10-K 1 xxia20140409_10k.htm FORM 10-K xxia20140409_10k.htm  



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-K

 

 

(Mark One)

[X]

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

 

For the Fiscal Year Ended December 31, 2013

 

OR

 

[ ]

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

 

For the transition period from ________ to ________

 

Commission File Number 000-31523

 

IXIA

(Exact name of Registrant as specified in its charter)

 

California

95-4635982

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

26601 West Agoura Road, Calabasas, CA 91302

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code: (818) 871-1800

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

Name of Each Exchange on Which Registered

Common Stock, without par value

The NASDAQ Stock Market LLC

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X]

 

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

  

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes [X] No [ ]

 

 
 

 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

 

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 definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [X]

Accelerated filer [ ]

Non-accelerated filer [ ]

Smaller reporting company [ ]

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X]

 

The aggregate market value of the shares of the Registrant’s Common Stock held by nonaffiliates of the Registrant as of June 28, 2013, computed by reference to the closing sales price on the Nasdaq Global Select Market on that date, was approximately $1,056,492,377.

 

As of June 16, 2014, the number of shares of the Registrant’s Common Stock outstanding was 76,981,053.

 



 

 
 

 

 

IXIA

 

FORM 10-K

 

TABLE OF CONTENTS

Page

 

 

PART I

 
     

Item 1.

Business

4

Item 1A.

Risk Factors

20

Item 1B.

Unresolved Staff Comments

39

Item 2.

Properties

39

Item 3.

Legal Proceedings

39

Item 4.

Mine Safety Disclosures

39

     
  PART II  
     

Item 5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

40

Item 6.

Selected Financial Data

42

Item 7.

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

44

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

64

Item 8.

Financial Statements and Supplementary Data

65

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

65

Item 9A.

Controls and Procedures

65

Item 9B.

Other Information

69

     
 

PART III

 
     

Item 10.

Directors, Executive Officers and Corporate Governance

73

Item 11.

Executive Compensation

76

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

115

Item 13.

Certain Relationships and Related Transactions, and Director Independence

118

Item 14.

Principal Accounting Fees and Services

119

     
 

PART IV

 
     

Item 15.

Exhibits, Financial Statement Schedules

120

     
SIGNATURES 125

 

 
3

 

 

PART I

 

Item 1. Business

Overview

 

Ixia was incorporated on May 27, 1997 as a California corporation. We are a leading provider of converged Internet Protocol (IP) network validation and network visibility solutions. Equipment manufacturers, service providers, enterprises, and government agencies use our solutions to design, verify, and monitor a broad range of Ethernet, Wi-Fi, 3G, and 4G/LTE equipment and networks. Our product solutions consist of our hardware platforms, such as our chassis, interface cards and appliances, software application tools, and services, including our warranty and maintenance offerings and professional services.

 

Our solutions deliver actionable insight through real-time monitoring, real-world testing, and predictive analytics. This end-to-end visibility provides organizations with complete understanding into user behavior, security vulnerabilities, network capacity, application performance, and IT resiliency. From the research labs to the network to the cloud, Ixia solutions optimize networks’ and data centers’ to accelerate, secure, and scale application and service delivery.

 

During the year ended December 31, 2013, we received orders from 1,483 new and existing end customers. Based on product shipments for the year ended December 31, 2013, our significant customers by category included:

 

 

Leading network equipment manufacturers such as Cisco Systems, Alcatel-Lucent, Juniper Networks and Dell;

 

 

Voice, broadband and/or wireless service providers such as AT&T, NTT, LGU+ and Verizon;

 

 

Enterprises such as Microsoft, Amazon, JP Morgan and Wells Fargo; and

 

 

Government contractors, departments, and agencies such as Boeing, the US Air Force and the U.S. Army.

 

No matter what profession or position in the world, connecting to networked applications quickly and securely – from any location – is paramount to success. The convergence of new technologies is complicating the IT landscape – smartphone ubiquity, cloud proliferation, challenges of big data, demands of the social consumer, pervasive cyber threats – intensifying the challenge of constantly, securely, and quickly connecting users to their applications. The delivery of communications and entertainment applications and services is moving to an always-connected, always-on paradigm.

 

From the lab, to the network, to the cloud, Ixia has a rich repository of expertise and solutions that optimize the secure, accelerated and scaled application delivery and performance businesses require. Ixia solutions battle-test wired and wireless network infrastructures, monitor user behavior, and dynamically filter application traffic.

 

Our solutions are scalable, easy-to-use, and adaptable, automatically providing companies with comprehensive coverage of the latest applications and security attacks in order to optimize performance and protect against threats. Our goal is to enhance network application and service delivery by providing comprehensive, easy-to-use, and automated solutions that empower our customers to drive their business forward by taking the guesswork out of network reliability and the application services.

 

Recent Acquisition History

 

In June 2009, we acquired Catapult Communications Corporation (“Catapult”). The IxCatapult product line adds in-depth testing of wireless network components. In particular, these products include test hardware and software that address 2G, 3G, 4G and Long-Term Evolution (LTE) wireless network access and core components. We have leveraged our IxLoad product to assist the IxCatapult solution with testing the mobile core network.

 

 
4

 

 

In October 2009, we acquired the N2X Data Network Testing Product Line (“N2X”) from Agilent Technologies, Inc. (“Agilent”) and created the IxN2X test solution. In addition to broadband and carrier access protocol capabilities, the IxN2X product line is known for its intuitive and powerful user interface and excellent quality. Our development team is integrating IxN2X’s best practices into the IxNetwork system architecture, and IxN2X customers are taking advantage of Ixia’s layer 4-7 and wireless testing on new, high-density hardware that support both IxN2X and Ixia applications.

 

In July 2011, we acquired VeriWave, Inc. (“VeriWave”), a performance testing company for wireless LAN (WLAN) and Wi-Fi enabled smart devices. This acquisition expands our portfolio of supported network media and addresses the need for an end-to-end solution that completely tests converged Wi-Fi, wired, 3G, and 4G/LTE ecosystems.

 

In June 2012, we acquired Anue Systems, Inc. (“Anue”). Anue solutions provide visibility into live networks and the applications running within them in order to efficiently aggregate and filter traffic. With this acquisition, we have expanded our addressable market, broadened our product portfolio and grown our customer base.

 

In August 2012, we acquired BreakingPoint Systems, Inc. (“BreakingPoint”). BreakingPoint is a leader in application and security assessment and testing, and its solutions provide global visibility into emerging threats and applications, along with advance insight into the resiliency of an organization’s network infrastructure. With this acquisition, we have expanded our addressable market, broadened our product portfolio and grown our customer base.

 

In December 2013, we acquired Net Optics, Inc. (“Net Optics”). Net Optics is a leading provider of total application and network visibility solutions. The acquisition of Net Optics solidifies our position as a market leader with a comprehensive product offering including network packet brokers, comprehensive physical and virtual taps and application aware capabilities. Additionally, the acquisition has expanded our product portfolio, strengthens our service provider and enterprise customer base and broadens our sales channel and partner programs.

 

 The Demand for Ixia Solutions

 

Today’s networks and data centers are continuously improving their performance and scale in order to accommodate the plethora of networking applications and services we now rely upon to do business, communicate, capture memories, plan, travel, and more. Applications drive network capacity, influence quality of experience, introduce potential vulnerabilities, and lead to more innovations. Every organization from device manufacturers, to service providers, to government organizations, to enterprises is seeking to optimize networks and data centers in order to accelerate, secure, and scale the delivery of these applications.

 

Ixia network solutions provide the predictive data needed for organizations to make real-time decisions that will enhance performance, harden security, and increase scalability of networks facing constantly changing requirements. The Ixia line of hardware, software, and services fits the needs of every organization – from the lab, to the network, to the cloud. Ixia solutions provide an end-to-end approach for organizations to test devices and systems prior to deployment, assess the performance and security of networks and data centers after every change, and constantly monitor and filter traffic to optimize performance.

 

 
5

 

 

Test | Assess | Monitor

 

 

The acquisitions of Anue, BreakingPoint and Net Optics expanded our product portfolio and end customer base, and increased our overall total addressable market. We are now providing more services and solutions to each of our customer segments.

 

 

Network Equipment Manufacturers (NEMs). NEMs provide voice, video, and data and service infrastructure equipment to customer network operators, service providers, and network users. Such users require high standards of functionality, performance, security, and reliability. To meet these higher standards, NEMs must ensure the quality of their products during development and manufacturing (prior to deployment). Failure to ensure the consistent functionality and performance of their products may result in the loss of customers, increased research and development costs, increased support costs, and losses resulting from the return of products. NEMs, for example, use our network test systems to run large-scale subscriber and service emulations, generating extreme traffic loads to verify the performance and capacity of their wired and wireless devices prior to deployment in production networks.


Our systems are also used by NEMs in the sales and acceptance process to demonstrate to their customers (e.g., service providers and enterprises) how the NEMs’ products will operate under real-world conditions. In addition, our conformance test suites are used by NEMs to ensure that their devices conform to published standards – ensuring that they will be interoperable with other equipment. These equipment manufacturers are also, in many cases, large enterprises and therefore have the same challenges that can be met using our assessment and monitoring solutions within their own internal network.

 

 

Service Providers. Service providers seek to deliver a growing variety of high quality, advanced network services ranging from traditional telecommunications and Internet services, to social networking, cloud storage, and entertainment streaming. Failure to provide a quality experience to the end user can be costly through high subscriber churn rates and reduced revenues. To ensure quality of experience (QOE) and service assurance, service provider R&D and network engineering groups must verify the performance and functionality of staged networks during equipment selection and network design, prior to deployment and after any change to the production network. Service providers also use our network test systems to emulate millions of mobile (3G/4G/LTE) subscribers to realistically predict end-user quality of experience delivered by providers’ infrastructure and services. Service providers must also ensure security for customers and their own networks, as the keepers of vast amounts of business and personal data. And finally, service providers depend on our monitoring solutions to filter application traffic in order to prioritize, de-duplicate, and optimize wired and wireless data streams.

 

 
6

 

 

 

Enterprises and Government. Enterprise and government organizations depend on their networks and data centers to get business done, and they devote enormous resources to ensure applications and services run optimally and securely. These customers rely on our solutions to help evaluate during selection, optimize and harden them in their labs prior to roll-out, and then assess each device and system in the production network once they are “live.” Notably, enterprises and government organizations must always be vigilant against the impact of the very latest security attacks and application deployments, and our network test and assessment solutions consistently ensure that their network and data center are optimized and resilient. These organizations also require visibility into the application traffic itself, and use our monitoring solutions to further enhance the performance, scalability, and reliability of the applications their users depend on. Finally, government organizations have also installed our cyber range solutions for the training of a new generation of “cyber warriors” to recognize and defend against massive cyber-attacks.

 

Ixia Business Strategy

 

Our goal is to enhance network application and service delivery by providing the most comprehensive, easy-to-use, and automated solutions in the industry. Over the past few years, Ixia has made a number of significant moves to acquire technology and talent that has positioned the Company as a preeminent provider of network test and visibility solutions. This has been accomplished by growing our portfolio of products and addressable markets through acquiring technologies, businesses, and assets; expanding our international presence, sales channels and customer base; continuing to deliver high quality products and support to our customers; and developing our employees. Key elements of our strategy to achieve our objective include the following:

 

 

Continue to Expand our Addressable Markets. We plan to further expand our addressable markets into growth areas for network and application security, next-generation networking technologies, monitoring network applications and services, and more.

 

 

Maintain Focus on Technology Leadership. We will continue to focus on research and development in order to maintain our technology leadership position, and to offer solutions that address new and evolving network technologies. We intend to maintain an active role in industry standards committees such as IEEE and the Internet Engineering Task Force (IETF), and to continue our active involvement in industry forums, associations and alliances such as the Ethernet Alliance, Metro Ethernet Forum, Open Networking Foundation (ONF), Wi-Fi Alliance, International Telecommunications Union (ITU), Small Cell Forum, Telecommunications Industry Association (TIA) and 3GPP. We also plan to continue to work closely with some of our established customers who are developing emerging network technologies, as well as leading edge start-up companies, to enhance the performance and functionality of our existing systems and to design future products that specifically address our customers’ needs as they evolve.

 

 

License and Acquire New Products. We will continue our strategy of acquiring products in key technologies that expand our product offerings, address customer needs, and enhance the breadth of our evolving product portfolio. In 2013, following acquisitions of Anue Systems and BreakingPoint Systems in 2012, we acquired Net Optics, helping us round out our solutions in network visibility and security. Future acquisitions may be made in the form of partnering with industry leaders, acquiring or licensing technology assets associated with product lines, or acquiring other companies.

 

 

Expand and Further Penetrate Customer Base. We plan to strengthen and further penetrate our existing customer relationships, and expand our reach into new enterprise, government, and service provider customers by:

 

 

o

Continuing to develop and offer new and innovative solutions that meet our existing and potential customers’ needs,

 

o

Expanding our sales and marketing efforts through direct channels and partner relationships to increase penetration in under-represented vertical and geographic market segments,

 

o

Building upon and further strengthening our reputation and brand name recognition, and

 

o

Continuing our focus on customer support by maintaining and expanding the capabilities of our highly qualified and specialized internal personnel.

 

 
7

 

 

 

Expand International Market Presence. We will further pursue sales in key international markets, including the Europe, Middle East and Africa regions (EMEA), and the Asia Pacific region. In order to pursue sales in these markets, we intend to develop and expand our relationships with key customers, partners, resellers and distributors, as well as expand our direct sales and marketing presence within these markets.

 

Ixia Solutions

 

We are a leading provider of converged Internet Protocol (IP) network validation and network visibility solutions. Equipment manufacturers, service providers, enterprises, and government agencies use our solutions to design, verify, and monitor a broad range of Ethernet, Wi-Fi, 3G, and 4G/LTE equipment and networks. Our solutions provide the predictive data needed for organizations to make real-time decisions that will enhance performance, harden security, and increase scalability of networks facing constantly changing requirements.

 

Real-world test solutions must recreate the true behavior of wired and wireless users, at massive scale, with increasing fidelity. Network testing solutions must be highly scalable and capable of generating large amounts of data at high speeds over increasingly complex configurations, and be up to date with the very latest applications and security attacks. Comprehensive, integrated testing must occur throughout network design, development, production, deployment, and operation stages. Because this testing and verification must take place across multiple layers of the network infrastructure and for all network protocols, network testing solutions are also required to be highly flexible, extensible, and modular. This rapid evolution of complex network technologies and protocols – which includes leading-edge technologies such as higher speed Ethernet, LTE and the latest Wi-Fi standards – has resulted in the need for an integrated platform solution that is easy to use, with minimal training and set-up.

 

Our network visibility solutions intelligently connect the data center network with monitoring tools that aggregate, filter, load balance, and de-duplicate network traffic. Our filtering and de-duplication technology ensure that each monitoring tool gets exactly the right data needed for analysis which is powered by an easy to use, drag-and-drop management system. This improves the way our customers manage their data centers, prevents network application and service downtime, and maximizes return on IT investment.

 

Our systems provide our customers with the following key benefits:

 

 

Versatile High Performance. Our network test solutions generate and receive data traffic at full line rate – the maximum rate that data traffic can be transmitted over a network medium. Our systems provide accurate analysis across multiple layers of the overall network and of individual network components in real time. Our systems can be configured to either generate programmed packets of data or conduct complete sessions.

 

Our systems can analyze each discrete packet of information, thereby allowing our customers to precisely measure the performance of their networks and individual network components. This precision allows customers to accurately measure critical quality of service parameters such as throughput, latency, loss, and jitter. It also verifies data integrity, packet sequencing throughout the network, and quality of service (QoS).

 

When used for realistic application sessions or conversations between network endpoints, our systems emulate highly complex and specialized applications such as transferring electronic mail, browsing the Internet, conveying voice and video information, managing databases, and establishing wireless calls. This emulation allows our customers to accurately measure critical characteristics of their networks such as session setup rate, session tear down rate, and session capacity. By analyzing the content of these sessions, our customers can also accurately measure QoS and media quality.

 

Our network visibility solutions allow customers to dynamically aggregate, regenerate, distribute, filter, and condition packets from all parts of the network at full line rate. These high performance systems enable broader network visibility and enhance the performance of customers’ monitoring solutions while reducing costs.

 

 
8

 

 

 

Highly Scalable. Each of our network test interface cards provides one or more ports through which our systems generate and receive data traffic. Each physical port contains its own dedicated logic circuits, with substantial memory and compute resources. Our customers can easily scale the size of their test bed or the amount of data traffic generated by inserting additional interface cards. By connecting multiple chassis and synchronizing hundreds of ports to operate simultaneously, our customers can simulate extremely large networks. Our GPS-based components even allow our chassis to be distributed throughout the world, while maintaining the close time synchronization necessary for precision tests. We believe that our systems can offer our customers one of the highest port density and scalable space efficient systems available. In addition, our client-server architecture allows multiple users in the same or different geographic locations to simultaneously access and operate different ports contained in the same chassis to run independent tests. Customers using our high-density network visibility platform can easily scale their visibility needs through flexible port licensing and modular extensions that can grow with their expanding network monitoring needs.

 

 

Highly Modular Hardware Platform. We offer network test hardware platforms with interchangeable interfaces, using a common set of applications and APIs. Our architectures enable the emulation of millions of network users on scalable platforms, with a mixture of both network and application layer traffic. These architectures offer our customers an integrated test environment that might otherwise require multiple products to cover the same test scenarios. We believe that our network test hardware platform solutions decrease the overall cost while increasing productivity and scalability, and reducing training requirements for our customers. Our network test hardware products consist of stackable and portable chassis which, depending on the chassis model, can be configured with a mix of interface cards. This modular design allows our customers to quickly and easily create realistic, customized test configurations. Our open architecture accelerates the integration of additional network technologies into existing systems through the addition of new interface cards and distributed software. Our modular approach to network visibility allows customers to increase port density, add higher speed links, and/or advanced features – helping customers to future proof their network monitoring and visibility investments.

 

 

Flexible. Our customers can easily expand our systems to address changing technologies, protocols, and applications without changing system hardware or replacing interface cards. This protects and optimizes customers’ investments by eliminating the need for “forklift upgrades” or the purchase of additional niche products. Additionally, customers under our Application and Threat Intelligence (ATI) service receive automatic bi-weekly updates of the latest applications and attacks for use in their real-world testing scenarios.

 

 

Automation. Our systems make it easy to create automated tests and network monitoring rules that can run unattended. We offer our customers a growing library of automated tests and monitoring automation scripts that simplify and streamline the test and monitoring processes. The automated tests are repeatable and the results are presented in a structured format for easy analysis. Ixia offers “Click-Thru Automation” that records and repeats interactive operation, providing automation without programming. In addition, Ixia's Tool Command Language (Tcl) API is a comprehensive programming interface to our hardware, as well as to our software applications. The Tcl API enables libraries of automated scripts to be quickly built with specificity to a customer's environment. We also offer a utility that exports configurations created in our graphical user interface (GUI) as Tcl scripts.

 

 

Ease of Use. We have designed our systems so that users can install and operate them with minimal training and setup. Our network test systems are easy to use and offer our customers a wide range of readily accessible pre-designed test configurations. These tests include industry standard and use case-specific tests. Users can easily configure and operate our systems to generate and analyze data traffic over any combination of interface cards or ports through our graphical user interface that features a familiar Microsoft™ Windows™ point-and-click environment. Once tests are designed in our GUIs, they can be saved for reuse or in Tcl script form for customization and even greater levels of automation. Our network visibility systems also offer customers best in class ease-of-use, with a point-and-click GUI that enables customers to quickly develop complex filtering and packet distribution algorithms with simple, but powerful, drop-down menus. These configurations can be saved for reuse and automated using our RESTful API.

 

 
9

 

 

Products

 

Our product solutions consist of our hardware platforms, such as our chassis, interface cards and appliances, software application tools, and services, including our warranty and maintenance offerings and professional services. Our highly scalable and flexible products enable our customers to configure solutions based on their specific networks and use cases. For example, if our customer wants to analyze the performance of an Ethernet router, the customer could purchase our network test hardware platform, including a chassis and one or more Ethernet interface cards, and our IxNetwork software application. The Company is headquartered in Calabasas, California with operations across the U.S. and the rest of the world.  Our revenues are principally derived from shipments within the U.S. and to the EMEA and Asia Pacific regions. See Note 5 to the consolidated financial statements included in this Annual Report on Form 10-K (this “Form 10-K”) for entity-wide disclosures about products and services, geographic areas and major customers 

 

Hardware Products

 

Sales of our network test hardware products typically include a chassis and one or more Ethernet interface cards. Our software applications and APIs allow our customers to create and manage integrated, easy-to-use automated test environments. Our hardware platform consists largely of interchangeable interface cards which fit into multi-slot chassis. Our chassis are metal cases that incorporate a computer, a power supply, and a backplane which connects the interface cards to the chassis. The interface cards generate, receive and analyze a wide variety of traffic types at multiple network layers.

 

Our primary 12-slot network test chassis (e.g., XGS12 and XG12) provides a high-density, highly-flexible test platform. Operating in conjunction with our software applications, our chassis provide the foundation for a complete, high-performance test environment. A wide array of interface cards is available for our primary chassis. The 12-slot Ixia chassis supports up to 192 Gigabit ports, 384-10GE ports, 48-40GE ports and 24-100 GE ports. These interface cards provide the network interfaces and distributed processing resources needed for executing a broad range of data, signaling, voice, video, and application testing for layers 1-7 of the network stack. Each chassis supports an integrated test controller that manages all system and testing resources. Resource ownership down to a per-port level, coupled with hot-swappable interface modules, ensures a highly-flexible, multi-user testing environment. Backward compatibility is maintained with key existing Ixia interface cards and test applications to provide seamless migration from and integration with existing Ixia test installations.

 

We offer a number of interface cards that operate at speeds of up to 100 gigabits per second. Each one of our interface cards contains one to 32 independent traffic generation and analysis ports. These ports operate at line rate. Each port on most interface cards has a unique transmit stream engine that is used to generate packets of information and a real-time receive analysis engine capable of analyzing the packets as they are received. The transmit stream engine generates millions of data packets or continuous test sequences at line rate that are transmitted through the network and received by the analysis engine. When data packets have been generated, the analysis engine then measures throughput, latency, loss and jitter, and checks data integrity and packet sequence on a packet-by-packet basis. In addition, our systems measure the effectiveness of networks in prioritizing different types of traffic. Most of our current generation interface cards also include a microprocessor per port to generate and analyze sophisticated routing protocols, such as BGP and MPLS, as well as application traffic such as TCP/IP, HTTP and SSL. Each one of our Ixia BreakingPoint load modules can recreate more than 35,000 attacks, including exploits, malware, denial of service (DoS), and mobile malware. These load modules provide application and threat assessment solutions at Internet-scale, and create massive-scale, high fidelity simulation and testing conditions for battle-testing infrastructures, devices, applications, and people.

 

Our network visibility products improve the way our enterprise, service provider, and government customers manage their data centers, save valuable IT time, and maximize return on IT investments. Ixia network visibility solutions revolutionize the way customers monitor their network - enabling complete network visibility into physical and virtual networks, and optimizes monitoring tool performance whether out-of-band or in-line.  Our network visibility platform ranges from network access (TAPs), to solution-specific appliances for smaller implementations to large, high-density, up to 100GE, and NEBS3 compliant chassis designed for large and complex data centers.  These products help our customers monitor their rapidly growing number of 1GE, 10GE, 40GE and 100GE ports with existing monitoring tools.  Sales of our network visibility products typically consist of an integrated, purpose-built hardware appliance with proprietary software which includes patented filtering and packet handling technology that ensures each monitoring tool gets exactly the right data needed for analysis, all powered by the easy to use, drag-and-drop management system.  We also offer advanced feature modules that easily slide into certain of our appliances for additional advanced intelligence and functionality including de-duplication, packet slicing and time-stamping.

 

 
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In addition to our core network visibility functionality, we also have a number of available features that give customers greater flexibility and intelligence for their network visibility implementations. Customers can deploy our network visibility solutions not only out-of-band in physical networks, but in-line for security applications and in virtual environments with our inline technologies and Phantom virtual TAP software application, respectively. Another example is the GTP Session Controller that intelligently manages high-scale, session-aware, mobility load balancing deployments. In addition, our ControlTower solution allows customers to deploy, manage and maintain distributed implementations with ease.

 

Software Applications

 

As part of certain of our network testing hardware platforms, we offer a comprehensive suite of software applications to address specific technologies. These applications measure and analyze the performance, functionality, interoperability, service quality, and conformance of networks, network equipment and applications that run on these networks. These applications enable network equipment manufacturers, service providers, enterprises and governments to evaluate the performance of their equipment and networks during the design, manufacture, and pre-deployment stages, as well as after the equipment is deployed in a network. Our technology-specific application test suites are targeted at a wide range of popular requirements:

 

Video Testing

 

Ixia’s IxLoad tests the performance of video servers, multicast routers and the IP video delivery network. This is accomplished by emulating video servers and millions of video subscribers in video on demand and multicast video scenarios. IxChariot tests video transport networks. This is accomplished by emulating video traffic, and measuring end-to-end video quality. Measurements include throughput, latency, loss, jitter, and media delivery index (MDI).

 

Voice Testing

 

IxLoad tests the functionality of VoIP and PSTN devices and services by emulating end devices and servers. IxChariot tests the voice transport network. This is accomplished by emulating voice traffic and measuring end-to-end voice quality. Measurements include throughput, latency, loss, jitter, and mean opinion score (MOS).

 

Intelligent Network Testing

 

IxLoad tests the performance of content-aware networks and devices including server load balancers (SLB), deep packet inspection (DPI) devices, firewalls, web servers and mail servers. This is accomplished by emulating millions of clients and a variety of servers in realistic performance testing scenarios.

 

Conformance Testing

 

IxANVL provides automated network/protocol validation. Developers and manufacturers of networking equipment and Internet devices can use IxANVL to validate protocol compliance and interoperability. IxANVL supports all industry standard test interfaces including 10Mbps/100Mpbs/1Gbps/10Gbps Ethernet, ATM, Serial, Async, T1/E1, and POS. It provides conformance, negative and regression testing on a large selection of protocols.

 

 
11

 

 

Security Testing

 

IxLoad Attack tests the performance of stateful and deep packet inspection security devices, including firewalls, SSL gateways, virus scanners, spam filters, and intrusion detection systems (IDS). This is accomplished by emulating clients and servers, as well as through the use of distributed denial of service (DDoS) attacks. Key capabilities include the ability to mix valid user traffic with malicious traffic and to attach viruses to emails.

 

IxLoad tests IPsec VPN gateways and systems. This is accomplished by establishing and authenticating IPsec tunnels, and then generating traffic load over the tunnels to verify performance. Site-to-site and remote access VPN testing is supported, as well as DES, 3DES, and AES encryption.

 

IxNetwork, IxLoad, and IxN2X test broadband access devices supporting 802.1x authentication. This is accomplished by high scalable emulation of 802.1x clients (supplicants).

 

Application Testing

 

IxLoad tests the performance of enterprise applications. This is accomplished by emulating a large number of real users accessing applications. Technologies supported include JavaScript, XML, Java, Document Object Model (DOM) and databases (e.g., Oracle, SQL, Access).

 

Router Testing

 

IxNetwork and IxN2X tests core/edge/customer routers and layer 3 switches. This is accomplished by emulating entire network infrastructures and generating high traffic loads across these emulated topologies to verify performance. IxAutomate is an automated test harness that can run turnkey tests using Ixia’s underlying APIs. Multiple turnkey test suites are available to execute control and data plane performance and functionality testing.

 

Switch Testing

 

IxNetwork and IxN2X test layer 2-3 switches and forwarding devices. This is accomplished by generating traffic load across a mesh of interfaces, and then measuring results down to a per flow basis. IxAutomate tests layer 2-3 switches in an automated fashion. A set of predefined test suites is used to execute performance and functionality tests.

 

IxExplorer tests layer 2-3 switches and forwarding devices. This is accomplished by generating traffic load with very granular control of packet parameters and detailed results analysis. Measurements include throughput, latency, inter-arrival time, data integrity and sequence checking.

 

Wireless Testing

 

IxCatapult tests legacy and wireless network protocols associated with 2G, 3G and 4G/LTE wireless networks. This is accomplished through emulation of each network component. These emulations are used in combinations to isolate and test each component or group of components.

 

IxLoad tests 3G and 4G/LTE core networks, including the new evolved packet core (EPC) network. This is accomplished by emulating application traffic whether data, voice, or video and measuring end-to-end performance and quality. Measurements include throughput, latency, jitter, mean opinion score (MOS) and media delivery index (MDI).

 

Wi-Fi Testing

 

IxVeriWave's tools are specifically designed to test Wi-Fi devices and wireless LAN networks using a client-centric model, as well as offering a solution that precisely measures the real-world behavior of a mobile device, its impact on other devices, and overall network performance. This approach delivers repeatable large-scale, real-world test scenarios which are virtually impossible to create by any other means.

 

 
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Broadband Testing

 

IxNetwork, IxLoad and IxN2X test broadband aggregation devices including B-RAS, DSLAMs, CMTSs, and edge routers. This is accomplished by emulating millions of broadband clients and generating traffic load over those connections. IxChariot tests the broadband access transport network. This is accomplished by emulating application traffic – whether data, voice, or video – and measuring end-to-end performance and quality. Measurements include throughput, latency, jitter, mean opinion score (MOS), and media delivery index (MDI).

 

Automated Testing

 

Test case repeatability is critical for developers and test engineers alike. Given shrinking test cycles and higher time to market pressures, automation of test cases is paramount to quality assurance. Ixia offers a wide range of automation tools to suit different needs for flexibility and ease of use. We incorporated a powerful Macro Recorder in our IxNetwork product that records all GUI click-through operations into a repeatable sequence of steps.

 

IxAutomate provides a complete automation environment for testing layer 2-3 routers, switches, and similar devices. A set of predefined test suites is used to execute performance and functionality tests. Multiple tests, whether predefined or custom developed, can be scheduled for execution together with configuration of the device under test.

 

Test Conductor is a comprehensive, highly-scalable regression harness that is compatible with some of our other key network testing tools. Test Conductor imports tests, associates them with a named regression test sequences, and allows detailed scheduling. Tests can be scheduled in series or in parallel based on a Windows Outlook™-like calendar tool. At-a-glance logs and summary reports display color-coded pass/fail results, as well as the progress of the tests within each regression. Automated device under test (DUT) configuration scripts can be scheduled to run in synchronization with the individual tests or with complete regression runs.

 

Our Tcl automation environment provides a comprehensive set of tools and APIs for automating testing with our hardware and software applications. Custom test libraries covering all of a customer's layer 2-7 testing requirements can be created in a single automation environment.

  

Services

 

Our service revenues primarily consist of our technical support, warranty and software maintenance services. We also offer training and professional services.

 

We offer technical support, warranty and software maintenance services with the sale of our hardware and software products. Many of our products include up to one year of these services with the initial product purchase. Our customers may choose to extend the services for annual or multi-year periods. Our technical support services are delivered by our global team of technically knowledgeable and responsive customer service and support staff, and include assistance with the set-up, configuration and operation of Ixia products. Our warranty and software maintenance services include the repair or replacement of defective product, bug fixes, and unspecified when and if available software upgrades.

 

Our technical support and software maintenance services also include the Ixia BreakingPoint Application and Threat Intelligence (ATI) service for the Ixia BreakingPoint platform, which provides a comprehensive suite of application protocols, software updates and responsive technical support. The Ixia BreakingPoint ATI provides full access to the latest security attacks and application updates for use in real-world test and assessment scenarios.

 

Our technical support and software maintenance services also include the Ixia BreakingPoint Application and Threat Intelligence (ATI) service for the Ixia BreakingPoint platform, which provides a comprehensive suite of application protocols, software updates and responsive technical support. The Ixia BreakingPoint ATI provides full access to the latest security attacks and application updates for use in real-world test and assessment scenarios. Our customers may choose to purchase the Ixia BreakingPoint ATI service for annual or multi-year periods.

 

 
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Products in Development

 

We continue to develop our IP testing capabilities, and throughout 2014 we intend to remain focused on improving our position in performance, security, monitoring, functional, interoperability, service quality and conformance in several technology areas including:

 

 

10, 40, and 100GE

 

Application delivery

 

Carrier, Metro, and Data Center Ethernet

 

MPLS and MPLS-TP

 

IPv6

 

Voice and Video over IP

 

Security

 

IPsec

 

Test Automation

 

LTE, LTEAdvanced

 

HetNet, Small Cell

 

VoLTE

 

Femtocell

 

Wi-Fi

 

Network Monitoring/Visibility

 

We may delay or cancel the introduction of new products to the market as a result of a number of factors, some of which are beyond our control. For more information regarding these factors, see “Business Research and Development” and “Risk Factors If we are unable to successfully develop or introduce new products to keep pace with the rapid technological changes that characterize our market, our results of operations will be significantly harmed.”

 

Technology

 

The design of all of our systems requires a combination of sophisticated technical competencies, including designs utilizing field programmable gate arrays (FPGAs) and network processors (NPs). FPGAs are integrated circuits that can be repeatedly reprogrammed to perform different sets of functions as required. NPs are special programmable integrated circuits optimized for networking applications. Many of our systems also require high-speed digital hardware design, software engineering and optical and mechanical engineering. We have built an organization of professional staff with skills in all of these areas. The integration of these technical competencies enables us to design and manufacture test systems which are highly scalable to meet the needs of our customers.

 

Complex Logic Design. Our systems use FPGAs that are programmed by the host computer and therefore can be reconfigured for different applications. Our newest products have high clock frequencies, which are the timing signals that synchronize all components within our system, and logic densities, which are the number of individual switching components, or gates, of more than four million gates per chip. Our customers may obtain updates and enhancements from our website, thereby allowing rapid updates of the system. Almost all of our logic chips are designed in the VHDL hardware description language, a unique programming language tailored to the development of logic chips. This language enables the easy migration of the hardware design to application specific integrated circuits as volumes warrant. We develop VHDL code in a modular fashion for reuse in logic design, which comprises a critical portion of our intellectual property. This reusable technology allows us to reduce the time-to-market for our new and enhanced products.

 

Network Processor Technology. Our patented NP technology enables our products to emulate complex networks and data centers at a very high scale. The programmability of the NPs allows our customers to remain current with new networking technologies, by allowing customers to obtain frequent updates and enhancements from our website.

 

 
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Software Technology. We devote substantial engineering resources to the development of software technology for use in our product lines. We have developed software to control our systems, analyze data collected by our systems, and monitor, maintain and self-test our hardware and field programmable gate array subsystems. A majority of our software technology and expertise is focused on the use of object-oriented development techniques to design software subsystems that can be reused across multiple product lines. These objects are client and server independent allowing for distributed network applications. This software architecture allows all of the software tools developed for our existing products to be utilized in all of our new products with very little modification. Another important component of our software technology is our graphical user interface design. Customer experience with our test and visibility products has enabled us to design a simple yet effective method to display complex configurations in clear and concise graphical user interfaces for intuitive use by engineers.

 

Customers

 

Since our incorporation in May 1997 through December 31, 2013, we have shipped our systems to over 4,700 end customers. No customer other than Cisco Systems together with AT&T accounted for more than 10% of our total revenues over the past three years. Cisco Systems accounted for 10.6% of our total revenues in 2013, 13.5% of our total revenues in 2012 and 14.0% of our total revenues in 2011. AT&T accounted for 14.3% of our total revenues in 2013, 7.4% of our total revenues in 2012 and 3.8% of our total revenues in 2011. See Note 5 to the consolidated financial statements included in this Form 10-K for entity-wide disclosures about products and services, geographic areas and major customers.

 

We do not have long-term or volume purchase contracts that commit our customers to future product purchases, and as a result our customers may reduce or discontinue purchasing from us at any time.

 

Products are generally shipped and billed shortly after receipt of an order. Timing of revenue recognition for services may vary depending on the contractual service period or when the services are rendered. Because of the generally short cycle between order and shipment and occasional customer changes in delivery schedules or cancellation of orders (which are made without significant penalty), we do not believe that our backlog, as of any particular date, is necessarily indicative of actual revenues for any future period. Our backlog includes orders for products scheduled to be shipped and for services scheduled to be delivered to customers within 90 days. Our backlog at December 31, 2013 was approximately $13.6 million, compared with backlog of approximately $29.9 million at December 31, 2012.

 

Competition

 

The market for providing network test and monitoring systems is highly competitive, and we expect this competition to continue in the future. We currently compete with network test and monitoring solution vendors such as Spirent Communications, Gigamon, Danaher, Aeroflex, JDS Uniphase, and NetScout. We also compete either directly or indirectly with large Ethernet switch vendors and network management, analysis, compliance and test tool vendors that offer point solutions that address a subset of the issues that we solve. Additionally, some of our significant customers have developed, or may develop, in-house products for their own use or for sale to others.

 

We believe that the principal competitive factors in our market include:

 

 

Breadth of product offerings and features on a single test or monitoring platform,

 

 

Timeliness of new product introductions,

 

 

Product quality, reliability and performance,

 

 

Price and overall cost of product ownership,

 

 

Ease of installation, integration and use,

 

 

Customer service and technical support, and

 

 

Company reputation and size.

 

We believe that we compete favorably in the key competitive factors that impact our markets. We intend to remain competitive through ongoing research and development efforts that enhance existing systems and to develop products and features. We will also seek to expand our market presence through marketing and sales efforts. However, our markets in which we compete continue to evolve and we may not be able to compete successfully against current or future competitors.

 

 
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We expect to continue to experience significant competition from our existing competitors, and from companies that may enter our existing or future markets. And, as we move into new market segments within the broader network test and monitoring arena, we will be challenged by new competitors. These companies may develop similar or substitute solutions that may be more cost-effective or provide better performance or functionality than our systems. Also, as we broaden our product offerings, we may move into new markets in which we will have to compete against companies already established in those markets. Some of our existing and potential competitors have longer operating histories, substantially greater financial, product development, marketing, service, support, technical and other resources, significantly greater name recognition, and a larger installed base of customers than we do. In addition, many of our competitors have well established relationships with our current and potential customers and have extensive knowledge of our industry. It is possible that new competitors or alliances among competitors will emerge and rapidly acquire market share. Moreover, our competitors may consolidate with each other, or with other companies, giving them even greater capabilities with which to compete against us.

 

To be successful, we must continue to respond promptly and effectively to the challenges of changing customer requirements, technological advances and competitors’ innovations. Accordingly, we cannot predict what our relative competitive position will be as the market evolves for network test and monitoring solutions.

 

Sales, Marketing and Technical Support

 

Sales. We use our global direct sales force to market and sell our systems. In addition, we use distributors and other resellers to complement our direct sales and marketing efforts for certain vertical and geographical markets. We depend on many of our distributors, partners and other resellers to generate sales opportunities and manage the sales process. Our direct sales force maintains close contact with our customers and supports our distributors and other resellers. Another key component of our go-to-market strategy for certain products is strategic relationships with technical partners. These technical partners consist of network monitoring and management companies, including CA, IBM, Network Instruments, Riverbed, HP, ArcSight, and many others that understand the added visibility and return on investment Ixia solutions contribute to the overall monitoring approach. We work with technical partners in two main ways: (i) through customer referrals and recommendations and (ii) through automation integration/interoperability that provides a differentiated solution for our customers.

 

Marketing. We have a number of programs to support the sale and distribution of our systems and to inform existing and potential customers, partners and distributors about the capabilities and benefits of our systems. Our marketing efforts also include promoting our business by:

 

 

Sponsoring technical seminars and webinars that highlight our solutions,

 

 

Participating in industry trade shows and technical conferences,

 

 

Writing and distribution of various forms of collateral, including brochures, white papers, and application notes,

 

 

Demonstrating the performance and scalability of our products at our iSimCity proof-of-concept labs,

 

 

Communicating through our corporate website and various social media outlets, such as LinkedIn, Twitter and our corporate blog, and

 

 

Writing articles for online and print trade journals.

 

Technical Support. We maintain a technically knowledgeable and responsive global customer support team that is critical to our development of long-term customer relationships. Our team can:

 

 

Assist new customers with product installation and licensing,

 

 

Provide configuration assistance and expert advice on how to best use Ixia products,

 

 

Investigate user issues and work to quickly resolve them, and

 

 

Respond to reported hardware failures and repair or replace, if needed.

 

 
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Manufacturing and Supply Operation

 

Our supply operations consist primarily of supply chain management, procurement, quality control, logistics, final assembly, configuration testing and distribution. We outsource the manufacture, assembly and testing of printed circuit board assemblies, certain interface cards and certain chassis to third party contract manufacturers and assembly companies, the most significant of which are located in Malaysia. This manufacturing process enables us to operate without substantial space and personnel dedicated to solely manufacturing operations. As a result, we can leverage a significant portion of the working capital and capital expenditures that may be required for other operating needs.

 

We are dependent upon sole or limited source suppliers for some key components and parts used in our systems, including among others, field programmable gate arrays, memory devices, processors, oscillators and optical modules. We and our contract manufacturers forecast consumption and purchase components through purchase orders. We have no guaranteed or long-term supply arrangements with our respective suppliers. In addition, the availability of many components is dependent in part on our ability and the ability of our contract manufacturers and assembly companies to provide suppliers with accurate forecasts of future requirements, as well as the global commodity market. Any extended interruption in the supply of any of the key components currently obtained from a sole or limited source or delay in transitioning to a replacement supplier’s product or replacement component into our systems could disrupt our operations and significantly harm our business in any given period.

 

Lead times for materials and components ordered by us and by our contract manufacturers vary and depend on factors such as the specific supplier, purchase terms, global allocations and demand for a component at a given time. We and our contract manufacturers acquire materials, complete standard subassemblies and assemble fully-configured systems based on sales forecasts and historical purchasing patterns. If orders do not match forecasts or substantially deviate from historical patterns, we and our contract manufacturers and assembly companies may have excess or inadequate supply of materials and components.

 

Research and Development

 

We believe that research and development is critical to our business. Our development efforts include anticipating and addressing the network performance analysis and monitoring needs of network equipment manufacturers, service providers, enterprises and government customers, and focusing on emerging high growth network technologies.

 

Our future success depends on our ability to continue to enhance our existing products and to develop new products that address the needs of our customers. We closely monitor changing customer needs by communicating and working directly with our customers, partners and distributors. We also receive input from our active participation in industry groups responsible for establishing technical standards.

 

Development schedules for technology products are inherently difficult to predict, and there can be no assurance that we will introduce any proposed new products in a timely fashion. Also, we cannot be certain that our product development efforts will result in commercially successful products or that our products will not contain software errors or other performance problems or be rendered obsolete by changing technology or new product announcements by other companies.

 

We plan to continue to make significant investments in research and development, including investments in certain product initiatives. Our research and development expenses were $117.5 million in 2013, $98.2 million in 2012, and $75.1 million in 2011. These expenses included stock-based compensation expense of $8.1 million in 2013, $6.2 million in 2012, and $4.3 million in 2011.

 

Intellectual Property and Proprietary Rights

 

Our success and ability to compete are dependent in part upon our ability to establish, protect and maintain our proprietary rights to our intellectual property. We currently rely on a combination of patent, trademark, trade secret and copyright laws, and restrictions on disclosure and use, to establish, protect, and maintain our intellectual property rights. We have patent applications and existing patents in the United States, the European Union and other jurisdictions. We cannot be certain that these applications will result in the issuance of any patents, or that any such patents, if they are issued, or our existing patents, will be upheld. We also cannot be certain that such patents, if issued, or our existing patents, will be effective in protecting our proprietary technology. We have registered the Ixia name, the Ixia logo and certain other trademarks in the United States, the European Union and other jurisdictions, and have filed for registration of additional trademarks.

 

 
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We generally enter into confidentiality agreements with our officers, employees, consultants and vendors, and in many instances, our customers. We also generally limit access to and distribution of our source code and further limit the disclosure and use of other proprietary information. However, these measures provide only limited protection of our intellectual property rights. In addition, we may not have signed agreements containing adequate protective provisions in every case, and the contractual provisions that are in place may not provide us with adequate protection in all circumstances.

 

Despite our efforts to protect our intellectual property rights, unauthorized parties may attempt to copy or otherwise obtain or use technology or information such as trade secrets that we regard as confidential and proprietary. We cannot be certain that the steps taken by us to protect our intellectual property rights will be adequate to prevent misappropriation of our proprietary technology or that our competitors will not independently develop technologies that are similar or superior to our proprietary technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. Any infringement or misappropriation of our intellectual property rights could result in significant litigation costs, and any failure to adequately protect our intellectual property rights could result in our competitors’ offering similar products, potentially resulting in loss of competitive advantage, loss of market share and decreased revenues. Litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources and could significantly harm our business.

 

The telecommunication and data communications industries are characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies or related standards that are important to our business. We generally have not conducted searches to determine whether the technologies that we use infringe upon or misappropriate intellectual property rights held by third parties. Any claims asserting that any of our products or services infringe or misappropriate proprietary rights of third parties, if determined adversely to us, could significantly harm our business. See Part I, Item 1A of this Form 10-K for additional information regarding the risks associated with patents and other intellectual property.

 

Employees

 

As of December 31, 2013, we had 1,846 full time employees, 962 of whom were located in the U.S. We also from time to time hire temporary and part-time employees and independent contractors. Our future performance depends, to a significant degree, on our continued ability to attract and retain highly skilled and qualified technical, sales and marketing, and senior management personnel. Our employees are not represented by any labor unions, and we consider our relations with our employees to be good.

 

 
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Available Information

 

Our website address is www.ixiacom.com. Information on our website does not constitute part of this report. We make available free of charge through a link provided at such website our Forms 10-K, 10-Q and 8-K as well as any amendments thereto. Such reports are available as soon as reasonably practicable after they are filed with the Securities and Exchange Commission.

 

The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website that contains reports, proxy and information statements and other information regarding the Company that we file electronically with the SEC at www.sec.gov.

 

 
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Item 1A. Risk Factors

 

The statements that are not historical facts contained in this Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect the current belief, expectations or intent of our management and are subject to and involve certain risks and uncertainties. Many of these risks and uncertainties are outside of our control and are difficult for us to forecast or mitigate. In addition to the risks described elsewhere in this Form 10-K and in certain of our other SEC filings, the following important factors, among others, could cause our actual results to differ materially from those expressed or implied by us in any forward-looking statements contained herein or made elsewhere by or on behalf of us.

 

Our business may be adversely affected by unfavorable general economic and market conditions

 

Our business is subject to the effects of general economic conditions in the United States and globally and, in particular, market conditions in the communications and networking industries. In the past, our operating results have been adversely affected as a result of unfavorable economic conditions and reduced or deferred capital spending in the United States, Europe, Asia and other parts of the world.

 

The global financial crisis began in 2008 and the subsequent recovery from the downturn has been challenging and inconsistent. Instability in the global credit markets, the impact of uncertainty regarding the U.S. federal budget including the effect of the recent sequestration, tapering of bond purchases by the U.S. Federal Reserve, the instability in the geopolitical environment in many parts of the world and other disruptions may continue to put pressure on global economic conditions. If global economic and market conditions, or economic conditions in key markets, remain uncertain or deteriorate further, we may experience material impacts on our business. Unfavorable and/or uncertain economic and market conditions such as these may result in lower capital spending by our customers on network test and monitoring solutions, and therefore demand for our products could decline, adversely impacting our revenue and our ability to accurately forecast the future demand and revenue trends for our products and services. Challenging economic and market conditions may also impair the ability of our customers to pay for the products and services they have purchased.

 

In addition, prolonged unfavorable economic conditions and market turbulence may also negatively impact our contract manufacturers’ and suppliers’ capability to timely supply and manufacture our products, thereby impairing our ability to meet our contractual obligations to our customers. These effects, as well as any other currently unforeseeable effects, are difficult to forecast and mitigate. As a result, we may experience material adverse impacts on our business, operating results, financial condition and stock price.

 

Acquisitions undertaken and any that we may undertake could be difficult to integrate, disrupt our business, dilute shareholder value and significantly harm our operating results

 

Acquisitions are inherently risky and no assurance can be given that our previous acquisitions, including our 2013 acquisition of Net Optics, our 2012 acquisitions of Anue and BreakingPoint, or our future acquisitions will be successful or will not materially and adversely affect our business, operating results or financial condition. We expect to continue to review opportunities to acquire other businesses or technologies that would add to our existing product line, complement and enhance our current products, expand the breadth of our markets, enhance our technical capabilities or otherwise offer growth opportunities. While we are not currently a party to any pending acquisition agreements, we may acquire additional businesses, products or technologies in the future. If we make any further acquisitions, we could issue stock that would dilute existing shareholders’ percentage ownership, and we could incur substantial debt or assume liabilities. Acquisitions involve numerous risks, including the following:

 

 

problems or delays in assimilating or transitioning to Ixia the acquired operations, systems, processes, controls, technologies, products or personnel;

 

 

loss of acquired customer accounts;

 

 

unanticipated costs associated with the acquisition;

 

 
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our failure to identify in the due diligence process significant issues with product quality or development and liabilities related to operational issues, intellectual property infringement or tax or other regulatory matters;

 

 

multiple and overlapping product lines as a result of our acquisitions that are offered, priced and supported differently, which could cause customer confusion and delays;

 

 

higher than anticipated costs in continuing support and development of acquired products;

 

 

diversion of management’s attention from our core business and the challenges of managing larger and more widespread operations resulting from acquisitions;

 

 

adverse effects on existing business relationships of Ixia or the acquired business with its suppliers, licensors, contract manufacturers, customers, resellers and industry experts;

 

 

significant impairment, exit and/or restructuring charges if the products or technologies acquired in an acquisition do not meet our sales expectations or are unsuccessful;

 

 

insufficient revenues to offset increased expenses associated with acquisitions;

 

 

risks associated with entering markets in which we have no or limited prior experience; and

 

 

potential loss of the acquired organization’s or our own key employees.

 

Mergers and acquisitions are inherently risky and subject to many factors outside of our control, and we cannot be certain that we would be successful in overcoming problems in connection with our past or future acquisitions. Our inability to do so could significantly harm our business, revenues and results of operations. See Note 2 in the consolidated financial statements included in this Form 10-K.

 

Competition in our market could significantly harm our results of operations

 

The market for our products is highly competitive. We currently compete with network test and monitoring solution vendors such as Spirent Communications, Gigamon, Danaher, Aeroflex, JDS Uniphase, and NetScout. We also compete either directly or indirectly with large Ethernet switch vendors and network management, analysis, compliance and test tool vendors that offer point solutions that address a subset of the issues that we solve. Additionally, some of our significant customers have developed, or may develop, in-house products for their own use or for sale to others. For example, Cisco Systems, our largest customer, has used internally developed test products for a number of years. Although Cisco Systems has in the past accounted for a significant portion of our revenues, we cannot be certain that it will continue to do so.

 

As we broaden our product offerings, we may move into new markets and face additional competition. Moreover, our competitors may have more experience operating in these new markets and be better established with the customers in these new markets.

 

Some of our competitors and potential competitors have greater brand name recognition and greater financial, technical, marketing, sales and distribution capabilities than we do. Moreover, our competitors may consolidate with each other, or with other companies, giving them even greater capabilities with which to compete against us.

 

Increased competition in the network test and monitoring markets could result in increased pressure on us to reduce prices and could result in a reduction in our revenues and/or a decrease in our profit margins, each of which could significantly harm our results of operations. In addition, increased competition could prevent us from increasing our market share, or cause us to lose our existing market share, either of which would harm our revenues and profitability.

 

 
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We cannot predict whether our current or future competitors will develop or market technologies and products that offer higher performance or more features, or that are more cost-effective than our current or future products. To remain competitive, we must continue to develop cost-effective products and product enhancements which offer higher performance and more functionality. Our failure to do so will harm our revenues and results of operations.

 

If we are unable to successfully develop or introduce new products to keep pace with the rapid technological changes that characterize our market, our results of operations will be significantly harmed

 

The market for our products is characterized by:

 

 

rapid technological change such as the recent advancements of IP-based networks and wireless technologies (e.g., LTE);

 

 

frequent new product introductions such as higher speed and more complex routers;

 

 

evolving industry standards;

 

 

changing customer needs such as the increase in advanced IP services agreed to between service providers and their customers;

 

 

short product life cycles as a result of rapid changes in our customers’ products; and

 

 

new paradigms like Virtualization and Software Defined Networks (SDN).

 

Our performance will depend on our successful development and introductions and on market acceptance, of new and enhanced products that address new technologies and changes in customer requirements. If we experience any delay in the development or introduction of new products or enhancements to our existing products, our operating results may suffer. For instance, undetected software or hardware errors, which frequently occur when new products are first introduced, could result in the delay or loss of market acceptance of our products and the loss of credibility with our customers. In addition, if we are not able to develop, or license, or acquire from third parties, the underlying core technologies necessary to create new products and enhancements, our existing products are likely to become technologically obsolete over time and our operating results will suffer. If the rate of development of new technologies and transmission protocols by our customers is delayed, the growth of the market for our products and therefore our sales and operating results may be harmed.

 

Our ability to successfully introduce new products in a timely fashion will depend on multiple factors, including our ability to:

 

 

anticipate technological changes and industry trends;

 

 

properly identify customer needs;

 

 

innovate and develop and license or acquire new technologies and applications;

 

 

hire and retain necessary technical personnel;

 

 

successfully commercialize new technologies in a timely manner;

 

 

timely obtain key components for the manufacture of new products;

 

 
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manufacture and deliver our products in sufficient volumes and on time;

 

 

price our products competitively;

 

 

provide high quality, timely technical support; and

 

 

differentiate our offerings from our competitors’ offerings.

 

The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technology and market trends. We cannot be certain that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely or cost-effective basis. Further, we cannot be certain that our new products will gain market acceptance or that we will be able to respond effectively to technological changes, emerging industry standards or product announcements by our competitors. If we fail to respond to technological change and the needs of our markets, we will lose revenues and our competitive position will suffer.

 

We depend on sales of a narrow range of products and, if customers do not purchase our products, our revenues and results of operations would be significantly harmed

 

Our business and products are concentrated in the markets for systems that analyze and measure the performance of wired and wireless IP-based networks and for systems that provide network visibility into physical and virtual networks and optimize monitoring tool performance. These markets continue to evolve, and there is uncertainty regarding the size and scope of these markets. Our performance will depend on increased sales of our existing systems and the successful development, introduction and market acceptance of new and enhanced products. We cannot be certain that we will be successful in increasing these sales or in developing and introducing new products. Our failure to do so would significantly harm our revenues and results of operations.

 

Because we depend on a limited number of customers for a majority of our revenues, any cancellation, reduction or delay in purchases by one or more of these customers could significantly harm our revenues and results of operations

 

Historically, a small number of customers has accounted for a significant portion of our total revenues. Sales to our top five customers accounted for 30% to 40% of total revenues for each of the three years ended December 31, 2013, 2012 and 2011. Additionally, sales to our two largest customers, Cisco Systems and AT&T, accounted for 24.9% of our total revenues in 2013, 20.9% of our total revenues in 2012 and 17.8% of our total revenues in 2011. We expect that some customer concentration will continue for the foreseeable future and that our operating results will continue to depend to a significant extent upon revenues from a small number of customers. Our dependence on large orders from a limited number of customers makes our relationships with these customers critical to the success of our business. We cannot be certain that we will be able to retain our largest customers, that we will be able to increase our sales to our other existing customers or that we will be able to attract additional customers. From time to time, we have experienced delays and reductions in orders from some of our major customers. In addition, our customers have sought price reductions or other concessions from us and will likely continue to do so. We typically do not have long-term or volume purchase contracts with our customers, and our customers can stop purchasing our products at any time without penalty and are free to purchase products from our competitors. The loss of one or more of our largest customers, any reduction or delay in sales to one of these customers, our inability to successfully develop and maintain relationships with existing and new large customers, or requirements that we make price reductions or other concessions could significantly harm our revenues and results of operations.

 

Our large customers have substantial negotiating leverage, which may require that we agree to terms and conditions that may have an adverse effect on our business

 

Large network equipment manufacturers and service providers have substantial purchasing power and leverage in negotiating contractual arrangements with us. These customers may require us to develop additional features, reduce our prices or grant other concessions. As we seek to sell more products to these large customers, we may be required to agree to such terms and conditions. These terms may affect the amounts and timing of revenue recognition and our profit margins, which may adversely affect our profitability and financial condition in the affected periods.

 

 
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If we do not diversify our customer base, we may not be able to grow our business or increase our profitability

 

To date, the majority of our total revenues have been generated from sales to network equipment manufacturers. Our growth depends, in part, on our ability to diversify our customer base by increasing sales to service provider, enterprise, and government customers. To effectively compete for the business of these customers, we must develop new products and enhancements to existing products and expand our direct and indirect sales, marketing and customer service capabilities, which will result in increases in operating costs. If we cannot offset these increases in costs with an increase in our revenues, our operating results may be adversely affected. Some of our existing and potential competitors have existing relationships with many service providers, enterprise, and government customers. We cannot be certain that we will be successful in increasing our sales presence in these customer markets. Any failure by us to diversify our customer base and to increase sales in these markets would adversely affect our growth.

 

We have not been in compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Nasdaq’s requirements for continued listing and, as a result, our common stock may be delisted and suspended from trading on the Nasdaq Global Select Market

 

We have been delinquent in the filing of our periodic financial reports with the SEC and, as a result, we are not in compliance with the Nasdaq rule that requires the timely filing of our periodic financial reports with the SEC. On May 2, 2014, Nasdaq notified us that due to our delay in filing with the SEC our Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 and this Form 10-K, our common stock would be delisted unless we timely requested a hearing before a Nasdaq Listings Qualification Panel (a “Hearings Panel”). We timely requested such a hearing, which was held on June 12, 2014. At the hearing, we presented a plan to regain compliance with the rule and requested an extension of time for the filing of our delayed reports, including our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 (the “2014 Form 10-Q”). On May 15, 2014, Nasdaq also advised us that the delayed filing of the 2014 Form 10-Q serves as an additional basis for Nasdaq’s delisting determination. After filing this Form 10-K with the SEC, we will continue to be delinquent in our filings with the SEC due to our delay in filing the 2014 Form 10-Q. There can be no assurance that the Hearings Panel will grant us additional time to regain compliance with the listing rule or that, if granted such an extension, we will be successful in regaining compliance with the listing rule during the extension period. If our common stock is delisted, there can no assurance whether or when it would again be listed for trading on Nasdaq or any other exchange. If our common stock is delisted, the market price of our shares will likely decline and become more volatile, and our shareholders may find that their ability to trade in our stock will be adversely affected. A delisting from Nasdaq may also have other negative implications, including the potential loss of confidence by customers and employees, the loss of institutional investor interest, fewer business development opportunities and a requirement, under the Indenture, that we offer to repurchase the Notes.

   

The restatement of certain of our prior period consolidated financial statements reflected in our Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Annual Report on Form 10-K”)  (the “2012 Restatement”) and the restatements of the first and second quarterly periods of 2013 reflected in the applicable amended Quarterly Reports on Form 10-Q/A (the “2013 Restatement”) may affect shareholder confidence, may consume a significant amount of our time and resources and may have a material adverse effect on our business and stock price 

 

As discussed in our previously filed 2012 Annual Report on Form 10-K and in our amended Quarterly Reports on Form 10-Q/A for the first and second quarterly periods of 2013, we restated certain prior period consolidated financial statements to correct errors in the timing of when revenue was recognized, and to reflect the income tax effects of such revenue errors.

  

 We cannot be certain that the measures we have taken since we completed the restatements will ensure that restatements will not occur in the future. The restatements may affect investor confidence in the accuracy of our financial statements and disclosures, may raise reputational issues for our business and may result in a decline in our share price and related shareholder lawsuits. These risks with respect to the 2013 Restatement may be heightened due to our having restated certain prior period financial statements in our 2012 Restatement. We are currently a party to three shareholder lawsuits relating to the 2012 Restatement.

 

 

 
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The 2013 Restatement was resource-intensive and involved a significant amount of internal resources, including attention from management, and significant legal and accounting costs. Although we have now completed the 2013 Restatement, we cannot guarantee that we will not receive inquiries from the SEC or Nasdaq regarding our restated financial statements or matters relating thereto. Any future inquiries from the SEC or Nasdaq as a result of the 2013 Restatement of our historical financial statements will, regardless of the outcome, likely consume a significant amount of our internal resources and result in additional legal and accounting costs.

 

Each of these risks described above could have a material adverse effect on our business, results of operations and financial condition.

 

We cannot assure investors that we will be able to fully address the material weaknesses in our internal controls or that remediation efforts will prevent future material weaknesses

 

We have identified control deficiencies in our financial reporting process that constitute material weaknesses, which contributed to the restatement of the condensed consolidated financial statements in our previously filed Forms 10-Q’s for the quarters ended March 31, 2013 and June 30, 2013. We have initiated certain measures, including initiating the implementation of a new revenue recognition system and increasing the number of employees on, and the expertise of, our accounting team, to remediate these weaknesses, and plan to implement additional appropriate measures as part of this effort. There can be no assurance that we will be able to fully remediate our existing material weaknesses or that the implementation of the new revenue recognition system and increasing the number and expertise of our accounting team will remediate or prevent these weaknesses from re-occurring in the future.

 

Further, there can be no assurance that we will not suffer from other material weaknesses in the future. If we fail to remediate these material weaknesses or fail to otherwise maintain effective internal controls over financial reporting in the future, such failure could result in a material misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and which could cause investors and other users to lose confidence in our financial statements, limit our ability to raise capital and have a negative effect on the trading price of our common stock. Additionally, failure to remediate the material weaknesses or otherwise failing to maintain effective internal controls over financial reporting may also negatively impact our operating results and financial condition, impair our ability to timely file our periodic and other reports with the SEC, subject us to additional litigation and regulatory actions and cause us to incur substantial additional costs in future periods relating to the implementation of remedial measures.

 

Our quarterly and annual operating results have historically fluctuated or may fluctuate significantly in the future as a result of new product introductions, changes in judgments or estimates, and/or other factors, which fluctuations could cause our stock price to decline significantly

 

Our quarterly and annual operating results are difficult to predict and have fluctuated and may fluctuate significantly due to a variety of factors, many of which are outside of our control. Some of the factors that could cause our quarterly and annual operating results to fluctuate include the other risks discussed in this “Risk Factors” section.

 

We may experience a shortfall or delay in generating or recognizing revenues for a number of reasons. Orders on hand at the beginning of a quarter and orders generated in a quarter do not always result in the shipment of products and the recognition of revenues for that quarter. For example, failure to ship products by the end of the quarter in which they are ordered or our inability to recognize revenue for products shipped in a quarter due to nonstandard terms in our sales arrangements may adversely affect our operating results for that quarter. Our agreements with customers typically provide that the customer may delay scheduled delivery dates and cancel orders prior to shipment without penalty. Because we incur operating expenses based on anticipated revenues and a high percentage of our expenses are fixed in the short term, any delay in generating or recognizing forecasted revenues could significantly harm our results of operations.

 

 
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In addition, a significant portion of our orders generated and product shipments in each quarter occurs near the end of the quarter. Since individual orders can represent a meaningful percentage of our revenues and net income in any quarter, the deferral or cancellation of or failure to ship an order in a quarter can result in a revenue and net income shortfall that causes us to fail to meet securities analysts’ expectations, our business plan or financial guidance provided by us to investors for that period, and may cause fluctuations in our revenue in subsequent periods.

 

Our operating results may also vary as a result of the timing of our release of new products. The introduction of a new product in any quarter may cause an increase in revenues in that quarter that may not be sustainable in subsequent quarters. Conversely, a delay in introducing a new product in a quarter may result in a decrease in revenues in that quarter and lost sales. Our results may also fluctuate based on the mix of products and services (i.e., hardware, software and extended warranty and maintenance services) ordered in a particular quarter.

 

Further, actual events, circumstances, outcomes, and amounts differing from judgments, assumptions and estimates used in determining the values of certain assets (including the amounts of related valuation allowances), liabilities and other items reflected in our consolidated financial statements could significantly harm our results of operations.

 

The factors described above are difficult to forecast and mitigate. As a consequence, operating results for a particular period are difficult to predict, and therefore, prior results are not necessarily indicative of results to be expected in future periods. Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations and financial condition and could adversely affect our stock price.

 

We expect our gross margins to vary over time and our recent level of gross margins may not be sustainable, which may have a material adverse effect on our future profitability

 

Our recent level of gross margins may not be sustainable and may be adversely affected by numerous factors, including:

 

 

increased price competition;

 

 

changes in customer, geographic or product mix (such as the mix of software versus hardware product sales);

 

 

the pricing we are able to obtain from our component suppliers and contract manufacturers;

 

 

new product introductions by us and by our competitors;

 

 

changes in shipment volume;

 

 

excess or obsolete inventory costs;

 

 

increased industry consolidation among our customers, which may lead to decreased demand for, and downward pricing pressure on, our products; and

 

 

increases in labor costs.

 

Each of the above factors may be exacerbated by a decrease in demand for our established products and our transition to our next-generation products. Our failure to sustain our recent level of gross margins due to these or other factors may have a material adverse effect on our results of operations.     

 

 
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We are a defendant in a class action and in a consolidated shareholder derivative action, and these lawsuits and any future such lawsuits may adversely affect our business, financial condition, results of operations and cash flows

 

We and certain of our current and former executive officers and directors are defendants in a federal securities class action lawsuit and a consolidated shareholder derivative action. These lawsuits are described in Part I, Item 3 “Legal Proceedings” in this Form 10-K. These lawsuits may divert our attention from our ordinary business operations, and we may incur significant expenses associated with their defense (including, without limitation, substantial attorneys’ fees and other fees of professional advisors and potential obligations to indemnify current and former officers and directors who are or may become parties to such actions). Depending on the outcome of the class action lawsuit, we may be required to pay material damages and fines, consent to injunctions on future conduct and/or suffer other penalties, remedies or sanctions. Accordingly, the ultimate resolution of these matters could have a material adverse effect on our business, results of operations, financial condition, liquidity and ability to meet our debt obligations and, consequently, could negatively impact the trading price of our common stock. In addition, there is the potential for additional shareholder litigation and for governmental investigations and/or enforcement actions. Any existing or future shareholder lawsuits and any future governmental investigations and/or enforcement actions could adversely impact our reputation, our relationships with our customers and our ability to generate revenue.

 

The loss of any of our key personnel or our inability to successfully hire a permanent CEO and CFO could significantly harm our business, results of operations and competitive position

 

In order to compete, we must attract, retain, and motivate executives and other key employees. Hiring and retaining qualified executives, scientists, engineers, technical staff, and sales representatives are critical to our business, and competition for experienced employees in our industry can be intense. Our former President and Chief Executive Officer (CEO) resigned in October 2013, and our Board of Directors is working to identify a successor. In the meantime, Errol Ginsberg is our Acting Chief Executive Officer. Mr. Ginsberg also currently serves as our Chairman of the Board and Chief Innovation Officer. Our former Chief Financial Officer (CFO) resigned in March 2014, and our Board of Directors is working to identify a successor. In the meantime, Brent Novak is our Acting Chief Financial Officer. Mr. Novak also currently serves as our Vice President of Finance. The succession and transition process may have a direct or indirect adverse effect on our business, results of operations, and competitive position. To help attract, retain, and motivate qualified employees, we use share-based incentive awards such as employee stock options and restricted stock units. If the value of such stock awards does not appreciate as measured by the performance of the price of our common stock, or if our share-based compensation otherwise ceases to be viewed as a valuable benefit, our ability to attract, retain, and motivate employees could be weakened, which could harm our results of operations.

   

Moreover, companies in our industry whose employees accept positions with competitors frequently claim that those competitors have engaged in unfair hiring practices. We may be subject to such claims as we seek to retain or hire qualified personnel, some of whom may currently be working for our competitors. Some of these claims may result in material litigation. We could incur substantial costs in defending ourselves against these claims, regardless of their merits. Such claims could also discourage potential employees who currently work for our competitors from joining us.

 

Continued growth will strain our operations and require us to incur costs to maintain and upgrade our management and operational resources

 

We have experienced growth in our operations, including number of employees, sales, products, facility locations and customers, including as a result of our recent acquisitions, and expect to continue to experience growth in the future. Unless we manage our past and future growth effectively, we may have difficulty in operating our business. As a result, we may inaccurately forecast sales and materials requirements, fail to integrate new personnel or fail to maintain adequate internal controls or systems, which may result in fluctuations in our operating results and cause the price of our stock to decline. We may continue to expand our operations to enhance our product development efforts and broaden our sales reach, which may place a significant strain on our management and operational resources. In order to manage our growth effectively, we must improve and implement our operational systems, procedures and controls on a timely basis. If we cannot manage growth effectively, our profitability could be significantly harmed.

 

 
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If we are unable to expand and maintain our sales and distribution channels or are unable to successfully manage our expanded sales organization, our revenues and results of operations will be harmed

 

Historically, we have relied primarily on a direct sales organization, supported by distributors, partners and other resellers, to sell our products. We may not be able to successfully expand our sales and distribution channels, and the cost of any expansion may exceed the revenues that we generate as a result of the expansion. To the extent that we are successful in expanding our sales and distribution channels, we cannot be certain that we will be able to compete successfully against the significantly larger and better-funded sales and marketing operations of many of our current or potential competitors. In some cases, we may grant exclusive rights to certain distributors to market our products in their specified territories. Our distributors may not market our products effectively or devote the resources necessary to provide us with effective sales, marketing and technical support. In the past, we have had distributors who entered bankruptcy or who performed poorly and were therefore terminated as distributors of our products. Moreover, if we terminate a distribution relationship for performance-related or other reasons, we may be subject to wrongful termination claims which may result in material litigation and could adversely impact our profitability. Our inability to effectively manage the expansion of our sales and support staff, or to maintain existing or establish new relationships with successful distributors and partners, would harm our business, revenues and results of operations.

 

Changes in industry and market conditions could lead to charges related to discontinuances of certain of our products and asset impairments

 

In response to changes in industry and market conditions, we may be required to strategically realign our resources by restructuring our operations and/or our product offerings. Any decision to limit investment in or dispose of a product offering may result in the recording of special charges to earnings, such as inventory, fixed asset and technology-related write-offs and charges relating to consolidation of excess facilities, which could adversely impact our business, results of operations and financial position.

 

International activity may increase our cost of doing business or disrupt our business

 

We plan to continue to maintain or expand our international operations and sales activities. Operating internationally involves inherent risks that we may not be able to control, including:

 

 

difficulties in recruiting, hiring, training and retaining international personnel;

 
 

increased complexity and costs of managing international operations;

 
 

growing demand for and cost of technical personnel;

  
 

changing governmental laws and regulations, including those related to income taxes, the UK Anti-Bribery Act, and the Foreign Corrupt Practices Act;

 
 

increased exposure to foreign currency exchange rate fluctuations;

 
 

political and economic instability, including military conflict and social unrest;

 
 

commercial laws and business practices that favor local competition;

 
 

differing labor and employment laws;

 
 

supporting multiple languages;

 
 

reduced or limited protections of intellectual property rights;

 
 

more complicated logistical and distribution arrangements; and

  
 

longer accounts receivable cycles and difficulties in collecting receivables.

 

The above risks associated with our international operations and sales activities can restrict or adversely affect our ability to sell in international markets, disrupt our business and subject us to additional costs of doing business.

 

 
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Some key components in our products come from sole or limited sources of supply, which exposes us to potential supply shortages that could disrupt the manufacture and sale of our products

 

We and our contract manufacturers currently purchase a number of key components used to manufacture our products from sole or limited sources of supply for which alternative sources may not be available. From time to time, we have experienced shortages of key components, including chips, oscillators, memory devices and optical modules. We and our contract manufacturers have no guaranteed or long-term supply arrangements for these or other components, including field programmable gate arrays (FPGAs) and Network Processors (NPs), which are integrated circuits that can be repeatedly reprogrammed to perform different sets of functions as required. Financial or other difficulties faced by our suppliers or significant changes in market demand for necessary components could limit the availability to us and our contract manufacturers of these components. Any interruption or delay in the supply of any of these components could significantly harm our ability to meet scheduled product deliveries to our customers and cause us to lose sales.

 

In addition, the purchase of these components on a sole or limited source basis subjects us to risks of price increases and potential quality assurance problems. Consolidation involving suppliers could further reduce the number of alternatives available to us and affect the availability and cost of components. An increase in the cost of components could make our products less competitive and result in lower gross margins.

 

There are limited substitute supplies available for many of these components, including field programmable gate arrays. All of these components are critical to the production of our products, and competition exists with other manufacturers for these key components. In the event that we can no longer obtain materials from a sole source supplier, we might not be able to qualify or identify alternative suppliers in a timely fashion, or at all. Any extended interruption in the supply of any of the key components currently obtained from a sole or limited source or delay in transitioning to a replacement supplier’s product or replacement component into our systems could disrupt our operations and significantly harm our business in any given period.

 

Our reported financial results could suffer if there is an impairment of goodwill or acquired intangible assets

 

We are required (i) to test annually, and review when circumstances warrant, the value of our goodwill associated with past acquisitions and any future acquisitions, and (ii) to test the value of our acquisition-related intangible assets when circumstances warrant determining if an impairment has occurred. If such assets are deemed impaired, an impairment loss equal to the amount by which the applicable carrying amount exceeds (i) the implied fair value of the goodwill or (ii) the estimated fair value of acquired intangible assets would be recognized. This would result in an incremental charge for that quarter which would adversely impact our earnings for the period in which the impairment was determined to have occurred. For example, such impairment could occur if the market value of our Common Stock falls below the carrying value of our net assets for a sustained period. The recent economic downturn contributed to extreme price and volume fluctuations in global stock markets that reduced the market price of many technology company stocks, including ours. Such declines in our stock price or the failure of our stock price to recover from these declines, as well as any marked decline in our level of revenues or profit margins, increase the risk that goodwill may become impaired in future periods. We cannot accurately predict the amount and timing of any impairment of our goodwill or acquired intangible assets.

 

Restructuring our workforce can be disruptive and harm our operating results and financial condition

 

We have in the past restructured or made other adjustments to our workforce in response to the economic environment, performance issues, acquisitions and other internal and external considerations. Restructurings can among other things result in a temporary lack of focus and reduced productivity. These effects could recur in connection with future acquisitions and other restructurings and, as a result, our operating results and financial condition could be negatively affected.

 

 
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Legal proceedings may harm our business, results of operations and financial condition

 

We are a party to lawsuits and other legal proceedings in the normal course of our business. Litigation and other legal proceedings can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. We cannot provide assurance that we will not be a party to additional legal proceedings in the future or that we will be able to favorably resolve our current lawsuits. To the extent legal proceedings continue for long time periods or are adversely resolved, our business, results of operations and financial position could be significantly harmed. For additional information regarding certain of the legal matters in which we are involved, see Item 3, “Legal Proceedings,” contained in Part I of this Form 10-K and in Note 10 to the consolidated financial statements included in this Form 10-K. For information regarding the risks associated with the shareholder class action and the consolidated shareholder derivative action, see “We are a defendant in a class action and in a consolidated shareholder derivative action, and these lawsuits and any future such lawsuits may adversely affect our business, financial condition, results of operations and cash flows” above.

 

Claims that we infringe third-party intellectual property rights could result in significant expenses or restrictions on our ability to sell our products

 

From time to time, other parties may assert patent, copyright, trademark and other intellectual property rights to technologies and items that are important to our business. We cannot provide assurance that others will not claim that we have infringed upon or misappropriated their intellectual property rights or that we do not in fact infringe upon or misappropriate those intellectual property rights. We have not generally conducted searches to determine whether the technology we have in our products infringes or misappropriates intellectual property rights held by third parties.

 

Any claims asserting that any of our products or services infringe or misappropriate proprietary rights of third parties, if determined adversely to us, could significantly affect our ability to conduct business and harm our results of operations. Any such claims, with or without merit, could:

 

 

be time-consuming;

 
 

result in costly and protracted litigation;

 
 

divert the efforts of our technical and management personnel;

 
 

require us to modify the products or services at issue or to develop alternative technology, thereby causing delivery delays and the loss or deferral of revenues;

 
 

require us to cease selling the products or services at issue;

 
 

require us to pay substantial damage awards;

 
 

expose us to indemnity claims from our customers;

 
 

damage our reputation; or

 
 

require us to enter into royalty or licensing agreements which, if required, may not be available on terms acceptable to us, if at all.

 

In the event any such claim against us was successful and we could not obtain a license to the relevant technology on acceptable terms, license a substitute technology or redesign our products or services to avoid infringement or misappropriation, our revenues, results of operations, and competitive position could be harmed.

 

 
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If we fail to accurately forecast our manufacturing requirements, we could incur additional costs and experience manufacturing delays

 

We provide our contract manufacturers with rolling forecasts based on anticipated product orders to determine our manufacturing requirements. Some of the components used in our products have significant lead times or lead times which may unexpectedly increase depending on factors such as the specific supplier, contract terms and the demand for components at a given time. Because of these long lead times, we are often required to forecast and order products before we know what our specific manufacturing requirements will be. If we overestimate our product orders, our contract manufacturers may have excess inventory of completed products which we would be obligated to purchase. This will lead to increased costs and the risk of obsolescence. If we underestimate our product orders, our contract manufacturers may have inadequate inventory, which could result in delays in shipments, the loss or deferral of revenues and/or higher costs of sales. Costs are also added to our products when we are required to expedite delivery of our products to customers or of components with long lead times to our contract manufacturers. We cannot be certain that we will be able to accurately forecast our product orders and may in the future carry excess or obsolete inventory, be unable to fulfill customer demand, or both, thereby harming our revenues, results of operations and customer relationships.

 

Failure by our contract manufacturers to provide us with adequate supplies of high quality products could harm our revenues, results of operations, competitive position and reputation

 

We currently rely on a limited number of contract manufacturers to manufacture and assemble our products. We may experience delays in receiving product shipments from contract manufacturers or other problems, such as inferior quality and insufficient quantity of product. We cannot be certain that we will be able to effectively manage our contract manufacturers or that these manufacturers will meet our future requirements for timely delivery of products of sufficient quality and quantity. We intend to introduce new products and product enhancements, which will require that we rapidly achieve adequate production volumes by effectively coordinating with our suppliers and contract manufacturers. The inability of our contract manufacturers to provide us with adequate supplies of high-quality products or the loss of any of our contract manufacturers would cause a delay in our ability to fulfill customer orders while we obtain a replacement manufacturer and would harm our revenues, results of operations, competitive position and reputation.

 

To the extent that our customers consolidate, they may reduce purchases of our products and demand more favorable terms and conditions from us, which would harm our revenues and profitability

 

Consolidation of our customers could reduce the number of customers to whom our products could be sold. These merged customers could obtain products from a source other than us or demand more favorable terms and conditions from us, which would harm our revenues and profitability. In addition, our significant customers may merge with or acquire our competitors and discontinue their relationships with us.

 

Our products may contain defects which may cause us to incur significant costs, divert our attention from product development efforts and result in a loss of customers

 

Our existing products and any new or enhanced products we introduce may contain undetected software or hardware defects when they are first introduced or as new versions are released. These problems may cause us to incur significant damages or warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relation problems or loss of customers and reputation, all of which would harm our results of operations. A successful claim against us for an amount exceeding the limit on our product liability insurance policy would force us to use our own resources, to the extent available, to pay the claim, which could result in an increase in our expenses and a reduction of our working capital available for other uses, thereby harming our profitability and capital resources.

 

Our failure to protect our intellectual property may significantly harm our results of operations and reputation

 

Our success and ability to compete is dependent in part on our ability to establish, protect and maintain our proprietary rights to our intellectual property. We currently rely on a combination of patent, trade secret, trademark and copyright laws, and restrictions on disclosure and use, to establish, protect, and maintain our intellectual property rights. To date, we have relied primarily on trade secret laws to protect our proprietary processes and know-how. We also have patent applications and existing patents in the United States and other jurisdictions. We cannot be certain that any of these applications will be approved or that any such patents, if issued, or our existing patents, will be upheld. We also cannot be certain that our existing patents and any such additional patents, if issued, will be effective in protecting our proprietary technology.

 

 
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We generally enter into assignment of rights and confidentiality agreements with our officers, employees and consultants. We also generally limit access to and distribution of our source code and further limit the disclosure and use of our other proprietary information. However, these measures provide only limited protection of our intellectual property rights. In addition, we may not have signed agreements containing adequate protective provisions in every case, and the contractual provisions that are in place may not provide us with adequate protection in all circumstances. Any infringement or misappropriation of our intellectual property rights could result in significant litigation costs, and any failure to adequately protect our intellectual property rights could result in our competitors’ offering similar products, potentially resulting in loss of one or more competitive advantages, loss of market share and decreased revenues.

 

Despite our efforts to protect our intellectual property rights, existing trade secret, copyright, patent and trademark laws afford us only limited protection. In addition, the laws of some foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States. Accordingly, we may not be able to prevent misappropriation of our proprietary technologies or to deter others from developing similar technologies. Others may attempt to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Further, monitoring the unauthorized use of our products and our intellectual property rights is difficult. Litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources and could significantly harm our results of operations and reputation.

 

The inability to successfully defend claims from taxing authorities or the adoption of new tax legislation could adversely affect our operating results and financial position

 

We conduct business in many countries, which requires us to interpret the income tax laws and rulings in each of those jurisdictions. Due to the complexity of tax laws in those jurisdictions as well as the subjectivity of factual interpretations, our estimates of income tax liabilities may differ from actual payments or assessments. Claims from tax authorities related to these differences could have an adverse impact on our results of operations, financial condition and cash flows. In addition, legislative bodies in the various countries in which we do business may from time to time adopt new tax legislation that could have a material adverse effect on our results of operations, financial condition and cash flows.

 

Servicing our debt will require a significant amount of cash, and we may not have sufficient cash flow from our business to service our existing debt or debt we may incur

 

Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our existing or new indebtedness, including our convertible senior notes and any indebtedness under our 2012 credit facility, depends on our future performance, which is subject to economic, financial, competitive and other factors, many of which are beyond our control. Our business may not continue to generate cash flow from operations in the future sufficient to service our indebtedness and make necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our existing or future debt obligations.

 

The issuance of shares of our Common Stock upon any conversion of our Convertible Senior Notes would dilute the ownership interest of our existing shareholders, including holders who had previously converted their Convertible Senior Notes

 

The issuance of shares of our Common Stock upon conversion of our Notes, including the effect on the conversion rate should a make whole adjustment event occur, would dilute the ownership interests of our existing shareholders. Any sales in the public market of our Common Stock issuable upon such conversion could adversely affect prevailing market prices of our Common Stock. In addition, the existence of the Notes may encourage short selling by market participants because the conversion of the Notes could depress the price of our Common Stock.

 

 
32

 

 

The fundamental change repurchase feature of the Convertible Senior Notes may delay or prevent an otherwise beneficial attempt to take over our company

 

The terms of the Notes require us to offer to repurchase the Notes for cash in the event of a fundamental change (such as a change in control event or if our Common Stock ceases to be listed or quoted on any of the New York Stock Exchange, the Nasdaq Global Select Market or the Nasdaq Global Market or any of their respective successors). A non-stock takeover of our company may also trigger the requirement that we repurchase the Notes. These features may have the effect of delaying or preventing a takeover of our company that would otherwise be beneficial to investors.

 

We have outstanding debt and may incur other debt in the future, which could adversely affect our financial condition, liquidity and results of operations

 

On December 21, 2012, we entered into a credit agreement establishing a senior secured revolving credit facility (the “Credit Facility”) with certain institutional lenders that provides for an aggregate loan amount of up to $150.0 million. We may in the future borrow amounts under this Credit Facility and use the proceeds to fund working capital needs and capital expenditures and for other general corporate purposes, including acquisitions, stock repurchases and any partial refinancing of our Notes. Increases in our aggregate levels of debt may adversely affect our operating results and financial condition by, among other things:

 

 

increasing our vulnerability to downturns in our business, to competitive pressures and to adverse economic and industry conditions;

 
 

requiring the dedication of an increased portion of our expected cash from operations to service our indebtedness, thereby reducing the amount of expected cash flow available for other purposes; and

 
 

limiting our flexibility in planning for, or reacting to, changes in our business and our industry.

 

If we fail to comply with certain covenants under our Credit Facility, any borrowings must be repaid, we may be prevented from further borrowing and/or the Credit Facility may be terminated by the lenders

 

Our Credit Facility established in December 2012 imposes restrictions on us, including restrictions on our ability to create liens on our assets and the ability of certain of our subsidiaries to incur indebtedness, and requires us to maintain compliance with specified financial ratios. The financial covenants in the related credit agreement require us to maintain a maximum leverage ratio below a specific threshold and minimum interest coverage above a specified threshold. The credit agreement also requires us, among other things, to timely deliver certain financial statements to the lenders. We may also be in default under the credit agreement if our payment obligations under the Notes are accelerated or if we are required to offer to repurchase the Notes in the event of any delisting of our common stock. Our failure to comply with such covenants and any such events under the Indenture could cause a default under the credit agreement. We may then be required to repay any borrowings under the Credit Facility with capital from other sources. We could also be blocked from borrowing or obtaining letters of credit under the Credit Facility and the Credit Facility could be terminated by the lenders. Under these circumstances, other sources of capital may not be available to us or may be available only on unfavorable terms. In the event of a default, it is possible that assets of the Company and certain of our subsidiaries may be attached or seized by the lenders. While we would otherwise be in default of our obligations under the credit agreement to deliver certain financial statements to the lenders and to comply with the financial reporting requirements under the Indenture, the lenders have agreed to extend the period for such deliveries and to provide temporary waivers of any default arising from our failure to comply with the Indenture. There can be no assurance, however, that any such waivers or extensions will be available in the future or will extend until such time as we are able to deliver all required financial statements under the credit agreement.

 

 
33

 

 

Because we are in default under the Indenture governing our Notes and are subject to potential delisting by Nasdaq, we may become subject to material financial obligations under the Indenture

 

Under the Indenture for our Notes, we are required to file with the trustee our reports that we file with the SEC within 15 days after they are required to be filed with the SEC. We are currently in default of this obligation and, following the filing of this Form 10-K, will remain in default due to our failure to file with the trustee within 15 days after its prescribed due date our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 (the “2014 First Quarter Form 10-Q”). If the trustee or the holders of at least 25% in aggregate principal amount of the Notes give us notice of, and direct us to cure, such default, and the default is not cured within 60 days after our receipt of such notice, then an event of default will occur. Upon any such event of default, we may elect that for the first 180 days (or such lesser amount of time during which the event of default continues), the sole remedy be the payment to the holders of the Notes of additional interest at an annual rate equal to 0.50% of the aggregate principal amount of the Notes. If we make such an election and the event of default is not cured within 180 days, or if we do not make such an election when the event of default first occurs, the trustee or the holders of at least 25% in aggregate principal amount of the Notes may declare the Notes to be due and payable immediately. Under the Indenture, if our common stock were to cease to be listed on the Nasdaq Global Select Market as a result of the delayed filing of the 2014 First Quarter Form 10-Q or for any other reason, then any holder of Notes could require us to repurchase the holder’s Notes in accordance with the terms of the Indenture. In the event of any acceleration or repurchase obligations, sources of funding may not be available to us or may only be available on unfavorable terms. Any acceleration of the Notes or required offer to repurchase the Notes could have a material adverse effect on our liquidity and financial condition.

 

Our investment portfolio may become impaired by deterioration of the financial markets

 

We follow an established investment policy and set of objectives designed to preserve principal and liquidity, to generate a market return given the policy’s guidelines and to avoid certain investment concentrations. The policy also sets forth credit quality standards and limits our exposure to any one non-government issuer. Our investment portfolio as of December 31, 2013 consisted of money market funds, U.S. Treasury, government agency debt securities and corporate debt securities.

 

These investments are classified as available-for-sale and are recorded on our consolidated balance sheets at fair value. Although our investment portfolio’s amortized cost approximated fair value as of December 31, 2013, we cannot predict future market conditions or market liquidity, or the future value of our investments. As a result, we can provide no assurance that our investment portfolio will not be impaired in the future and that any such impairment will not materially and adversely impact our financial condition, results of operations and cash flows.

 

Changes in laws, regulations and financial accounting standards may affect our reported results of operations

 

A change in accounting policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New pronouncements and varying interpretations of existing pronouncements have occurred with frequency and may occur in the future. Changes to existing rules, or changes to the interpretations of existing rules, could lead to changes in our accounting practices, and such changes could adversely affect our reported financial results or the way we conduct our business and could have an adverse effect on our stock price.

 

Our business is subject to changing regulation that has resulted in increased costs and may continue to result in additional costs in the future

 

We are subject to laws, rules and regulations of federal and state regulatory authorities, including The Nasdaq and financial market entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. During the past few years, these entities, including the Public Company Accounting Oversight Board, the SEC and Nasdaq, have issued new requirements and regulations and continue to develop additional regulations and requirements partly in response to laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002 (“SOX”) and, more recently, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Our efforts to comply with these requirements and regulations have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of substantial management time and attention from revenue-generating activities to compliance activities.

 

 
34

 

 

In particular, our efforts to comply with Section 404 of SOX and the related regulations regarding our required assessment of our internal control over financial reporting and our independent registered public accounting firm’s audit of the effectiveness of our internal control over financial reporting, have required, and continue to require, the commitment of significant financial and managerial resources. To the extent that we identify areas of our disclosures controls and procedures and/or internal controls requiring improvement (such as the material weaknesses, discussed in Item 9A herein, that existed as of December 31, 2013), we may have to incur additional costs and divert management’s time and attention.

 

Because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.

 

We are also subject to laws, rules and regulations of authorities in other countries where we do business, and these laws, rules and regulations are also subject to change and uncertainty regarding their application and interpretation. The growth of our operations, both domestically and internationally, has resulted in and is likely to continue to result in increased expense, resources and time spent on matters relating to compliance, including monitoring and training activities.

 

In addition, in May 2013, the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) issued a new version of its internal control framework, which will be effective December 15, 2014. We have not yet developed a plan to integrate the 2013 edition of the COSO framework into our assessment of our internal controls over financial reporting.  We may determine, following implementation of the 2013 COSO framework, that deficiencies exist in our internal controls over financial reporting, which may adversely affect our financial results and result in a loss of investor confidence in the reliability of our financial statements.

 

Compliance with recently adopted rules of the SEC relating to “conflict minerals” may require us and our suppliers to incur substantial expense and may result in disclosure by us that certain minerals used in products we contract to manufacture are not “DRC conflict free”

 

The SEC recently adopted disclosure requirements under Section 1502 of the Dodd-Frank Act, regarding the source of certain conflict minerals for issuers for which such conflict minerals are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by that issuer, which are mined from the Democratic Republic of Congo (“DRC”) and adjoining countries. The metals covered by the rules include tin, tantalum, tungsten and gold, commonly referred to as “3TG.” Because Ixia contracts to manufacture products which may contain tin, tantalum, tungsten, or gold, we will be required under these rules to determine whether those minerals are necessary to the functionality or production of our products and, if so, the rules require us to conduct a reasonable country of origin inquiry to determine if we know or have reason to believe any of the minerals used in the production process may have originated from the DRC or an adjoining country (collectively referred to as “covered countries”). The time required to be spent by our management and the management of our suppliers in this endeavor could be significant. There may be material costs associated with complying with the disclosure requirements, such as costs related to the due diligence process of determining the source of certain minerals used in our products, as well as costs of possible changes to products, processes, or sources of supply as a consequence of such verification activities. There can be no assurance that these costs will not have an adverse effect on our business, financial condition or results of operations. If we are unable to determine the minerals did not originate from a covered country or conclude that there is no reason to believe that the minerals used in the production process may have originated in a covered country, then we and our suppliers would be required to perform supply chain due diligence on the source and chain of custody of conflict minerals to determine if they originated in one of the covered countries and, if so, whether they financed or benefited armed groups in the covered countries. The implementation of these requirements could affect the sourcing and availability of products we purchase from our suppliers and contract manufacturers. This may also reduce the number of suppliers who provide products containing conflict free metals, and may affect our ability to obtain products in sufficient quantities, in a timely manner or at competitive prices. Our material sourcing is broad based and multi-tiered, and we may not be able to easily verify the origins for all metals used in our products. We may also encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict-free, which could place us at a competitive disadvantage if we are unable to do so. The new rule went into effect for calendar year 2013 and we filed our first disclosure report with the SEC on June 2, 2014.

 

 

 
35

 

 

If we fail to maintain our relationships with industry experts, our products may lose industry and market recognition and sales could decline

 

Our relationships with industry experts, in particular in the field of performance analysis and measurement of networks and network equipment, are critical for maintaining our industry credibility and for developing new products. These experts have established standard testing methodologies that evaluate new network equipment products and technologies. We provide these experts and their testing labs with our products and engineering assistance to perform tests on these new network equipment products and technologies. These industry experts refer to our products in their publications which has given our products industry recognition. In addition, these labs offer us the opportunity to test our products on the newest network equipment and technologies, thereby assisting us in developing new products that are designed to meet evolving technological needs. We cannot be certain that we will be able to maintain our relationships with industry experts or that our competitors will not maintain similar or superior relationships with industry experts. If we are unable to maintain our relationships with industry experts or if competitors have superior relationships with them, our products may lose industry and market recognition which could harm our reputation and competitive position and cause our sales to decline.

 

Our business and operations are subject to the risks of earthquakes, floods, hurricanes and other natural disasters

 

Our operations could be subject to natural disasters and other business disruptions, which could adversely affect our business and financial results. A number of our facilities and those of our suppliers, our contract manufacturers, and our customers are located in areas that have been affected by natural disasters such as ice and snow storms, earthquakes, floods or hurricanes in the past. For example, currently, our corporate headquarters and many of our customers are located in California. California historically has been vulnerable to natural disasters and other risks, such as earthquakes, fires and floods, which at times have disrupted the local economy and posed physical risks to our property. To mitigate some of this risk, certain of our U.S. and international locations are insured up to certain levels against losses and interruptions caused by earthquakes, floods and/or other natural disasters. However, there can be no guarantee that such insurance may be adequate in the event of a natural disaster and a significant natural disaster could have a material adverse impact on our business, operating results and financial condition.

 

Man-made problems such as cybersecurity attacks, computer viruses or terrorism may disrupt our operations and harm our business, reputation and operating results

 

Despite our implementation of network security measures, our network may be vulnerable to cybersecurity attacks, computer viruses, break-ins and similar disruptions. Cybersecurity attacks, in particular, are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Any such event could have a material adverse effect on our business, operating results and financial condition. We are not aware of any security breaches or cyber-attacks to our networking infrastructure.

 

Our daily business operations require us to retain sensitive data such as intellectual property, proprietary business information and data related to customers, suppliers and business partners within our networking infrastructure. The ongoing maintenance and security of this information is pertinent to the success of our business operations and our strategic goals, and organizations like Ixia are susceptible to multiple variations of attacks on our networks on a daily basis.

 

Our networking infrastructure and related assets may be subject to unauthorized access by hackers, employee errors, or other unforeseen activities. Such issues could result in the disruption of business processes, network degradation and system downtime, along with the potential that a third party will exploit our critical assets such as intellectual property, proprietary business information and data related to our customers, suppliers and business partners. To the extent that such disruptions occur, they may cause delays in the manufacture or shipment of our products and the cancellation of customer orders and, as a result, our business operating results and financial condition could be materially and adversely affected resulting in a possible loss of business or brand reputation.

 

In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruption to the economy and create further uncertainties in the economy. Energy shortages, such as gas or electricity shortages, could have similar negative impacts. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

 

 
36

 

 

Our use of open source software in our products could adversely affect our ability to sell our products and subject us to possible litigation

 

Many of our products contain software modules licensed to us by third-party authors under “open source” licenses. If we combine our proprietary software with open source software in a certain manner and then distribute the combined software, we could, under certain open source licenses, be required to license that combined software under the terms of that open source license as well as release the source code of the combined software to third parties. This could allow third parties to use our proprietary software at no charge, could enable our competitors to create similar products with lower development effort and time, and ultimately could result in a loss of product sales and lower revenues for us.

 

Although we attempt to monitor our use of open source software to avoid subjecting our products to conditions we do not intend, we cannot assure you that our processes for controlling our use of open source software in our products will be effective. Further, there have been claims against companies that distribute or use open source software in their products and services, asserting that open source software infringes the claimants’ intellectual property rights. We could be subject to suits by parties claiming infringement of intellectual property rights in what we believe to be licensed open source software. If we are held to have breached the terms of an open source software license, we could be required to seek licenses from third parties to continue offering our products, to re-engineer our products, to discontinue the sale of our products if re-engineering could not be accomplished in a timely manner, to allow third parties to use our products at no charge under the terms of that open source software license, or to make generally available, in source code form, our proprietary software, any of which could adversely affect our business, operating results, and financial condition.

 

In addition to risks related to license requirements, use of open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or assurance of title or controls on origin of the software. Many of the risks associated with the use of open source software, such as the lack of warranties or assurances of title, cannot be eliminated, and could, if not properly addressed, adversely affect our business.

 

Provisions of our articles of incorporation and bylaws may make it difficult for a third party to acquire us, despite the possible benefits to our shareholders

 

Our Board of Directors has the authority to issue up to 1,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders. The rights of the holders of our Common Stock are subject to, and may be adversely affected by, the rights of the holders of any preferred stock that we may issue. The issuance of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. Furthermore, some provisions of our articles of incorporation and bylaws could delay or make more difficult a merger, tender offer or proxy contest involving us. Our articles of incorporation include provisions that limit the persons who may call special meetings of shareholders and establish advance notice requirements for nominations for election to our Board of Directors and/or for proposing matters that can be acted on by shareholders at shareholder meetings. These and other provisions of our articles of incorporation and bylaws may have the effect of delaying, deferring or preventing a change in our control despite possible benefits to our shareholders, may discourage bids at a premium over the market price of our Common Stock and may harm the market price of our Common Stock and the voting and other rights of our shareholders.

 

 
37

 

 

Our stock price may continue to be volatile

 

The trading price of our Common Stock has fluctuated substantially in recent years. The trading price may be subject to future fluctuations in response to, among other events and factors: (i)  the global economic environment; (ii) variations in our quarterly operating results; (iii) the gain, loss or timing of significant orders; (iv) changes in earnings estimates by analysts who cover our stock or the stock of our competitors; (v) changes in our revenue and/or earnings guidance as periodically announced in our earnings calls or press releases; (vi) announcements of technological innovations and new products by us or our competitors; (vii) changes in domestic and international economic, political and business conditions; (viii) consolidation and general conditions in our industry; (ix) the announcement of significant transactions, such as a proposed business acquisition; and (x) changes in our executive management team. In addition, the stock market in general has experienced extreme price and volume fluctuations that have affected the market prices for many companies in our industry that have been unrelated to the operating performance of these companies. These market fluctuations have affected and may continue to affect the market price of our Common Stock.

 

 
38

 

 

Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

As of December 31, 2013, our leased and owned properties in total provided us with aggregate square footage of approximately 509,000, of which approximately 1,000 square feet is owned. Our corporate headquarters are located in Calabasas, California, where we currently lease approximately 116,000 square feet of space which houses research and development, sales and marketing, finance and administration, and manufacturing operations. This lease terminates on May 31, 2023, with no extension options. We also lease office space for sales, support, marketing, operations and administration in the United Kingdom, Ireland, Germany, France, Finland, Sweden, Canada, South Korea, Japan, China, Singapore, India, Malaysia, United Arab Emirates, Spain, and Israel and in various states throughout the United States. Additionally, we have leased research and development facilities in Romania, India, and Canada. We believe that our existing properties, including both owned and leased sites, will be adequate to meet our needs for the next 12 months, or that we will be able to obtain additional space when and as needed on acceptable terms.

 

From time to time we consider various alternatives related to our long-term facility needs. While we believe our existing facilities are adequate to meet our immediate needs, it may become necessary to lease or acquire additional or alternative space to accommodate future business needs.

 

Item 3. Legal Proceedings

 

For information on our legal proceedings, see Note 10 to the consolidated financial statements included in this Form 10-K.

 

Item 4. Mine Safety Disclosures

  

Not applicable.

 

 
39

 

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

 

(a)

Market Price, Dividends and Related Matters

 

Ixia’s Common Stock is traded on the Nasdaq Global Select Market under the symbol “XXIA.” The following table sets forth the high and low sales prices of our Common Stock as reported on the Nasdaq Global Select Market for the following time periods.

 

   

High

   

Low

 

2013

               

Fourth quarter

  $ 16.33     $ 11.89  

Third quarter

    18.93       13.31  

Second quarter

    21.81       14.11  

First quarter

    22.50       17.20  
                 

2012

               

Fourth quarter

  $ 17.40     $ 13.00  

Third quarter

    16.54       11.66  

Second quarter

    13.21       9.95  

First quarter

    14.88       9.75  

 

On June 16, 2014, the closing sales price reported for our Common Stock was $12.07 per share, and as of that date there were approximately 19 shareholders of record.

 

We have never declared or paid cash dividends on our Common Stock and do not anticipate paying any dividends in the foreseeable future. 

 

The following graph compares the cumulative total return on the Company's Common Stock with the cumulative total returns of the Nasdaq Composite Index and the Nasdaq Telecommunications Index for the five-year period commencing December 31, 2008. Ixia is one of the companies that makes up the Nasdaq Telecommunications Index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in the Company’s Common Stock and in each of the indices on December 31, 2008, and their relative performance is tracked through December 31, 2013. These indices are included only for comparative purposes as required by the rules of the Securities and Exchange Commission and do not necessarily reflect management’s opinion that such indices are an appropriate measure of the relative performance of the Company’s Common Stock. The stock price performance shown on the graph below is not necessarily indicative of future price performance. This graph shall not be deemed "filed" for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing of Ixia under the Securities Act of 1933, as amended, or the Exchange Act.

 

 
40

 

 

 

 

 

   

12/31/08

   

12/31/09

   

12/31/10

   

12/31/11

   

12/31/12

   

12/31/13

 

Ixia

  $ 100.00     $ 128.89     $ 290.31     $ 181.83     $ 293.77     $ 230.28  

Nasdaq Composite Index

    100.00       144.88       170.58       171.30       199.99       283.39  

Nasdaq Telecommunications Index

    100.00       137.81       148.84       131.52       136.58       189.00  

 

(b)

Use of Proceeds

 

None.

 

(c)

Issuer Repurchases of Equity Securities

 

None.

 

 
41

 

 

Item 6. Selected 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 consolidated financial statements and the notes to those consolidated financial statements. The consolidated statement of operations data set forth below for the years ended December 31, 2013, 2012 and 2011 and the consolidated balance sheet data as of December 31, 2013 and 2012 are derived from, and are qualified in their entirety by reference to, the Company’s audited consolidated financial statements included elsewhere in this Form 10-K. The consolidated statements of operations data set forth below for the years ended December 31, 2010 and 2009 and the consolidated balance sheet data as of December 31, 2011, 2010 and 2009 are prepared on a consistent basis with the consolidated financial statements presented herein and are derived from other consolidated financial statement information.

 

   

2013(3)

   

2012(4)

   

2011(5)

   

2010

   

2009(6)

 
                                         

Consolidated Statement of Operations Data (in thousands, except per share data):

                                       

Revenues:

                                       

Products

  $ 352,712     $ 330,315     $ 249,423     $ 227,682     $ 146,378  

Services

    114,544       83,119       61,947       50,825       34,357  

Total revenues

    467,256       413,434       311,370       278,507       180,735  
                                         

Costs and operating expenses: (1)

                                       

Cost of revenues – products (2)

    89,136       71,668       56,801       54,378       36,722  

Cost of revenues – services

    13,867       10,493       6,520       6,327       3,859  

Research and development

    117,502       98,169       75,101       72,488       53,977  

Sales and marketing

    137,724       117,214       87,011       79,986       60,374  

General and administrative

    47,158       45,607       33,648       35,142       28,061  

Amortization of intangible assets

    40,805       30,018       15,980       17,545       11,391  

Acquisition and other related

    6,920       11,861       1,100       2,991       6,179  

Restructuring(7)

    1,840       4,077             3,587       4,637  

Total costs and operating expenses

    454,952       389,107       276,161       272,444       205,200  

Income (loss) from operations

    12,304       24,327       35,209       6,063       (24,465 )

Interest income and other, net(8)

    6,269       2,255       2,059       10,970       2,160  

Interest expense(9)

    (7,771 )     (7,215 )     (7,200 )     (480 )      

Other-than-temporary impairment on investments(10)

                            (2,761 )

Income (loss) before income taxes

    10,802       19,367       30,068       16,553       (25,066 )

Income tax (benefit) expense(11)

    (1,068 )     (26,093 )     3,355       3,723       16,183  

Net income (loss)

  $ 11,870     $ 45,460     $ 26,713     $ 12,830     $ (41,249 )
                                         

Earnings (loss) per share:

                                       

Basic

  $ 0.16     $ 0.63     $ 0.39     $ 0.20     $ (0.66 )

Diluted

  $ 0.15     $ 0.59     $ 0.37     $ 0.19     $ (0.66 )
                                         

Weighted average number of common and common equivalent shares outstanding:

                                       

Basic

    75,757       72,183       69,231       65,157       62,710  

Diluted

    77,513       84,505       71,664       67,769       62,710  

 

 
42

 

 


(1)

Stock-based compensation included in:

Cost of revenues – products

  $ 550     $ 423     $ 402     $ 524     $ 478  

Cost of revenues - services

    209       162       153       198       182  

Research and development

    8,065       6,242       4,286       5,195       4,491  

Sales and marketing

    7,367       5,352       3,296       3,592       2,989  

General and administrative

    4,571       7,462       4,454       3,406       2,395  

 

 

(2)

Cost of revenues – products excludes amortization of intangible assets, related to purchased technology of $26.0 million, $20.3 million, $10.8 million, $12.8 million and $9.2 million for the years ended December 31, 2013, 2012, 2011, 2010 and 2009, respectively, which is included in Amortization of intangible assets.

 

 

(3)

During the year ended December 31, 2013, we completed the acquisition of Net Optics, Inc. for approximately $193.8 million.

 

 

(4)

During the year ended December 31, 2012, we completed the acquisition of Anue, Inc. and BreakingPoint Systems, Inc. for approximately $152.4 million and $163.7 million, respectively.

 

 

(5)

During the year ended December 31, 2011, we completed the acquisition of VeriWave, Inc. for approximately $15.8 million.

 

 

(6)

During the year ended December 31, 2009, we completed the acquisition of Catapult, Inc. and the aquissition of N2X product line for approximately $106.6 million and approximately $42.8 million, respectively.

 

 

(7)

In 2009, 2010, and 2012 our management approved, committed to and initiated a plan to restructure our operations in light of our acquisitions of Catapult, N2X, and BreakingPoint, respectively. In 2009, prior to the acquisition of Catapult, management approved, committed to and initiated a plan to restructure our operations (“Ixia Restructuring”). In 2013, management approved, committed to and initiated a plan to restructure certain operations related to our network test products. 

 

 
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(8)

In 2010, we recorded $8.9 million and $1.0 million, respectively, relating to (i) settlement proceeds received for claims asserted by us against our former investment manager for damages and losses relating to our previous investments in auction rate securities with an aggregate par value of $19.0 million, and (ii) proceeds received for the sale of certain of these auction rate securities that were previously written-off. In 2013, we recorded realized gains of $2.9 million related to the sale of previously written down auction rate and corporate debt securities.

 

 

(9)

In December 2010, we issued $200.0 million in aggregate principal amount of 3.00% convertible senior notes that mature on December 15, 2015, if not converted. Interest expense consists of interest due to the holders of our notes, as well as the amortization of the associated debt issuance costs. The interest is payable semi-annually on June 15 and December 15 of each year, beginning on June 15, 2011. During 2011, 2012 and 2013, we made interest payments of $6.0 million.

 

 

(10)

Our 2009 results include a pre-tax other-than-temporary impairment charge of $2.8 million to earnings related to our investments in auction rate securities.

 

 

(11)

In 2012, we released $34.8 million of our valuation allowance previously established against our U.S. deferred tax assets. The 2012 partial releases related primarily to the net deferred tax liabilities recorded as part of the Anue and BreakingPoint acquisitions. In 2009, our income tax expense includes a $28.1 million charge related primarily to the establishment of a valuation allowance against our remaining net U.S. deferred tax assets.

 

   

2013

   

2012

   

2011

   

2010

   

2009

 
                                         

Consolidated Balance Sheet Data (in thousands):

                                       

Cash and cash equivalents

  $ 34,189     $ 47,508     $ 42,729     $ 76,082     $ 15,061  

Short-term investments in marketable securities

    51,507       126,851       156,684       151,696       10,337  

Working capital

    122,542       227,309       234,723       256,034       48,987  

Long-term investments in marketable securities

          3,119       185,608       111,440       53,582  

Total assets

    894,464       819,249       634,467       589,883       309,088  

Convertible senior notes

    200,000       200,000       200,000       200,000        

Total liabilities

    395,352       371,751       282,231       293,467       69,109  

Total shareholders’ equity

    499,112       447,498       352,236       296,416       239,979  

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors, many of which are outside of our control and are difficult for us to forecast or mitigate. The factors that could cause our actual results to differ materially from those expressed or implied by us in any forward-looking statements contained herein or made elsewhere by or on behalf of us include the risks described elsewhere in this Form 10-K and in certain of our other Securities and Exchange Act Commission filings.

 

The consolidated results of operations for the years ended December 31, 2013, 2012 and 2011 are not necessarily indicative of the results that may be expected for any future period. The following discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Part IV, Item 15 of this Form 10-K and in conjunction with the “Risk Factors” included in Part I, Item 1A of this Form 10-K.

 

 
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Business Overview

 

We are a leading provider of converged Internet Protocol (IP) network validation and network visibility solutions. Equipment manufacturers, service providers, enterprises, and government agencies use our solutions to design, verify, and monitor a broad range of Ethernet, Wi-Fi, 3G, and 4G/LTE equipment and networks. Our product solutions consist of our hardware platforms, such as our chassis, interface cards and appliances, software application tools, and services, including our warranty and maintenance offerings and professional services.

 

During 2013, total revenues increased 13.0% to $467.3 million from $413.4 million in 2012 due to the inclusion of a full year of revenues from our 2012 acquisitions of Anue and BreakingPoint which also enabled us to increase our business with service provider, enterprise and government customers. We also increased our addressable market with our December 2013 acquisition of Net Optics by broadening our products that we can offer current or future network visibility customers. We used existing cash and investments to fund the Net Optics acquisition, which caused our cash and investment balance (in the aggregate) to decline to $85.7 million as of December 31, 2013 from $177.5 million as of December 31, 2012. The use of our existing cash and proceeds from the sale of investments to finance the Net Optics acquisition was partially offset by the cash we generated from our operations of $86.5 million, which represents a 7.7% increase over the operating cash flow generated in 2012. During 2013, we did not utilize our $150.0 million senior secured revolving credit facility.

  

Establishment of Senior Secured Revolving Credit Facility. On December 21, 2012, we established a senior secured revolving credit facility (the “Credit Facility”) pursuant to a Credit Agreement (the “Credit Facility Agreement”) entered into with certain institutional lenders that provides for an aggregate loan amount of up to $150.0 million. The Credit Facility is available to be used to, among other things, fund our working capital needs, capital expenditures and for other general corporate purposes, including acquisitions, stock repurchases and any partial refinancing of our convertible senior notes. We may also request (but are not guaranteed) an increase in the Credit Facility by an amount of up to $50.0 million. The Credit Facility is scheduled to mature on December 21, 2016, subject to acceleration under certain circumstances during the six-month period beginning on June 15, 2015. See Note 3 to the consolidated financial statements included in this Form 10-K.

 

In connection with the delayed delivery to the lenders under our Credit Facility of our financial statements for the quarters ended September 30, 2013, December 31, 2013 and March 31, 2014 and of our audited financial statements for the fiscal year ended December 31, 2013, we have entered into agreements with the lenders that amended the Credit Facility Agreement to extend the dates for such deliveries. We otherwise would have been in breach of certain covenants under the Credit Facility Agreement. Most recently, on June 12, 2014, we amended the Credit Facility Agreement to extend the date for delivery of (i) our audited financial statements for the fiscal year ended December 31, 2013 to June 20, 2014 and (ii) our financial statements for the quarter ended March 31, 2014 to June 27, 2014. The Company intends to deliver such audited financial statements to the lenders on the date of the filing of this Form 10-K with the SEC. 

 

Effective April 30, 2014, we entered into a waiver agreement with the lenders that included a waiver of any breach of the Credit Facility Agreement (which requires us to comply with the Indenture governing our Convertible Senior Notes (the “Notes”)) arising out of our failure to comply with certain covenants in the Indenture. Those covenants require us to timely file with the trustee under the Indenture our periodic financial and other reports that we are required to file with the SEC. Under the waiver, the lenders temporarily waived any default arising out of our failure to timely file with the trustee (i) our Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 (the “2013 Third Quarter Form 10-Q”), (ii) this Form 10-K and (iii) a Current Report on Form 8-K/A relating to our acquisition of Net Optics. that was due to be filed with the SEC no later than on February 18, 2014. The temporary waiver automatically expires on the earlier of (i) 60 days after receipt of notice from either the trustee or the holders of 25% of the principal amount of the Notes demanding that remedial action be taken in respect of the delayed filings and (ii) the occurrence of any other default or event of default under the Indenture. Our need for this waiver will expire upon the filing with the SEC of (i) our 2013 Third Quarter Form 10-Q, (ii) this Form 10-K and (iii) our Current Report on Form 8-K/A relating to Net Optics. 

 

On May 15, 2014 we entered into an amendment and waiver agreement that included a waiver from the lenders of any breach of the Credit Facility Agreement arising out of our failure to comply with the provision in the Indenture that requires us to timely file with the trustee our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 (the “2014 First Quarter Form 10-Q”). This waiver is only effective as long as (i) no event of default occurs under the Indenture due to our failure to complete any necessary remedial action in respect of the delayed filing within 60 days of receipt of notice from either the trustee under the Indenture or the holders of 25% of the principal amount of our Notes demanding such remedial action (as of the date of the filing of this Form 10-K with the SEC, no such notice has been given) and (ii) no delisting of our common stock from the Nasdaq Global Select Market occurs. Because we are not currently in compliance with the Nasdaq rule that requires the timely filing of our periodic financial reports with the SEC, our common stock is subject to delisting from the Nasdaq Global Select Market. See Note 3 to the consolidated financial statements included herein.

 

 
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Acquisition of Net Optics, Inc. On December 5, 2013, we completed our acquisition of all of the outstanding shares of common stock and other equity interests of Net Optics, Inc. (“Net Optics”). The aggregate cash consideration paid totaled $193.8 million, or $191.8 million net of Net Optics’ existing cash and cash equivalents balances at the time of the acquisition. The acquisition was funded from our existing cash and sale of investments. Net Optics is a leading provider of total application and network visibility solutions. The acquisition of Net Optics solidifies our position as a market leader with a comprehensive product offering including network packet brokers, comprehensive physical and virtual taps and application aware capabilities. Additionally, the acquisition has expanded our product portfolio, strengthens our service provider and enterprise customer base and broadens our sales channel and partner programs. These factors, among others, contributed to a purchase price in excess of the estimated fair value of Net Optics’ net identifiable assets acquired and, as a result, we have recorded goodwill in connection with this transaction. The results of operations of Net Optics have been included in our consolidated statements of operations and cash flows since the date of the acquisition. See Note 2 to the consolidated financial statements included in this Form 10-K.

 

Acquisition of BreakingPoint Systems, Inc. On August 24, 2012, we completed our acquisition of all of the outstanding shares of capital stock of BreakingPoint Systems, Inc. (“BreakingPoint”). The aggregate cash consideration paid totaled $163.7 million, or $150.3 million net of BreakingPoint’s existing cash and cash equivalents balances at the time of the acquisition. The acquisition was funded from our existing cash and sale of investments. BreakingPoint is a leader in security testing, and its solutions provide global visibility into emerging threats and applications, along with advance insight into the resiliency of an organization’s information technology infrastructure under operationally relevant conditions and malicious attacks. With this acquisition, we have expanded our addressable market, broadened our product portfolio and grown our customer base. The results of operations of BreakingPoint have been included in our consolidated statements of operations and cash flows since the date of the acquisition. See Note 2 to the consolidated financial statements included in this Form 10-K.

 

Acquisition of Anue Systems, Inc. On June 1, 2012, we completed our acquisition of all of the outstanding shares of capital stock, and all other equity interests of Anue Systems, Inc. (“Anue”). The aggregate consideration paid totaled $152.4 million, or $148.7 million net of Anue’s existing cash and cash equivalents balances at the time of the acquisition. The acquisition was funded from our existing cash and sale of investments. Anue provides solutions to monitor and test complex networks, including Anue’s Net Tool Optimizer solution that efficiently aggregates and filters network traffic to help optimize network monitoring tool usage. With this acquisition, we have expanded our addressable market, broadened our product portfolio and grown our customer base. The results of operations of Anue have been included in our consolidated statements of operations and cash flows since the date of the acquisition. See Note 2 to the consolidated financial statements included in this Form 10-K.

 

Revenues. Our revenues are principally derived from the sale and support of our network test and visibility solutions.

 

Sales of our network test hardware products primarily consist of traffic generation and analysis hardware platforms containing multi-slot chassis and interface cards.  Our primary network test hardware platform is enabled by our operating system software that is essential to the functionality of the hardware platform. Sales of our network visibility hardware products typically include an integrated, purpose-built hardware appliance with essential, proprietary software.  Our software products consist of a comprehensive suite of technology-specific applications for certain of our network test hardware platforms.  Our software products are typically installed on and work with these hardware products to further enhance the core functionality of the overall network test system, although some of our software products can be operated independently from our network test platforms.

 

Our service revenues primarily consist of technical support, warranty and software maintenance services revenues related to our network test and visibility hardware and software products. Most of our products include up to one year of these services with the initial product purchase, and our customers may separately purchase extended services for annual or multi-year periods. Our technical support, warranty and software maintenance services include assistance with the set-up, configuration and operation of our products, repair or replacement of defective products, bug fixes, and unspecified when and if available software upgrades. For certain network test products, our technical support and software maintenance service revenues also include our Application and Threat Intelligence (ATI) service, which provides a comprehensive suite of application protocols, software updates and technical support. The ATI service provides full access to the latest security attacks and application updates for use in real-world test and assessment scenarios. Our customers may purchase the ATI service for annual or multi-year periods. Service revenues also include training and other professional services revenues.

 

 
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During the three years ended December 31, 2013, our network test Ethernet interface cards, including our 1 Gigabit Ethernet, 10 Gigabit Ethernet and 40/100 Gigabit Ethernet interface cards, represented the majority of our product revenues. During 2013, our 10 Gigabit Ethernet interface cards continued to be our strongest seller, but we also saw significant year-over-year demand for our 40/100 Gigabit Ethernet cards as a result of network infrastructure upgrades. Over the longer term, while we expect the sale of our network test Ethernet interface cards to represent a significant amount of our revenues, we expect to see some decline as a percentage of total revenues as the sales of our network visibility and other network test solutions increase.

 

Sales to our two largest customers, AT&T and Cisco Systems, accounted for $116.3 million, or 24.9%, of our total revenues in 2013, $86.3 million, or 20.9%, of our total revenues in 2012 and $55.6 million, or 17.8%, of our total revenues in 2011. To date, we have generated the majority of our revenues from sales to network equipment manufacturers, but this percentage has been declining over the past several years. While we expect that we will continue to have some customer concentration with network equipment manufacturers for the foreseeable future, we expect to continue to see some declines as a percentage of total revenues, given that we expect to to sell our products to a wider variety and increasing number of service providers, enterprise and government customers. To the extent that we develop a broader and more diverse customer base, our reliance on any one customer or customer type should diminish. We also expect that our 2013 acquisition of Net Optics and our 2012 acquisitions of Anue and BreakingPoint will continue to further diversify our customer base.

 

From a geographic perspective, we generated revenues from shipments to international locations of $172.5 million, or 36.9% of our total revenues, in 2013, $171.4 million, or 41.4% of our total revenues, in 2012, and $153.9 million, or 49.4%, of our total revenues, in 2011. During 2013, our total revenues generated from shipments to international locations decreased in percentage terms when compared to the same period in 2012, due primarily to our 2012 acquisitions of Anue and BreakingPoint, which have a higher concentration of revenue in the United States as compared to Ixia. Over the next 12 months, we expect to leverage and expand our international sales force to sell our Anue and BreakingPoint products to a more global customer base, and as a result, we expect to increase our percentage of revenue from shipments to international locations over time. Total revenues from product shipments to Japan were $36.4 million, or 7.8%, of our total revenues in 2013, $43.6 million, or 10.6%, of our total revenues in 2012, and $29.4 million, or 9.4%, of our total revenues in 2011.

 

Stock-Based Compensation. Share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, are required to be recognized in our financial statements based on the estimated fair values for accounting purposes on the grant date. For the years ended December 31, 2013, 2012 and 2011, stock-based compensation expense was $20.8 million, $19.6 million and $12.6 million, respectively. Our stock-based compensation expense increased for the year ended December 31, 2013 as compared to 2012 due in part to (i) a full year of stock-compensation for share-based awards granted in the second half of 2012 to Anue and Breaking Point employees as part of our 2012 acquisitions of Anue and BreakingPoint and (ii) an increase in the number of participants in our employee stock purchase plan. The aggregate balance of gross unrecognized stock-based compensation to be expensed in the years 2014 through 2017 related to unvested share-based awards as of December 31, 2013 was approximately $26.3 million. To the extent that we grant additional share-based awards, future expense may increase by the additional unearned compensation resulting from those grants. We anticipate that we will continue to grant additional share-based awards in the future as part of our long-term incentive compensation programs. The impact of future grants cannot be estimated at this time because it will depend on a number of factors, including the amount of share-based awards granted and the then current fair values of such awards for accounting purposes.

 

Cost of Revenues. Our cost of revenues related to the sale of our hardware and software products includes materials, payments to third-party contract manufacturers, royalties, and salaries and other expenses related to our manufacturing and supply operations personnel. We outsource the majority of our manufacturing operations, and we conduct supply chain management, quality assurance, documentation control, shipping and some final assembly and testing at our facilities in Calabasas, California; Austin, Texas and Penang, Malaysia. Accordingly, a significant portion of our cost of revenues related to our products consists of payments to our contract manufacturers. Cost of revenues related to the provision of services includes salaries and other expenses associated with technical support services, professional services and cost of extended warranty and maintenance services. Cost of revenues does not include the amortization of purchased technology related to our acquisitions of certain businesses, product lines and technologies of $26.0 million, $20.3 million and $10.8 million for the years ended December 31, 2013, 2012 and 2011, respectively, which are included within our Amortization of intangible assets line item on our consolidated statements of operations.

 

 
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Our cost of revenues as a percentage of total revenues is primarily affected by the following factors:

 

 

our pricing policies and those of our competitors;

 

 

the pricing we are able to obtain from our component suppliers and contract manufacturers;

 

 

the mix of customers and sales channels through which our products are sold;

 

 

the mix of our products sold, such as the mix of software versus hardware product sales;

 

 

new product introductions by us and by our competitors;

 

 

demand for and quality of our products; and

 

 

shipment volume.

 

In the near term, although we anticipate that our cost of revenues as a percentage of total revenues will remain relatively flat, we expect to continue to experience pricing pressure on larger transactions and from larger customers as a result of competition.

 

Operating Expenses. Our operating expenses are generally recognized when incurred and consist of research and development, sales and marketing, general and administrative, amortization of intangible assets, acquisition and other related costs and restructuring expenses. In dollar terms, we expect total operating expenses, excluding stock-based compensation expense discussed above and amortization of intangible assets, acquisition, other related and restructuring expenses discussed below, to increase in 2014 when compared to 2013, due primarily to a full year of expenses from our acquisition of Net Optics in December 2013.

 

 

Research and development expenses consist primarily of salaries and other personnel costs related to the design, development, testing and enhancement of our products. We expense our research and development costs as they are incurred. We also capitalize and depreciate over a five-year period costs of our products used for internal purposes.

 

 

Sales and marketing expenses consist primarily of compensation and related costs for personnel engaged in direct sales, sales support and marketing functions, as well as tradeshow, promotional and advertising expenditures. We also capitalize and depreciate over a two-year period costs of our products used for sales and marketing activities, including product demonstrations for potential customers.

 

 

General and administrative expenses consist primarily of salaries and related expenses for certain executive, finance, legal, human resources, information technology and administrative personnel, as well as professional fees (e.g., legal and accounting), facility costs related to our corporate headquarters, insurance costs and other general corporate expenses.

 

 

Amortization of intangible assets consists of the recognition of the purchase price of various intangible assets over their estimated useful lives. The future amortization expense of acquired intangible assets depends on a number of factors, including the extent to which we acquire additional businesses, technologies or product lines or are required to record impairment charges related to our acquired intangible assets. See Note 8 to the consolidated financial statements included in this Form 10-K.

 

 
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Acquisition and other related costs are expensed as incurred and consist primarily of transaction and integration related costs such as success-based banking fees, professional fees for legal, accounting, tax, due diligence, valuation and other related services, change in control payments, amortization of deferred compensation, consulting fees, required regulatory costs, certain employee, facility and infrastructure transition costs, and other related expenses. We expect our acquisition and other related expenses to fluctuate over time based on the timing of our acquisitions and related integration activities.

 

 

Restructuring expenses consist primarily of employee severance costs and other related charges, as well as facility-related charges to exit certain locations. See Note 4 to the consolidated financial statements included in this Form 10-K.

 

Interest income and other, net represents interest on cash and a variety of securities, including money market funds, U.S. government and government agency debt securities, corporate debt securities and auction rate securities, realized gains/losses on the sale of investment securities, certain foreign currency gains and losses, and other non-operating items.

 

Interest expense consists of interest due to the holders of our 3.00% convertible senior notes issued in December 2010 and interest expense pertaining to our Credit Facility established in December 2012, as well as the amortization of the associated debt issuance costs and commitment fees on the unused portion of the Credit Facility. See Note 3 to the consolidated financial statements included in this Form 10-K.

 

Income Tax is determined based on the amount of earnings and enacted federal, state and foreign tax rates, adjusted for allowable credits and deductions, and for other effects of equity compensation plans. Our income tax provision may be significantly affected by changes to our estimates for tax in jurisdictions in which we operate and other estimates utilized in determining the global effective tax rate. Actual results may also differ from our estimates based on changes in economic conditions. Such changes could have a substantial impact on the income tax provision. Our income tax provision could also be significantly impacted by estimates surrounding our uncertain tax positions and the recording of valuation allowances against certain deferred tax assets and changes to these valuation allowances in future periods. We reevaluate the judgments surrounding our estimates and make adjustments, as appropriate, each reporting period.

 

During the year ended December 31, 2012, we released $34.8 million of our valuation allowance previously established against our U.S. deferred tax assets. Management’s conclusion to release the valuation allowance was due to, among other reasons, (i) the three-year cumulative pre-tax accounting income realized in the U.S., (ii) the significant utilization of its net operating loss carryfowards and R&D credits during 2011, and 2012, and (iii) the significant net deferred tax liabilities recorded in connection with the 2012 acquisitions of Anue and BreakingPoint. We continue to maintain a valuation allowance in the amount of $3.2 million and $900,000 against our U.S. and Australian deferred tax assets, respectively. The release of the remaining valuation allowance, or a portion thereof, will have a favorable impact on our effective tax rate. We will continue to monitor the need for a valuation allowance each reporting period, and at this time, it is uncertain when and if such a release may occur.

 

On January 2, 2013, the American Taxpayer Relief Act of 2012 was enacted, which includes a reinstatement of the federal research and development credit for the tax year ended December 31, 2012. The 2012 research and development tax benefit in the amount of $2.6 million was recorded in 2013.

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts, write-downs for obsolete inventory, income taxes, acquisition purchase price allocation, impairments of long-lived assets, goodwill and marketable securities, stock-based compensation, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ materially from these estimates.

 

 
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We apply the following critical accounting policies in the preparation of our consolidated financial statements:

 

 

Revenue Recognition Policy. We exercise significant judgment and use estimates in connection with the determination of the amount of revenue that is recognized in each accounting period and the allocation of those amounts to either product or services revenue. We recognize our revenue in accordance with authoritative guidance on both hardware and software revenue recognition. For our hardware and software products, and related services, we recognize revenue based on the following four criteria: whether (i) evidence of an arrangement exists, which is typically in the form of a customer purchase order; (ii) delivery has occurred (i.e., risks and rewards of ownership have passed to the customer); (iii) the sales price is fixed or determinable; and (iv) collectibility is deemed reasonably assured (or probable for software-related deliverables). Provided that the above criteria are met, revenue from hardware and software product sales is typically recognized upon shipment and service revenues are recognized as the services are provided or completed. Our service revenues from our initial and separately purchased technical support, warranty and software maintenance arrangements are recognized on a straight-line basis over the applicable contractual period.

 

Our systems are generally fully functional at the time of shipment and do not require us to perform any significant production, modification, customization or installation after shipment. If our arrangements include acceptance provisions based on customer specified criteria for which we cannot reliably demonstrate that the delivered product meets all the specified criteria, revenue is deferred until the earlier of the receipt of written customer acceptance or the expiration of the acceptance period. In addition, our arrangements generally do not include any provisions for cancellation, termination or refunds.

 

When sales arrangements involve a combination of hardware and software elements, we use a two-step process to allocate value to each element in the arrangement. First, we allocate the total arrangement fee to the separate non-software deliverables (e.g., chassis, interface cards, and software post contract customer support and maintenance (“PCS”) related to our operating system software that is essential to the functionality of our hardware platform) and the software-related deliverables as a group (e.g., application software and software PCS) based on a relative selling price (“RSP”) method applied to all elements in the arrangement using the selling price hierarchy. Then, we allocate the value assigned to the software group for the software-related deliverables to each software element based on the residual method, whereby value is allocated first to the undelivered elements, typically PCS, and the residual portion of the value is then allocated to the delivered elements (typically the software products) and recognized as revenue, provided all other revenue recognition criteria discussed above have been met.

 

Under the RSP method, the selling price to be used in the allocation of the total arrangement fee to each of the elements, or deliverables, is based on a selling price hierarchy, where the selling price for each element is based on (i) VSOE, if available; (ii) third-party evidence (“TPE”), if available and VSOE is not available; or (iii) the best estimate of selling price (“BESP”), if neither VSOE nor TPE are available.

 

The allocation of value to each deliverable in a multiple element arrangement is completed at the inception of an arrangement, which is typically the receipt of a customer purchase order. While changes in the allocation of the estimated selling price between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could affect our results of operations.

 

 

 
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The allocated value of each non-software deliverable is then recognized as revenue when each element is delivered, provided all of the other revenue recognition criteria discussed above have been met. For software deliverables, the total software group allocation (or total arrangement consideration for customer orders that include only software products and related services) is assigned to each deliverable based on VSOE in accordance with software revenue recognition guidance as described under step two of the allocation process above. We determine VSOE of fair value based on a bell-shaped curve approach, considering the actual sales prices charged to customers when the same element is sold separately, provided it is substantive. As we do not sell our software products without technical support, warranty and software maintenance services, we are unable to establish VSOE for our software products, and therefore use the residual method under the software revenue recognition guidance to allocate the software group (or arrangement) value to each software deliverable. Under the residual method, the software group (or arrangement) value is allocated first to the undelivered elements, typically technical support, warranty and software maintenance services based on VSOE, and the residual portion of the value is then allocated to the delivered elements (typically the software products) and recognized as revenue, provided all other revenue recognition criteria discussed above have been met. If VSOE cannot be established for an undelivered element within the software group (or arrangement), we defer the entire value allocated to the software group (or arrangement) until the earlier of (i) delivery of all elements (other than technical support, warranty and software maintenance services, provided VSOE has been established) or (ii) establishment of VSOE of the undelivered element(s). If the only undelivered element(s) relates to a service for which VSOE has not been established, the entire allocated value of the software group (or arrangement) is recognized as revenue over the longer of the service or contractual period of the technical support, warranty and software PCS. Refer to Note 1, Significant Accounting Policies, for further detail regarding the allocation of value and revenue recognition timing on multiple element revenue arrangements.

 

Our pricing practices may be required to be modified as our business and offerings evolve over time, which could result in changes in selling prices, including both VSOE and BESP, in subsequent periods. In determining BESPs, we apply significant judgment as we weigh a variety of factors, based on the facts and circumstances of the arrangement. The facts and circumstances we may consider include, but are not limited to, prices charged for similar offerings, if any, our historical pricing practices as well as the nature and complexity of different technologies being licensed, geographies and the number of users allowed for a given license.

 

We use distributors and resellers to complement our direct sales and marketing efforts in certain markets and/or for certain products. Due to the broad range of features and options available with our hardware and software products, distributors and resellers generally do not stock our products and typically place orders with us after receiving an order from an end customer. These distributors and resellers receive business terms of sale similar to those received by our other customers; and payment to Ixia is not contingent on sell-through to and receipt of payment from the end customer. As such, for sales to distributors and resellers, we recognize revenue when the risks and rewards of ownership have transferred to the distributor or reseller provided that the other revenue recognition criteria noted above have been met.

 

 

Acquisition Purchase Price Allocation. When we acquire a business, product line or rights to a product or technology, we allocate the purchase price to the various tangible and intangible assets acquired and the liabilities assumed, based on their estimated fair values. Determining the fair value of certain assets and liabilities acquired is subjective in nature and often involves the use of significant estimates and assumptions, some of which may be based in part on historical experience and information obtained from the management of the acquired business, and are inherently uncertain. Many of the estimates and assumptions used to determine fair values, such as those for purchased technologies and customer relationships, are made based on forecasted information and discount rates. To assist in the purchase price allocation process, as well as the determination of estimated useful lives of acquired intangible assets, we may obtain appraisals from valuation specialists. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates and assumptions.

 

 

Write-Down of Obsolete Inventory. We write down inventory for estimated obsolescence, excessive quantities or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon market and economic conditions; technology changes, new product introductions, and changes in strategic business direction; and requires estimates that may include elements that are uncertain. If actual future demand is less favorable than our initial estimate, additional inventory write-downs may be required and would be reflected in cost of goods sold in the period the revision is made. Once written down, the inventory reserves are not reversed.

 

 
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Allowance for Doubtful Accounts. We review the allowance for doubtful accounts monthly and provisions are made upon a specific review of all significant past due receivables. For those receivables not specifically reviewed, provisions are provided at a general rate that considers historical write-off experience and current economic trends. . We also consider the concentration of receivables outstanding with a particular customer in assessing the adequacy of our allowances for doubtful accounts. If a major customer's creditworthiness deteriorates, if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our operating results. Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered. 

 

 

Income Taxes. We operate in numerous states and countries through our various subsidiaries, and must allocate our income, expenses, and earnings under the various laws and regulations of each of these taxing jurisdictions.  Accordingly, our provision for income taxes represents our total estimate of the liability that we have incurred in doing business each year in all of our locations.  Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered. In determining whether we need to record a valuation allowance against our deferred tax assets, management must make a number of estimates, assumptions and judgments, including estimates of future earnings and taxable income. We establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. The determination to record or release valuation allowances requires significant judgment. During 2013, management concluded that it is more likely than not that all of its U.S. deferred tax assets, with the exception of its U.S. deferred tax assets for capital loss carry-forwards, will be realized.  Management’s conclusion was due to, among other reasons, (i) the three-year cumulative pre-tax accounting income realized in the U.S. and (ii) the significant utilization of its net operating loss carry-forwards and R&D credits during 2013, 2012 and 2011.

 

Annually, we file tax returns that represent our filing positions with each jurisdiction and settle our tax return liabilities.  Each jurisdiction has the right to audit those returns and may take different positions with respect to income and expense allocations and taxable earnings determinations. We may provide for estimated liabilities in our consolidated financial statements associated with uncertain tax return filing positions that are subject to audit by various tax authorities.  Because the determinations of our annual provisions are subject to assumptions, judgments and estimates, it is likely that actual results may vary from those recognized in our consolidated financial statements.  As a result, additions to, or reductions of, income tax expense will occur each year for prior reporting periods as our estimates or judgments change, or as actual tax returns and tax audits are settled.  We recognize any such prior year adjustment in the discrete quarterly period in which it is determined.

 

 

Goodwill. We record goodwill as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the acquired net tangible and intangible assets. We review our goodwill for impairment annually, or more frequently when events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable. The impairment evaluation includes a comparison of the carrying value of the reporting unit to its fair value. If the reporting unit fair value exceeds its carrying value, then no impairment exists. If the fair value does not exceed its carrying value, then additional analysis is performed to determine the amount of any goodwill impairment. Assumptions and estimates about fair values of our goodwill are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. Our ongoing consideration of all the factors described previously could result in impairment charges in the future, which could adversely affect our net income.

 

 
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Long-lived Asset Valuation (Intangible Assets and Property, Plant and Equipment). We test long-lived assets or asset groups for recoverability when events or changes in circumstances indicate that their carrying amounts may not be recoverable. Circumstances which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; and current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life. When such events or changes in circumstances occur, we assess recoverability by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. Fair value is determined using a discounted cash flow analysis that involves the use of significant estimates and assumptions, some of which may be based in part on historical experience, forecasted information and discount rates. No such impairment charges were recorded during the years ended December 31, 2013, 2012 and 2011.

 

 

Stock-Based Compensation. Share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, are recognized based on the estimated fair values for accounting purposes on the grant date. We use the Black-Scholes option pricing model to estimate the fair value for accounting purposes of stock options and employee stock purchase rights. We use the grant date closing share sales price of a share of our common stock to estimate the fair value for accounting purposes of restricted stock units. The determination of the fair value of share-based awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life and risk-free interest rate. The expected life and expected volatility are estimated based on historical data. The risk-free interest rate assumption is based on observed interest rates appropriate for the lives of our share-based awards. Stock-based compensation expense recognized in our consolidated financial statements is based on awards that are ultimately expected to vest. The amount of stock-based compensation expense is reduced for estimated forfeitures based on historical experience as well as future expectations. We recognize stock-based compensation expense based on the graded, or accelerated multiple-option, approach over the vesting period.

 

 

Impairment of Marketable Securities. We regularly review our investment portfolio to determine if any security is other-than-temporarily impaired, which would require us to record an impairment charge in the period any such determination is made. In making this judgment, we evaluate, among other things, the duration and extent to which the fair value of a security is less than its cost and our intent and ability to sell, or whether we will more likely than not be required to sell, the security before recovery of its amortized cost basis. We have evaluated our investments as of December 31, 2013 and have determined that no investments with unrealized losses are other-than-temporarily impaired.

 

 

Contingencies and Litigation. We evaluate contingent liabilities, including threatened or pending litigation, and record accruals when the loss is deemed probable and the liability can reasonably be estimated. We make these assessments based on the facts and circumstances of each situation and in some instances based in part on the advice of outside legal counsel.

 

 
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Results of Operations

 

The following table sets forth certain statement of operations data as a percentage of total revenues for the periods indicated:

 

   

2013

   

2012

   

2011

 
                         

Revenues:

                       

Products

    75.5 %     79.9 %     80.1 %

Services

    24.5       20.1       19.9  

Total revenues

    100.0       100.0       100.0  
                         

Costs and operating expenses: (1)

                       

Cost of revenues - products (2)

 

19.1

      17.3       18.2  

Cost of revenues - services

    3.0       2.5       2.1  

Research and development

    25.1       23.7       24.2  

Sales and marketing

    29.5       28.4       27.9  

General and administrative

    10.1       11.0       10.8  

Amortization of intangible assets

    8.7       7.3       5.1  

Acquisition and other related

    1.5       2.9       0.4  

Restructuring

    0.4       1.0        

Total costs and operating expenses

    97.4       94.1       88.7  

Income from operations

    2.6       5.9       11.3  

Interest income and other, net

    1.3       0.5       0.7  

Interest expense

    (1.7 )     (1.7 )     (2.3 )

Income before income taxes

    2.2       4.7       9.7  

Income tax (benefit) expense

    (0.2 )     (6.3 )     1.1  

Net income

    2.4 %     11.0 %     8.6 %

 


 

(1)

Stock-based compensation included in:

Cost of revenues - products

    0.1 %     0.1 %     0.1 %

Cost of revenues - services

    0.0       0.0       0.0  

Research and development

    1.7       1.5       1.4  

Sales and marketing

    1.6       1.3       1.1  

General and administrative

    1.0       1.8       1.4  

 

 

(2)

Cost of revenues – products excludes amortization of intangible assets, related to purchased technology of $26.0 million, $20.3 million and $10.8 million for the years ended December 31, 2013, 2012 and 2011, respectively, which is included in Amortization of intangible assets.

 

 
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Comparison of the Years Ended December 31, 2013 and 2012

 

As a result of our acquisitions of Net Optics (“Net Optics”) on December 5, 2013, Anue Systems, Inc. (“Anue”) on June 1, 2012, and BreakingPoint Systems, Inc. (“BreakingPoint”) on August 24, 2012 (the “2012 Acquisitions”), our 2013 and 2012 consolidated results of operations include the financial results of these acquisitions from their respective acquisition dates. To assist the readers of our financial statements in reviewing our year-over-year consolidated operating results, we have estimated the impacts of these acquisitions for the applicable periods in the related statement of operations sections below.

 

Revenues. In 2013, total revenues increased 13.0% to $467.3 million from $413.4 million in 2012. The increase in total revenues for 2013 and 2012 included $138.2 million and $54.9 million related to the 2012 Acquisitions. Total revenues for 2013 included $4.8 million related to the 2013 acquisition of Net Optics. Excluding the revenues from our 2013 acquisition of Net Optics and the 2012 Acquisitions, revenues decreased by $34.3 million or 9.6%, to $324.2 million in 2013 primarily due to a $25.6 million decrease in shipments of our hardware products (primarily our core network test Gigabit and 10 Gigabit Ethernet interface cards) partially offset by an increase in the recognition of revenues from initial and extended technical support, warranty and software maintenance services. The year-over-year decrease in shipments of our hardware products (primarily our core network test Gigabit and 10 Gigabit Ethernet interface cards), was a byproduct of the challenges we saw in the test market (e.g., reduced spend from our network equipment manufacturer customers, as well as increased pricing pressures). While our Gigabit and 10 Gigabit Ethernet interface cards declined in terms of dollar volume on a year-over-year basis, we saw an increase in shipments of our 40 and 100 Gigabit Ethernet interface cards as our customers move to next generation higher speed network infrastructures.

 

Total revenue from services increased 37.8% to $114.5 million from $83.1 million in 2012. Total services revenues for 2013 and 2012 included $40.2 million and $11.8 million related to the 2012 Acquisitions. Excluding the services revenues from our 2013 acquisition of Net Optics and the 2012 Acquisitions, services revenues increased by $3.0 million or 4.2%, to $74.3 million in 2013.

 

Cost of Revenues. As a percentage of total revenues, our total cost of revenues increased to 22.0 % in 2013 from 19.8% in 2012. The increase in total cost of revenues as a percentage of total revenues was primarily due to the increase in our cost of product revenues as a percentage of total revenues, which was 19.1% in 2013 as compared to 17.3% in 2012. The increase from the prior year to the current year was primarily driven by larger year-over-year percentage increase in personnel and related costs and material-related costs, including additional charges related to inventory excess and obsolescence when compared to our growth in total revenues. Cost of revenues does not include the amortization of purchased technology related to our acquisitions of certain businesses, product lines and technologies of $26.0 million and $20.3 million for the years ended December 31, 2013 and 2012, respectively, which are included within our Amortization of intangible assets line item on our consolidated statements of operations.

 

Research and Development Expenses. In 2013, research and development expenses increased 19.7% to $117.5 million from $98.2 million in 2012. Research and development costs attributable to the activities of the acquired operations were approximately $31.7 million and $11.4 million for 2013 and 2012, respectively. Research and development costs included stock-based compensation expense of $8.1 million and $6.2 million for 2013 and 2012, respectively.

 

Excluding activities of the acquired operations and stock-based compensation, research and development expenses in 2013 decreased 3.5% to $77.8 million compared to $80.6 million in 2012. This decrease was primarily due to a decrease in compensation and related employee costs of $2.9 million. The decrease in compensation and related employee costs was primarily a result of lower bonus expense as we did not fully achieve our annual company-wide objectives in 2013.

 

We believe that continuing our investments in research and development is critical to attaining our strategic objectives. We plan to continue to strategically invest in research and development and new products/technology that will further differentiate us in the marketplace. However, we do not expect our research and development costs to significantly increase as a percentage of revenues in future quarters as we will look to instead re-allocate our existing spend to these new areas/initiatives.

 

 

 
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Sales and Marketing Expenses. In 2013, sales and marketing expenses increased 17.5% to $137.7 million from $117.2 million in 2012. Sales and marketing expenses attributable to the activities of the acquired operations were approximately $34.3 million and $19.0 million for 2013 and 2012, respectively. Sales and marketing costs included stock-based compensation expense of $7.4 million and $5.4 million for 2013 and 2012, respectively.

 

 Excluding activities of the acquired operations and stock-based compensation, sales and marketing expenses in 2013 increased 3.4% to $96.0 million compared to $92.8 million in 2012. This increase was primarily due to an increase in (i) marketing events and related costs (e.g., trade shows) of $2.9 million, (ii) net compensation and related employee costs of $1.4 million, and (iii) travel costs of $1.0 million. These increases were partially offset by a decrease in depreciation expense related to demonstration equipment. The increase in compensation and related employee costs was primarily due to increased headcount in sales and marketing personnel.

 

General and Administrative Expenses. In 2013, general and administrative expenses increased 3.5% to $47.2 million from $45.6 million in 2012. General and administrative expenses attributable to the activities of the acquired operations were approximately $4.2 million and $2.6 million for 2013 and 2012, respectively. General and administrative expenses included stock-based compensation expense of $4.6 million and $7.5 million for 2013 and 2012, respectively.

 

Our general and administrative expenditures in 2013 included charges of $1.5 million related to the internal investigation initiated by the Audit Committee of the Board of Directors as a result of the resignation of our former chief executive officer (Victor Alston) and $1.0 million for costs related to the April 2013 restatement of certain of our previously filed financial statements. These charges were partially offset by $1.2 million of proceeds from the settlement of a legal matter in the first quarter of 2013. Our general and administrative expenditures in 2012 included charges of $1.7 million incurred in the first quarter of 2012 in connection with the transition of our former chief executive officer (Atul Bhatnagar) and $401,000 incurred in the second quarter of 2012 to settle a legal matter.

 

Excluding activities of the acquired operations, stock-based compensation and the charges and settlements noted above, general and administrative expenses in 2013 increased 10.4% to $37.0 million compared to $33.5 million in 2012. This increase was primarily due to an increase in professional services fees (e.g., accounting and legal services) and outside services (e.g., certain IT infrastructure and support costs) of $1.5 million and $1.1 million, respectively.

 

Amortization of Intangible Assets. In 2013, amortization of intangible assets increased 35.9% to $40.8 million from $30.0 million in 2012. These increases were primarily due to the full year and incremental amortization of intangibles related to our 2012 Acquisitions, and to a lesser extent, the 2013 Net Optics acquisition, partially offset by the completion of amortization periods for certain intangible assets.

 

Acquisition and Other Related Expenses. Acquisition and other related expenses for 2013 and 2012 were $6.9 million and $11.9 million, respectively. For 2013, acquisition and other related expenses were principally due to our 2013 Net Optics acquisition and consisted of transaction and integration related costs such as success-based banking fees, professional fees for legal, accounting and tax services, integration related consulting fees, certain employee, facility and infrastructure costs, and other acquisition-related costs. For 2012, acquisition and other related expenses were principally due to our 2012 Acquisitions and consisted of transaction and integration related costs such as success-based banking fees, professional fees for legal, accounting and tax services, integration related consulting fees, amortization of deferred compensation payable to certain pre-acquisition employees of BreakingPoint, certain employee, facility and infrastructure costs, and other acquisition-related costs.

 

Restructuring. Restructuring expenses for 2013 totaled $1.8 million and consisted primarily of one-time employee termination benefits. During the fourth quarter of 2013, our management approved, committed to and initiated a plan to restructure our operations primarily impacting our offshore research and development group in India. The restructuring was substantially completed during the fourth quarter of 2013, and included a net reduction in force of approximately 120 positions.

 

 
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Restructuring expenses for 2012 totaled $4.1 million and consisted primarily of one-time employee termination benefits, costs related to the closure of our office in Melbourne, Australia, and other associated costs. During the third quarter of 2012, our management approved, committed to and initiated a plan to restructure our operations following our August 2012 acquisition of BreakingPoint (the “BreakingPoint Restructuring”). The BreakingPoint Restructuring was substantially completed during the fourth quarter of 2012, and included a net reduction in force of approximately 29 positions (primarily impacting our research and development team in Melbourne, Australia). For additional information, see Note 4 to the consolidated financial statements.

 

Interest Income and Other, Net. Interest and other income, net increased to $6.3 million in 2013 from $2.3 million in 2012. These increases were primarily due to a $2.9 million realized gain recorded during the second quarter of 2013 for the sale of certain auction rate securities that were previously written-down and a $1.0 million realized gain recorded during the third quarter of 2013 for the sale of corporate bonds that were previously written-down.

 

Interest expense. Interest expense, including the amortization of debt issuance costs, were $7.8 million and $7.2 million for 2013 and 2012. Interest expense relates to our convertible senior notes issued during December 2010, as well as the amortization of deferred issuance costs and commitment fees related to our credit facility, which we established in December 2012. For additional information, see Note 3 to the consolidated financial statements.

 

Income Tax Expense. Income tax benefit was ($1.1) million, or an effective rate of (9.9%), in 2013 as compared to an income tax benefit of ($26.1) million, or an effective rate of (134.7%), in 2012. The lower effective tax rate of (9.9%) when compared to the federal statutory income tax rate was mainly due to R&D credits generated during the year, benefit recorded for the 2012 Federal R&D credit during the first quarter of 2013 as a result of the statutory extension of the credit during the first quarter, and the release of accrual for uncertain tax benefits. The lower effective tax rate in 2012 of (134.7%) when compared to the federal statutory income tax rate was primarily due to the $34.8 million partial release of valuation allowances against its U.S. deferred tax assets.

 

Our effective tax rate also differs from the federal statutory rate due to state taxes, significant permanent differences, federal and foreign tax rate differences, inter-company royalties, research and development tax credits and adjustments to our valuation allowance. Significant permanent differences arise due to stock-based compensation expense that are not expected to generate a tax deduction, such as stock-based compensation expenses on grants to foreign employees, offset by tax benefits from disqualifying dispositions. For additional information, see Note 9 to the consolidated financial statements.

 

Realization of our deferred tax assets is dependent primarily on the generation of future taxable income. In considering the need for a valuation allowance we consider our historical, as well as future, projected taxable income along with other objectively verifiable evidence.  Objectively verifiable evidence includes the Company’s significant realization of tax attributes, assessment of tax credits and utilization of net operating loss carryforwards during the year.

  

Comparison of the Years Ended December 31, 2012 and 2011

 

As a result of our acquisitions of Anue Systems, Inc. (“Anue”) on June 1, 2012 and BreakingPoint Systems, Inc. (“BreakingPoint”) on August 24, 2012 (the “2012 Acquisitions”), our 2012 consolidated results of operations include the financial results of these acquisitions from their respective acquisition dates. To assist the readers of our financial statements in reviewing our year-over-year consolidated operating results, we have estimated the impacts of these acquisitions for the applicable periods in the related statement of operations sections below.

 

Revenues. In 2012, total revenues increased 32.8% to $413.4 million from $311.4 million in 2011. Total revenues for 2012 included $54.9 million related to the 2012 Acquisitions. Excluding the revenues from our 2012 Acquisitions, revenues increased 15.1% to $358.5 million in 2012 primarily due to a $36.7 million increase in shipments of our hardware products (primarily our core network test 10 Gigabit and 40/100 Gigabit Ethernet interface cards and our IxVeriwave solutions) and an increase in the ratable recognition of our revenues from initial and extended technical support, warranty and software maintenance services.

 

 
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Cost of Revenues. As a percentage of total revenues, our total cost of revenues decreased to 19.8% in 2012 from 20.3% in 2011. Excluding the impact of our 2012 Acquisitions, our cost of revenues as a percentage of total revenues in 2012 increased slightly to 20.8%, primarily due to increases in personnel-related costs attributable to professional services and technical support. Cost of revenues does not include the amortization of purchased technology related to our acquisitions of certain businesses, product lines and technologies of $20.3 million and $10.8 million for the years ended December 31, 2012 and 2011, respectively, which are included within our Amortization of intangible assets line item on our consolidated statements of operations.

 

Research and Development Expenses. In 2012, research and development expenses increased 30.7% to $98.2 million from $75.1 million in 2011. As a result of our 2012 Acquisitions, our research and development expenses in 2012 included approximately $11.4 million related to the research and development activities of the acquired operations. Excluding the incremental research and development operating costs related to the 2012 Acquisitions and stock-based compensation expenses of $6.2 million and $4.3 million for 2012 and 2011, respectively, research and development expenses in 2012 increased 13.8% to $80.6 million compared to $70.8 million in 2011. This increase was primarily due to an increase in compensation and related employee costs of $9.4 million, partially offset by a one-time charge of $900,000 incurred in the first quarter of 2011 to terminate and settle a product development contract. The increase in compensation and related employee costs was primarily a result of (i) additional investments in our product development teams, including the Wi-Fi development team added as part of our acquisition of VeriWave in July 2011 and our teams in the United States, Romania and India, and (ii) higher bonus expense as our 2012 performance exceeded that of 2011 when compared to the applicable annual company-wide objectives.

 

Sales and Marketing Expenses. In 2012, sales and marketing expenses increased 34.7% to $117.2 million from $87.0 million in 2011. As a result of our 2012 Acquisitions, our sales and marketing expenses in 2012 included approximately $19.0 million related to the sales and marketing activities of the acquired operations. Excluding the incremental sales and marketing operating costs related to the 2012 Acquisitions and stock-based compensation expenses of $5.4 million and $3.3 million for 2012 and 2011, respectively, sales and marketing expenses increased 11.0% to $92.8 million compared to $83.7 million in 2011. This increase was primarily due to an increase in compensation and related employee costs, including travel, of $7.7 million and a higher depreciation expense of $969,000 primarily related to an increase in the number of our demonstration units in the field. The increase in compensation and related employee costs was primarily due to higher sales commissions as revenue levels increased in 2012 over the same period in the prior year and higher salaries due, in part, to annual merit increases in 2012 and an increase in 2012 in the number of our sales personnel.

 

General and Administrative Expenses. In 2012, general and administrative expenses increased 35.5% to $45.6 million from $33.6 million in 2011. As a result of our 2012 Acquisitions, our general and administrative expenses in 2012 included approximately $2.6 million related to the general and administrative activities of the acquired operations. Our general and administrative expenditures in 2012 also included one-time charges of $1.7 million incurred in the first quarter of 2012 in connection with the departure of our former CEO and $401,000 incurred in the second quarter of 2012 to settle a legal matter, and stock-based compensation expenses of $7.5 million and $4.5 million for 2012 and 2011, respectively. Excluding these one-time charges, the incremental general and administrative costs related to the 2012 Acquisitions, and stock-based compensation expenses, general and administrative expenses in 2012 increased 14.8% to $33.5 million compared to $29.2 million in 2011. This increase was primarily due to an increase in compensation and related employee costs of $2.8 million, which was due, in part, to a higher bonus expense in the 2012 period as our 2012 performance exceeded that of 2011 when compared to the applicable annual company-wide objectives.

 

Amortization of Intangible Assets. In 2012, amortization of intangible assets increased 87.8% to $30.0 million from $16.0 million in 2011. These increases were primarily due to the incremental amortization of intangibles related to our acquisitions of VeriWave in July 2011, Anue in June 2012 and BreakingPoint in August 2012, as partially offset by the completion of amortization periods for certain intangible assets.

 

Acquisition and Other Related Expenses. Acquisition and other related expenses for 2012 and 2011 were $11.9 million and $1.1 million, respectively. For 2012, acquisition and other related expenses were principally due to our 2012 Acquisitions and consisted of transaction and integration related costs such as success-based banking fees, professional fees for legal, accounting and tax services, integration related consulting fees, amortization of deferred compensation payable to certain pre-acquisition employees of BreakingPoint, certain employee, facility and infrastructure costs, and other acquisition-related costs. For 2011, acquisition and other related expenses were principally due to our acquisition of VeriWave and consisted primarily of professional fees for legal, due diligence and valuation services, certain employee transition costs and other related costs. For additional information, see Note 2 to Consolidated Financial Statements.

 

 
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Restructuring. Restructuring expenses for 2012 totaled $4.1 million and consisted primarily of one-time employee termination benefits, costs related to the closure of our office in Melbourne, Australia, and other associated costs. During the third quarter of 2012, our management approved, committed to and initiated a plan to restructure our operations following our August 2012 acquisition of BreakingPoint (the “BreakingPoint Restructuring”). The BreakingPoint Restructuring was substantially completed during the fourth quarter of 2012, and included a net reduction in force of approximately 29 positions (primarily impacting our research and development team in Melbourne, Australia). There were no restructuring expenses incurred in 2011. For additional information, see Note 4 to the consolidated financial statements.

 

Interest Income and Other, Net. Interest and other income, net increased to $2.3 million in 2012 from $2.1 million in 2011.

 

Interest expense. Interest expense, including the amortization of debt issuance costs, was $7.2 million for each of 2012 and 2011, and related to our convertible senior notes issued during December 2010. Interest expense, including the amortization of debt issuance costs, pertaining to our Credit Facility was not significant for 2012. For additional information, see Note 3 to the consolidated financial statements.

 

Income Tax Expense. Income tax benefit was $26.1 million, or an effective rate of (134.7%), in 2012 as compared to an income tax expense of $3.4 million, or an effective rate of 11.2%, in 2011. The decrease in our overall tax expense was primarily due to the $34.8 million partial release of valuation allowances during 2012.

 

  Liquidity and Capital Resources

 

We have funded our operations with our cash balances generated primarily from operations and proceeds from our October 2000 initial public offering (“IPO”), our December 2010 convertible debt offering and exercises of share-based awards.

 

The following table sets forth our cash and short- and long-term investments as of December 31, 2013, 2012 and 2011 (in thousands):

 

   

As of December 31,

 
   

2013

   

2012

   

2011

 
                         

Cash and cash equivalents

  $ 34,189     $ 47,508     $ 42,729  
                         

Short-term marketable securities

    51,507       126,851       156,684  
                         

Long-term marketable securities

    -       3,119       185,608  
    $ 85,696     $ 177,478     $ 385,021  

 

Our cash, cash equivalents and short- and long-term investments, when viewed as a whole, decreased to $85.7 million as of December 31, 2013 from $177.5 million as of December 31, 2012, primarily due to the $188.3 million of net cash used for our 2013 acquisition of Net Optics and capital expenditures of $12.1 million. These amounts were partially offset by the $86.5 million in net cash provided by our operating activities and $19.4 million of cash generated from the exercises of share-based option awards.

 

Our cash, cash equivalents and short- and long-term investments, when viewed as a whole, decreased to $177.5 million as of December 31, 2012 from $385.0 million as of December 31, 2011, primarily due to the $299.0 million of net cash used for our 2012 Acquisitions (i.e., Anue in the second quarter of 2012 for $148.3 million and BreakingPoint in the third quarter of 2012 for $150.7 million) and capital expenditures of $17.7 million. These amounts were partially offset by the $80.3 million in net cash provided by our operating activities and $26.6 million of cash generated from the exercises of share-based option awards.

 

 
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Of our total cash, cash equivalents and short and long-term investments, $25.3 million and $22.5 million was held outside of the United States in various foreign subsidiaries as of December 31, 2013 and December 31, 2012, respectively.

 

Cumulative undistributed earnings of foreign subsidiaries for which no deferred income taxes have been provided approximated $91.8 million and $80.4 million at December 31, 2013 and 2012, respectively. No provision for U.S. income and foreign withholding taxes has been made for unrepatriated foreign earnings because it is expected that such earnings will be reinvested indefinitely outside of the U.S. Under current tax laws and regulations, if our cash, cash equivalents or investments associated with the subsidiaries’ undistributed earnings were distributed to the United States in the form of dividends or otherwise, it would be included in our U.S. taxable income and we would be subject to additional U.S. income taxes and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable. We had no exposure to European sovereign debt as of December 31, 2013.

 

The following table sets forth our summary cash flows for the years ended December 31, 2013, 2012 and 2011 (in thousands):

 

   

Year Ended December 31,

 
   

2013

   

2012

   

2011

 
                         

Cash provided by operating activities

  $ 86,500     $ 80,314     $ 61,331  

Cash used in investing activities

    (121,710 )     (104,216 )     (111,424 )

Cash provided by financing activities

    21,891       28,681       16,740  

 

Cash Flows from Operating Activities

 

Operating cash inflows are principally provided by cash collections on sales to our customers. Our primary uses of cash from operating activities are for personnel-related expenditures, product costs and facility-related payments. Going forward, our cash flows from operating activities will be impacted by (i) the extent to which we grow our customer sales, (ii) the extent to which we increase our headcount and enhance our infrastructure to generate additional business, develop new products and features, and support our growth, (iii) our working capital management, and (iv) interest paid to service our long-term debt (See Note 3 to consolidated financial statements).

 

Net cash provided by operating activities was $86.5 million for the year ended December 31, 2013 compared to $80.3 million for the year ended December 31, 2012. This increase in cash flow generated from operations was primarily driven by higher revenues from our 2012 acquisitions of Anue and BreakingPoint (full year of activity in 2013), partially offset by a much smaller increase in accounts receivable balances in 2013 compared to 2012. Cash was also impacted by a $3.1 million decrease in working capital changes resulting from an increase in inventory in 2013 as compared to 2012 and the timing of payments made on accounts payable and accrued liabilities (i.e., higher accrued balances as of December 31, 2013 as compared to December 31, 2012) partially offset by and an increase in deferred revenues in 2013 as compared to 2012 from a higher volume of extended warranty and software maintenance contracts.

  

Net cash provided by operating activities was $80.3 million for the year ended December 31, 2012 compared to $61.3 million for the year ended December 31, 2011. This increase in cash flow generated from operations was primarily due to a $17.4 million increase related to net working capital changes in 2012 as compared to 2011. The working capital changes were principally due to the timing of payments of accounts payable and accrued liabilities (i.e., higher accrued balances as of December 31, 2012 as compared to December 31, 2011), such as the higher bonus payables as of December 31, 2012 as compared to December 31, 2011, and an increase in deferred revenues in 2012 as compared to 2011 primarily due to an increase in extended warranty and software maintenance contracts in 2012 as compared to 2011. These increases in working capital were partially offset by the increase in our accounts receivable balances in 2012 when compared to 2011 (due primarily to the higher sales levels in 2012).

 

 
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Cash Flows from Investing Activities

 

Our cash inflow from investing activities principally relates to proceeds from the sale and maturities of our investments in marketable securities. Our primary uses of cash from investing activities are for payments to acquire products, technologies and businesses, purchases of marketable securities investments and capital expenditures to support our growth. Going forward, we expect our cash flows from investing activities to fluctuate based on the number of product, technology and/or business acquisitions, if any, we close using cash, and the timing of our sales, maturities and purchases of marketable securities.

 

Net cash used in investing activities was $121.7 million and $104.2 million for the years ended December 31, 2013 and 2012, respectively. Excluding marketable securities purchases and proceeds, net cash used in investing activities was $201.3 million and $317.5 million in 2013 and 2012, respectively. The decrease in net cash used in 2013 was primarily due to less aggregate cash used for our acquisition of Net Optics in 2013 as compared to our acquisitions of Anue and BreakingPoint in 2012.

 

Net cash used in investing activities was $104.2 million and $111.4 million for the years ended December 31, 2012 and 2011, respectively. Excluding marketable securities purchases and proceeds, net cash used in investing activities was $317.5 million and $31.5 million in 2012 and 2011, respectively. The increase in net cash used in 2012 was primarily due to the 2012 Acquisitions, which resulted in aggregate cash used, net of cash acquired, of $299.0 million.

 

Cash Flows from Financing Activities

 

Prior to December 2010, our cash inflow from financing activities had been principally related to proceeds from the exercise of stock options and employee stock purchase plan options. On December 7, 2010, we raised $194.0 million in net proceeds from the issuance of convertible senior notes. On December 21, 2012, we entered into a credit agreement under which we established a senior secured revolving credit facility (the “Credit Facility”) with certain institutional lenders that provides for an aggregate loan amount of up to $150.0 million. No amounts were drawn down under this Credit Facility as of December 31, 2013. Going forward, we expect our cash flows from financing activities to fluctuate based on (i) the number of exercises of share-based awards which is partially dependent on the performance of our stock price and (ii) the utilization of our Credit Facility. If deemed appropriate, and approved by our Board of Directors, we may raise capital through additional debt or equity financings, refinance our existing debt, or initiate stock buyback programs.

 

Net cash provided by financing activities was $21.9 million and $28.7 million for the years ended December 31, 2013 and 2012, respectively. This decrease in cash flow provided by financing activities was primarily due to a $7.2 million decrease in proceeds received from exercises of share-based awards in 2013 as compared to 2012.

 

Net cash provided by financing activities was $28.7 million and $16.7 million for the years ended December 31, 2012 and 2011, respectively. This increase in cash flow provided by financing activities was primarily due to a $9.9 million increase in proceeds received from exercises of share-based awards, partially offset by a $947,000 payment of debt issuance costs related to our Credit Facility established in December 2012.

  

We believe that our existing balances of cash and cash equivalents, investments and cash flows expected to be generated from our operations, and borrowings available under our Credit Facility established in December 2012, will be sufficient to satisfy our operating requirements for at least the next 12 months. Our Credit Facility is expected to mature on December 21, 2016, but may mature on September 14, 2015 if we do not have available liquidity (domestic cash and investments, plus availability under the Credit Facility) of $25.0 million in excess of the amount required to repay our Notes of $200.0 million in full beginning on June 15, 2015. If we satisfy this requirement between June 15, 2015 and September 14, 2015, but fail to do so after September 15, 2015 and prior to December 15, 2015, the maturity date is the date on which the requirement is no longer satisfied.

 

 
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We have received extensions from the lenders under the Credit Facility in connection with the delays in the deliveries to the lenders of our financial statements for the quarters ended September 30, 2013, December 31, 2013 and March 31, 2014 and of our audited financial statements for the fiscal year ended December 31, 2013. Upon the filing of this Form 10­-K, we will have completed all such deliveries other than with respect to the deliverable for the quarter ended March 31, 2014. An amendment dated June 12, 2014 to the Credit Facility Agreement provides an extension through June 27, 2014 for the submission to the lenders of our condensed consolidated financial information for the first quarter of 2014. Should we fail to complete appropriate remedial action regarding such delayed filing prior to the expiration of such waiver, we will be in default under the Credit Facility and will not be able to effect borrowings thereunder. The lenders may also deem any breach of our covenants under the Indenture governing our Notes to be a breach of the Credit Facility Agreement, which requires that we comply with the provisions of the Indenture. We have received temporary waivers from the lenders in respect of our delayed filings with the SEC to the extent such noncompliance with the Indenture may constitute an event of default under the Credit Facility Agreement. See Note 3 to the consolidated financial statements included herein.

 

Nonetheless, we may seek additional sources of capital as necessary or appropriate to fund acquisitions or to otherwise finance our growth or operations; however, there can be no assurance that such funds, if needed, will be available on favorable terms, if at all.

 

Our access to the capital markets to raise funds, through the sale of equity or debt securities, is subject to various factors, including the conditions in the U.S. capital markets and the timely filing of our periodic reports with the Commission, and our failure to timely file this Form 10-K, the 2013 Third Quarter Form 10-Q and the 2014 First Quarter Form 10-Q with the SEC currently limits our ability to access the capital markets using short-form registration.

 

Our Notes were issued under an Indenture dated as of December 21, 2010 (the “Indenture”) that includes various default provisions, which, under certain circumstances, could result in the acceleration of our repayment obligations under the Notes and/or an increase for up to 180 days in the overall interest rate charged on the Notes. On approximately May 1, 2014, the trustee under the Indenture provided us with notice that we were in default under the Indenture of our obligation to timely file with the trustee this Form 10-K, our 2013 Third Quarter Form 10-Q and a Current Report on Form 8-K/A relating to our acquisition of Net Optics. that was required to be filed with the SEC no later than on February 18, 2014. The trustee’s notice directed us to cure these defaults. If we do not cure the defaults within 60 days after our receipt of the notice and unless we obtain a waiver from the holders of more than 50% in aggregate principal amount of the Notes, an “event of default” will occur under the Indenture. Upon an event of default, we may, and intend to, elect that for the first 180 days thereafter (or such lesser amount of time during which the event of default continues), the sole remedy will be the payment to the holders of the Notes of additional interest at an annual rate equal to 0.50%. If we elect to pay additional interest and the event of default is not cured within 180 days, or if we do not make such an election when the event of default first occurs, the trustee or the holders of at least 25% in aggregate principal amount of the Notes may declare the principal amount of the Notes to be due and payable immediately. In the event that after the date of the filing of this Form 10-K the trustee or the holders of at least 25% aggregate principal amount of the Notes provide us with notice of and directs us to cure the default under the Indenture that relates to our not having timely filed our 2014 First Quarter Form 10-Q with the trustee, then we will be subject to the 60-day cure period and other consequences discussed above.

 

The Indenture provides that if our common stock ceases to be listed on the Nasdaq Global Select Market, then any holder of the Notes could require us to repurchase the holder’s Notes in accordance with the terms of the Indenture. In May 2014, The NASDAQ Stock Market LLC (“Nasdaq”) notified us that due to our delay in filing this Form 10-K, the 2013 Third Quarter Form 10-Q and the 2014 First Quarter Form 10-Q, our common stock would be delisted unless we timely requested a hearing before a Nasdaq Listings Qualification Panel (the “Panel”). The Company timely requested such a hearing, which was held on June 12, 2014. At the hearing, the Company presented an updated plan to regain compliance with the Nasdaq requirement that we be timely in the filing of our periodic financial reports with the SEC and requested an extension of time for the filing of our delinquent reports. After filing this Form 10-K and the 2013 Third Quarter Form 10-Q with the SEC, we will continue to be delinquent in the filing of our periodic financial reports with the SEC due to our delay in filing the 2014 First Quarter Form 10-Q. The delisting of our common stock has been stayed until the Panel’s decision regarding our listing status has been issued.

 

Any acceleration of our repayment obligations or requirement that we pay additional interest under the Notes, or any requirement that we offer to repurchase the Notes, could materially and adversely impact our liquidity.

 

 
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Contractual Obligations

 

Our significant financial commitments at December 31, 2013 are as follows (in thousands):

 

   

Total

   

Less than

1 year

   

1-3 years

   

3-5 years

   

More than 5 

years

   

Other

 
   

(in thousands)

 

Operating leases (1)

    54,953       11,261       18,454       10,347       14,891          

Purchase obligations (2)

    18,829       18,829                                  

Net liability for uncertain tax positions (3)

    8,602                                       8,602  

Convertible Senior notes (Principal and Interest) (4)

    221,867       6,000       215,867                          

Total

  $ 304,251     $ 36,090     $ 234,321     $ 10,347     $ 14,891     $ 8,602  

 

(1)

Minimum lease payments have not been reduced by minimum sublease rentals of $0.8 million due in the future under noncancelable subleases. See Note 10 to consolidated financial statements.

 

(2)

Purchase obligations in the table above consist of purchase orders issued to certain of our contract manufacturers in the normal course of business to purchase specified quantities of our hardware products. It is not our intent, nor is it reasonably likely, that we would cancel these executed purchase orders.

 

(3)

This net liability for uncertain tax positions may be payable by us in the future. The ultimate resolution of this unrecognized tax benefit depends on many factors and assumptions; accordingly, we are not able to reasonably estimate the timing of the payments or the amount by which this net liability for uncertain tax positions will increase or decrease over time, net of amounts offset against net operating loss carryforwards. See Note 9 to consolidated financial statements.

 

(4)

In December 2010, we issued $200.0 million in aggregate principal amount of 3.00% convertible senior notes that mature on December 15, 2015, if not converted. The interest is payable semi-annually on June 15 and December 15 of each year, beginning on June 15, 2011. During 2013, we made interest payments of $6.0 million. See Note 3 to consolidated financial statements.

 

Recent Accounting Pronouncements

 

Information regarding new accounting pronouncements is included in Note 1 to the consolidated financial statements.

 

 
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Interest Rate Sensitivity

 

Investment Activities

 

We maintain a portfolio of cash equivalents and investments in a variety of fixed and variable rate securities, including U.S. government and federal agency securities, corporate debt securities, and money market funds. The primary objective of our investment activities is to maintain the safety of principal and preserve liquidity while maximizing yields without significantly increasing risk. We do not enter into investments for trading or speculative purposes. Fixed-rate securities are subject to market risk so changes in prevailing interest rates may adversely impact their fair market value should interest rates rise. While we do not intend to sell these fixed rate securities prior to maturity based on a sudden change in market interest rates, should we choose to sell these securities in the future, our consolidated operating results or cash flows may be adversely affected. A smaller portion of our cash equivalents and investment portfolio consists of variable interest rate securities. Accordingly, we also have interest rate risk with these variable rate securities as the income produced may decrease if interest rates fall. We do not use derivatives or similar instruments to manage our interest rate risk. Due to the high investment quality and relatively short duration of these investments, we do not believe that they present any material exposure to changes in fair market value as a result of changes in interest rates.

 

Senior Secured Revolving Credit Facility 

 

On December 21, 2012, we entered into a credit agreement establishing a senior secured revolving credit facility (the “Credit Facility”) with certain institutional lenders that provides for an aggregate loan amount of up to $150.0 million. Borrowings under the Credit Facility bear interest at either (i) the Base Rate, which is equal to the highest of (a) the Agent's (i.e., Bank of America) prime rate, (b) the federal funds rate plus 0.50% and (c) the London Interbank Offered Rate ("LIBOR") for a one-month interest period plus 1.00% or (ii) the LIBOR plus applicable margin. The applicable margin ranges are from 1.75% to 2.25% for LIBOR loans and 0.75% to 1.25% for Base Rate loans, and depends on the Company’s total leverage ratio. Interest is payable quarterly. No amounts were drawn down under this Credit Facility as of December 31, 2013.

 

Convertible Senior Notes

 

On December 7, 2010, we closed our offering of $200.0 million aggregate principal amount of 3.00% Notes (the “Notes”). The Notes bear a fixed interest rate of 3.00% per year, payable semi-annually in arrears on June 15 and December 15 of each year, beginning on June 15, 2011. During 2013, we made interest payments of $6.0 million. A hypothetical change in interest rates would not impact the interest expense or carrying value of the Notes as the coupon rate is fixed. The Notes are carried on the consolidated balance sheet at amortized cost and they are not hedged.

 

Exchange Rate Sensitivity

 

The majority of our revenue and expenses are denominated in U.S. dollars. However, since we have sales, research and development, and other operations outside of the United States, we do incur operating expenses in foreign currencies, primarily the Japanese Yen, Romanian Lei, Indian Rupee, Chinese Yuan, Australian Dollar, Canadian Dollar, Euro and British Pound. If these currencies strengthen against the U.S. dollar, our costs reported in U.S. dollars will increase, which would adversely affect our operating expenses. Approximately 30% of our operating expenses, excluding stock-based compensation expense and amortization of intangible assets, are exposed to foreign currency movements, and historically, we have not entered into foreign currency forward contracts to hedge our operating expense exposure to foreign currencies, but we may do so in the future.

 

The fair value of our foreign currency forward contracts are sensitive to changes in foreign currency exchange rates. When possible, we use foreign currency forward contracts to minimize the short-term impact of currency fluctuations on foreign currency receivables that are denominated in Japanese Yen, Euros and British Pounds. The duration of our foreign currency forward contracts typically have maturities of one to four months. We do not enter into foreign exchange forward contracts for speculative or trading purposes. Due to the relatively short duration of these forward contracts, we do not believe that they present any material exposure to changes in fair market value as a result of changes in foreign currency exchange rates. Additionally, these contracts are intended to offset exchange losses and gains on underlying exposures in foreign currency receivables. During the years ended December 31, 2013 and 2012, the impact to operating income for changes to foreign currency exchange rates was not material.

 

As of December 31, 2013, we held five open foreign currency forward contracts with a notional value of $7.0 million and a net fair value of approximately $54,000. As of December 31, 2012, we held 20 open foreign currency forward contracts with a notional value of $6.5 million and a net fair value of approximately $99,000.

 

 
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Item 8. Financial Statements and Supplementary Data

 

Our financial statements and supplementary data required by this Item are provided in the consolidated financial statements of the Company included in this Form 10-K as listed in Item 15(a) of this Form 10-K.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None. 

 

Item 9A. Controls and Procedures

 

Background

 

As reported in the Current Report on Form 8-K filed by the Company with the SEC on March 5, 2014, on February 26, 2014, the Audit Committee (the “Audit Committee”) of the Company’s Board of Directors completed and made its findings with respect to an internal investigation (the “Audit Committee Investigation”) initiated as a result of the resignation on October 24, 2013 of the Company’s former President and Chief Executive Officer, Vic Alston (the “Former CEO”). The Audit Committee Investigation included performing procedures to assess the Company’s recording of financial transactions and the corresponding impact on the Company’s financial reporting. As a result of the investigation and the Company’s own internal accounting review, certain errors in the Company’s revenue recognition practices that affect the timing of the Company’s recognition of revenue were identified, as are described in more detail below under “Management’s Report on Internal Control Over Financial Reporting.” The identified errors also resulted in the restatement of our previously issued condensed consolidated financial statements for the first two quarterly periods in the year ended December 31, 2013.

 

Evaluation of Disclosure Controls and Procedures

 

Based on our management's evaluation (with the participation of our Acting Chief Executive Officer and Acting Chief Financial Officer), as of the end of the period covered by this Annual Report, our Acting Chief Executive Officer and Acting Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were not effective as of December 31, 2013 to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our Acting Chief Executive Officer and Acting Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

 

Notwithstanding the material weaknesses in our internal controls over financial reporting as of December 31, 2013, management has concluded that the consolidated financial statements included in this Form 10-K present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed by, or under the supervision of, our Acting Chief Executive Officer and our Acting Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, our internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.

 

 
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As of December 31, 2013, our management (with the participation of our Acting Chief Executive Officer and our Acting Chief Financial Officer) conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Management's assessment of and conclusion on the effectiveness of internal control over financial reporting as of December 31, 2013 did not include the internal controls of Net Optics, Inc. (“Net Optics”), which was acquired in a purchase business combination by the Company on December 5, 2013. The net and total assets of Net Optics constitute, in aggregate, less than 3% of each of the net and total assets of the Company, and the revenues and net income of Net Optics comprise, in aggregate, less than 1% of the revenues and of net income of the Company, as such amounts for the Company are reflected in the Company’s consolidated financial statements as of and for the fiscal year ended December 31, 2013 included in this Form 10-K. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. In connection with management’s assessment of our internal control over financial reporting described above, management has identified the following deficiencies that constituted individually, or in the aggregate, material weaknesses in our internal control over financial reporting as of December 31, 2013.

 

 

Control Environment – The control environment, which includes the Company’s Code of Conduct and its Ethics Policy, is the responsibility of senior management, sets the tone of our organization, influences the control consciousness of employees, and is the foundation for the other components of internal control over financial reporting. Given the Audit Committee’s determination that the Former CEO had misstated his academic credentials, age and early employment history, we determined that the Company did not have sufficient background check policies to validate the age, education and employment history of existing employees that were subsequently promoted to senior management positions or of acquired employees placed in senior management positions. Further, the results of the Audit Committee Investigation concluded that the aggressive tone at the top set by the Former CEO, and the Company’s former Chief Financial Officer’s lack of leadership in terms of counterbalancing that aggressive tone at the top, contributed to an ineffective control environment. We believe that the Former CEO and the former Chief Financial Officer provided insufficient attention to key controls. We also believe that controls over whistleblower allegation investigations were improperly designed to perform timely investigations into all whistleblower matters with appropriate scope, procedures and conclusions reached. In addition, the Company also does not have controls that are operating effectively to appropriately segregate duties within certain areas of the organization. Finally, in light of the Company’s recent growth and the relative complexity of its transactions, together with the results of the Audit Committee Investigation, we believe the Company lacks certain monitoring controls necessary to detect circumstances in which management may override controls or deviate from expected standards of conduct. Such monitoring controls are often addressed through the use of an internal audit function. This ineffective control environment contributed significantly to the material weaknesses described below.  

 

 

Sufficiency of Accounting Department Resources –The Company has insufficient competent and diligent accounting department resources to develop and operate effective internal controls over financial reporting. The lack of certain appropriate resources in the Company’s accounting department led to widespread control deficiencies in the Company’s financial reporting process and contributed significantly to the Company’s inability to properly identify and assess revenue recognition as described below.  

 

 

Revenue Recognition – The Company’s internal controls were not designed to: (i) appropriately identify and assess the accounting impact of certain multiple-element arrangements that were executed as separate sales transactions, (ii) identify and account for all deliverables in certain multiple-element arrangements for which certain future deliverables existed and were not considered and (iii) properly identify and account for arrangements that included payment terms that extended beyond the Company’s customary terms. The Company has also insufficiently trained its accounting department, sales force and other personnel involved in the sales process with respect to the Company’s revenue recognition policies and procedures. In addition, the Company has not adequately designed controls to ensure the proper assessment of sales arrangements documented in foreign languages. As a result of these design defects, our policies and controls related to the Company’s revenue recognition practices were not effective in ensuring that revenue was recorded in the correct period and that the accounting department was informed of all elements and deliverables of certain arrangements. In addition, the Company lacked appropriate controls to ensure the completeness and accuracy of data within certain data warehouse reports used to support the revenue recognition process. The Company also did not have effective general information technology controls around the data warehouse and licensing systems. 

 

 

Manual Journal Entries – The Company’s internal controls over manual journal entries were not designed to prevent inappropriate manual journal entries from being recorded in its books and records. Further, management’s review process over recorded manual journal entries did not include the appropriate level of approval or evidence of such approval and, at times, lacked the appropriate journal entry supporting documentation.  

 

 
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The material weaknesses described above resulted in material misstatements in our consolidated financial statements for the year ended December 31, 2013. Because of these material weaknesses, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2013.

 

The effectiveness of our internal control over financial reporting as of December 31, 2013 has been audited by Deloitte & Touche LLP, our independent registered public accounting firm, as stated in its report which is included elsewhere herein.

 

Changes in Internal Control Over Financial Reporting

 

During the quarter ended December 31, 2013, the only change in our internal control over financial reporting that materially affected or is reasonably likely to materially affect our internal control over financial reporting was the resignation of our former Chief Executive Officer on October 24, 2013. 

 

Remediation Efforts to Address Newly Identified Material Weaknesses

 

Our management has worked, and continues to work, to strengthen our internal control over financial reporting. We are committed to ensuring that such controls are designed and operating effectively. Since identifying the material weaknesses in our internal control over financial reporting, we have corrected the identified errors in the financial statements. We have developed and are continuing to develop remediation plans to fully address these control deficiencies. If not remediated, these control deficiencies could result in further material misstatements to our financial statements. Our Board of Directors and management take internal controls over and the integrity of the Company’s financial statements seriously and believe that the remediation steps described below, including with respect to personnel changes, are essential to maintaining a strong and effective internal controls over financial reporting and a strong internal control environment. The following steps are among the measures that have been implemented or will be implemented as soon as practicable after the date of this filing:

 

Control Environment

 

 

Our Former CEO is no longer employed by the Company, and we are engaged in a search both within and outside of Ixia for a new Chief Executive Officer who will provide strong leadership to the Company. The Company’s Chief Innovation Officer and Chairman of the Board, who also served as the Company’s President from May 1997 until September 2007 and as its Chief Executive Officer from September 2000 until March 2008, is currently also serving as our Acting CEO.

 

 

Our Former CFO is no longer employed by the Company, and we are engaged in a search both within and outside of Ixia, for a new CFO who will provide strong leadership to the Company and, in particular, to our finance and accounting function. The Company’s Vice President, Finance, who joined the Company as Senior Director, Finance in 2004 and served in that position until he became Vice President, Finance in 2006, is now also serving as our Acting CFO.

 

 

We are developing and preparing to implement a training program, to be led by our Acting CEO and Acting CFO (and reinforced by senior accounting personnel with the appropriate level of expertise), for executives, finance and accounting personnel, operations personnel, sales personnel and other personnel involved in the sales process to enhance awareness and understanding of the Company’s revenue recognition policies and procedures, as well as the importance of financial reporting integrity and the Company’s Code of Conduct and Ethics Policy.

 

 

We are developing a program to enhance the visibility of the Company’s whistleblower hotline, as well as the process, policies and procedures to assess, evaluate and communicate matters arising from whistleblower communications, including the Audit Committee’s direct oversight and monitoring of senior management’s actions undertaken to assess, evaluate and resolve whistleblower matters.

 

 

We are in the process of implementing an independent internal audit function reporting directly to the Audit Committee.

 

 

We will develop a roles and responsibilities matrix for the key accounting and operations personnel to incorporate segregation of duties considerations.

 

 
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Sufficiency of Accounting Department Resources

 

 

We have enhanced and plan to continue to enhance the Company’s finance and accounting department staff, in terms of both number and competency of personnel and particularly in the area of revenue recognition. Specifically:

 

 

1.