risks associated with fluctuation in currency rates will become greater, and we will continue to reassess our approach to managing this risk. In addition, currency fluctuations or a weakening U.S. dollar can increase the costs of our international expansion efforts.

 

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BUSINESS

Overview

We have pioneered innovative, carrier-grade networking solutions that transform disparate and inefficient legacy networks into open, high-performance networks. Our solutions include high-capacity, multi-layer switching and transport platforms as well as a carrier-grade software-defined networking platform and applications. Our solutions enable network operators to virtualize their networks, accelerate service delivery and increase scalability and performance, while reducing costs. We have designed our solutions to provide a variety of existing and emerging premium applications, including business Ethernet, wireless backhaul, broadband backhaul and cloud connectivity. By deploying our solutions, network operators can transform legacy networks into open, multi-vendor, carrier-grade software-defined networks, or SDNs. Our solutions not only reduce network operators’ ongoing capital and operating expenses, but also enable their networks to more flexibly support rapidly changing service requirements and new business models.

Network operators, which include service providers as well as others with similar network requirements, are facing immense pressure on their existing networks and business models. New applications and communications trends are driving tremendous growth in bandwidth demand, resulting in increased service requirements as well as dramatic shifts in overall network traffic patterns. At the same time, competition from traditional vendors as well as new market entrants is limiting service providers’ ability to sustain and grow revenue. As a result, service providers must upgrade their networks, and in particular their regional and metro or “middle mile” networks, both to handle the exponential scaling challenges driven by these trends as well as to profitably deliver the growing breadth of premium services demanded by their subscribers. Other network operators are also facing these scalability requirements while seeking to deliver new applications that improve the productivity and efficiency of their businesses. We designed our solutions to enable network operators to address these challenges while scaling their networks and services efficiently.

Fundamental to our solution is our software-defined networking approach that enables an array of Cyan as well as third-party applications to manage and control underlying network infrastructure. In December 2012, we introduced our Blue Planet platform, a carrier-grade software-defined networking solution purpose-built to address network operator requirements. Blue Planet is the latest implementation of our network virtualization and management software that we first introduced in 2009 to work in combination with our high-capacity, multi-layer switching and transport platforms. Blue Planet is designed to simplify the development, deployment and orchestration of scalable communications and business applications over high-performance networks. Blue Planet enables our customers to make more efficient use of existing network assets, cost-effectively expand network capacity and significantly accelerate the delivery of premium, revenue-generating services to their customers. By deploying Blue Planet, our customers can also provide their subscribers with network-as-a-service, or NaaS, allowing for real-time tailoring and customization of their network architecture and services to meet their end-customers’ specific needs.

We also offer high-capacity, multi-layer switching and transport platforms, known as our Cyan Z-Series, designed to support the multiple concurrent technologies used in regional and metro networks, including both Ethernet-based services as well as optical services. Our Z-Series platforms have been designed to transport traffic over the most efficient network layer, utilizing both electrical and optical domains, to enable network operators to maximize network capacity at the lowest cost per bit. Our solutions are designed to support a variety of use cases from traffic aggregation at the network edge to multi-terabit switching optimized for handoff at the network core.

 

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We were founded in October 2006 to simplify network operations and accelerate innovation through a centralized, open, multi-vendor, software orchestration model. We launched our first Z-Series platform in September 2009. Since then, we have led emerging, carrier-grade SDN initiatives in the industry through our development of open, multi-vendor and multi-layer planning, management and verification software. In April 2010, we launched one of the first multi-layer network management solutions. In December 2012, we launched Blue Planet, our carrier-grade SDN platform that is designed to allow network operators of all types to virtualize their networks and simplify the development, deployment and orchestration of scalable communications and business applications over high-performance networks.

Our customers range from service providers to high-performance data center and large, private network operators. We target our customers through our direct sales force and through channel partners. Our solutions have been deployed primarily across North America as well as in Asia and Europe by over 125 customers, including, among our top ten customers by revenue in 2012, Great Plains Communications Inc., Intelleq Communications LLC, Lynx Network Group, Inc., US Carrier Telecom, LLC, US Signal Company, LLC, Vision Net, Inc. and Windstream Corporation.

Our revenue increased from $23.5 million in 2010, to $40.4 million in 2011, and to $95.9 million in 2012. Our net losses were $16.3 million, $15.9 million and $16.6 million in 2010, 2011 and 2012, respectively.

Industry Background

Service providers are facing an imperative for significant network and business model transformation. Despite growing demand for bandwidth and expanded service offerings, service provider revenue has remained relatively flat, mainly due to competitive pressures. Accordingly, service providers are increasingly challenged to provide their services in a cost-effective manner and to deliver new services that drive additional revenue streams. In addition, the service provider business model is changing from one of deploying fixed bandwidth to one of dynamically provisioning services. However, due to the proprietary and inflexible nature of existing networks and infrastructure, dynamically provisioning services and managing these networks and infrastructure has become cost-prohibitive. This is especially true in regional and metro networks. In addition, other network operators are also facing these scalability requirements while seeking to deliver new applications that improve the productivity and efficiency of their businesses.

Regional and metro networks sit between core networks—the networks that provide national connectivity—and access networks—the networks that provide the connection point to fixed and mobile business and consumer users. Regional and metro networks distribute the traffic from the core to the access networks and back, thereby enabling the end-to-end communications that connect content and applications to the enterprises and consumers who use them. These networks also typically serve as critical aggregation points, aggregating traffic for transport to other regional and metro networks via core networks.

Traditional regional and metro network architectures were built over decades, and were typically designed to deliver voice and legacy data services, such as frame relay, to business and residential subscribers that were primarily local or proximate to that specific regional or metro network. As services were added or offerings were scaled to serve more subscribers, network operators typically built, operated and managed segregated networks running in parallel. Network operators have historically used a variety of technologies to deliver reliable service at scale, including Ethernet as well as legacy optical technologies such as fixed DWDM and SONET/SDH, which has added to the complex and disparate nature of these legacy regional and metro networks. Given the limitations of legacy optical technology and network design practices, these dedicated and disparate networks are

 

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struggling to accommodate the explosion of services with high-bandwidth or strict service level agreement, or SLA, requirements.

Technology Shifts are Pressuring Network Operators to Increase Bandwidth and Enhance Performance

Today’s networks require dramatic transformation to meet the service demands driven by significant technology shifts, including:

 

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Proliferation of Mobile Devices.    Users of all types are increasingly connecting to networks through powerful mobile devices ranging from smartphones to tablets. According to a September 2012 report, IDC estimates that the market for smart connected devices—a combination of PCs, smartphones and tablets—will grow from 1.2 billion devices in 2012 to over 2 billion devices by 2016. These devices include multiple forms of connectivity such as Wi-Fi and cellular, including 3G and 4G Long-Term Evolution, or LTE, enabling users to remain connected wherever they are and to consume more content. Additionally, according to an August 2012 study, Gartner expects worldwide mobile device traffic to grow from 6.4 million terabytes in 2011 to 91.3 million terabytes in 2016.

 

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Rapid Adoption of Bandwidth-Intensive Applications.    Innovation in consumer and enterprise applications has driven rapid adoption and increases in time spent online, both in mobile and fixed environments. Moreover, these new types of applications, such as video, social media, gaming and enterprise software-as-a-service, are increasingly bandwidth intensive and latency sensitive. For example, according to a June 2012 IDC report, global video captured by device users grew by approximately 15% in 2011 to 9.1 billion gigabytes, of which 3.2 billion gigabytes were recorded on mobile phones, representing a 68% year-over-year increase.

 

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Growth in Cloud Computing.    Enterprises and consumers are rapidly adopting cloud-based technologies to host an increasing number of applications, store their data and leverage on-demand computing resources.

At the same time, the nature of data traffic has transformed from static point-to-point fixed connections to dynamic provisioning of new services. As a result, network operators are being forced to upgrade their networks to profitably deliver these premium services as well as to handle the increased demands of their end-customers, which include higher throughput and utilization, better performance and increased provisioning speed in order to deliver high-quality services cost-effectively.

Ethernet has Emerged as the Dominant Network Protocol

As network operators have sought to meet the demand for greater bandwidth and deliver a variety of services at lower costs, their networks increasingly have come under stress. To address these pressures, they have increasingly looked to deploy Ethernet-based technologies. Ethernet standards have evolved significantly and now support carrier-grade public network requirements. Moreover, Ethernet now supports high-bandwidth, carrier-grade environments with enhanced granularity at a significantly lower price per bit than traditional technologies. As subscribers have also been rapidly adopting Ethernet, transitioning to packet-based architectures affords network operators greater flexibility and efficiency in service delivery. According to a December 2012 report, Gartner estimates that revenue from enterprise Ethernet data services is expected to be $20 billion in 2012 and grow to $26 billion in 2016. As a result, we believe that network operators will shift more of their capital budgets towards purchasing Ethernet-based solutions.

 

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Regional and Metro Networks Are Increasingly Critical to Network Operators’ Abilities to Scale and Provide Enhanced Services

As the demands on networks increase, regional and metro networks are becoming increasingly critical to network operators’ abilities to scale network capacity as well as aggregate, deliver and manage required services and content efficiently. Additionally, network operators are now seeking to offer new premium services with guaranteed service levels, as opposed to relying on traditional best-efforts service delivery models. Network operators desire to offer premium services for the following applications:

 

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Business Ethernet.    Providing scalable bandwidth and flexible Ethernet services to support business applications with high service level requirements.

 

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Cloud Connectivity.    Offering direct, high-speed links to cloud-based services and between data centers.

 

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Broadband Backhaul.    Transporting traffic for advanced services such as video between the core network and subscribers.

 

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Wireless Backhaul.    Providing high-capacity transport services at strict service levels optimized for cellular networks.

 

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Wholesale Transport.    Offering backbone infrastructure to deliver scalable services at low latency under high service levels.

 

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Private Networks.    The ability to implement IP, Ethernet and optical-based private networks for secure and dedicated bandwidth services.

Legacy Approaches are Inadequate to Address Network Growth and Performance Requirements

Regional and metro networks are highly capital intensive to build, operate and maintain. Historically, network operators have upgraded capacity only as technology and subscriber demands on their networks have changed. Although network operators must increase the scale of their complex networks to accommodate the increased demand for packet-based services, they must also maintain legacy services for subscribers over their existing networks. Legacy approaches to augmenting regional and metro networks suffer from multiple challenges, including limitations on scalability, performance, flexibility and ability to provision new services efficiently and cost-effectively. These legacy approaches include:

 

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Adding Dedicated Networks.    The historical practice of adding new dedicated and often disparate overlay networks has failed to cost-effectively scale. Deploying disparate overlay networks with hardware and software infrastructure from multiple vendors increases the operational and management complexity and expense associated with operating these networks. Moreover, the capital expense associated with scaling services to other areas of the network is burdensome.

 

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Deploying Router-Based Products.    Routers have historically been deployed to forward traffic between network connections leveraging a variety of physical mediums and protocols. A router essentially processes every packet that it forwards using commonly available computer processors. Although innovation in router technology has improved processing performance over time, the approach of adding more routers to address continually increasing capacity requirements remains cost-prohibitive. Despite improvements in technology, it is impractical to scale a router-based architecture to address these increasing network requirements, such as 10 gigabit-per-second, or 10G, and 100 gigabit-per-second, or 100G, environments. While routers are required at select network locations, they would be cost-prohibitive to deploy throughout regional and metro transport networks.

 

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Modifying Existing Operations Support Systems.    Core operations support systems, or OSS, were designed decades ago to support routine administrative tasks associated with network operations. They interact poorly with modern software systems, are not designed to address the higher level network planning, management and coordination functions necessary in today’s networks and do not provide holistic visibility over the entire network. Traditionally, network operators have implemented a patchwork of disparate software systems that run on top of legacy OSS systems to augment their functionality. This creates difficulties coordinating between systems or network layers, increases maintenance costs and slows the provisioning of new services.

Need for Network Transformation

We believe that the legacy approaches to designing regional and metro networks are inadequate to effectively handle next-generation service demands. Network operators require a new approach to drive network transformation, including new levels of scalability and service flexibility, while reducing their ongoing capital and operating expenses. They are seeking an open architecture that is conducive to deploying multi-vendor, best-of-breed networks and to supporting future innovations while enhancing network efficiency and performance. Moreover, to remain competitive, network operators need to evolve their networks to support higher-bandwidth requirements, introduce new revenue-generating, premium services and manage network traffic at the optimal layer in a low-latency, cost-optimized way using both the optical and Ethernet layers. Accordingly, we believe that network operators require new approaches to both their software and infrastructure to achieve network transformation.

 

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Software Transformation.    To virtualize their networks and realize the promise of NaaS, network operators must deploy SDNs. SDNs simplify networks and create a more open environment by removing proprietary control planes from legacy network elements and replacing them with a network control plane using protocols such as OpenFlow to orchestrate connections and services over cost-optimized, multi-vendor networks. Utilizing an SDN approach would enable network operators to customize and differentiate their networks and would allow for the development of third-party applications.

Similar to the changes brought about by server virtualization in which IT managers can decouple applications and their environments from the underlying hardware, introducing greater levels of freedom and flexibility in the data center environment, SDNs decouple network logic and policies from the underlying switching hardware, bringing new flexibility into the wide-area networking environment. Network operators that virtualize their networks can partition subsets of their network resources to present a custom network to each enterprise customer, enabling the activation, control and provisioning of services on demand.

 

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Infrastructure Transformation.    Given the heterogeneous characteristics of regional and metro networks, network operators should embrace multi-layer platforms that provide embedded switching capabilities. These platforms would enable a more flexible network architecture, reducing the dependency on legacy technologies, such as routers, that do not scale cost-effectively. An optimal approach would leverage packet and optical technologies to transport and deliver network traffic over the most appropriate layer, thereby maximizing network capacity and minimizing the cost per bit of traffic.

Network operators need a new approach that incorporates the benefits of software-defined networking and multi-layer switching platforms. We believe that this transformation of network architecture would provide network operators with improved flexibility, increased scalability and performance, accelerated time to value from new services, delivery of a broad range of applications and lower total cost of ownership through decreased capital expenditure and operating expenses.

 

 

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We believe that an innovative solution which meets capital budget constraints for both green field deployments and existing network environments is imperative. We also believe that this type of solution would enable network operators to address a range of network upgrades associated with spending typically earmarked for products and markets including Ethernet services edge routing, access aggregation, metro WDM, multi-service provisioning platforms and packet-optical equipment. According to ACG Research, markets for these products were forecasted to collectively represent approximately $15.7 billion in worldwide revenue in 2012. We believe that our solutions address a substantial portion of these aggregated markets. In addition, our solutions also address a portion of the OSS market which is not included in the ACG Research forecast above.

Our Solution

We have pioneered innovative, carrier-grade networking solutions that transform disparate and inefficient legacy networks into open, high-performance networks. Our solutions include high-capacity, multi-layer switching and transport platforms, as well as a carrier-grade software-defined networking platform and applications.

Fundamental to our solution is our software-defined networking approach, which enables an array of Cyan and third-party applications to manage and control underlying network infrastructure. In December 2012, we introduced our Blue Planet platform, a carrier-grade software-defined networking solution purpose-built to address network operator requirements. Blue Planet is the latest implementation of our network virtualization and management software that we first introduced in 2009 to work in combination with our high-capacity, multi-layer switching and transport platforms. We also offer high-capacity, multi-layer switching and transport platforms, known as our Cyan Z-Series, designed to support the multiple concurrent technologies used in regional and metro networks, including both Ethernet-based services as well as optical services. Our solutions are designed to support a variety of use cases from traffic aggregation at the network edge to multi-terabit switching optimized for handoff at the network core.

Customers may choose to deploy Blue Planet either on a standalone basis or integrated with our Z-Series platforms. By deploying our solutions, network operators can realize the following benefits:

 

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Deliver Virtual Networks.    Our solutions enable our customers to activate, control and modify network services through our centralized, software control plane. By deploying our Blue Planet platform, network operators can present a custom network to each enterprise customer and rapidly offer services based on packet, OTN and WSS-based wavelength aggregation and switching technologies. Additionally, our approach embraces a multi-vendor environment by integrating with third-party network devices and centralizing the visualization and management of the disparate network elements. Our solutions also integrate with open protocols, such as OpenStack, to enable end-to-end virtualization of networks including data center interconnect.

 

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Enhance Flexibility and Support Open Architectures.    Our multi-layer solutions give network operators the flexibility to support a changing service mix and the ability to evolve their networks to a packet-based approach at their own pace. For example, our Z-Series platforms are modular and support any combination of Ethernet and legacy optical services that can be swapped or added at any time. Our solutions were designed for network-wide deployment and support a variety of use cases from aggregation at the network edge to multi-terabit platforms optimized for handoff at the network core. Our solutions have open APIs that our customers can use to develop custom business applications or integrate with third-party applications.

 

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Increase Capacity and Scalability.    Our solutions are designed to scale in a distributed and highly available manner to manage large networks of thousands of network elements supporting tens of thousands of services. Moreover, our Z-Series family of high-capacity,

 

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multi-layer switching and transport platforms increase network capacity and optimize cost per bit by tailoring traffic transport to the appropriate network layer, leveraging both electrical and optical domains. Because aggregation may be performed at one layer and multiplexing and transport at others, networks that incorporate our solutions require fewer router ports and offer lower latency than legacy approaches. Additionally, our purpose-built Z-Series platforms support high-capacity networks using industry standard components, facilitating backplane and switch fabric interconnect rates in excess of 100G per line card slot, enabling an easy migration to future 40G and 100G Ethernet services.

 

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Accelerate Time to Value.    Our Blue Planet platform includes advanced network and service planning applications, enabling network operators to design multi-layer networks quickly and cost-effectively. Advanced algorithms and an intuitive user interface simplify and accelerate the network planning process. Advanced three-dimensional visualization tools combined with network virtualization technology enable on-demand provisioning and deployment of customized services to subscribers. Additionally, our carrier-grade SDN approach enables network operators to access network peripherals and functions remotely, thereby allowing them to rapidly extend the delivery of new services throughout their networks. Because network operators can deploy our software independently from our Z-Series platforms, we can offer valuable network operations services to our customers on an expedited basis.

 

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Enhance Performance and Intelligence.    Our Blue Planet platform includes real-time and historical analytics to track network performance and assist in capacity planning. This intelligence is available through a centralized service portal that our customers can utilize, and through which they can provide secure access to their customers in order to provide a differentiated service offering. This service portal not only provides the ability to verify compliance of SLAs and a variety of other metrics, but can also be configured to allow end-user bandwidth changes for the contracted service and automatically provide this data to billing systems via APIs. Network operators and their end-customers can use Blue Planet extensively to troubleshoot network performance issues, monitor and report on network SLAs and make better business planning decisions.

 

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Offer a Broad Range of Premium Applications.    Our solutions enable network operators to offer a wide range of applications in their regional and metro networks. Blue Planet enables network operators to deliver differentiated Ethernet services that enhance their end-customers’ experiences, allowing network operators to derive additional sources of revenue. For example, our customers frequently offer business Ethernet, wireless backhaul, broadband backhaul, cloud connectivity and wholesale transport. Our solution simplifies and accelerates the delivery of these services for all types of customers, including multinational, regional, wholesale and retail service providers. Moreover, Blue Planet allows network operators to either develop their own custom applications, utilize our applications or seamlessly integrate third-party applications.

 

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Scale Networks Cost-Effectively.    Our solutions enable network operators to reduce capital and operating expenses by minimizing the need for disparate legacy networks and related software. Moreover, our Z-Series platforms reduce the need for unnecessary routers and optimize cost per bit by transporting traffic over the appropriate network layer according to the needs of the application. Our platforms leverage industry standard components and are designed to be controlled by software, thereby reducing capital expenditures associated with deploying as well as operating expenses associated with monitoring and maintaining our products. The modular design of our solutions further reduces costs by enabling our customers to add services and functionality on a pay-as-you-grow basis as well as by limiting field technician dispatches. Our Blue Planet platform with flexible hosting models, including private, public and hybrid cloud options, significantly reduces costs and administrative burdens associated with network management, software updates, SLA monitoring and network

 

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planning. Additionally, our multi-layer approach to networks enhances long-term capital efficiency and reduces operating expenses by enabling our customers to migrate to packet-based networks over time.

Our Strategy

Our goal is to establish our position as a leading provider of open, multi-vendor, carrier-grade networking solutions. The key elements of our strategy include:

 

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Extend Our Technology Leadership in High-Performance, Carrier-Grade Networking.    Our carrier-grade SDN solution is purpose-built for high-performance network requirements. We intend to leverage our technology leadership position by continuing to define the market requirements for carrier-grade SDNs and high-capacity, multi-layer switching and transport solutions. We also plan to continue to invest in sales and marketing resources to raise awareness of the full benefits of virtualizing high-performance networks. A key element of this strategy is to continue to develop innovative Blue Planet applications, as well as leverage third-party application development through our open APIs.

 

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Develop Innovative Products and Technology.    We plan to continue to introduce new software and hardware products that enable our customers to more effectively offer new services and increase their profitability. For example, we are developing new applications that enhance the value of our Blue Planet platform as well as new line cards that augment our Z-Series platforms for new use cases. Our strong relationships with our customers provide us with valuable insights into deployment demands, market trends and end-user needs. We plan to leverage these relationships and insights to continue to develop and enhance our solutions.

 

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Expand Our Service Provider Customer Base.    Because our approach enables service providers to improve the return on their existing networks while transitioning to packet-based networks over time, we target customers through multiple initial deployment opportunities. We have found that our solutions are well suited to deployments that involve green field network projects as well as helping our customers replace or evolve legacy architectures. We recently launched our Blue Planet platform that can be purchased with or without deploying our Z-Series platforms, thus enabling network operators to deploy our network operations services quickly and efficiently in legacy networks. We intend to target new service provider customers by continuing to invest in our sales force, field operations and support functions as well as by deepening our engagement with our current partners and establishing relationships with new channel partners.

 

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Sell Additional Solutions to Existing Customers.    We intend to sell additional solutions to our growing installed base of existing customers. Our customers have historically purchased our solutions using an incremental approach that begins with a targeted product purchase to address specific services or portions of their networks and expands to additional product purchases as they experience the benefits of our solutions. The loyalty of our customer base is evidenced by the fact that over 90% of our customers, who have been our customers for more than six months, placed additional orders with us following their initial deployments. Our solutions are well suited for a pay-as-you-grow approach. We intend to continue investing in our existing customer relationships to drive the adoption of additional products as our customers scale and evolve their network services over time.

 

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Extend Our Presence in New Geographies.    We believe that international markets represent a significant growth opportunity for us. As of December 31, 2012, we had over 125 customers with initial deployments, primarily in North America. We have found that establishing relationships with recognized network operators in a new region enables us to win new business at other additional potential customers in the region more rapidly and at a lower acquisition cost. In Asia, Europe and South America, we plan to leverage our relationships with

 

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our existing customers to enhance our brand recognition and broaden deployment by other customers in the region. Additionally, we have or are in the process of engaging channel partners in various regions outside of the United States, and we are growing our channel partner network as we continue our growth and international expansion.

 

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Expand in Emerging Customer Verticals.    We have initially targeted our solutions to traditional service providers, such as local access service providers and regional transport providers. We plan to target emerging customer verticals with use cases well suited to the benefits of our solutions, including large data center networks, governments, cable MSOs as well as enterprises that build and operate large, private networks.

Our Technology

The key strength of our solutions is the integration of our various packet, optical and software technologies across our range of products. Since our founding in October 2006, we have focused our efforts on developing solutions based on a centralized, open, multi-vendor software orchestration model. Our hardware solutions are comprised of the integration of commercially available network components into a robust packet-optical, high-capacity, multi-layer switching and transport platform. Our software has been designed to provide our customers with the benefits of our solutions regardless of whether deployed in conjunction with our hardware platforms or with third-party hardware platforms. The differentiating elements of our proprietary technology include:

 

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Scalability.    While 10G Ethernet services are the dominant interface of choice in most current networks elements, 100G Ethernet is rapidly evolving and projected to be an increasingly dominant service interface over the next several years. Our Z-Series family of high-capacity, multi-layer switching and transport platforms provide for scalability and density, supporting well over 100G per card slot and hundreds of gigabits to terabits of non-blocking platform capacity. Our Z-Series platforms support 100G of card-to-card interconnectivity through ultra-high-capacity backplanes and switch fabrics providing a simple migration path to 100G Ethernet services support. This non-blocking 100G grooming capability, combined with DWDM line cards, supports a mix of 10G and 100G wavelength services and provides a robust foundation to scale future services. Leveraging our Z-Series architectural scalability and software capabilities, Ethernet services of up to 10G are supported on current line cards, while the ability to support over 100G of protected service capacity per line card slot will enable the migration to future 40G and 100G Ethernet line cards as those technologies mature and become more broadly adopted. In addition, certain features and functionalities, including capacity upgrades, can be enabled remotely through our provisioning software.

 

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Multi-Layer Technology.    Our Z-Series platforms, as controlled by our orchestration software, direct network traffic across the most appropriate and efficient network layer, including both electrical and optical paths. Our regional and metro network solutions encompass the Ethernet service layer, and other transport layers including connection-oriented Ethernet, SONET, SDH, G.709 OTN and wavelength transport technologies. Our Z-Series platforms facilitate the transition from legacy time-division multiplexing, or TDM, to packet and/or DWDM. Our Z-Series platforms support a complete range of transport requirements across aggregation, transit and hub locations.

 

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Open Software Development Process.    We have designed our technology to integrate with legacy networks and third-party vendor network infrastructure. The capabilities of our platforms allow our customers to continue to leverage their legacy network investments while migrating to more software-oriented, packet-based networks at their own pace. Additionally, our technology can be integrated into regional and metro networks currently utilizing decades-old OSS and provide our customers with a bridge to migrate from these antiquated systems to our Blue

 

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Planet and Z-Series solutions. Additionally, our open APIs allow our customers to custom build their own applications or integrate third-party applications, thereby diversifying the services they can offer and allowing our customers to tailor services to the specific needs of their end-user customers.

 

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Abstraction and Visualization.    Through the abstraction and centralization of network control software, our technology allows network planning and control decisions to be made with full knowledge of all available network resources and all contractually committed services. These attributes also enable the virtualization of the network for NaaS and other dynamic service capabilities. High-performance networks are comprised of multiple technologies and a number of logical layers which include fibers, DWDM wavelengths, TDM and packet transport technologies and services. We have developed technology that allows for an integrated view and software control of these network elements with unique three-dimensional network visualization. Our software provides end-to-end visibility and control over how circuits and services are groomed and routed as well as the ability to visualize the data path across the nodes, shelves, line cards and optical fibers across the different transport layers of the network. The visibility provided by our software increases the efficiency of network configurations and reduces errors when making additions or changes to the network.

Products and Solutions

We provide comprehensive solutions consisting of our family of Z-Series high-capacity, multi-layer switching and transport platforms, our Blue Planet carrier-grade SDN orchestration platform and applications and a range of professional services. Network operators can use our software solutions either on a standalone basis or integrated with our hardware solutions, to realize the benefits of our solutions and enable multi-vendor, best-of-breed networks.

We launched our first Z-Series platform in September 2009. Since then, we have led emerging SDN initiatives in the industry through our development of open, multi-vendor, multi-layer planning, management and verification software. In April 2010, we announced one of the industry’s first multi-layer network management solutions. Building on our continued expansion of our software offerings over time, in December 2012, we launched Blue Planet, a carrier-grade SDN platform for regional and metro networks that allows network operators of all types to virtualize networks and simplify the development, deployment and orchestration of scalable communications and business applications over high-performance networks.

Cyan Z-Series

Our Z-Series family of high-capacity, multi-layer switching and transport platforms is comprised of three different chassis that support interchangeable Z-Series line cards that network operators can deploy to allow for scalable solutions from the access edge of the network, across the metro and regional network to the core of the network. Each Z-Series platform is comprised of a chassis that supports a variety of interchangeable line cards to provide a wide range of applications for Ethernet services, TDM or wavelength aggregation, signal grooming and transport services. Our Z-Series platforms integrate with our software, including Blue Planet and our predecessor multi-layer network management solutions, to provide network operators with a range of software solutions.

Our Z-Series platforms are scalable with a backplane and switch fabric design that supports over 100G per line card slot. 100G services can be deployed across our Z-Series platforms via line cards and, in certain cases, software upgrades. Our Z-Series line cards can be software upgraded remotely for future features and functionality. We enable this functionality through our Blue Planet software and associated Z-Series software upgrades without the need for costly field technician deployment.

 

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The Z-Series platforms range in size and capability from the Z22 to the Z77, allowing our Z-Series products to be deployed from the edge to the core of the network as well as in high-performance networks of varying size and capacity. We also offer our Cyan Z-Series L-AMP, which is a fully self-contained line card that is a bi-directional mid-span optical amplifier/repeater. We currently offer approximately 20 different line cards that provide varying functionality to our Z-Series chassis, each of which can be utilized in all of our Z-Series chassis.

The following table highlights our Z-Series platforms:

 

LOGO

Our Z-Series platforms provide a level of integration that exceeds that available from legacy platforms. For example, a single Z-Series platform natively supports the transportation of packet, TDM and wavelength services with the option of supporting a reconfigurable optical add/drop multiplexer. The solution also supports the functionality and scale of Ethernet transport switches with connection oriented Ethernet transport standards and Metro Ethernet Forum-based services. The Z-Series platforms can be remotely provisioned using our Blue Planet operations app, which provides multi-layer, three-dimensional network visualization, simplifies provisioning and provides ongoing operations support for improved operational performance.

 

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Certain features of our Z-Series platforms can be activated remotely utilizing Blue Planet or our previous network management solutions. For example, many of our Z-Series platforms contain multiple functionalities, some of which may not initially be utilized by our customers. Once a customer decides to implement these capabilities, they can be enabled through Blue Planet.

Cyan Blue Planet

Cyan Blue Planet is a carrier-grade software-defined networking platform that provides network virtualization and service-enabling applications, including networks and service planning, operations and monitoring. This carrier-grade SDN platform includes a core management platform and a range of applications to meet diverse requirements of network virtualization and control across the multiple layers of regional, metro and data center networks. Blue Planet provides for control of multi-vendor networks, and allows network operators to virtualize their networks, make more efficient use of their network assets and accelerate delivery of services to their customers. The Blue Planet platform and apps provide our customers with visibility and centralized control over disparate network elements.

Blue Planet is the latest implementation of the network virtualization and management software that we first introduced in 2009 to work in combination with our Z-Series platforms. Blue Planet is offered as a SaaS subscription model deployed from the cloud or through term licenses with the software installed at our customers’ premises. Blue Planet is available to customers using our Z-Series platforms as well as customers desiring to control networks that do not have any of our hardware deployed.

 

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The Blue Planet software platform is comprised of three fundamental elements: a core operating system, or SDN orchestration layer; applications which provide the interface for and delivery of specific services, referred to as apps; and element adapters that allow customers using Blue Planet to control a wide range of Cyan and third-party network elements in their networks. The following diagram depicts the key elements of the Blue Planet platform:

 

LOGO

The core of Blue Planet is a carrier-grade SDN orchestration platform, which includes an operating system, a hypervisor, a messaging system, middleware and a web portal, all running on a scalable, distributed, computing environment. Blue Planet provides an open architecture with advanced clustering and database management to meet performance and availability requirements.

Blue Planet offers the capability to deploy an array of apps, including both our own Blue Planet apps, as well as apps built by third-party developers or our customers themselves, to monitor and control underlying network infrastructure and plan, manage, and verify networks and services. Blue

 

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Planet allows apps to interact not only with OpenFlow compliant network devices, but also with legacy devices deployed prior to the development of carrier-grade SDN, thereby providing our customers with added flexibility in network deployment. By allowing our customers to deploy their own apps or third-party apps on Blue Planet, we allow our customers to provide their own unique set of value-added service offerings.

We currently offer the following apps:

 

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Blue Planet Planning Apps.    Blue Planet provides multi-layer network and service planning apps that provide conventional optical layer network design and support concurrent packet, TDM and optical layer designs. Blue Planet integrates with web-based mapping software to provide network architecture location planning for network design. Blue Planet also features latency modeling and prediction applications that factor in the latency allocations of all layers of network service aggregation and transport, as well as fiber latency for accurate predictive SLA performance modeling prior to the deployment of equipment.

 

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Blue Planet Operations App.    Blue Planet provides a multi-layer operations app that uses three-dimensional network visualization tools to simplify provisioning and fault management with built-in fault correction. This operations app uses our carrier-grade SDN to extend management control to third-party network hardware to further simplify provisioning and troubleshooting. The operations app also offers simplified operations and robust fault management, configuration, accounting, performance and security, referred to as FCAPS. Additionally, our operations app links with our planning app for network provisioning and integration of ongoing network changes, enabling simple and accurate incremental planning activities.

 

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Blue Planet Trail Analyzer App.    Blue Planet provides a comprehensive top-down view of flows across multiple nodes composing an end-to-end service connection, illustrating the paths of network traffic. We provide “x-ray” vision capabilities to expand visual information, displaying the line cards, ports and faceplate or backplane interconnections associated with each service. The health and status of every monitored point is displayed, across every node, card, port and switch fabric, allowing for focus on the source of service impacting network conditions.

 

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Blue Planet Performance and SLA Monitoring App.    Blue Planet offers performance monitoring, SLA assurance services and other value-added service extensions. This app allows network operators to provide their customers real-time and historical visibility into the usage and performance of their services. End-to-end SLA performance monitoring and reporting capabilities are offered in order to enhance a network operator’s ability to confirm that they are meeting their service level commitments. The app will also trigger alerts whenever committed metrics are in danger of being violated.

 

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CyClone App.    Blue Planet allows our customers the ability to create renderings of simulated networks in the cloud, which allows them to alter their networks in a virtual setting in order to simulate the effects of such changes without effecting network services and without the risk of network downtime.

The third component of the Blue Planet platform is element adapters. These element adapters act as the control and communications interface between the Blue Planet orchestration platform and apps and the specific hardware installed in a network. In addition to providing element adapters for our own Z-Series platforms, we currently offer element adapters that enable monitoring and/or control of approximately 50 network devices from a number of network hardware manufacturers.

 

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Customer Service, Support and Training

CyNOC Professional Services

CyNOC is our network operations center service that offers monitoring and managing of our customers’ services, providing our customers with an added layer of services and support for those that subscribe to this service. CyNOC expands on the power of our Blue Planet platform with network operations center services provided by our customer service engineers. CyNOC services are available in multiple service levels ranging from proactively monitoring to full scale managing of our customer’s Z-Series platforms and legacy network elements. We offer our customers partial or complete NOC services to manage their entire multi-vendor networks. Additionally, a number of our customers who maintain their own internal NOC leverage our services as a backup NOC. These services are typically sold to our customers for a one-year term at the time of the initial product sale, subject to annual renewals thereafter.

Maintenance, Support and Training Services

We offer Cyan PRO professional services to provide ongoing technical support with our hardware and software products through a variety of service packages to meet the requirements of most network operators as well as customized packages to meet more specialized requirements. We provide this variety of customer service products and support through our technical support engineers as well as through our growing network of authorized and certified channel partners. Our customer support organization operates 24 hours a day and is available by phone, email and online through our customer portal and offers a single point of contact for technical assistance with hardware, software and network issues. Additionally, we offer our end-user customers access to ongoing software updates, upgrades, bug fixes and repairs when and if available. We also have a customer portal available through our website which allows our channel partners and our customers to manage support tickets, download software and search our online knowledge database. These services are sold to our customers typically for one-year terms at the time of the initial product sale, subject to annual or multi-year renewals thereafter.

CySupport is our integrated software maintenance and technical support services package, which provides all essential software and services in one simple and cost-effective package.

CyService encompasses a range of additional professional services to assist our customers in their operations, including network deployment and installation services. We offer an innovative suite of professional services to ensure successful network deployment that can be tailored to the needs of our customers and range from site surveys to test plan creation. In addition to complete engineer, furnish and install, or EF&I, services, we also offer assistance with network design, integration and migration planning, network performance analysis, and installation of both our products as well as third-party equipment. These services are invoiced separately at the time of the initial product sale.

We also provide training services to educate our end-customers on the implementation, use, functionality and ongoing maintenance of our products. These training services can be provided at our facilities, on-site at the location of our customer’s choice or through a variety of multimedia resources based upon customer preference.

Customers

We sell our Z-Series and Blue Planet platforms and other services primarily to service providers and high performance data center and private network operators.

 

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As of December 31, 2012, our solutions have been sold to over 125 customers, including, among our top ten customers by revenue in 2012, Great Plains Communications Inc., Intelleq Communications LLC, Lynx Network Group, Inc., US Carrier Telecom, LLC, US Signal Company, LLC, Vision Net, Inc. and Windstream Corporation. For the years ended December 31, 2011 and 2012, our largest customer was Windstream Corporation, which accounted for approximately 37% and 45% of our revenue, respectively. No other customer represented greater than 10% of our revenue in either of these periods.

All orders by Windstream are made pursuant to purchase orders but not pursuant to a long-term purchase commitment. We expect our revenue derived from sales to Windstream to decline in future periods. Revenue from customers located outside of the United States was approximately 1% and 5% of our revenue for the years ended December 31, 2011 and 2012, respectively. The loyalty of our customer base is evidenced by the fact that over 90% of our customers, who have been our customers for more than six months, placed additional orders with us following their initial deployments.

Our sales are made primarily pursuant to purchase orders with our customers rather than pursuant to committed long-term supply contracts. At any given time, we have backlog orders for products that have not shipped. Our backlog consists of confirmed orders for products scheduled to be shipped to customers, generally within the same quarter. Because customers may cancel purchase orders or change delivery schedules without significant penalty, we believe that our backlog at any given date may not be a reliable indicator of future operating results. The amount of our aggregate order backlog was approximately $11.1 million and $12.6 million as of December 31, 2011 and 2012, respectively.

Case Studies

We believe that the following case studies provide a representative sample of how our customers deployed and benefited from our solutions.

Leading U.S. Telecommunications Provider

The Problem: A leading nationwide provider of telecommunication and network services to business and residential customers needed to expand its network’s transport capacity to accommodate increasing demands for Ethernet services. This customer’s existing SONET-based optical network and legacy MSPP platforms were unable to cost-effectively transport Ethernet and other packet-based services or efficiently leverage its existing fiber network.

Solutions and Benefits: This customer deployed our Z33 platforms to transition to a packet-optical network optimized for Ethernet and other premium services. Our Z-Series platforms, equipped with our WDM line cards, significantly increased our customer’s network capacity by efficiently transporting both Ethernet and SONET traffic over a single fiber pair while leveraging its existing SONET-based hardware. By deploying our solutions, this customer was also able to significantly reduce its capital expenditures relative to alternative solutions it evaluated. Additionally, in order to fully realize the capabilities of our Z-Series platforms, this customer embraced the management capabilities of our CyMS management solution. Subsequently, this customer deployed the full suite of our Z-Series solutions throughout its extensive network and selected us as one of its primary suppliers for regional and metro network infrastructure hardware and management software solutions.

Wireless Backhaul Provider

The Problem: A large regional provider of wireless backhaul and other network transport services needed to provide its wireless service provider customers with monitoring and assurance solutions that could confirm that SLA performance metrics were being met. This customer operates a multi-vendor network delivering packet and optical services requiring significant personnel resources and various

 

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software systems to monitor the third-party equipment separately. This multi-faceted monitoring environment made it difficult for our customer to monitor its SLA compliance, and was incapable of providing real-time visibility to its end-customers.

Solutions and Benefits: This customer installed CyPortal, an early version of our Blue Planet performance and SLA monitoring app, to provide SLA performance monitoring for its own operations personnel as well as to its end-customers. Through the deployment of our solution, this customer was able to provide its end-customers with reporting and visibility of its SLA compliance through a cloud-based web portal. In addition, the open, standards-based architecture of CyPortal supports a number of third-party hardware elements in the network, allowing our customer and its end-customers to monitor network services from end-to-end across multi-vendor environments riding third-party waves and ITU standard DWDM channels. Following the deployment of our software solution, this customer approached us and another vendor to provide backhaul services to support a wireless service provider’s LTE deployment. Together, we designed and deployed a new metro Ethernet-based backhaul network that incorporated our Z-Series platforms. Our hardware and software solutions were integrated with third-party products to manage and operate the multi-vendor network as well as provide SLA assurance.

Global Telecommunications Provider

The Problem: A global telecommunications provider wanted to develop a more scalable metro network architecture to cost-effectively interconnect its data centers, extend 10G metro network services to its enterprise customers and better leverage its extensive global IP network. The customer had been utilizing a router-based approach for its metro network, which had limited capacity and did not allow for the cost-efficient deployment of new network infrastructure or services on an as-needed basis.

Solutions and Benefits: This customer used our CyService offering to design its network and installed our Z33 platforms to implement WDM over leased optical fibers between its data centers, thereby increasing the capacity and flexibility of its metro network to better serve its enterprise customers in one large U.S. metropolitan area. Our scalable Z-Series architecture enabled our customer to cost-effectively build out its metro network on an as-needed basis. The customer subsequently implemented our Blue Planet carrier-grade SDN platform and management application, and later developed and deployed its own Blue Planet app that facilitated system configuration and integration of its OSS with network elements. This customer has since utilized our Z-Series and Blue Planet platforms to build out metro networks in multiple cities in the United States, Europe and Asia to better leverage its global IP footprint. By deploying Blue Planet, this customer accelerated its time to delivery of new services and reduced ongoing network management and monitoring costs.

Sales and Marketing

We sell our products and services in the United States through a direct sales force. During 2012 we began to direct a portion of our sales and marketing efforts to international markets. Although initial sales outside of the United States were through our direct sales force, we are continuing to build our network of channel partners through which we expect to make a substantial portion of our international sales in future periods. As of December 31, 2012, we had 93 employees in our sales and marketing organization. Our direct sales teams are typically comprised of a combination of a sales representative and a systems engineer. Each sales team is responsible for a specific geographical territory, has responsibility for a number of major direct end-user customer accounts or has assigned accounts in a specific vertical market. Our direct sales force is primarily based in our headquarters in Petaluma, California with additional sales personnel located in select locations elsewhere in the United States as well as in the United Kingdom, the Netherlands, Germany, Hong Kong, Japan and Australia.

 

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Our sales process entails planning discussions with prospective customers, analyzing their existing networks and identifying how these potential customers can leverage our solutions within their network. The sales cycle for the initial targeted product purchase, from the time of prospect qualification to the completion of the first sale, may span multiple quarters. Typically, after we have completed an initial sale with a customer, we experience shorter sales cycles for additional orders as a result of the customer having previously implemented our solutions. The loyalty of our customer base is evidenced by the fact that over 90% of our customers, who have been our customers for more than six months, placed additional orders with us following their initial deployments.

We currently have channel partners in Asia and Europe to whom we provide marketing assistance, technical training and support. In addition to their lead generation and sales activities, our channel partners perform installation services as well as some level of support to their customers. We are in the process of expanding our channel partner network both internationally and in the United States.

Our marketing strategy is focused on building our brand, communicating product advantages and increasing customer awareness of our solutions, particularly our recently launched Blue Planet platform. We execute on this strategy through a variety of marketing vehicles, including trade shows, advertising, public relations, industry research, our website and collaborative relationships with technology vendors. Our marketing activities, including demand generation activities, are focused primarily on local access service providers, regional transport providers, data center operators, cable MSOs, private network operators and wholesale carriers. We also focus on ongoing account management for existing customers and the development of follow-on sales as our existing end-user customers continue to expand and enhance their demand for our products.

Our sales and marketing expenses were $25.2 million, or 26.3% of our revenue, in 2012, $12.8 million, or 31.7% of our revenue, in 2011, and $7.9 million, or 33.7% of our revenue, in 2010.

Research and Development

The intensely competitive nature of the industry in which we operate makes it critical that we continue to focus on investment in research and development. To this end, we utilize data-driven development methodologies to accelerate our time to market. Our research and development efforts focus primarily on improving and enhancing our existing hardware and software solutions as well as developing new products and additional features and functionality.

As of December 31, 2012, we had 97 employees in our research and development organization, the substantial majority of whom were located at our headquarters in Petaluma, California. Our research and development expenses were $18.4 million, or 19.2% of our revenue, in 2012, $13.0 million, or 32.1% of our revenue, in 2011, and $10.4 million, or 44.4% of our revenue, in 2010. We plan to continue to dedicate significant resources to our research and development efforts.

Manufacturing

We subcontract the manufacture of all of our hardware products to a leading contract manufacturer, Flextronics, which purchases components from our approved list of suppliers and builds our hardware appliances according to our specifications at its Milpitas, California facility. Our outsourcing of our hardware manufacturing extends from prototypes to full production and includes activities such as material procurement, software implementation, and final assembly and testing. Once the completed products are manufactured and tested, Flextronics ships our products directly or

 

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through our third-party distribution centers to our customers for installation. By utilizing this outsourcing strategy, we are able to optimize our operations by lowering costs and reducing time to market.

Our contract manufacturer generally manages the procurement of the components and parts used in our products. We also engage in direct sourcing of certain strategic components. While our preference is to select components and materials that are available from multiple sources, we utilize a number of components that are available from only one source. Generally, neither we nor our contract manufacturer have written agreements with these sole-source component providers to guarantee the supply of the key components used in our hardware products. However, we regularly monitor the supply of components and the availability of qualified and approved alternative sources. We provide forecasts to Flextronics so that they can purchase key components in advance of their anticipated use, with the objective of maintaining an adequate supply of those components.

We have entered into a manufacturing services agreement with Flextronics, dated June 22, 2007, pursuant to which Flextronics manufactures, assembles and tests our products. This agreement permits Flextronics to procure materials and components required for the manufacture and testing of our products while also reserving our right to direct Flextronics to purchase specific materials and components from specified vendors. We also provide Flextronics with a list of preferred vendors from which it will attempt to source components first before seeking other sources of supply. The initial term of this agreement was five years, with the term automatically renewing for additional one-year terms, unless terminated by either party by giving 90 days or more written notice prior to the end of the then current term. Additionally, either party may terminate the agreement by giving written notice if the other party has materially breached its obligations under the agreement, subject to applicable cure periods.

Although the contract manufacturing services required to manufacture and assemble our products may be readily available from a number of established manufacturers, it is time consuming and costly to qualify and implement contract manufacturer relationships. As a result, if Flextronics or our sole-source component suppliers suffer an interruption in their businesses, or experience delays, disruptions or quality control problems in their manufacturing operations, or we have to change or add additional contract manufacturers or suppliers of our sole-sourced components, our ability to ship our products to our customers could be delayed, and our business, operating results and financial condition could be adversely affected.

Competition

The markets in which we compete are highly competitive and characterized by rapidly changing customer needs and continually evolving industry standards. We expect competition to intensify in the future as existing competitors and new market entrants introduce new products or enhance existing products. Our business will be adversely affected if we are unable to meet the demand for existing products and innovate to bring new products and solutions to market.

We compete either directly or indirectly with large networking and optical companies, such as Alcatel-Lucent SA, Ciena Corporation, Cisco Systems, Inc., Fujitsu Limited, Huawei Technologies Co. Limited and Juniper Networks, Inc., and specialized technology providers that offer point solutions that address a portion of the issues that we solve. In addition, we seek to replace legacy network control tools and processes that have already been purchased or were internally developed, and potential customers may be reluctant to adopt a solution that replaces or changes existing tools and processes in which they have made significant investments.

The principal competitive factors applicable to our products include:

 

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service breadth and functionality;

 

 

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performance, reliability and security;

 

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price;

 

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speed and ease of use and deployment;

 

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existing deployed base; and

 

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brand awareness and reputation within the market.

Although we believe that we compete favorably with respect to the above factors, we expect competition and competitive pressure, from both new and existing competitors, to increase in the future. Additionally, some of our competitors have greater name recognition, longer operating histories, well-established relationships with customers or channel partners in our market and substantially greater financial, technical, personnel and other resources than we have. Our competitors may be able to anticipate, influence or adapt more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the promotion and sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisitions or other opportunities more readily and develop and expand their product and service offerings more quickly than we can. In addition, competitors with substantially larger installed customer bases beyond the packet-optical solutions and NaaS markets may leverage their relationships based on other products or incorporate functionality into existing products in a manner that may discourage users from purchasing our solutions. These larger competitors may also have more diversified businesses that allow them to better withstand significant reduction in capital spending by end-user customers. Moreover, potential customers may also prefer to purchase from their existing providers rather than a new provider, regardless of product performance or features, because our solutions may require additional investment of time and funds to install. In addition, as a result of these transition costs, competition to secure contracts with potential customers is particularly intense. Some of our competitors may offer substantial discounts or rebates to win new customers. If we are forced to reduce prices in order to secure customers, we may be unable to sustain gross margins at desired levels or achieve profitability. In the future, in selling Blue Planet we may also compete with companies that are focused on providing virtualization software solutions for other end-markets as they may try to adapt their solutions to meet the needs of network operators or compete with networking companies that develop or acquire SDN solutions. Some of our competitors have made acquisitions of businesses that may allow them to offer more directly competitive and comprehensive solutions than they had previously offered.

Intellectual Property

Our success as a company depends critically upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including trade secret laws, copyrights, patents and trademarks, as well as customary contractual protections. As of December 31, 2012, we had two issued U.S. patents set to expire in 2029 and 2030. We have received a notice of allowance for an additional U.S. patent. We also license software from third parties for integration into our products, including open source software and other commercially available software.

We generally control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including contractual protections with employees, contractors, customers and partners, and our software is protected by U.S. and international copyright laws. We also incorporate certain generally available software programs into Blue Planet and our other software solutions pursuant to license agreements with third parties.

The steps we have taken to protect our intellectual property rights may not be adequate. Third parties may infringe or misappropriate our intellectual property rights. We may initiate claims against

 

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third parties that we believe are infringing our intellectual property rights if we are unable to resolve matters satisfactorily through negotiation. If we fail to protect our intellectual property rights adequately, our competitors could offer similar products, potentially harming our business.

Employees

As of December 31, 2012, we had 219 employees. None of our employees is represented by a labor union or is a party to any collective bargaining arrangement in connection with his or her employment with us and we consider our relations with our employees to be good.

Facilities

Our headquarters occupy approximately 22,780 square feet in Petaluma, California under a lease, a portion of which expires in May 2015 and the remainder of which expires in October 2018. We have leased additional offices for our sales and marketing personnel in additional locations on leases that generally have term of one year or less. Our current facilities are adequate to meet our existing needs. However, to the extent we meet our current growth expectations, we will need to expand our facilities. We believe that we will be able to obtain additional or substitute facilities on commercially reasonable terms.

Regulation

We are subject to federal, state and local laws, regulations, guidelines and determinations, common laws, codes of conduct and other similar parameters that directly and indirectly impact our business and methods of operation, including export control classifications. We also work closely with our contract manufacturer to ensure that their activities on our behalf also comply with applicable regulations, including export regulations.

Legal Proceedings

We are not party to any legal proceedings the outcome of which, we believe, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our future business, consolidated results of operations, cash flows or financial position. We may, from time to time, be subject to legal proceedings and claims arising from the normal course of business activities.

On February 11, 2013, John Halliwell, a former employee of ours, filed a lawsuit against us in the Superior Court of the State of California alleging that we wrongfully terminated his employment. The complaint seeks damages of an unspecified amount. We believe that we have meritorious defenses to the allegations set forth in the complaint and intend to vigorously defend the action. While it is not possible at this stage to predict the outcome of this matter, we do not believe that, even in the event of an unfavorable outcome, the damages would have a material impact on us.

 

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Table of Contents

MANAGEMENT

Executive Officers and Directors

The following table provides information regarding our executive officers, key employees and directors as of February 19, 2013:

 

Name

   Age     

Position

Executive Officers      

Mark A. Floyd

     57       Chief Executive Officer and Chairman of the Board

Michael L. Hatfield

     50       President and Director

Scott T. Bauer

     43      

Vice President of Finance

Norman L. Foust

     47       Vice President of Operations

James A. Hamilton

     49       Senior Vice President of Worldwide Sales

Scott A. Pradels

     38       Vice President of Engineering

Kenneth M. Siegel

     54       Vice President and General Counsel

Michael W. Zellner

     47       Vice President and Chief Financial Officer
Key Employees      

Eric M. Clelland

     49       Chief Marketing Officer and Vice President of North American Sales

Thomas A. Corker

     48       Vice President of Product Management and Business Development

J. Rick Johnston

     51       Vice President of Business Operations and Customer Service

Steve J. West

     56       Chief Technology Officer
Non-Employee Directors      

Michael J. Boustridge

     50       Director

Paul A. Ferris

     42       Director

Promod Haque

     64       Director

M. Niel Ransom

     63       Director

Robert E. Switz

     66       Director

Executive Officers

Mark A. Floyd has served as our Chief Executive Officer since May 2012 and on our board of directors since October 2008 and was appointed chairman of our board of directors in November 2011. Prior to joining us, Mr. Floyd served as Chief Executive Officer of SafeNet, Inc., a data security company, from July 2009 to July 2011. From May 2008 to June 2009, Mr. Floyd served as a venture partner at Sevin Rosen Ventures, and from March 2007 to March 2008 served in the same capacity at El Dorado Ventures, each of which is a venture capital firm. Previously, Mr. Floyd ser