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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended August 31, 2015

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 001-36162

 

 

BARRACUDA NETWORKS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   83-0380411

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

3175 S. Winchester Blvd.

Campbell, California 95008

(408) 342-5400

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

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

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

The number of shares outstanding of the registrant’s common stock outstanding as of September 30, 2015 was 53,376,731.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page  
PART I—FINANCIAL INFORMATION   
Item 1.   Financial Statements      5  
  Condensed Consolidated Balance Sheets      5  
  Condensed Consolidated Statements of Operations      6  
  Condensed Consolidated Statements of Comprehensive Income (Loss)      7  
  Condensed Consolidated Statements of Cash Flows      8  
  Notes to Condensed Consolidated Financial Statements      9  
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      18  
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      28  
Item 4.   Controls and Procedures      28  
PART II—OTHER INFORMATION   
Item 1.   Legal Proceedings      29  
Item 1A.   Risk Factors      29  
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      48  
Item 3.   Defaults Upon Senior Securities      48  
Item 4.   Mine Safety Disclosures      48  
Item 5.   Other Information      48  
Item 6.   Exhibits      48  


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect” and the negative and plural forms of these words and similar expressions are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements concerning the following:

 

    our future financial performance, including our expectations regarding our revenue, cost of revenue, gross profit or gross margin, operating expenses, including changes in research and development, sales and marketing and general and administrative expenses, and our ability to achieve and maintain future profitability;

 

    our business plan and our ability to effectively manage our growth and associated investments;

 

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

 

    market acceptance of recently introduced security and storage solutions;

 

    beliefs about and objectives for future operations;

 

    our ability to increase sales of our solutions and renewals of our subscriptions;

 

    our ability to attract and retain customers;

 

    our ability to cross-sell to our existing customers;

 

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

 

    our ability to timely and effectively scale and adapt our existing solutions;

 

    our ability to develop new solutions and bring them to market in a timely manner;

 

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

 

    our ability to continue to expand internationally;

 

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

 

    sufficiency of cash to meet cash needs for at least the next 12 months;

 

    future acquisitions or investments;

 

    our ability to stay in compliance with laws and regulations that currently apply or become applicable to our business both in the United States and internationally;

 

    economic and industry trends or trend analysis;

 

    the attraction and retention of qualified employees and key personnel;

 

    the estimates and estimate methodologies used in preparing our condensed consolidated financial statements;

 

    our stock repurchase program; and

 

    the future trading prices of our common stock.

We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs; however, these forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended February 28, 2015. Moreover, we operate in a very competitive and rapidly changing environment and new risks emerge from time to time. It is not possible for us to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed with the SEC as exhibits to this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

 

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Table of Contents

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

 

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Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

BARRACUDA NETWORKS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(unaudited)

 

     As of
August 31,
2015
    As of
February 28,
2015
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 173,683     $ 151,373  

Marketable securities

     44,066       40,754  

Accounts receivable, net of allowance for doubtful accounts of $1,717 and $1,531 as of August 31, 2015 and February 28, 2015, respectively

     43,026       40,725  

Inventories, net

     5,579       4,454  

Prepaid income taxes

     7,879       8,245  

Deferred costs

     31,926       30,221  

Deferred income taxes

     152       479  

Other current assets

     4,615       4,015  
  

 

 

   

 

 

 

Total current assets

     310,926       280,266  

Property and equipment, net

     27,787       27,839  

Deferred costs, non-current

     28,288       27,715  

Deferred income taxes, non-current

     384       443  

Other non-current assets

     5,128       4,123  

Intangible assets, net

     8,748       9,217  

Goodwill

     40,063       39,742  
  

 

 

   

 

 

 

Total assets

   $ 421,324     $ 389,345  
  

 

 

   

 

 

 

Liabilities and stockholders’ deficit

  

Current liabilities:

  

Accounts payable

   $ 18,530     $ 16,356  

Accrued payroll and related benefits

     11,424       11,656  

Other accrued liabilities

     13,003       12,465  

Deferred revenue

     225,387       209,904  

Deferred income taxes

     362       563  

Note payable

     259       252  
  

 

 

   

 

 

 

Total current liabilities

     268,965       251,196  

Long-term liabilities:

  

Deferred revenue, non-current

     164,519       163,253  

Deferred income taxes, non-current

     2,250       2,396  

Note payable, non-current

     4,251       4,383  

Other long-term liabilities

     7,769       7,201  

Commitments and contingencies (Note 8)

  

Stockholders’ deficit:

  

Preferred stock, $0.001 par value; 20,000,000 shares authorized; zero shares issued and outstanding as of August 31, 2015 and February 28, 2015

     —         —    

Common stock, $0.001 par value; 1,000,000,000 shares authorized; 53,347,890 and 52,881,002 shares issued and outstanding as of August 31, 2015 and February 28, 2015, respectively

     53       53  

Additional paid-in capital

     333,316       316,035  

Accumulated other comprehensive loss

     (2,789 )     (4,233 )

Accumulated deficit

     (357,010 )     (350,939 )
  

 

 

   

 

 

 

Total stockholders’ deficit

     (26,430     (39,084 )
  

 

 

   

 

 

 

Total liabilities and stockholders’ deficit

   $ 421,324      $ 389,345   
  

 

 

   

 

 

 

See accompanying notes.

 

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BARRACUDA NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

     Three Months Ended
August 31,
    Six Months Ended
August 31,
 
     2015     2014     2015     2014  

Revenue:

        

Appliance

   $ 22,288     $ 20,676     $ 45,970     $ 41,512  

Subscription

     56,083       47,976       110,375       93,349  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     78,371       68,652       156,345       134,861  

Cost of revenue

     15,935       14,044       31,901       28,450  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     62,436       54,608       124,444       106,411  

Operating expenses:

        

Research and development

     17,502       13,826       35,502       26,778  

Sales and marketing

     34,470       31,031       68,602       60,510  

General and administrative

     10,770       8,624       21,468       17,188  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     62,742       53,481       125,572       104,476  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (306 )     1,127       (1,128 )     1,935  

Other income (expense), net

     97       (681 )     (471 )     (738 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (209 )     446       (1,599 )     1,197  

Benefit from (provision for) income taxes

     (2,030 )     292       (4,472 )     (308 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) (Note 9)

   $ (2,239 )   $ 738     $ (6,071 )   $ 889  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

        

Basic

   $ (0.04 )   $ 0.01     $ (0.11 )   $ 0.02  

Diluted

   $ (0.04 )   $ 0.01     $ (0.11 )   $ 0.02  

Weighted-average shares used to compute net income (loss) per share:

        

Basic

     53,270       51,667       53,133       51,412  

Diluted

     53,270       53,743       53,133       53,675  

See accompanying notes.

 

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BARRACUDA NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

 

     Three Months Ended
August 31,
    Six Months Ended
August 31,
 
     2015     2014     2015     2014  

Net income (loss)

   $ (2,239 )   $ 738     $ (6,071 )   $ 889  

Other comprehensive income (loss), net of tax:

        

Change in net foreign currency translation adjustment

     375       (606 )     324       (575 )

Available-for-sale investments:

        

Change in net unrealized gains (losses) (net of tax effect of $0, $0, $0 and $0)

     (733 )     —          1,122       —    

Less: reclassification adjustment for net gains (losses) included in net income (loss) (net of tax effect of $0, $0, $1 and $0)

     1       —          (2 )     —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     (732 )     —          1,120       —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     (357 )     (606 )     1,444       (575 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (2,596 )   $ 132     $ (4,627 )   $ 314  
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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BARRACUDA NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Six Months Ended
August 31,
 
     2015     2014  

Operating activities

    

Net income (loss)

   $ (6,071 )   $ 889  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Depreciation and amortization expense

     4,469       4,422  

Stock-based compensation expense

     13,710       6,818  

Excess tax benefits from equity compensation plans

     (3,260 )     (4,338 )

Deferred income taxes

     239       (6,198 )

Other

     670       31  

Changes in operating assets and liabilities:

    

Accounts receivable, net

     (2,143 )     (8,527 )

Inventories, net

     (1,125 )     463  

Income taxes, net

     4,019       3,073  

Deferred costs

     (2,284 )     (4,412 )

Other assets

     (933 )     (147

Accounts payable

     2,225       (1,267 )

Accrued payroll and related benefits

     2,298       (29 )

Other liabilities

     53       531   

Deferred revenue

     16,752       29,573  
  

 

 

   

 

 

 

Net cash provided by operating activities

     28,619       20,882  

Investing activities

    

Purchase of marketable securities

     (14,240 )     —    

Proceeds from the sale of marketable securities

     7,177       —    

Proceeds from the maturity of marketable securities

     4,667       —    

Purchase of investments in non-marketable equity and debt securities

     (350 )     (600 )

Purchase of property and equipment

     (3,443 )     (3,775 )

Business combinations, net of cash acquired

     (749     (4,791
  

 

 

   

 

 

 

Net cash used in investing activities

     (6,938 )     (9,166 )

Financing activities

    

Proceeds from issuance of common stock

     4,300       7,246  

Taxes paid related to net share settlement of equity awards

     (4,026     (2,340

Excess tax benefits from equity compensation plans

     3,260       4,338   

Employee loans extended, net of repayment

     (2,484 )     (70

Repayment of note payable

     (125 )     (118

Other

     (181 )     —    
  

 

 

   

 

 

 

Net cash provided by financing activities

     744       9,056   

Effect of exchange rate changes on cash and cash equivalents

     (115 )     (92
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     22,310       20,680   

Cash and cash equivalents at beginning of period

     151,373       135,879   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 173,683     $ 156,559  
  

 

 

   

 

 

 

See accompanying notes.

 

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BARRACUDA NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Overview and Basis of Presentation

Nature of Operations

Barracuda Networks, Inc., also referred to in this report as “we,” “our,” “us,” “Barracuda” or “the Company,” is headquartered in Campbell, California, and designs and delivers powerful yet easy-to-use security and storage solutions. We offer cloud-connected solutions that help our customers address security threats, improve network performance and protect and store their data. Our solutions are designed to simplify IT operations for our customers, allowing them to enhance their return on technology investments.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We evaluate our estimates on an ongoing basis, including those related to the fair values of stock-based awards, income taxes and contingent liabilities, among others. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from those estimates and such differences could be material to our condensed consolidated financial position and results of operations.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP, and follow the requirements of the U.S. Securities and Exchange Commission (the “SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP are condensed or omitted. In management’s opinion, the unaudited condensed financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of our financial information. The results for the three and six months ended August 31, 2015 are not necessarily indicative of the results expected for the full fiscal year. The condensed consolidated balance sheet as of February 28, 2015 has been derived from audited financial statements at that date but does not include all of the information required by GAAP.

The accompanying unaudited condensed consolidated financial statements include the accounts of Barracuda Networks, Inc. and our wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

The accompanying unaudited condensed consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and related footnotes included in our most recent Annual Report on Form 10-K. There have been no material changes in our significant accounting policies from those that were disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015.

Foreign Currency

We have foreign subsidiaries that operate and sell our products and services in various countries and jurisdictions around the world. As a result, we are exposed to foreign exchange risks. We utilize foreign exchange forward contracts to manage foreign currency risk associated with foreign currency denominated monetary assets and liabilities, primarily trade receivables, and to reduce the volatility of earnings and cash flows related to foreign currency transactions. The fair values of our contracts as of August 31, 2015 and February 28, 2015 were not significant. The change in the fair value of these foreign currency forward contracts is recorded as gain (loss) in other income (expense), net in the condensed consolidated statement of operations.

For those subsidiaries whose functional currency is not the U.S. dollar, assets and liabilities are translated into U.S. dollar equivalents at the exchange rate in effect on the balance sheet date and revenues and expenses are translated into U.S. dollars using the average exchange rate over the period. Resulting currency translation adjustments are recorded in accumulated other comprehensive income (loss) in the condensed consolidated balance sheets. We recorded net gains (losses) resulting from foreign exchange transactions of $0.1 million and $(0.5) million for the three and six months ended August 31, 2015, respectively. We recorded net losses resulting from foreign exchange transactions of $0.6 million for the three and six months ended August 31, 2014.

Recent Accounting Pronouncements

In September 2015, the Financial Accounting Standards Board (the “FASB”) issued an accounting standard to simplify the accounting for measurement period adjustments in connection with business combinations by requiring that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standard update is effective for fiscal years

 

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beginning after December 15, 2015 and interim periods within those fiscal years. The standard update is to be applied prospectively to adjustments of provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. We do not expect the adoption of this standard to have an impact on our condensed consolidated financial statements.

In July 2015, the FASB issued an accounting standard to simplify the measurement of inventory by changing the subsequent measurement guidance from the lower of cost or market to the lower of cost and net realizable value for inventory. The standard update is effective for fiscal years beginning after December 15, 2016 and interim periods within those years, and early adoption is permitted. The standard is to be applied prospectively and does not apply to inventory that is measured using last-in, first-out or the retail inventory method. We do not expect the adoption of this standard to have an impact on our condensed consolidated financial statements.

In May 2014, the FASB issued an accounting standard which completes the joint effort by the FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and improving financial reporting by creating common revenue recognition guidance for GAAP and International Financial Reporting Standards. The core principle of this update is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The original effective date would have required us to adopt this update in the first quarter of fiscal 2018. However, in July 2015, the FASB amended the standard to provide a one-year deferral of the effective date, as well as providing the option to early adopt the standard on the original effective date. Accordingly, we may adopt the standard in either the first quarter of fiscal 2018 or the first quarter of fiscal 2019. The standard allows for full retrospective adoption applied to all periods presented or retrospective adoption with the cumulative effect of initially applying this update recognized at the date of initial application. We are currently evaluating the impact of adopting this update on our condensed consolidated financial statements.

2. Balance Sheet Information

Cash, Cash Equivalents and Marketable Securities

The following table summarizes our cash and cash equivalents by category (in thousands):

 

     As of
August 31,
2015
     As of
February 28,
2015
 

Cash

   $ 121,402      $ 97,187  

Money market funds

     52,281        54,186  
  

 

 

    

 

 

 
   $ 173,683      $ 151,373  
  

 

 

    

 

 

 

The following tables summarize our marketable securities by category (in thousands):

 

     As of August 31, 2015  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

Asset-backed securities

   $ 4,951      $ 9      $ (1    $ 4,959  

Corporate debt securities

     21,621        3        (17      21,607  

Equity securities

     3,095        1,152        —          4,247  

Foreign government bonds

     207        —          (1      206  

Mortgage-backed securities

     2,657        2        (14      2,645  

U.S. government agency securities

     7,542        7        (33      7,516  

U.S. government notes

     2,886        —          —          2,886  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 42,959      $ 1,173      $ (66    $ 44,066  
  

 

 

    

 

 

    

 

 

    

 

 

 
     As of February 28, 2015  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

Asset-backed securities

   $ 4,846      $ 3      $ (4 )    $ 4,845   

Corporate debt securities

     21,241        17        (13 )      21,245   

Equity securities

     1,211        37        (32 )      1,216   

Foreign government bonds

     201        —          —          201   

Mortgage-backed securities

     2,716        4        (10 )      2,710   

U.S. government agency securities

     7,310        8        (24 )      7,294   

U.S. government notes

     3,242        1        —          3,243   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 40,767      $ 70      $ (83    $ 40,754  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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We use the specific-identification method to determine any realized gains or losses from the sale of our marketable securities classified as available-for-sale. Such realized gains and losses were insignificant for each of the three and six months ended August 31, 2015 and 2014. We reflect these gains and losses as a component of other income (expense), net in the condensed consolidated statements of operations.

The following tables present gross unrealized losses and fair values for those marketable securities that were in an unrealized loss position aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in thousands):

 

     As of August 31, 2015  
     Less Than 12 Months     12 Months or Greater      Total  
     Fair
Value
     Unrealized
Losses
    Fair Value
     Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Asset-backed securities

   $ 1,018      $ (1 )   $ —        $ —        $ 1,018      $ (1

Corporate debt securities

     13,846         (17     —          —          13,846         (17

Foreign government bonds

     207         (1     —          —          207         (1

Mortgage-backed securities

     2,219        (14 )     —          —          2,219        (14

U.S. government agency securities

     4,421        (33 )     —          —          4,421        (33
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
   $ 21,711      $ (66   $ —        $ —        $ 21,711      $ (66
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
     As of February 28, 2015  
     Less Than 12 Months     12 Months or Greater      Total  
     Fair
Value
     Unrealized
Losses
    Fair Value
     Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Asset-backed securities

   $ 2,385      $ (4 )   $ —        $ —        $ 2,385      $ (4

Corporate debt securities

     11,346        (13 )     —          —          11,346        (13

Equity securities

     978        (32 )     —          —          978        (32

Mortgage-backed securities

     1,923        (10 )     —          —          1,923        (10

U.S. government agency securities

     4,331        (24 )     —          —           4,331        (24
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
   $ 20,963      $ (83   $ —        $ —        $ 20,963      $ (83
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

We periodically review our marketable securities for other-than-temporary impairment. We consider factors such as the duration, severity and the reason for the decline in value, the potential recovery period and whether we intend to sell. For marketable debt securities, we also consider whether (i) it is more likely than not that we will be required to sell the debt securities before recovery of their amortized cost basis, and (ii) the amortized cost basis cannot be recovered as a result of credit losses. Unrealized losses related to these investments are due to interest rate fluctuations as opposed to changes in credit quality. We do not intend to sell and it is not more likely than not that we would be required to sell these investments before recovery of their amortized cost basis, which may be at maturity. As of August 31, 2015, we have recognized no other-than-temporary impairment loss.

The following table summarizes the estimated fair value of our investments in marketable debt securities by contractual maturities (in thousands):

 

     As of
August 31,
2015
 

Due in 1 year

   $ 13,738  

Due in 1 year through 5 years

     21,259  

Due in 5 years through 10 years

     580  

Due after 10 years

     4,242  
  

 

 

 
   $ 39,819  
  

 

 

 

 

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Fair Value Measurements

We determine fair value based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value assumes that the transaction to sell the asset or transfer the liability occurs in the principal or most advantageous market for the asset or liability and establishes that the fair value of an asset or liability shall be determined based on the assumptions that market participants would use in pricing the asset or liability. The classification of a financial asset or liability within the hierarchy is based upon the lowest level input that is significant to the fair value measurement. The fair value hierarchy prioritizes the inputs into three levels that may be used to measure fair value:

 

Level 1:    Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2:    Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3:    Inputs are unobservable inputs based on our assumptions.

Cash equivalents and marketable equity securities are classified within Level 1 because they are valued using quoted market prices or alternative pricing sources and models utilizing market observable inputs. Marketable debt securities and derivative assets are classified within Level 2 if the investments are valued using model driven valuations which use observable inputs such as quoted market prices, benchmark yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. Our marketable securities are held by custodians who obtain investment prices from a third-party pricing provider that incorporates standard inputs in various asset price models.

We estimated the fair value of our Level 3 contingent consideration liabilities based on a weighted probability assessment of achieving the milestones related to certain of our acquisitions. Significant increases (decreases) in the probability assumptions in isolation would result in a significantly higher (lower) fair value measurement. In developing these estimates, we considered unobservable inputs that are supported by little or no market activity and reflect our own assumptions. The following table summarizes the change in fair value of our Level 3 contingent consideration amounts (in thousands):

 

Balance as of February 28, 2015

   $ 3,028   

Acquisition addition

     334   

Total remeasurement recognized in earnings

     147  

Settlements

     (25
  

 

 

 

Balance as of August 31, 2015

   $ 3,484  
  

 

 

 

For the three and six months ended August 31, 2015, the contingent consideration remeasurement was recognized within research and development and sales and marketing expenses in our condensed consolidated statement of operations.

Financial assets measured at fair value on a recurring basis are summarized below (in thousands):

 

     As of August 31, 2015  
     Level 1      Level 2      Level 3      Total  

Cash equivalents:

           

Money market funds

   $ 52,281      $ —        $ —        $ 52,281  

Marketable securities:

           

Asset-backed securities

   $ —        $ 4,959      $ —        $ 4,959  

Corporate debt securities

   $ —        $ 21,607      $ —        $ 21,607  

Equity securities

   $ 4,247      $ —        $ —        $ 4,247  

Foreign government bonds

   $ —        $ 206      $ —        $ 206  

Mortgage-backed securities

   $ —        $ 2,645      $ —        $ 2,645  

U.S. government agency securities

   $ —        $ 7,516      $ —        $ 7,516  

U.S. government notes

   $ —        $ 2,886      $ —        $ 2,886  

Other accrued liabilities (current):

           

Contingent consideration

   $ —        $ —        $ 1,293      $ 1,293  

Other long-term liabilities:

           

Contingent consideration

   $ —        $ —        $ 2,191      $ 2,191  

 

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     As of February 28, 2015  
     Level 1      Level 2      Level 3      Total  

Cash equivalents:

           

Money market funds

   $ 54,186      $ —        $ —        $ 54,186  

Marketable securities:

           

Asset-backed securities

   $ —        $ 4,845      $ —        $ 4,845  

Corporate debt securities

   $ —        $ 21,245      $ —        $ 21,245  

Equity securities

   $ 1,216      $ —        $ —        $ 1,216  

Foreign government bonds

   $ —        $ 201      $ —        $ 201  

Mortgage-backed securities

   $ —        $ 2,710      $ —        $ 2,710  

U.S. government agency securities

   $ —        $ 7,294      $ —        $ 7,294  

U.S. government notes

   $ —        $ 3,243      $ —        $ 3,243  

Derivative assets not designated (current):

           

Foreign exchange contracts

   $ —        $ 31      $ —        $ 31  

Other accrued liabilities (current):

           

Contingent consideration

   $ —        $ —        $ 1,150      $ 1,150  

Other long-term liabilities:

           

Contingent consideration

   $ —        $ —        $ 1,878      $ 1,878  

Inventories, Net

Inventories, net consisted of the following (in thousands):

 

     As of
August 31,
2015
     As of
February 28,
2015
 

Raw materials

   $ 2,802      $ 2,455  

Finished goods

     3,448        2,729  

Reserves

     (671 )      (730
  

 

 

    

 

 

 
   $ 5,579      $ 4,454  
  

 

 

    

 

 

 

Deferred Costs

Deferred costs consisted of the following (in thousands):

 

     As of
August 31,
2015
     As of
February 28,
2015
 

Appliance

   $ 42,777       $ 41,052   

Commissions

     17,437         16,884   
  

 

 

    

 

 

 
   $ 60,214       $ 57,936   
  

 

 

    

 

 

 

Property and Equipment, Net

Property and equipment, net consisted of the following (in thousands):

 

     As of
August 31,
2015
     As of
February 28,
2015
 

Land

   $ 9,418      $ 9,354  

Building

     6,549        6,549  

Computer hardware and software

     20,023        17,860  

Vehicles, machinery and equipment

     4,089        3,546  

Leasehold improvements

     3,307        2,965  
  

 

 

    

 

 

 
     43,386        40,274  

Accumulated depreciation and amortization

     (15,599 )      (12,435 )
  

 

 

    

 

 

 
   $ 27,787      $ 27,839  
  

 

 

    

 

 

 

Depreciation and amortization expense related to property and equipment was $1.7 million and $3.3 million for the three and six months ended August 31, 2015, respectively, and $1.2 million and $2.3 million for the three and six months ended August 31, 2014, respectively.

 

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Investment in Non-marketable Equity Security

As of February 28, 2015, we have invested approximately $1.3 million in stock of a private company, which was accounted for under the equity method. We recognize our proportional share of earnings and losses of the investee in our financial statements and adjust the carrying amount of our investment accordingly. In August 2015, we acquired additional shares of stock in the privately held company for approximately $0.4 million to maintain our approximately 24% ownership interest.

For the three and six months ended August 31, 2015, our proportionate share of the investee’s losses was $0.1 million and $0.2 million, respectively. For the three and six months ended August 31, 2014, our proportionate share was not material. The investment is classified in other non-current assets in our condensed consolidated balance sheets.

Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss) (“AOCI”), net of tax, were as follows (in thousands):

 

     Foreign
Currency
Translation
Adjustments
     Unrealized Gains
(Losses) on
Available-for-
Sale Investments
     Total  

Balance as of February 28, 2015

   $ (4,225 )    $ (8    $ (4,233 )

Other comprehensive income (loss) before reclassifications

     324         1,122        1,446  

Amounts reclassified from AOCI

     —          (2      (2 )
  

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     324         1,120        1,444  
  

 

 

    

 

 

    

 

 

 

Balance as of August 31, 2015

   $ (3,901 )    $ 1,112      $ (2,789 )
  

 

 

    

 

 

    

 

 

 

3. Acquisition

In the three months ended August 31, 2015, we completed an acquisition for total consideration of approximately $1.1 million, which included an estimated fair value for contingent consideration of $0.3 million. $0.7 million was attributed to intangible assets and $0.3 million was attributed to goodwill. The goodwill is primarily attributed to the synergies expected to be realized following the acquisition and is expected to be deductible for income tax purposes.

As of the acquisition date, customer relationships and developed technology and other had weighted-average useful lives of 7.0 years and 1.0 years, respectively. The results of operations, since the acquisition date, were not material to our condensed consolidated results of operations for the three and six months ended August 31, 2015. Pro forma results of operations have not been presented because they are not material to our condensed consolidated results of operations.

4. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill are summarized as follows (in thousands):

 

Balance as of February 28, 2015

   $ 39,742   

Goodwill acquired

     336   

Effect of foreign exchange rates

     (15 )
  

 

 

 

Balance as of August 31, 2015

   $ 40,063  
  

 

 

 

Intangible assets subject to amortization are summarized as follows (in thousands):

 

     As of August 31, 2015  
     Gross
Carrying
Amount
     Accumulated
Amortization
     Net
Carrying
Value
 

Acquired developed technology

   $ 28,944       $ (23,724 )    $ 5,220   

Software license

     400         (400 )      —    

Customer relationships

     8,799         (6,360 )      2,439   

Patents

     1,625         (1,151 )      474   

Trade name

     519         (200 )      319   

Acquired developed software

     200         (200 )      —    
  

 

 

    

 

 

    

 

 

 
   $ 40,487       $ (32,035 )    $ 8,452   
  

 

 

    

 

 

    

 

 

 

 

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     As of February 28, 2015  
     Gross
Carrying
Amount
     Accumulated
Amortization
     Net
Carrying
Value
 

Acquired developed technology

   $ 28,799      $ (22,987 )    $ 5,812  

Software license

     400        (400 )      —    

Customer relationships

     8,233        (6,032 )      2,201  

Patents

     1,625        (1,058 )      567  

Trade name

     513        (172 )      341  

Acquired developed software

     200        (200 )      —    
  

 

 

    

 

 

    

 

 

 
   $ 39,770      $ (30,849 )    $ 8,921  
  

 

 

    

 

 

    

 

 

 

In addition to the above, we maintained other intangible assets not subject to amortization of $296,000 as of August 31, 2015 and February 28, 2015.

Amortization expense was $0.6 million and $1.2 million for the three and six months ended August 31, 2015, respectively, and $1.1 million and $2.1 million for the three and six months ended August 31, 2014, respectively.

As of August 31, 2015, amortization expense for intangible assets in future periods was as follows: $1.3 million for the remainder of fiscal 2016, $2.3 million for fiscal 2017, $1.9 million for fiscal 2018, $1.0 million for fiscal 2019, $0.8 million for fiscal 2020 and $1.2 million thereafter.

5. Stockholders’ Deficit

Stock-Based Compensation Activities

Our 2012 Equity Incentive Plan (the “2012 Plan”) authorizes the granting of stock options, stock appreciation rights, restricted stock and restricted stock units (“RSUs”) to employees, directors and contractors. Options granted are exercisable for periods not to exceed 10 years. Options and RSUs granted typically vest over four years contingent upon employment or service with us on the vesting date.

As of August 31, 2015, net of forecasted forfeitures, there was $21.4 million of unrecognized compensation cost related to outstanding stock options, expected to be recognized over a weighted-average period of 2.71 years and $40.3 million of unrecognized compensation cost related to unvested RSUs, expected to be recognized over a weighted-average period of 3.07 years. To the extent the actual forfeiture rate is different from what management has anticipated, stock-based compensation expense related to these equity awards will be different from management’s expectations.

Total stock-based compensation expense has been classified as follows in the accompanying condensed consolidated statements of operations (in thousands):

 

     Three Months Ended August 31,      Six Months Ended August 31,  
     2015      2014      2015      2014  

Cost of revenue

   $ 255      $ 73      $ 466      $ 125  

Research and development

     2,000        902        3,835        1,650  

Sales and marketing

     1,639        821        3,189        1,403  

General and administrative

     3,272        1,940        6,220        3,640  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 7,166      $ 3,736      $ 13,710      $ 6,818  
  

 

 

    

 

 

    

 

 

    

 

 

 

Employee Stock Purchase Plan

Following approval by our board of directors, in July 2015, our stockholders approved the adoption of the 2015 Employee Stock Purchase Plan (the “ESPP”) by the Company. The ESPP allows eligible employee participants to purchase shares of our common stock at a discount through payroll deductions. The ESPP consists of offering periods that are approximately six months in length and employees may purchase shares in each period at 85% of the lower of the Company’s fair market value on the first trading day of each offering period or on the purchase date. The ESPP will continue until the earlier to occur of (i) the termination of the ESPP by our board of directors, or (ii) June 15, 2035.

 

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As of August 31, 2015, we had reserved 750,000 shares of our common stock for issuance under the ESPP and all such shares remain available for future issuance.

6. Income Taxes

For the three and six months ended August 31, 2015, we recorded an income tax provision of $2.0 million and $4.5 million, respectively. For the three and six months ended August 31, 2014, we recorded an income tax benefit of $0.3 million and an income tax provision of $0.3 million, respectively.

In fiscal 2015, we established a valuation allowance against a significant portion of our deferred tax assets, including U.S. federal and state deferred tax assets and certain foreign deferred tax assets, because realization of these tax benefits through future taxable income did not meet the more-likely-than-not threshold. We intend to maintain the valuation allowances until sufficient positive evidence exists to support its reversal.

The difference between the income tax benefit that would be derived by applying the statutory rate to our before tax loss for the six months ended August 31, 2015 and the income tax provision actually recorded is primarily due to the temporary differences we did not benefit from during the period due to our valuation allowance, as well as non-deductible stock-based compensation expense and other currently non-deductible items.

7. Segment Information

Our chief operating decision maker reviews the financial information presented on a consolidated basis for purposes of allocating resources and evaluating our financial performance. Accordingly, we have determined that we operate in a single reporting segment.

Revenue by geographic region is presented as follows (in thousands):

 

     Three Months Ended
August 31,
     Six Months Ended
August 31,
 
     2015      2014      2015      2014  

North America

   $ 57,027      $ 50,219      $ 113,068      $ 98,538  

United States

     53,730        47,234        106,534        92,564  

Other

     3,297        2,985        6,534        5,974  

Latin America

     1,096        786        2,112        1,595  

Asia-Pacific

     4,850        4,503        9,505        8,990  

EMEA

     15,398        13,144        31,660        25,738  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 78,371      $ 68,652      $ 156,345      $ 134,861  
  

 

 

    

 

 

    

 

 

    

 

 

 

8. Commitments and Contingencies

Legal Matters

In late 2011, following a voluntary internal review of our compliance with U.S. export control and sanctions laws, our management team became aware that certain of our physical appliances had been sold indirectly into embargoed countries via our distributors and resellers, potentially in violation of U.S. export control and economic sanctions laws. In addition, certain of our solutions incorporate encryption components and may be exported from the United States only with the required approvals; in the past, we may have exported products prior to receiving these required authorizations. After completion of a comprehensive internal investigation conducted by outside counsel, we submitted voluntary disclosures regarding these matters to the U.S. Commerce Department, Bureau of Industry and Security (“BIS”), and to the U.S. Treasury Department, Office of Foreign Assets Control (“OFAC”). These disclosures summarized potential violations of export controls and economic sanctions laws, including reexports by third parties and provision of services to end users in embargoed countries including Iran, Sudan and Syria. We agreed to a settlement with OFAC in May 2015 pursuant to which we agreed to pay $38,930 as consideration for the final resolution of all issues related to the voluntary disclosure that we submitted to OFAC.

We received a Proposed Charging Letter from BIS on August 21, 2014, which asserts certain export violations against us and our UK subsidiary. Based on discussions with BIS, we expect a one-time monetary penalty to be imposed, and do not currently expect any criminal charges, denial of export privileges or ongoing monitoring actions. We intend to continue cooperating with BIS in an effort to resolve this matter. However, at this time, we are unable to estimate the timing or amount of any final resolution.

On January 23, 2015, Wetro Lan LLC (“Wetro Lan”) filed a lawsuit against us in the U.S. District Court for the Eastern District of Texas, Marshall Division, Wetro Lan LLC v. Barracuda Networks, Inc., Case No. 2:15-CV-46, alleging that certain of our products infringe U.S. Pat. No. 6,795,918.

 

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We were notified by RPX Corporation (“RPX”) that it had entered into a settlement and license agreement with Wetro Lan for the patents in the lawsuit. As a result, we expect that the lawsuit will be dismissed with prejudice and we will not pay any fees associated with the settlement and license.

On June 3, 2015, Verifire Network Solutions, LLC (“Verifire”) filed a lawsuit against us in the U.S. District Court for the Eastern District of Texas, Marshall Division, Verifire Network Solutions, LLC v. Barracuda Networks, Inc., Case No. 2:15-CV-928, alleging that certain of our products infringe U.S. Pat. No. 8,463,727. We were notified by RPX that it had entered into a settlement and license agreement with Verifire for the patents in the lawsuit. As a result, the lawsuit was dismissed with prejudice on September 21, 2015 and we did not pay any fees associated with the settlement and license.

From time to time, we are party to litigation and subject to claims that arise in the ordinary course of our business, including actions with respect to employment claims and other matters. Although the results of litigation and claims are inherently unpredictable, we believe that the final outcome of such matters will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

9. Net Income (Loss) Per Share

The following table presents the calculation of basic and diluted net income (loss) per share (in thousands, except per share amounts):

 

     Three Months Ended
August 31,
     Six Months Ended
August 31,
 
     2015      2014      2015      2014  

Net income (loss)

   $ (2,239    $ 738       $ (6,071    $ 889   

Weighted-average shares used to compute net income (loss) per share, basic

     53,270         51,667         53,133         51,412   

Dilutive shares from stock options and RSUs

     —          2,076         —          2,263   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average shares used to compute net income (loss) per share, diluted

     53,270         53,743         53,133         53,675   

Net income (loss) per share, basic

   $ (0.04    $ 0.01       $ (0.11    $ 0.02   

Net income (loss) per share, diluted

   $ (0.04    $ 0.01       $ (0.11    $ 0.02   

10. Subsequent Events

Acquisition

On September 23, 2015, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Intronis, Inc., a Delaware corporation (“Intronis”), Igloo Merger Corp., a Delaware corporation and a wholly-owned subsidiary of the Company (“Merger Sub”), and certain other parties, pursuant to which Merger Sub will merge with and into Intronis, and Intronis will continue to exist as a wholly-owned subsidiary of the Company. Under the terms of the Merger Agreement, we will pay $65.0 million in cash (the “Purchase Price”) for the transaction subject to certain adjustments set forth in the Merger Agreement, which we expect to finance through available cash and cash equivalents. The Merger Agreement provides that $7.0 million of the Purchase Price will be held in escrow by us as partial security for the indemnification obligations of the equityholders of Intronis. The transaction is expected to close in the third quarter of fiscal 2016 and is subject to customary closing conditions, including, among others the delivery of certain third party consents, employment agreements and non-competition agreements and the approval of Intronis’ stockholders. Additionally, each of the Company, Merger Sub and Intronis has made customary representations, warranties and covenants in the Merger Agreement.

Stock Repurchase Program

In September 2015, our board of directors authorized a stock repurchase program. Under the program, we are authorized to repurchase shares of our common stock for an aggregate purchase price not to exceed $50.0 million through September 30, 2017. Although our board of directors has authorized the stock repurchase program, the stock repurchase program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares. Stock will be purchased from time to time, in the open market or through private transactions, subject to market condition, in compliance with applicable state and federal securities laws. The timing and amount of repurchases, if any, will depend upon several factors, including market and business conditions, the trading price of our common stock and the nature of other investment opportunities.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations together with the condensed consolidated financial statements and related notes that are included elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended February 28, 2015. The last day of our fiscal year is February 28/29. Our fiscal quarters end on May 31, August 31, November 30 and February 28/29. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended February 28, 2015.

Overview

Barracuda designs and delivers powerful yet easy-to-use security and storage solutions. We offer cloud-connected solutions that help our customers address security threats, improve network performance and protect and store their data. Our solutions are designed to simplify IT operations for our customers, allowing them to enhance their return on technology investment. Our business model is built on the core values of speed and agility, which we apply to all aspects of our approach, including our technology innovations, the delivery and deployment of our solutions and responses to customer inquiries.

We derive revenue from sales of appliances and subscriptions. Revenue from the sale of our appliances includes hardware and a perpetual license. Subscription revenue is generated primarily from our subscription services such as our Barracuda Energize Updates as well as our cloud solutions. Subscription revenue also includes revenue from fixed term licenses of our virtual appliance software support and maintenance. Our subscription terms range from one to five years, the substantial majority of which are for one-year periods. Subscriptions are billed in advance of the purchased subscription period. As such, renewal rates from subscriptions are an important indicator of our future gross billings and revenue, and, on a dollars basis, were 95% and 94% for the three and six months ended August 31, 2015, respectively, and 96% and 95% for the three and six months ended August 31, 2014, respectively.

The growth of our business and our future success depend on many factors, including our ability to continue to expand our customer base, pursue cross-sale opportunities and grow revenues from our existing customer base, expand our distribution channels, particularly internationally, and continue to develop new solutions to promptly respond to our customers’ needs. As our existing customers’ IT buying needs evolve, or as our customers realize the benefits of the solutions that they previously purchased, our portfolio of solutions provides us an opportunity to cross-sell additional solutions. Customers who successfully deploy more than one type of solution provide substantially more customer lifetime value to us, and can derive greater value from our solutions as they benefit from synergies in management, support and functionality.

In addition to our cross-sell efforts, our sales and marketing initiatives are primarily focused on higher-growth segments within the security and storage markets. Our future success will depend in part on our ability to continue to timely identify these higher-growth segments and expand our sales within them. While these areas represent significant opportunities for us, they also pose risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results.

Furthermore, our business depends on the overall demand for security and storage solutions. Weak global economic conditions, particularly market and financial uncertainty and instability in the United States and Europe, or a reduction in security and storage solution spending even if general economic conditions are unaffected, could adversely impact our business, financial condition and operating results in a number of ways. Additionally, we face significant competition across all of our market segments, and must continue to execute across all functions and add qualified personnel to succeed.

Our Business Model

We invoice at the time of sale for the total price of the solutions we deliver, and we typically collect cash in 30 to 60 days. We refer to the total amount of invoices we issue in a period as gross billings. All of the gross billings we record are recognized as revenue ratably under GAAP, once all revenue recognition criteria have been met. Gross billings are initially recorded as deferred revenue, less reserves. The appliance component of our gross billings is recognized ratably as revenue over the estimated customer relationship period, which is typically three years, commencing upon the activation of the unit by the end customer. The subscription component of our gross billings is recognized ratably as revenue over the contractual period of the subscription. Because we bill in advance for the entire term, substantially all of our new and renewal gross billings increase our deferred revenue balance, which contributes significantly to our cash flow.

Key Metrics

We monitor the following key metrics to help us evaluate growth trends, establish budgets and assess operational efficiencies. In addition to our results determined in accordance with GAAP, we believe the following non-GAAP and operational measures are useful in evaluating our operating performance.

 

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The following table presents our key metrics and provides reconciliations of the most directly comparable GAAP financial measure to each non-GAAP financial measure (dollars in thousands):

 

     Three Months Ended August 31,     Six Months Ended August 31,  
     2015     2014     2015     2014  

Gross billings

   $ 98,445     $ 89,035     $ 192,719     $ 176,635  

Year-over-year percentage increase

     11       9  

Year-over-year percentage increase on a constant currency basis (1)

     14       13  

Adjusted EBITDA

   $ 17,655     $ 19,980     $ 33,446     $ 39,407  

Adjusted EBITDA as a percentage of total revenue

     23     29     21     29

Free cash flow

   $ 21,130     $ 13,679     $ 26,442     $ 17,882  

Free cash flow as a percentage of total revenue

     27     20     17     13

Active subscribers at period end

     261,613        225,600        261,613       225,600  

 

(1) In order to determine how our business performed exclusive of the effect of foreign currency fluctuations, we compare the percentage change in our gross billings from one period to another using a constant currency. To present this gross billings information, the current and comparative prior period results for entities that operate in other than U.S. dollars are converted into U.S. dollars at constant exchange rates. For example, the rates in effect at August 31, 2014, which was the last day of our prior fiscal year’s comparable quarter, were used to convert current and comparable prior period gross billings rather than the actual exchange rates in effect during the respective period.

Gross billings. We define gross billings as total revenue plus the change in deferred revenue and other adjustments which primarily reflect returns and reserves with respect to the 30-day right to return we provide to our customers, as well as rebates for certain channel partner activities, during a particular period. We use gross billings as a performance measurement, based on our business model of invoicing our customers at the time of sale of our solutions and recognizing revenue ratably over subsequent periods. Accordingly, we believe gross billings provide valuable insight into the sales of our solutions and the performance of our business. The gross billings we record in any period reflect sales to new customers plus renewals and additional sales to existing customers adjusted for returns, rebates and other offsets, which we do not expect to be recognized as revenue in future periods. In many cases, these returns, rebates and other offsets occur in periods different from the period of sale and are unrelated to the marketing efforts leading to the initial sale, and therefore by adjusting for such offsets, we believe our computation of gross billings better reflects the effectiveness of our sales and marketing efforts.

The following table reconciles total revenue to gross billings (dollars in thousands):

 

     Three Months Ended August 31,      Six Months Ended August 31,  
     2015     2014      2015     2014  

Total revenue

   $ 78,371      $ 68,652       $ 156,345      $ 134,861   

Total deferred revenue, end of period (1)

     389,835        342,663         389,835        342,663   

Less: total deferred revenue, beginning of period (1)

     (381,003 )     (328,488 )      (372,862 )     (313,157 )

Add: deferred revenue adjustments

     11,242        6,208         19,401        12,268   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total change in deferred revenue and adjustments

     20,074        20,383         36,374        41,774   
  

 

 

   

 

 

    

 

 

   

 

 

 

Gross billings

   $ 98,445      $ 89,035       $ 192,719      $ 176,635   
  

 

 

   

 

 

    

 

 

   

 

 

 

Year-over-year percentage increase

     11        9  

Year-over-year percentage increase on a constant currency basis (2)

     14        13  

 

(1) The balances for the periods presented exclude any amounts related to the acquisition date deferred revenue assumed from C2C Systems Limited (“C2C”), which closed in the second quarter of fiscal 2015. We believe adjusting for the fair value of the assumed performance obligation allows us to better compare gross billings and adjusted EBITDA from period to period in order to assess the ongoing results of our business.
(2) In order to determine how our business performed exclusive of the effect of foreign currency fluctuations, we compare the percentage change in our gross billings from one period to another using a constant currency. To present this gross billings information, the current and comparative prior period results for entities that operate in other than U.S. dollars are converted into U.S. dollars at constant exchange rates. For example, the rates in effect at August 31, 2014, which was the last day of our prior fiscal year’s comparable quarter, were used to convert current and comparable prior period gross billings rather than the actual exchange rates in effect during the respective period.

 

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In the three and six months ended August 31, 2015, gross billings increased 11% and 9%, respectively, over the prior year’s comparative periods. The increase in gross billings was primarily driven by our continued ability to cross-sell additional solutions to existing customers and the growth in our renewal subscriptions as a result of our high level of customer retention as well as additional lead generation opportunities and associated new customer billings. The year-over-year growth rates were impacted by underperformance in our EMEA region, where sales cycles for larger transactions lengthened and buying decisions were delayed. Furthermore, we experienced a slowdown in our storage business thus far in fiscal 2016. When evaluating our gross billings from period to period, we also evaluate our gross billings for the comparable period using a fixed exchange rate, thereby excluding the effect of currency fluctuations.

Adjusted EBITDA. We define adjusted EBITDA as net income (loss) plus non-cash and non-operating charges, which includes acquisition and other non-recurring charges. Because of our business model, where revenue from gross billings is recognized ratably over subsequent periods, substantially all of our gross billings increase deferred revenue. Therefore, we believe that adjusting net income (loss) for increases in deferred revenue and increases in the associated deferred costs provides another indication of profitability from our operations. We use adjusted EBITDA to measure our performance, prepare our budgets and establish metrics for variable compensation. Because adjusted EBITDA excludes certain non-cash and non-operating charges, this measure enables us to eliminate the impact of items we do not consider indicative of our core operating performance and to better measure our performance on a consistent basis from period to period.

The following table reconciles net income (loss) to adjusted EBITDA (dollars in thousands):

 

     Three Months Ended August 31,     Six Months Ended August 31,  
     2015     2014     2015     2014  

Net income (loss)

   $ (2,239 )   $ 738     $ (6,071 )   $ 889  

Total deferred revenue, end of period (1)

     389,835       342,663       389,835       342,663  

Less: total deferred revenue, beginning of period (1)

     (381,003 )     (328,488 )     (372,862 )     (313,157 )

Less: total deferred costs, end of period

     (60,214 )     (54,582 )     (60,214 )     (54,582 )

Total deferred costs, beginning of period

     59,255       52,549       57,936       50,279  

Other expense (income), net

     (97 )     681       471       738  

Provision for (benefit from) income taxes

     2,030       (292 )     4,472       308  

Depreciation and amortization expense (2)

     2,295       2,335       4,469       4,422  

Stock-based compensation expense

     7,166       3,736       13,710       6,818  

Acquisition and other non-recurring charges (3)

     627       640       1,700       1,029  
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 17,655     $ 19,980     $ 33,446     $ 39,407  
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA as a percentage of total revenue

     23 %     29 %     21 %     29 %

 

(1) The balances for the periods presented exclude any amounts related to the acquisition date deferred revenue assumed from C2C, which closed in the second quarter of fiscal 2015. We believe adjusting for the fair value of the assumed performance obligation allows us to better compare gross billings and adjusted EBITDA from period to period in order to assess the ongoing results of our business.
(2) Represents expenses for the amortization of intangible assets and property and equipment, as well as certain losses on disposal of long-lived assets.
(3) In calculating adjusted EBITDA and free cash flow, we also adjust for acquisition and other non-recurring charges that we do not expect to recur in our continuing operating results. We believe that adjusting for these charges allows us to better compare adjusted EBITDA and free cash flow from period to period in order to assess the ongoing operating results of our business. Refer to the “Acquisition and Other Non-Recurring Charges” section below for additional details regarding these charges.

Adjusted EBITDA decreased to $17.7 million in the three months ended August 31, 2015 from $20.0 million in the three months ended August 31, 2014, and $33.4 million in the six months ended August 31, 2015 from $39.4 million in the six months ended August 31, 2014. The fluctuations in adjusted EBITDA from period to period were primarily driven by the decreased growth rate of our gross billings and our increased investments in research and development.

Free cash flow. We define free cash flow as cash provided by operating activities, less purchases of property and equipment plus acquisition and other non-recurring charges. We consider free cash flow to be a useful liquidity measure that considers the investment in cloud and corporate infrastructure required to support our business and the impact of acquisition-related expenses and other non-recurring charges. We use free cash flow to assess our business performance and evaluate the amount of cash generated by our business after adjusting for purchases of property and equipment and acquisition and other non-recurring charges.

 

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The following table reconciles cash provided by operating activities to free cash flow (dollars in thousands):

 

     Three Months Ended August 31,     Six Months Ended August 31,  
     2015     2014     2015     2014  

Net cash provided by operating activities

   $ 22,317     $ 15,475     $ 28,619     $ 20,882  

Less: purchases of property and equipment

     (1,567 )     (2,186 )     (3,443 )     (3,775 )

Acquisition and other non-recurring charges (1)

     380       390       1,266       775  
  

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

   $ 21,130     $ 13,679     $ 26,442     $ 17,882  
  

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow as a percentage of total revenue

     27 %     20 %     17 %     13 %

 

(1) In calculating adjusted EBITDA and free cash flow, we also adjust for acquisition and other non-recurring charges that we do not expect to recur in our continuing operating results. We believe that adjusting for these charges allows us to better compare adjusted EBITDA and free cash flow from period to period in order to assess the ongoing operating results of our business. Refer to the “Acquisition and Other Non-Recurring Charges” section below for additional details regarding these charges.

Free cash flow increased to $21.1 million in the three months ended August 31, 2015 from $13.7 million in the three months ended August 31, 2014. The increase in free cash flow was driven primarily by an increase of $6.8 million in cash generated from operating activities and a decrease of $0.6 million in purchases of property and equipment for the three months ended August 31, 2015. Free cash flow increased to $26.4 million in the six months ended August 31, 2015 from $17.9 million in the six months ended August 31, 2014. The increase in free cash flow was driven primarily by an increase of $7.7 million in cash generated from operating activities and a decrease of $0.3 million in purchases of property and equipment for the six months ended August 31, 2015. Furthermore, during the six months ended August 31, 2015, we had additional payments of $0.5 million for acquisition and other non-recurring charges that we do not expect to recur in our continuing operating results.

Active subscribers. We define an active subscriber as a discrete appliance, virtual appliance or cloud-only service that has activated at least one valid subscription that has not been terminated. We monitor the total number of active subscribers as a measure of the growth in our installed base, the success of our sales and marketing activities and the value that our solutions bring to our customers. As of August 31, 2015 and 2014, we had 261,613 and 225,600 active subscribers, respectively. The increase in active subscribers over this period is primarily related to our ability to attract new and retain existing customers.

Our non-GAAP measures have limitations as analytical tools and you should not consider them in isolation or as a substitute for an analysis of our results under GAAP. There are a number of limitations related to the use of these non-GAAP financial measures versus their nearest GAAP equivalents. First, gross billings, adjusted EBITDA and free cash flow are not substitutes for total revenue, net income (loss) and cash provided by operating activities, respectively. Second, other companies may calculate non-GAAP financial measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. Finally, adjusted EBITDA excludes some costs, namely, non-cash stock-based compensation and depreciation and amortization expenses, which are recurring. Therefore adjusted EBITDA does not reflect the non-cash impact of stock-based compensation expense or working capital needs that will continue for the foreseeable future.

Acquisition and Other Non-Recurring Charges

In calculating adjusted EBITDA and free cash flow, we also adjust for acquisition and other non-recurring charges that we do not expect to recur in our continuing operating results. We believe that adjusting for these charges allows us to better compare adjusted EBITDA and free cash flow from period to period in order to assess the ongoing operating results of our business. We refer to costs related to acquisitions and export compliance as our “acquisition and other non-recurring charges” throughout this Quarterly Report on Form 10-Q. These costs consist of the following:

Acquisition costs. Acquisition costs include the legal, valuation consulting and other expenses incurred in connection with acquisitions, the fair value remeasurements of contingent considerations, the payments made under the terms of certain acquisition agreements and other non-recurring expenses, and are classified within operating expenses in our condensed consolidated statements of operations.

Export compliance. Export compliance costs include legal expenses incurred in connection with an internal investigation of our export controls compliance procedures and the submission of our voluntary self-disclosures to the U.S. government in this regard. These costs are classified as general and administrative expenses in our condensed consolidated statements of operations.

 

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The following table presents the details of our acquisition and other non-recurring charges and their impact on adjusted EBITDA (in thousands):

 

     Three Months Ended August 31,      Six Months Ended August 31,  
     2015      2014      2015      2014  

Acquisition costs

   $ 622      $ 588      $ 1,639      $ 960  

Export compliance

     5        52        61        69  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 627      $ 640      $ 1,700      $ 1,029  
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the details of our acquisition and other non-recurring charges and their impact on free cash flow (in thousands):

 

     Three Months Ended August 31,      Six Months Ended August 31,  
     2015      2014      2015      2014  

Acquisition costs

   $ 372      $ 372      $ 1,202      $ 744  

Export compliance

     8        18        64        31  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 380      $ 390      $ 1,266      $ 775  
  

 

 

    

 

 

    

 

 

    

 

 

 

Components of Results of Operations

Revenue

We generate revenue from the sales of our appliances and subscriptions.

 

    Appliance Revenue. Revenue from the sale of our appliances includes hardware and a perpetual license. We recognize appliance revenue over the estimated customer relationship period of three years, commencing with the end-user’s activation of the appliance and related subscription, provided all other criteria for the recognition of appliance revenue are met.

 

    Subscription Revenue. Subscription revenue is generated primarily from our subscription services such as our Barracuda Energize Updates as well as our cloud solutions. Subscription revenue also includes revenue from fixed term licenses of our virtual appliance software support and maintenance. Our subscription terms range from one to five years, the substantial majority of which are for one-year periods. We recognize revenue from subscriptions and support and maintenance over the contractual service period.

Cost of Revenue

Cost of revenue consists of costs related to our appliance and subscription revenue. Such costs include hardware, manufacturing, shipping and logistics, customer support, warranty, personnel costs, data center costs and amortization of intangible assets related to acquired technology. We expect our cost of revenue to increase in absolute dollars, although it may fluctuate as a percentage of total revenue from period to period, as we continue to grow.

Gross Profit

Gross profit as a percentage of total revenue, or gross margin, has been and will continue to be affected by a variety of factors, including manufacturing costs, cost of technical support and the mix of our solutions sold. We expect our gross profit to fluctuate over time depending on the factors described above.

Operating Expenses

Our operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation expense and travel-related expenses. Operating expenses also include allocated overhead costs for facilities, IT and depreciation. We expect operating expenses to increase in absolute dollars, although they may fluctuate as a percentage of total revenue from period to period, as we continue to grow. In particular, we expect our stock-based compensation expense to increase in absolute dollars as a result of our existing stock-based compensation expense to be recognized as options and restricted stock units (“RSUs”) vest and as we issue additional stock-based awards to attract and retain employees.

 

   

Research and development. Research and development expenses consist primarily of salaries, benefits and stock-based compensation for employees and executives on our engineering and technical teams who are responsible for increasing the functionality and enhancing the ease-of-use of our appliance and subscription services, as well as the development of new

 

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products. We expense our research and development costs as they are incurred. We expect research and development expenses to increase in absolute dollars as we continue to invest in our future solutions, although our research and development expenses may fluctuate as a percentage of total revenue.

 

    Sales and marketing. Our sales and marketing expenses consist primarily of advertising, as well as salaries, commissions, benefits and stock-based compensation for our employees and executives engaged in sales, sales support, marketing, business development and customer service functions. Our advertising expenses include the costs of cooperative marketing programs developed with our channel partners and other marketing programs such as online lead generation, promotional events and web seminars. We market and sell our subscription services worldwide through our sales organization and distribution channels, such as strategic resellers and distributors. We capitalize and amortize the direct and incremental portion of our sales commissions over the period the related revenue is recognized. We expect sales and marketing expenses to continue to increase in absolute dollars as we increase the size of our sales and marketing organizations, although our sales and marketing expenses may fluctuate as a percentage of total revenue.

 

    General and administrative. Our general and administrative expenses consist primarily of salaries, benefits and stock-based compensation for our finance, legal, regulatory and compliance, human resources and other administrative employees and executives. In addition, general and administrative expenses include outside consulting, legal and accounting services and facilities and other supporting overhead costs. We expect general and administrative expenses to increase in absolute dollars due to accounting, insurance, investor relations and other costs associated with being a public company, although our general and administrative expenses may fluctuate as a percentage of total revenue.

Other Income (Expense), Net

Other income (expense), net consists primarily of foreign exchange gains and losses, interest expense on our outstanding debt and interest income earned on our cash, cash equivalents and marketable securities. We expect interest income will vary each reporting period depending on our average investment balances during the period, types and mix of investments and market interest rates.

Benefit from (Provision for) Income Taxes

Our benefit from (provision for) income taxes consists primarily of federal and state income taxes in the United States and income taxes in foreign jurisdictions in which we conduct business. We estimate income taxes in each of the jurisdictions in which we operate. This process involves determining income tax expense together with calculating the deferred income tax expense related to temporary differences resulting from the differing treatment of items for tax and accounting purposes. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. These temporary differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheets. Deferred tax assets are recognized for deductible temporary differences, along with net operating loss and credits carryforwards, if it is more likely than not that the tax benefits will be realized.

Results of Operations

Comparison of the Three Months Ended August 31, 2015 and 2014

The following table summarizes our condensed consolidated results of operations for the periods presented and as a percentage of our total revenue for those periods (dollars in thousands):

 

     Three Months Ended August 31,  
     2015     % of
Total
Revenue
    2014     % of
Total
Revenue
    Change  

Revenue:

    

Appliance

   $ 22,288       28 %   $ 20,676       30 %   $ 1,612  

Subscription

     56,083       72       47,976       70       8,107  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     78,371       100       68,652       100       9,719  

Cost of revenue

     15,935       20       14,044       20       1,891  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     62,436       80       54,608       80       7,828  

Operating expenses:

    

Research and development

     17,502       22       13,826       20       3,676  

Sales and marketing

     34,470       44       31,031       45       3,439  

General and administrative

     10,770       14       8,624       13       2,146  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     62,742       80       53,481       78       9,261  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (306     —         1,127       2       (1,433

Other income (expense), net

     97       —         (681 )     (1 )     778   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (209     —         446       1       (655

Benefit from (provision for) income taxes

     (2,030 )     (3     292        —         (2,322
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (2,239     (3 )%   $ 738       1 %   $ (2,977
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Revenue

Total revenue increased $9.7 million, or 14%, for the three months ended August 31, 2015 compared to the three months ended August 31, 2014. Subscription revenue increased by $8.1 million, or 17%, primarily due to an increase in active subscribers during the period of 36,013, or 16%, from 225,600 active subscribers as of August 31, 2014 to 261,613 active subscribers as of August 31, 2015. This increase primarily resulted from our high level of customer retention and an increase in the number of customers purchasing subscriptions from us. Total appliance revenue increased by $1.6 million, or 8%, primarily due to increased demand for our solutions.

Cost of Revenue and Gross Margin

Cost of revenue increased $1.9 million, or 13%, for the three months ended August 31, 2015 compared to the three months ended August 31, 2014 commensurate with the increase in appliance and subscription revenue for the comparable periods. Gross margin remained consistent for the three months ended August 31, 2015 compared to the three months ended August 31, 2014. Additionally, our gross margin is impacted by product mix and the timing of investments in our cloud-based infrastructure and our technical support.

Operating Expenses

Research and development expense increased $3.7 million, or 27%, for the three months ended August 31, 2015 compared to the three months ended August 31, 2014, primarily due to increases of $1.9 million in compensation and personnel related costs, primarily attributable to an 11% increase in research and development headcount, $1.1 million in stock-based compensation expense, $0.3 million in IT-related infrastructure expenses and $0.2 million in license and service fees. As a percentage of total revenue, research and development expense slightly increased from prior year’s comparable period as we continued to invest to innovate and improve the functionality of our solutions.

Sales and marketing expense increased $3.4 million, or 11%, for the three months ended August 31, 2015 compared to the three months ended August 31, 2014, primarily due to increases of $2.5 million in compensation and personnel related costs, primarily attributable to a 14% increase in sales and marketing headcount, $0.8 million in stock-based compensation expense, $0.4 million in marketing expenses, primarily attributable to increases in search engine marketing services, media advertising and partner and event sponsorship costs, and $0.1 million in IT-related infrastructure expenses, partially offset by decreases of $0.4 million in consulting costs and $0.2 million in amortization expense from certain acquisition-related intangible assets becoming fully amortized during fiscal 2015. As a percentage of total revenue, sales and marketing expense remained relatively consistent for the comparable period.

General and administrative expense increased $2.1 million, or 25%, for the three months ended August 31, 2015 compared to the three months ended August 31, 2014, primarily due to increases of $1.3 million in stock-based compensation expense, $0.3 million in legal, compliance and consulting costs, $0.2 million in equipment and software expense, $0.1 million in compensation and personnel related costs, primarily attributable to an 1% increase in general and administrative headcount, $0.1 million in depreciation expense and $0.1 million in bad debt expense. As a percentage of total revenue, general and administrative expense remained relatively consistent for the comparable period.

Other Income (Expense), Net

The change in other income (expense), net was primarily due to net foreign exchange gains of $0.1 million in the three months ended August 31, 2015 compared to net foreign exchange losses of $0.6 million in the three months ended August 31, 2014.

Benefit from (Provision for) Income Taxes

We recorded an income tax provision of $2.0 million for the three months ended August 31, 2015. The difference between the income tax benefit that would be derived by applying the statutory rate to our before tax loss for the three months ended August 31, 2015 and the income tax provision actually recorded is primarily due to the temporary differences we did not benefit from during the period due to our valuation allowance, as well as non-deductible stock-based compensation expense and other currently non-deductible items. For the three months ended August 31, 2014, we recorded an income tax benefit of $0.3 million.

 

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Comparison of the Six Months Ended August 31, 2015 and 2014

The following table summarizes our condensed consolidated results of operations for the periods presented and as a percentage of our total revenue for those periods (dollars in thousands):

 

     Six Months Ended August 31,  
     2015     % of
Total
Revenue
    2014     % of
Total
Revenue
    Change  

Revenue:

    

Appliance

   $ 45,970       29 %   $ 41,512       31 %   $ 4,458  

Subscription

     110,375       71       93,349       69       17,026  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     156,345       100       134,861       100       21,484  

Cost of revenue

     31,901       20       28,450       21       3,451  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     124,444       80       106,411       79       18,033  

Operating expenses:

    

Research and development

     35,502       23       26,778       20       8,724  

Sales and marketing

     68,602       44       60,510       45       8,092  

General and administrative

     21,468       14       17,188       13       4,280  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     125,572       81       104,476       78       21,096  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (1,128     (1     1,935       1       (3,063

Other expense, net

     (471 )     —         (738 )     —         267   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (1,599     (1     1,197       1       (2,796

Provision for income taxes

     (4,472 )     (3     (308     —         (4,164
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (6,071     (4 )%   $ 889       1 %   $ (6,960
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Revenue

Total revenue increased $21.5 million, or 16%, for the six months ended August 31, 2015 compared to the six months ended August 31, 2014. Subscription revenue increased by $17.0 million, or 18%, primarily due to an increase in active subscribers during the period of 36,013, or 16%, from 225,600 active subscribers as of August 31, 2014 to 261,613 active subscribers as of August 31, 2015. This increase primarily resulted from our high level of customer retention and an increase in the number of customers purchasing subscriptions from us. Total appliance revenue increased by $4.5 million, or 11%, primarily due to increased demand for our solutions.

Cost of Revenue and Gross Margin

Cost of revenue increased $3.5 million, or 12%, for the six months ended August 31, 2015 compared to the six months ended August 31, 2014 commensurate with the increase in appliance and subscription revenue for the comparable periods. Gross margin remained consistent for the six months ended August 31, 2015 compared to the six months ended August 31, 2014.

Operating Expenses

Research and development expense increased $8.7 million, or 33%, for the six months ended August 31, 2015 compared to the six months ended August 31, 2014, primarily due to increases of $4.7 million in compensation and personnel related costs primarily attributable to an 11% increase in research and development headcount, $2.2 million in stock-based compensation expense, $0.8 million in IT-related infrastructure expenses, $0.3 million in travel and other related costs, $0.2 million in internal use development equipment and service, $0.2 million in license and service fees and $0.1 million in consulting costs. As a percentage of total revenue, research and development expense increased from prior year’s comparable period as we continued to invest to innovate and improve the functionality of our solutions.

Sales and marketing expense increased $8.1 million, or 13%, for the six months ended August 31, 2015 compared to the six months ended August 31, 2014, primarily due to increases of $4.0 million in compensation and personnel related costs, primarily attributable to a 14% increase in sales and marketing headcount, $2.2 million in marketing expenses, primarily attributable to increases in search engine marketing services, media advertising and partner and event sponsorship costs, $1.8 million in stock-based compensation expense and $0.5 million in IT-related infrastructure expenses, partially offset by a decrease of $0.6 million in consulting costs. As a percentage of total revenue, sales and marketing expense remained consistent for the comparable period.

 

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General and administrative expense increased $4.3 million, or 25%, for the six months ended August 31, 2015 compared to the six months ended August 31, 2014, primarily due to increases of $2.6 million in stock-based compensation expense, $0.8 million in legal, compliance and consulting costs, $0.7 million in compensation and personnel related costs, primarily attributable to an 1% increase in general and administrative headcount, and $0.3 million in equipment and software expense. As a percentage of total revenue, general and administrative expense remained relatively consistent for the comparable period.

Other Expense, Net

The change in other expense, net was primarily due to a decrease of $0.2 million in foreign exchange losses during the six months ended August 31, 2015 compared to the six months ended August 31, 2014.

Provision for Income Taxes

We recorded an income tax provision of $4.5 million for the six months ended August 31, 2015. The difference between the income tax benefit that would be derived by applying the statutory rate to our before tax loss for the six months ended August 31, 2015 and the income tax provision actually recorded is primarily due to the temporary differences we did not benefit from during the period due to our valuation allowance, as well as non-deductible stock-based compensation expense and other currently non-deductible items. For the six months ended August 31, 2014, we recorded an income tax provision of $0.3 million.

Liquidity and Capital Resources

 

     Six Months Ended August 31,  
     2015      2014  
     (in thousands)  

Cash provided by operating activities

   $ 28,619      $ 20,882  

Cash used in investing activities

   $ (6,938 )    $ (9,166 )

Cash provided by financing activities

   $ 744      $ 9,056   

As of August 31, 2015, we had cash and cash equivalents of $173.7 million, of which approximately $9.6 million was held outside of the United States and not presently available to fund domestic operations and obligations. In addition, we held marketable securities of $44.1 million as of August 31, 2015. If we were to repatriate cash held outside of the United States, it could be subject to U.S. income taxes, less any previously paid foreign income taxes. On September 23, 2015, we entered into the Merger Agreement with Intronis pursuant to which we will pay $65.0 million in cash for the transaction subject to certain adjustments set forth in the Merger Agreement, $7.0 million of which will be held in escrow by us as partial security for the indemnification obligations of the equityholders of Intronis. We expect to finance through available cash and cash equivalents. The transaction is expected to close in the third quarter of fiscal 2016 and is subject to customary closing conditions.

Furthermore, we have available to us a $25.0 million credit facility with Silicon Valley Bank (“SVB”) that expires in November 2015, which includes an option to request an increase of the available funds under the credit facility to $50.0 million. The credit facility is secured by a security interest on substantially all of our assets and contains restrictive covenants. Upon drawing the credit facility, the financial covenants will require us to maintain a minimum adjusted EBITDA, as defined in the credit facility, and a minimum adjusted quick ratio. The credit facility also sets forth specified events of default. No amounts had been drawn under the credit facility through August 31, 2015.

We believe that our existing cash, cash equivalents and short-term marketable securities, together with our existing credit facility, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced solutions and service offerings and the continuing market acceptance of our solutions. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

In addition, as described in the section “Legal Proceedings” we are currently involved in ongoing litigation. Any adverse settlements or judgments in any litigation could have a material adverse impact on our results of operations, cash balances and cash flows in the period in which such events occur.

 

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Operating Activities

Our primary source of cash from operating activities has been from cash collections from our customers. We expect cash inflows from operating activities to be affected by increases in sales and timing of collections. Our primary uses of cash from operating activities have been for personnel costs and investment in sales and marketing and research and development infrastructure. We expect cash outflows from operating activities to be affected by increases in sales and increases in personnel costs as we grow our business.

For the six months ended August 31, 2015, operating activities provided $28.6 million in cash primarily due to a positive change of $18.9 million in our net operating assets and liabilities and non-cash charges of $18.2 million related to stock-based compensation, depreciation and amortization expenses, partially offset by our consolidated net loss of $6.1 million and excess tax benefits from equity compensation plans of $3.3 million.

For the six months ended August 31, 2014, operating activities provided $20.9 million in cash primarily due to a positive change of $19.3 million in our net operating assets and liabilities, consolidated net income of $0.9 million and non-cash charges of $0.7 million.

Investing Activities

Our investing activities generally consist of transactions related to marketable and non-marketable securities, purchases of property and equipment, and activity in connection with acquisitions. We expect to continue to purchase property and equipment to support the continued growth of our business as well as continue to invest in our data center infrastructure.

Cash used in investing activities of $6.9 million in the six months ended August 31, 2015 was primarily related to purchases of marketable securities of $14.2 million, property and equipment of $3.4 million, acquisition related payments of $0.7 million and investments of $0.4 million in non-marketable securities, partially offset by proceeds from the sale and maturity of certain marketable securities of $11.8 million.

Cash used in investing activities of $9.2 million in the six months ended August 31, 2014 was primarily related to our acquisition of C2C and acquisition related escrow payments of $4.8 million, purchases of property and equipment of $3.8 million and investments of $0.6 million in non-marketable securities.

Our annual capital expenditures generally have varied between approximately 2% and 5% of annual total revenue. We believe future capital expenditures are likely to be consistent with historical experience with variations above or below the range depending upon specific strategic opportunities.

Financing Activities

Our financing activities generally consist of equity related transactions, including proceeds from the exercises of employee stock options, excess tax benefits from equity incentive plans and tax payments associated with the net share settlements of equity awards.

For the six months ended August 31, 2015, financing activities provided $0.7 million in cash primarily from various equity related transactions, including proceeds from stock option exercises of $4.3 million and excess tax benefits from equity compensation plans of $3.3 million. These cash inflows were partially offset by tax payments related to $4.0 million of net share settlements of equity awards and payments of $2.5 million related to remittances to tax authorities for employee equity transactions.

For the six months ended August 31, 2014, financing activities provided $9.1 million in cash primarily from various equity related transactions, including proceeds from stock option exercises of $7.2 million and excess tax benefits from equity compensation plans of $4.3 million. These cash inflows were partially offset by tax payments related to $2.3 million of net share settlements of equity awards.

Contractual Obligations and Commitments

On September 23, 2015, we entered into the Merger Agreement with Intronis pursuant to which we will pay $65.0 million in cash for the transaction subject to certain adjustments set forth in the Merger Agreement, $7.0 million of which will be held in escrow by us as partial security for the indemnification obligations of the equityholders of Intronis. The transaction is expected to close in the third quarter of fiscal 2016 and is subject to customary closing conditions. Other than the foregoing, there have been no material changes outside the ordinary course of our business in the contractual obligations disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015.

Off-Balance Sheet Arrangements

As of August 31, 2015, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

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Critical Accounting Policies and Estimates

Our condensed consolidated financial statements have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

There have been no significant changes to our critical accounting policies and estimates as disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2015.

JOBS Act Accounting Election

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startup Act of 2012 (the “JOBS Act”). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Recent Accounting Pronouncements

Refer to “Recent Accounting Pronouncements” in Note 1 to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The market risk exposures described in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended February 28, 2015 have not changed materially for the three and six months ended August 31, 2015.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Management, with the participation of our chief executive officer (“CEO”) and our chief financial officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures,” as defined in Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s (the “SEC”) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures, our CEO and CFO concluded that our disclosure controls and procedures were effective as of such date at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15 and 15d-15 of the Exchange Act that occurred during the three months ended August 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations of Internal Controls

        Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

Export Compliance

In late 2011, following a voluntary internal review of our compliance with U.S. export control and sanctions laws, our management team became aware that certain of our physical appliances had been sold indirectly into embargoed countries via our distributors and resellers, potentially in violation of U.S. export control and economic sanctions laws. In addition, certain of our solutions incorporate encryption components and may be exported from the United States only with the required approvals; in the past, we may have exported products prior to receiving these required authorizations. After completion of a comprehensive internal investigation conducted by outside counsel, we submitted voluntary disclosures regarding these matters to the U.S. Commerce Department, Bureau of Industry and Security (“BIS”), and to the U.S. Treasury Department, Office of Foreign Assets Control (“OFAC”). These disclosures summarized potential violations of export controls and economic sanctions laws, including reexports by third parties and provision of services to end users in embargoed countries including Iran, Sudan and Syria. We agreed to a settlement with OFAC in May 2015 pursuant to which we agreed to pay $38,930 as consideration for the final resolution of all issues related to the voluntary disclosure that we submitted to OFAC.

We received a Proposed Charging Letter from BIS on August 21, 2014, which asserts certain export violations against us and our UK subsidiary. Based on discussions with BIS, we expect a one-time monetary penalty to be imposed, and do not currently expect any criminal charges, denial of export privileges or ongoing monitoring actions. We intend to continue cooperating with BIS in an effort to resolve this matter. However, at this time, we are unable to estimate the timing or amount of any final resolution.

On January 23, 2015, Wetro Lan LLC (“Wetro Lan”) filed a lawsuit against us in the U.S. District Court for the Eastern District of Texas, Marshall Division, Wetro Lan LLC v. Barracuda Networks, Inc., Case No. 2:15-CV-46, alleging that certain of our products infringe U.S. Pat. No. 6,795,918. We were notified by RPX Corporation (“RPX”) that it had entered into a settlement and license agreement with Wetro Lan for the patents in the lawsuit. As a result, we expect that the lawsuit will be dismissed with prejudice and we will not pay any fees associated with the settlement and license.

On June 3, 2015, Verifire Network Solutions, LLC (“Verifire”) filed a lawsuit against us in the U.S. District Court for the Eastern District of Texas, Marshall Division, Verifire Network Solutions, LLC v. Barracuda Networks, Inc., Case No. 2:15-CV-928, alleging that certain of our products infringe U.S. Pat. No. 8,463,727. We were notified by RPX that it had entered into a settlement and license agreement with Verifire for the patents in the lawsuit. As a result, the lawsuit was dismissed with prejudice on September 21, 2015 and we did not pay any fees associated with the settlement and license.

From time to time, we are party to litigation and subject to claims that arise in the ordinary course of our business, including actions with respect to employment claims and other matters. Although the results of litigation and claims are inherently unpredictable, we believe that the final outcome of such matters will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

 

Item 1A. Risk Factors

Our operations and financial results are subject to various risks and uncertainties, including those described below. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that affect us. If any of the following risks occur, our business, financial condition, operating results and prospects could be materially and adversely affected. In that event, the price of our common stock could decline. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K, before making a decision to invest in our common stock.

Risks Related to Our Business and Our Industry

If we are unable to increase sales of our solutions to new customers and sell additional distinct solutions from our portfolio of solutions to our existing customers, our future revenue and operating results will be harmed.

Our future success depends on our ability to increase sales of our solutions to new customers as well as to increase sales of additional solutions to our existing customers. The rate at which new and existing customers purchase solutions depends on a number of factors, including certain factors outside of our control, such as customers’ perceived need for security and storage solutions and general economic conditions. If our efforts to sell our solutions to new customers and additional solutions to our existing customers are not successful, our business and operating results may suffer.

A substantial majority of our billings in any particular period are derived from sales to customers with whom we began to engage during that same period and therefore our sales and the size and time to close the deals may vary from period to period and be difficult to predict. Given this unpredictability, we may be unable to accurately forecast our sales in any given period. A failure to accurately predict the level of demand for our solutions may adversely impact our future revenue and operating results, and we are unlikely to forecast such effects with any certainty in advance.

 

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We rely significantly on revenue from subscriptions, which may decline, and, because we recognize revenue from subscriptions over the term of the relevant subscription period, downturns or upturns in sales are not immediately reflected in full in our operating results.

Our subscription revenue accounted for 71% and 70% of our total revenue for the six months ended August 31, 2015 and fiscal 2015. Customers that purchase our subscriptions have no contractual obligation to renew their contracts after the initial contract period, which typically ranges from one to five years, and we may not maintain our historical subscription renewal rates. The substantial majority of our subscriptions are for one-year periods. New or renewal subscriptions may decline or fluctuate as a result of a number of factors, including our customers’ level of satisfaction with our solutions and our customer support, the frequency and severity of subscription outages, our solution functionality and performance, the timeliness and success of solution and enhancement introductions by us and those of our competitors, the prices of our solutions, the prices of solutions offered by our competitors or reductions in our customers’ spending levels. If new or renewal subscriptions decline, our revenue or revenue growth may decline, and our business may suffer. In addition, we recognize subscription revenue ratably over the term of the relevant subscription period. As a result, much of the revenue we report each quarter is the recognition of billings from subscriptions entered into during previous quarters. Consequently, a decline in new or renewal subscriptions in any one quarter will not be fully reflected in revenue in that quarter, but will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales of our solutions would not be reflected in full in our results of operations until future periods.

We have experienced net losses on a GAAP basis in recent periods and may not achieve or maintain profitability in the future. If we cannot achieve or maintain profitability, our financial performance will be harmed.

We have not been profitable on a quarterly or annual basis in recent periods and while we generated net income on a U.S. generally accepted accounting principles (“GAAP”) basis for the three and six months ended August 31, 2014, we experienced net losses on a GAAP basis for the three and six months ended August 31, 2015 and fiscal 2015, 2014 and 2013. While we have experienced revenue growth over these same periods, we may not be able to sustain or increase our growth or achieve profitability in the future or on a consistent basis. Over the past year, we have spent substantial amounts of time and money to develop new security and storage solutions and enhanced versions of our existing security and storage solutions to position us for future growth. Additionally, we have incurred substantial expenses and expended significant resources upfront to market, promote and sell our solutions. We also expect to continue to invest for future growth.

As a result of our increased expenditures, we will have to generate and sustain increased revenue to achieve future profitability. Achieving profitability will require us to increase revenues, manage our cost structure and avoid significant liabilities. Revenue growth may slow, revenue may decline, or we may incur significant losses in the future for a number of possible reasons, including general macroeconomic conditions, increasing competition, a decrease in the growth of the markets in which we operate, or if we fail for any reason to continue to capitalize on growth opportunities. Additionally, we may encounter unforeseen operating expenses, difficulties, complications, delays and other unknown factors that may result in losses in future periods. If these losses exceed our expectations or our revenue growth expectations are not met in future periods, our financial performance will be harmed and our stock price could be volatile or decline.

If we cannot successfully execute on our strategy and continue to develop, manufacture and market solutions that respond promptly to the security and storage needs of our customers, our business and operating results may suffer.

The security and storage markets are characterized by constant change and innovation, and we expect them to continue to evolve rapidly. Moreover, many of our customers operate in markets characterized by rapidly changing technologies and business models, which require them to develop and manage increasingly complex enterprise networks, incorporating a variety of hardware, software applications, operating systems and networking protocols. Our historical success has been based on our ability to identify common customer needs and design solutions to address complex IT problems in an organization’s threat vectors including email, web browsing, mobile devices and remote access. Furthermore, our sales and marketing initiatives are primarily focused on higher-growth segments within the security and storage markets. To the extent we are unable to continue to identify common IT challenges and execute our business model to timely and effectively design and market solutions to address these challenges, as well as to continue to expand our sales to higher-growth segments within the security and storage markets, our business, operating results and financial condition will be adversely affected.

Additionally, the process of developing new technology is complex and uncertain, and if we fail to accurately predict customers’ changing needs, particularly in the higher-growth segments within the security and storage markets, and emerging technological trends or if we fail to achieve the benefits expected from our investments, our business could be harmed. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position and we must commit significant resources to developing new solutions before knowing whether our investments will result in solutions the market will accept. Our new solutions or enhancements could fail to attain sufficient market acceptance for many reasons, including:

 

    delays in releasing our new solutions or enhancements to the market;

 

    failure to accurately predict market demand or customer demands;

 

    inability to protect against new types of attacks or techniques used by hackers;

 

    defects, errors or failures in their design or performance;

 

    negative publicity about their performance or effectiveness;

 

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    introduction or anticipated introduction of competing solutions by our competitors;

 

    poor business conditions for our customers, causing them to delay IT purchases;

 

    the perceived value of our solutions or enhancements relative to their cost;

 

    easing of regulatory requirements around security or storage; and

 

    reluctance of customers to purchase solutions incorporating open source software.

There can be no assurance that we will successfully identify new opportunities, develop and bring new solutions to market on a timely basis or achieve market acceptance of our solutions, or that solutions and technologies developed by others will not render our solutions or technologies obsolete or noncompetitive, all of which could adversely affect our business and operating results. If our new solutions or enhancements do not achieve adequate acceptance in the market, or if our new solutions or enhancements do not result in increased subscriptions, our competitive position will be impaired, our revenue will be diminished and the negative impact on our operating results may be particularly acute because of the upfront research, development, marketing, sales and other expenses we incurred in connection with the new solutions or enhancements.

We have recently introduced, and will continue to introduce, new security and storage solutions and we may not gain broad market acceptance for these new solutions.

Over the past year, we have released several new security and storage solutions and enhanced versions of our existing security and storage solutions, which address the higher-growth segments of the security and storage markets, to incorporate additional features, improve functionality or deliver other enhancements in order to meet our customers’ rapidly evolving demands. The return on our investments in these development efforts may be lower, or may develop more slowly, than we expect. Further, given their recent introduction, we cannot assure you that these solutions will gain broad market acceptance and that they will prove to be profitable in the longer term. Additionally, we intend to continue introducing new security and storage solutions to respond to the needs of our customers. If we fail to achieve high levels of market acceptance for these solutions or if market acceptance is delayed, or if the market segments we address with our new solutions do not grow as expected, we may fail to justify the amount of our investment in developing and bringing them to market, and our business, operating results and financial performance could be adversely affected.

Our business is substantially dependent on sales leads from Internet search engines and if we are unable to generate significant volumes of such leads, traffic to our websites and our revenue may decrease.

We generate a substantial portion of our sales leads through visits to our websites by potential customers interested in our solutions. Many of these potential customers find our websites by searching for security and storage solutions through Internet search engines, particularly Google. A critical factor in attracting potential customers to our websites is how prominently our websites are displayed in response to search inquiries. If we are listed less prominently or fail to appear in search result listings for any reason, visits to our websites by customers and potential customers could decline significantly and we may not be able to replace this traffic. Furthermore, if the costs of search engine marketing services, such as Google AdWords, continue to increase we may be required to increase our sales and marketing expenses, which may not be offset by additional revenue, and our business and operating results could be adversely affected.

Our quarterly and annual operating results and key metrics have varied in the past and may continue to vary and be unpredictable, which may cause our stock price to fluctuate.

Our quarterly and annual operating results and key metrics have varied from period to period in the past, and we expect that they may continue to fluctuate as a result of a number of factors, many of which are outside of our control, including:

 

    the timing and success of introductions of our new solutions;

 

    changes in the growth rate of the security and storage markets;

 

    changes in renewal rates for our subscriptions and our ability to cross-sell additional solutions in a period;

 

    the size of orders and the time it takes to close larger orders;

 

    the timing of orders from our customers;

 

    the timing of our marketing expenditures;

 

    the mix of solutions sold;

 

    fluctuations in demand for our products and services, particularly seasonal variations in customer spending patterns in more than one of our addressable markets;

 

    our ability to control costs, including operating expenses, the costs of hardware and software components, and other manufacturing costs;

 

    the budgeting cycles and purchasing priorities of our customers;

 

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    the timing of payments of sales commissions, bonuses or performance earnouts;

 

    the timing and potential provision of valuation allowances against our deferred tax assets;

 

    the level of perceived threats to network security, which may fluctuate from period to period;

 

    government regulations and customer requirements surrounding data storage and protection;

 

    fines, penalties or changes or increases in liabilities for regulatory actions, litigation or warranty claims, including our current voluntary disclosures to BIS as described in greater detail below;

 

    deferral of orders from customers in anticipation of new solutions or solution enhancements announced by us or our competitors;

 

    any significant changes in the competitive environment, including the entry of new competitors and increased price competition;

 

    disruption in our supply chain and the availability of the components of our appliances;

 

    levels of solution returns, particularly in connection with our 30-day right to return;

 

    the timing of revenue recognition for our sales, which may be affected by the term of subscriptions;

 

    increases or decreases caused by fluctuations in foreign currency exchange rates, since a significant portion of our revenues are received, and our expenses are incurred and paid, in currencies other than U.S. dollars;

 

    general economic conditions, both domestically and in our foreign markets, which impact purchasing patterns of customers; and

 

    future accounting pronouncements or changes in our accounting policies.

Any one of the factors above, or the cumulative effect of some of the factors referred to above, may result in significant fluctuations in our quarterly or annual operating results, including fluctuations in our key financial metrics. This variability and unpredictability could result in our failing to meet our revenue, billings or operating results expectations or those of securities analysts or investors for any period. In addition, a significant percentage of our operating expenses are fixed in nature and based on forecasted revenue trends. Accordingly, in the event of revenue shortfalls, we are generally unable to mitigate the negative impact on operating results in the short term. If we fail to meet or exceed such expectations for these or any other reasons, our business and stock price could be materially adversely affected and we could face costly lawsuits, including securities class action suits.

We believe that our brand is integral to our success and if we fail to cost-effectively promote or protect our brand, our business and competitive position may be harmed.

We believe that cost-effectively promoting and maintaining awareness and integrity of our company and our brand are vital to achieving widespread acceptance of our existing and future solutions and are important elements in attracting new customers and retaining our existing customers, particularly as we seek to expand internationally. We believe that the importance of brand recognition will increase as competition in our market further intensifies. We have invested and expect to continue to invest substantial resources to promote and maintain our brand and generate sales leads, both domestically and internationally, but there is no guarantee that our brand development strategies will enhance the recognition of our brand or lead to increased sales. For example, we use radio advertisements, signs and billboards in key locations such as airports where target customers often travel and vehicles wrapped in highly-visible branding. We also engage in activities such as promotional events and attending trade shows. Some of our existing and potential competitors have well-established brands with equal or greater recognition than we have. If our efforts to cost-effectively promote and maintain our brand are not successful, our operating results and our ability to attract and retain customers may be adversely affected. In addition, even if our brand recognition and loyalty increases, our revenue may not increase at a level that is commensurate with our marketing spend.

In addition, independent industry analysts often provide reviews of our solutions, as well as those of our competitors, and perception of our solutions in the marketplace may be significantly influenced by these reviews. We have no control over what these industry analysts report, and because industry analysts may influence current and potential customers, our brand could be harmed if they do not provide a positive review of our solutions or view us as a market leader.

We face intense competition in the security and storage markets and other markets in which we compete, which are characterized by constant change and innovation, and we may lack sufficient financial or other resources to maintain or improve our competitive position.

        The markets for security and storage solutions are intensely competitive and are characterized by constant change and innovation, and we expect competition to increase in the future from larger, well-established competitors and new market entrants. Changes in the application, threat and technology landscape result in evolving customer requirements. Our main competitors in these markets fall into two categories:

 

    Independent network security, storage and application delivery vendors such as Check Point Software Technologies, Ltd., CommVault Systems, Inc., EMC Corporation, F5 Networks, Inc., Fortinet, Inc., Imperva, Inc., Juniper Networks, Inc., Palo Alto Networks, Inc., Proofpoint, Inc. and Symantec Corporation that offer competing solutions.

 

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    Diversified IT suppliers such as Cisco Systems, Inc., Dell Inc., Hewlett-Packard Company, the McAfee division of Intel and International Business Machines that have acquired large security specialist vendors in recent years, that have software- or hardware-based storage solutions or that have the technical and financial resources to bring competitive solutions to the market.

In addition, we compete with companies that offer point solutions that compete with some of the features present in our platform. As our market grows, we believe it will attract more highly specialized vendors as well as larger vendors that may continue to acquire or bundle their solutions more effectively.

Many of our existing competitors have, and some of our potential competitors could have, substantial competitive advantages such as:

 

    substantially greater financial, technical and other resources;

 

    greater name recognition, stronger reputations and longer operating histories;

 

    larger sales and marketing and customer support budgets and resources;

 

    broader distribution and established relationships with distribution partners and customers;

 

    lower labor and development costs;

 

    larger and more mature intellectual property portfolios; and

 

    greater resources to make acquisitions.

In addition, our larger competitors have substantially broader solution offerings and leverage their relationships based on other solutions or incorporate functionality into existing solutions to gain business in a manner that discourages customers and potential customers from purchasing our solutions, including through selling at low or negative margins, product bundling or closed technology platforms. Potential customers may also prefer to purchase from their existing suppliers rather than a new supplier regardless of solution performance, price or features. These larger competitors often have broader product lines and market focus and will therefore not be as susceptible to downturns in our markets, thereby reducing their overall risk profile as compared to ours. Many of our smaller competitors that specialize in providing protection from a single type of network security threat are often able to deliver these specialized network security solutions to the market more quickly than we can, which could reduce the addressable market for our new solutions or enhancements to existing solutions. Conditions in our market could change rapidly and significantly as a result of technological advancements, partnering by our competitors or continuing market consolidation. New start-up companies that innovate and large competitors that are making significant investments in research and development may invent similar or superior solutions and technologies that compete with our solutions and technology. Our current and potential competitors may also establish cooperative relationships among themselves or with third parties that may further enhance their ability to compete.

Some of our competitors have made acquisitions of businesses that may allow them to offer more directly competitive and comprehensive solutions than they had previously offered. As a result of such acquisitions, our current or potential competitors might be able to adapt more quickly to new technologies and customer needs, devote greater resources to the promotion or sale of their solutions and services, initiate or withstand substantial price competition, take advantage of acquisition or other opportunities more readily, or develop and expand their solution offerings more quickly than we do.

Organizations may be more willing to incrementally add solutions to their existing IT infrastructure from competitors than to replace it with our solutions. These competitive pressures in our market or our failure to compete effectively may result in price reductions, fewer orders, reduced revenue and gross profits and loss of market share. Any failure to meet and address these factors could seriously harm our business and operating results.

To remain competitive, we may be required to make substantial additional investments in research, development, marketing and sales in order to respond to competition, and there can be no assurance that these investments will achieve any returns for us or that we will be able to compete successfully in the future.

Our business is dependent on overall demand for security and storage solutions and therefore reduced security and storage solution spending or overall adverse economic conditions may negatively impact our business and operating results.

Our business depends on the overall demand for security and storage solutions. In addition, the purchase of our solutions is often discretionary. Weak global economic conditions, or a reduction in security and storage solution spending even if economic conditions improve, could adversely impact our business, financial condition and operating results in a number of ways, including longer sales cycles, lower prices for our solutions, higher default rates among our customers and channel partners, reduced subscription renewals and lower our sales levels. As global economic conditions continue to be volatile or economic uncertainty remains, trends in security and storage spending also remain unpredictable and subject to reductions due to credit constraints and uncertainties about the future. Deterioration of economic conditions, as well as economic uncertainty or an economic downturn, may harm our business and operating results in the future.

 

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We rely on third-party distributors and channel partners to fulfill substantially all of our sales orders. If our distributors and reseller channel partners fail to perform, our ability to sell our solutions will be limited, and, if we fail to optimize our distributor and reseller channel partner model going forward, our operating results will be harmed.

Substantially all of our sales orders are fulfilled by our channel partners, which include distributors and resellers. We depend upon our resellers to manage the customer sales process and to generate sales opportunities and our distributors to provide our solutions to our resellers. To the extent our distributors and resellers are unsuccessful in fulfilling our sales, managing the sales process or selling our solutions, or we are unable to enter into arrangements with, and retain a sufficient number of high-quality, motivated distributors and resellers in each of the regions in which we sell our offerings, our ability to sell our solutions and operating results will be harmed. In order to support our growth strategy, we continue to expand our distributor and reseller network, both in the United States and internationally. If we are unable to successfully develop new distributor and reseller relationships, or if we experience reseller shifts between distributors or any channel conflict occurs, it could negatively impact our ability to meet our revenue and profitability goals.

We provide our channel partners with specific programs to assist them in selling our solutions, but there can be no assurance that these programs will be effective. In addition, our channel partners may be unsuccessful in marketing, selling and supporting our solutions. Our channel partners do not have minimum purchase requirements. They may also market, sell and support solutions that are competitive with ours, and may devote more resources to the marketing, sales and support of such solutions. Our agreements with our channel partners may generally be terminated for any reason by either party with advance written notice and our channel partners may stop selling our solutions at any time. We cannot assure you that we will retain these channel partners, that channel partners will sell our solutions effectively or that we will be able to secure additional or replacement channel partners. The loss of one or more of our significant channel partners or a decline in the number or size of orders from them could harm our operating results. In addition, our channel partner sales structure could subject us to lawsuits, potential liability, and reputational harm if, for example, any of our channel partners misrepresent the functionality of our solutions to customers or violate laws or our corporate policies.

Significant developments in IT infrastructure deployments, particularly cloud computing and other alternative IT infrastructure technologies, may materially adversely affect the demand for our products.

Developments or changes in IT infrastructure, such as the emergence of hosted cloud storage, software as a service and mobile data access are driving significant changes in storage and compute architectures and solution requirements as well as presenting significant challenges in the security market, which may materially and adversely affect our business and prospects in ways we do not currently anticipate. The impact of these trends on overall long-term growth patterns is uncertain, especially in resource-constrained environments. The emergence of cloud computing and other alternative IT infrastructure technologies, in which technology services are provided on a remote-access basis, may have a significant impact on the market for security and storage solutions and may result in rapid changes in customer demands. This could be the case even if such advances do not deliver all of the benefits of our solutions. If alternative models gain traction, any failure by us to develop new or enhanced technologies or processes, or to react to changes or advances in existing technologies, could adversely affect our business and operating results.

We have made significant investments in recent periods to support our growth, including investments in our information technology, infrastructure and management team, and these investments may achieve delayed or lower than expected benefits, which could harm our operating results. Furthermore, if we do not effectively manage any future growth, or are unable to improve our systems and processes, our operating results will be adversely affected.

We continue to increase the breadth and scope of our offerings and, correspondingly, the breadth and scope of our operations. To support this growth, and to manage any future growth effectively, we must continue to improve and expand our information technology and financial infrastructure, our operating and administrative systems and our ability to manage headcount, capital and processes in an efficient manner. We have incurred, and will continue to incur, expenses as we invest in international operations and infrastructure such as the expansion of our sales and marketing presence globally, the addition of higher touch sales and marketing field resources to liaise with our channel partners as we continue to grow our sales both domestically and internationally and investments in software systems and additional data center resources to keep pace with the growth in the cloud and cloud-based solutions markets. We continue to make significant incremental investments in product development, corporate infrastructure and broadened distribution, and we intend to continue to invest in development of our solutions, our infrastructure and sales and marketing. We have recognized, and are likely to continue to recognize, the costs associated with these investments earlier than some of the anticipated benefits, and the return on these investments may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our operating results may be adversely affected.

We may acquire other businesses which could require significant management attention, disrupt our business, dilute stockholder value and adversely affect our operating results.

As part of our business strategy, we have in the past made, and may in the future make, acquisitions or investments in complementary companies, solutions and technologies that we believe fit within our business model and can address the needs of IT professionals. With respect to our previous acquisitions, we cannot ensure that we will be able to successfully integrate the technology and resources to increase subscriptions and grow revenue derived from these acquisitions. In the future, we may not be able to acquire and integrate other companies, solutions or technologies in a successful manner. We may not be able to find suitable acquisition candidates, and we may not be able to complete such acquisitions on favorable terms, if at all. Furthermore, we may not be able to find suitable acquisition candidates that enhance our subscription offerings. If we do complete acquisitions, we may not ultimately strengthen our competitive position or achieve our goals, including increases in subscriptions, and any acquisitions we complete could be viewed negatively by our customers, investors and industry analysts. Future acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable assets acquired. We may have to pay cash, incur debt or issue equity securities to pay for any such acquisition, each of which could adversely affect our financial condition or the value of our common stock. The sale of equity or issuance of debt to finance any such acquisitions could result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could also include covenants or other restrictions that would impede our ability to manage our operations. In addition, our future operating results may be impacted by performance earnouts or contingent bonuses. Furthermore, acquisitions may require large one-time charges and can result in increased debt or contingent liabilities, adverse tax consequences, additional stock-based compensation expense and the recording and subsequent amortization of amounts related to certain purchased intangible assets, any of which items could negatively impact our future results of operations. We may also record goodwill in connection with an acquisition and incur goodwill impairment charges in the future.

        In addition, if we are unsuccessful at integrating such acquisitions, or the technologies associated with such acquisitions, into our company, the revenue and operating results of the combined company could be adversely affected. Any integration process may result in unforeseen operating difficulties and require significant time and resources, and we may not be able to manage the process successfully. In particular, we may encounter difficulties assimilating or integrating the companies, solutions, technologies, personnel or operations we acquire, particularly if the key personnel are geographically dispersed or choose not to work for us. Acquisitions may also disrupt our core business, divert our resources and require significant management attention that would otherwise be available for development of our business. We may not successfully evaluate or utilize the acquired technology or personnel, or accurately forecast the financial impact of an acquisition transaction, including accounting charges. If we fail to properly evaluate, execute or integrate acquisitions or investments, the anticipated benefits may not be realized, we may be exposed to unknown or unanticipated liabilities, and our business and prospects could be harmed.

 

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We generate a significant amount of revenue from sales outside of the United States, and we are therefore subject to a number of risks associated with international sales and operations.

Sales outside of the United States represented 32% of our total revenue for both the six months ended August 31, 2015 and fiscal 2015. As a result, we must continue to hire and train experienced personnel to staff and manage our foreign operations. To the extent that we experience difficulties in recruiting, training, managing and retaining an international staff, and specifically staff related to sales management and sales personnel, we may experience difficulties in sales productivity in foreign markets. If we are not able to maintain successful channel partner and distributor relationships internationally or recruit additional companies to enter into strategic channel partner and distributor relationships, our future success in these international markets could be limited. Additionally, as sales outside of the United States have typically been denominated in U.S. dollars, fluctuations in exchange rates could cause our products to become relatively more expensive to our customers outside of the United States leading to a reduction in sales to those customers. Furthermore, an increasing portion of our operating expenses is incurred outside of the United States, is denominated in foreign currencies, and is subject to fluctuations due to changes in foreign currency exchange rates. A reduction in sales or an increase in operating expenses due to fluctuations in foreign currency exchange rates would have an adverse effect on our financial condition and operating results.

Additionally, our international sales and operations are subject to a number of risks, including the following:

 

    greater difficulty in enforcing contracts and accounts receivable collection and longer collection periods;

 

    increased expenses incurred in establishing and maintaining office space and equipment for our international operations;

 

    greater costs and expenses associated with international sales and operations;

 

    management communication and integration problems resulting from cultural and geographic dispersion;

 

    risks associated with trade restrictions and foreign legal requirements, including the importation, certification and localization of our solutions required in foreign countries;

 

    greater risk of unexpected changes in regulatory practices, tariffs and tax laws and treaties;

 

    the uncertainty of protection for intellectual property rights in some countries;

 

    greater risk of a failure of foreign employees to comply with both U.S. and foreign laws, including export and antitrust regulations, the U.S. Foreign Corrupt Practices Act and any trade regulations ensuring fair trade practices;

 

    heightened risk of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of, or irregularities in, financial statements;

 

    increased financial accounting and reporting burdens and complexities;

 

    the potential for political unrest, terrorism, hostilities or war; and

 

    multiple and possibly overlapping tax structures.

We have office locations in various international locations, including Austria, India and the United Kingdom. If we are unable to effectively manage a large and geographically dispersed group of employees or to anticipate our future growth and personnel needs, our business may be adversely affected. As we expand our business, we add complexity to our organization and must expand and adapt our operational infrastructure and effectively coordinate throughout our organization. As a result, we have incurred and expect to continue to incur additional expense related to our continued growth. In addition, the expansion of our existing international operations and entry into additional international markets have required and will continue to require significant management attention and financial resources.

Failure to manage any future growth effectively could harm our ability to gain future international revenues, result in increased costs, negatively impact our customers’ satisfaction with our solutions, and, consequently, materially impact our business, operating results and financial condition.

We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and operating results.

Given our volume of international sales, a substantial portion of our total revenue is subject to foreign currency risk. For example, for both the six months ended August 31, 2015 and fiscal 2015, 32% of our total revenue was generated from sales to customers located outside of the United States. Additionally, further strengthening of the U.S. dollar could increase the real cost of our solutions to our customers outside of the United States, which could adversely affect our financial condition and operating results. In addition, an increasing portion of our operating expenses is incurred outside of the United States, is denominated in foreign currencies, and is subject to fluctuations due to changes in foreign currency exchange rates. Beginning in fiscal 2015, we utilized foreign exchange forward contracts to manage foreign currency risk. If our foreign exchange forward contracts do not successfully manage our foreign currency risk or if we are not otherwise able to successfully manage or hedge against the risks associated with currency fluctuations, our financial condition and operating results could be adversely affected.

 

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We may be subject to fines or other penalties for past violations of U.S. export control and economic sanctions laws.

In late 2011, following a voluntary internal review of our compliance with U.S. export control and sanctions laws, our management team became aware that certain of our physical appliances had been sold indirectly into embargoed countries via our distributors and resellers, potentially in violation of U.S. export control and economic sanctions laws. These laws restrict or prohibit the sale of certain products, including our solutions, into certain countries, including Iran, Sudan and Syria. In addition, certain of our solutions incorporate encryption components and may be exported from the United States only with the required approvals; in the past, we may have exported products prior to receiving these required authorizations.

Commencing in late 2011, we took a series of corrective actions intended to remediate the effect of any unauthorized past actions, including actions to permanently disable appliances located in sanctioned countries and termination of certain distributors and resellers. In addition, we believe that we have implemented systematic and process changes to our sales and distribution processes to block and prohibit sale or use of our solutions in sanctioned countries or to denied parties.

After completion of a comprehensive internal investigation conducted by outside counsel, we submitted voluntary disclosures regarding these matters to BIS and to OFAC. These disclosures summarized potential violations of export controls and economic sanctions laws, including reexports by third parties and provision of services to end users in embargoed countries including Iran, Sudan and Syria. The voluntary disclosures also summarized the remedial actions we have taken, including those described above, as well as the hiring of an export compliance manager and a general counsel with export controls experience, and the enhancement of employee training programs, periodic notices to our resellers and company-wide policies and procedures designed to help us comply with these laws. We agreed to a settlement with OFAC in May 2015 pursuant to which we agreed to pay $38,930 as consideration for the final resolution of all issues related to the voluntary disclosure that we submitted to OFAC.

We received a Proposed Charging Letter from BIS on August 21, 2014, which asserts certain export violations against us and our UK subsidiary. Based on discussions with BIS, we expect a one-time monetary penalty to be imposed, and do not currently expect any criminal charges, denial of export privileges or ongoing monitoring actions. We intend to continue cooperating with BIS in an effort to resolve this matter. However, we are unable to estimate the timing or amount of any final resolution.

Any such penalties may be material to our financial results in the period in which they are imposed and could significantly affect our quarterly operating results for that quarter. The penalties may be imposed against us and/or our management. Also, disclosure of our conduct and any fines or other action relating to this conduct could harm our reputation and indirectly have a material adverse effect on our business, operating results and financial condition. We also cannot assure you that additional violations will not be discovered or that our policies and procedures will be effective to prevent future violations.

Failure to comply with governmental laws and regulations could harm our business.

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

Defects, errors or vulnerabilities in our solutions, the failure of our solutions to block a virus or prevent a security breach or a false detection of applications, viruses, spyware, vulnerability exploits, data patterns or URL categories could harm our reputation and adversely impact our operating results.

        Because our solutions are complex, they have contained and may in the future contain design or manufacturing defects or errors that are not detected until after their commercial release and deployment by our customers. For example, from time to time, certain of our customers have reported defects in our solutions related to performance, functionality and compatibility that were not detected before shipping the solution. Additionally, defects may cause our solutions to be vulnerable to security attacks, cause them to fail to help secure networks or temporarily interrupt customers’ networking traffic. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, our solutions may not be able to protect our customers’ networks. Our security solutions may also fail to detect or prevent viruses, worms or similar threats due to a number of reasons such as the evolving nature of such threats and the continual emergence of new threats that we may fail to add to our threat intelligence database or other virus databases in time to protect our customers’ networks. For example, in fiscal 2015, we and our customers were adversely impacted by the recently discovered Heartbleed vulnerability, which is a vulnerability in the secure sockets layer, as well as a denial of service attack which targeted our Barracuda Email Security Service. In addition, defects or errors in our subscription updates or our solutions could result in a failure to effectively update customers’ solutions and thereby leave our customers vulnerable to attacks. Our data centers and networks may experience technical failures and downtime, may fail to distribute appropriate updates, or may fail to meet the increased requirements of a growing customer base, any of which could temporarily or permanently expose our customers’ networks, leaving their networks unprotected against the latest security threats. Any defects, errors or vulnerabilities in our solutions could result in:

 

    expenditure of significant financial and product development resources in efforts to analyze, correct, eliminate or work-around errors or defects or to address and eliminate vulnerabilities;

 

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    loss of existing or potential customers;

 

    delayed or lost revenue;

 

    delay or failure to attain market acceptance;

 

    negative publicity, which will harm our reputation and brand;

 

    an increase in warranty claims compared with our historical experience, or an increased cost of servicing warranty claims, either of which would adversely affect our operating results; and

 

    litigation, regulatory inquiries, or investigations that may be costly and harm our reputation and brand.

Furthermore, our security solutions may falsely detect applications, content or threats that do not actually exist based on our classifications of application type, virus, malware, vulnerability exploits, data or URL categories. This risk is increased by the inclusion of “heuristics” analysis in our solutions, which attempts to identify threats not based on any known signatures but based on characteristics or anomalies which indicate that a particular item may be a threat. These false positives, while typical in our industry, may impair the perceived reliability of our solutions and may therefore adversely affect market acceptance of our solutions. Also, our anti-spam and anti-malware solutions may falsely identify emails or programs as unwanted spam or potentially unwanted programs, or alternatively fail to properly identify unwanted emails or programs, particularly as spam emails or malware are often designed to circumvent anti-spam or anti-malware solutions. Parties whose emails or programs are blocked by our solutions may seek redress against us for labeling them as spammers or malware or for interfering with their business. In addition, false identification of emails or programs as unwanted spam or potentially unwanted programs may reduce the adoption of our solutions. If our solutions restrict important files or applications based on falsely identifying them as malware or some other item that should be restricted, this could adversely affect customers’ systems and cause material system failures. Any such false identification of important files or applications could result in damage to our reputation, negative publicity, loss of customers and sales, increased costs to remedy any problem and risk of litigation.

If our security measures are breached or unauthorized access to customer data is otherwise obtained or our customers experience data losses, our brand, reputation and business could be harmed and we may incur significant liabilities.

Our customers rely on our security and storage solutions to secure and store their data, which may include financial records, credit card information, business information, customer information, health information, other personally identifiable information or other sensitive personal information. A breach of our network security and systems or other events that cause the loss or public disclosure of, or access by third parties to, our customers’ stored files or data could have serious negative consequences for our business, including possible fines, penalties and damages, reduced demand for our solutions, an unwillingness of our customers to use our solutions, harm to our brand and reputation, and time-consuming and expensive litigation. The techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently, often are not recognized until launched against a target, and may originate from less regulated or remote areas around the world. As a result, we may be unable to proactively prevent these techniques, implement adequate preventative or reactionary measures, or enforce the laws and regulations that govern such activities. In addition, because of the large amount of data that we store for our customers, it is possible that hardware failures, human errors or errors in our systems could result in data loss or corruption, or cause the information that we collect to be incomplete or contain inaccuracies that our customers regard as significant. If our customers experience any data loss, or any data corruption or inaccuracies, whether caused by security breaches or otherwise, our brand, reputation and business could be harmed. Moreover, if a high profile security breach occurs with respect to another provider of cloud services, our clients and potential clients may lose trust in the security of the cloud business model generally, which could adversely impact our ability to retain existing clients or attract new ones.

If an actual or perceived breach of network security occurs in our internal systems, our services may be perceived as not being secure and clients may curtail or stop using our solutions.

As a provider of network security solutions, we are a high profile target and our networks and solutions may have vulnerabilities that may be targeted by hackers and could be targeted by attacks specifically designed to disrupt our business and harm our reputation. We will not succeed unless the marketplace continues to be confident that we provide effective network and security protection. If an actual or perceived breach of network security occurs in our internal systems it could adversely affect the market perception of our solutions. We may not be able to correct any security flaws or vulnerabilities promptly, or at all. In addition, such a security breach could impair our ability to operate our business, including our ability to provide subscription and support services to our customers. If this happens, our business and operating results could be adversely affected.

Because our solutions could be used to collect and store personal information of our customers’ employees or customers, privacy concerns could result in additional cost and liability to us or inhibit sales of our solutions.

 

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Personal privacy has become a significant issue in the United States and in many other countries where we offer our solutions. The regulatory framework for privacy issues worldwide is currently complex and evolving, and it is likely to remain uncertain for the foreseeable future. Many federal, state and foreign government bodies and agencies have adopted or are considering adopting laws and regulations regarding the collection, use and disclosure of personal information. In the United States, these include rules and regulations promulgated under the authority of the Federal Trade Commission, the Health Insurance Portability and Accountability Act of 1996 and state breach notification laws. Internationally, virtually every jurisdiction in which we operate has established its own data security and privacy legal framework with which we or our customers must comply, including the Data Protection Directive established in the European Union (the “EU”) and the Federal Data Protection Act in Germany.

In addition to government regulation, privacy advocacy and industry groups may propose new and different self-regulatory standards that either legally or contractually apply to us. Because the interpretation and application of privacy and data protection laws are still uncertain, it is possible that these laws may be interpreted and applied in a manner that is in conflict with one another, and is inconsistent our existing data management practices or the features of our solutions. If so, in addition to the possibility of fines, lawsuits and other claims, we could be required to fundamentally change our business activities and practices or modify our software, which could have an adverse effect on our business. Any inability to adequately address privacy concerns, even if unfounded, or comply with applicable privacy or data protection laws, regulations and policies, could result in additional cost and liability to us, damage our reputation, inhibit sales and harm our business.

Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations, and policies that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our solutions. Privacy concerns, whether valid or not valid, may inhibit market adoption of our solutions particularly in certain industries and foreign countries.

Our business is subject to the risks of warranty claims and product liability claims and given our 30-day right to return policy on many of our solutions, we may experience increased frequency of returns, any of which may adversely affect our operating results and financial performance.

Our solutions have contained and may contain undetected defects or errors, especially when first introduced or when new versions are released. Defects or errors could affect the performance of our solutions and could delay the development or release of new solutions or new versions of solutions, adversely affect our reputation and our customers’ willingness to buy solutions from us and adversely affect market acceptance or perception of our offerings. Any such errors or delays in releasing new solutions or new versions of solutions or allegations of unsatisfactory performance could cause us to lose revenue or market share, increase our service costs, cause us to incur substantial costs in redesigning the solutions, cause us to lose significant customers, subject us to liability for damages and divert our resources from other tasks, any one of which could materially and adversely affect our business, operating results and financial condition. Furthermore, we offer customers a 30-day right to return for many of our solutions which is integral to our sales model. If we experience appliance defects, or if we experience increased frequency of returns, our sales cycles, operating results and financial performance may be adversely affected.

In addition, the occurrence of hardware or software errors which result in increased warranty or support claims could result in increased expenses or require us to maintain greater warranty reserves which would have an adverse effect on our business and financial performance.

Our ability to increase sales of our solutions is highly dependent on the quality of our customer support, and our failure to offer high-quality support would have an adverse effect on our business, reputation and operating results.

Our solutions are designed to be deployed by customers in resource-constrained IT environments. Our customers depend on our support services to assist them with questions as they implement our solutions within their IT infrastructure, and after deployment, our customers depend on our support organization to quickly resolve any issues relating to those solutions. A significant level of high-quality support is critical to ensure high rates of renewals and cross-selling of our solutions. Further, as we continue to broaden our portfolio of solutions, increase the size of our customer base and increase the size of our solution deployments within our customers IT infrastructure, we must continue to adapt our customer support organization to ensure that our customers continue to receive the high level of customer service which they have come to expect. If we fail to effectively assist our customers in deploying our solutions, succeed in helping them quickly resolve post-deployment issues or provide effective ongoing support, it could adversely affect our ability to sell our solutions to existing customers, decrease our subscription renewal rates and harm our reputation with potential new customers, all of which would have an adverse effect on our business, reputation and operating results.

If we are unable to hire, retain, train and motivate qualified personnel and senior management, or if our senior management team is unable to perform effectively, our business could suffer.

        Our future success depends, in part, on our ability to continue to attract and retain highly skilled personnel and the continued services of our senior management and other key personnel to execute on our business plan and to identify and pursue new opportunities and solution innovations. The loss of the services of our senior management or any of our key personnel, the inability to attract or retain qualified personnel, or delays in hiring required personnel, particularly in engineering and sales and marketing, could significantly delay or prevent the achievement of our development and strategic objectives, and may adversely affect our business, financial condition and operating results. Although we have entered into employment offer letters with our key personnel, these agreements have no specific duration and constitute at-will employment. Our productivity and the quality of our solutions may be adversely affected if we do not integrate and train our new employees quickly and effectively. Furthermore, if we are not effective in retaining our key personnel, our business could be adversely impacted and our operating results and financial condition could be harmed.

 

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Competition for highly skilled personnel is often intense, especially in the San Francisco Bay Area where we have a substantial presence and need for highly skilled personnel. We may not be successful in attracting, integrating or retaining qualified personnel to fulfill our current or future needs. Also, to the extent we hire personnel from competitors, we may be subject to allegations that they have been improperly solicited, or that they have divulged proprietary or other confidential information, or that their former employers own their inventions or other work product.

Our customer-centric and collaborative corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and teamwork fostered by our culture, and our business may be harmed.

We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, creativity, a customer-centric focus, collaboration and loyalty. As we grow and change, we may find it difficult to maintain these important aspects of our corporate culture, which could limit our ability to innovate and operate effectively. Any failure to preserve our culture could also negatively affect our ability to retain and recruit personnel, continue to perform at current levels or execute on our business strategy.

We rely on a single source or a limited number of sources for some of our components. Insufficient supply and inventory may result in lost sales opportunities or delayed revenue, while excess inventory may harm our gross profit.

Our inventory management systems and related supply chain visibility tools may be inadequate to enable us to forecast accurately and effectively manage the supply of our components. Additionally, we carry very little inventory of our appliances or components, and we rely on our suppliers to deliver necessary components in a timely manner. Insufficient supply levels may lead to shortages that result in delayed revenue or loss of sales opportunities altogether as potential customers turn to competitors’ solutions that could be more readily available. Additionally, any increases in the time required to manufacture our solutions could adversely affect our business, brand, sales cycle and reputation. If we are unable to effectively manage our supply and inventory, our operating results could be adversely affected.

We currently depend on a single source or a limited number of sources for certain components used in the manufacture of our solutions. We are therefore subject to the risk of shortages in supply of these components and the risk that component suppliers discontinue or modify components used in our solutions. If these suppliers were to discontinue production of a necessary part or component, we would be required to expend resources and time in locating and integrating replacement parts or components from another vendor. In addition, the introduction by component suppliers of new versions of their components, particularly if not anticipated by us, could require us to expend resources to incorporate these new components into our solutions. Our reliance on a single source or a limited number of suppliers involves a number of additional risks, including risks related to:

 

    supplier capacity constraints;

 

    price volatility;

 

    timely delivery;

 

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    component quality;

 

    failure of a key supplier to remain in business and adjust to market conditions;

 

    delays in, or the inability to execute on, a supplier roadmap for components and technologies; and

 

    natural disasters.

In addition, for certain components, we are subject to potential price increases and limited availability as a result of market demand for these components. In the past, unexpected demand for computer and network products has caused worldwide shortages of certain electronic parts. If similar shortages occur in the future, our business could be adversely affected. We rely on purchase orders rather than long-term contracts with these suppliers, and as a result we might not be able to secure sufficient components, even if they were available, at reasonable prices or of acceptable quality to build appliances in a timely manner and, therefore, might not be able to meet customer demands for our solutions, which would have a material and adverse effect on our business, operating results and financial condition.

Assertions by third parties of infringement or other violations by us of their intellectual property rights, or other lawsuits brought against us, could result in significant costs and substantially harm our business and operating results.

Patent and other intellectual property disputes are common in the IT markets in which we compete. Some companies in the IT markets in which we compete, including some of our competitors, own large numbers of patents, copyrights, trademarks and trade secrets, which they may use to assert claims of infringement, misappropriation or other violations of intellectual property rights against us. There also is a market for intellectual property rights and a competitor, or other entity, could acquire intellectual property rights and assert similar claims based on the acquired intellectual property rights. They may also assert such claims against our customers or channel partners. As the number of patents and competitors in our market increase and overlaps occur, claims of infringement, misappropriation and other violations of intellectual property rights may increase. From time to time, we face allegations that we, our customers or our channel partners have infringed, misappropriated and violated intellectual property rights, including allegations made by our competitors or by non-practicing entities. Our broad solution portfolio and the number of network and IT markets in which we compete further exacerbate this risk. Any claim of infringement, misappropriation or other violation of intellectual property rights by a third party, even those without merit, could cause us to incur substantial costs defending against the claim and could distract our management from our business.

In addition, future assertions of patent rights by third parties, and any resulting litigation, may involve non-practicing entities or other adverse patent owners who have no relevant revenue and against whom our own patents may therefore provide little or no deterrence or protection. We cannot assure you that we are not infringing or otherwise violating any third-party intellectual property rights.

An adverse outcome of a dispute may require us to, among other things, pay substantial damages including treble damages if we are found to have willfully infringed a third party’s patents or copyrights; cease making, using, selling, licensing, importing or otherwise commercializing solutions that are alleged to infringe or misappropriate the intellectual property rights of others; expend additional development resources to attempt to redesign our solutions or otherwise to develop non-infringing technology, which may not be successful; enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies or intellectual property rights or have royalty obligations imposed by a court; and indemnify our customers, partners and other third parties. Furthermore, we have agreed in certain instances to defend our channel partners against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to pay judgments entered on such claims. Any damages or royalty obligations we may become subject to, any prohibition against our commercializing our solutions and any third-party indemnity we may need to provide, as a result of an adverse outcome could harm our operating results.

Our use of open source technology could impose limitations on our ability to commercialize our solutions.

We use open source software in our solutions, and although we monitor our use of open source software to avoid subjecting our solutions to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. or foreign courts. As a result, there is a risk that these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our solutions. From time to time, we may face claims from third parties claiming ownership of, or demanding release of, the open source software or derivative works that we have developed using such software or otherwise seeking to enforce the terms of the applicable open source license. In such an event, we could be required to seek licenses from third parties to continue offering our solutions, to make our proprietary code generally available in source code form, to re-engineer our solutions or to discontinue the sale of our solutions if re-engineering could not be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.

Failure to protect our proprietary technology and intellectual property rights could substantially harm our business and operating results.

The success of our business depends on our ability to protect and enforce our patents, trademarks, copyrights, trade secrets and other intellectual property rights. We attempt to protect our intellectual property under patent, trademark, copyright and trade secret laws, and through a combination of confidentiality procedures, contractual provisions and other methods, all of which offer only limited protection.

 

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As of August 31, 2015, we had 57 issued patents in the United States, but this number of patents is relatively small in comparison to some of our competitors and potential competitors. Additionally, as of August 31, 2015, we had 27 pending U.S. patent applications, and may file additional patent applications in the future. The process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. We may choose not to seek patent protection for certain innovations and may choose not to pursue patent protection in certain jurisdictions. Furthermore, it is possible that our patent applications may not issue as granted patents, that the scope of our issued patents will be insufficient or not have the coverage originally sought, that our issued patents will not provide us with any competitive advantages, and that our patents and other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. In addition, issuance of a patent does not guarantee that we have an absolute right to practice the patented invention, or that we have the right to exclude others from practicing the claimed invention. As a result, we may not be able to obtain adequate patent protection or to enforce our issued patents effectively.

In addition to patented technology, we rely on our unpatented proprietary technology and trade secrets. Despite our efforts to protect our proprietary technology and trade secrets, unauthorized parties may attempt to misappropriate, reverse engineer or otherwise obtain and use them. The contractual provisions that we enter into with employees, consultants, partners, vendors and customers may not prevent unauthorized use or disclosure of our proprietary technology or intellectual property rights and may not provide an adequate remedy in the event of unauthorized use or disclosure of our proprietary technology or intellectual property rights. Moreover, policing unauthorized use of our technologies, solutions and intellectual property is difficult, expensive and time-consuming, particularly in foreign countries where the laws may not be as protective of intellectual property rights as those in the United States and where mechanisms for enforcement of intellectual property rights may be weak. We may be unable to determine the extent of any unauthorized use or infringement of our solutions, technologies or intellectual property rights.

From time to time, legal action by us may be necessary to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the intellectual property rights of others or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results, financial condition and cash flows. If we are unable to protect our intellectual property rights, we may find ourselves at a competitive disadvantage to others who need not incur the additional expense, time and effort required to create the innovative solutions that have enabled us to be successful to date.

We rely on the availability of third-party licenses for some of our solutions.

Some of our solutions include software or other intellectual property licensed from third parties. It may be necessary in the future to renew licenses relating to various aspects of these solutions or to seek new licenses for existing or new solutions. There can be no assurance that the necessary licenses will be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, could result in delays in solution releases until equivalent technology can be identified, licensed or developed, if at all, and integrated into our solutions and may have a material adverse effect on our business, operating results and financial condition. In addition, third parties may allege that additional licenses are required for our use of their software or intellectual property, and we may be unable to obtain such licenses on commercially reasonable terms or at all. Moreover, the inclusion in our solutions of software or other intellectual property licensed from third parties on a nonexclusive basis could limit our ability to differentiate our solutions from those of our competitors.

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

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. We are in the costly and challenging process of compiling the system and processing documentation necessary to perform the evaluation needed to comply with Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”). We may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective.

We do not expect that disclosure controls or internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. If we are unable to assert that our internal control over financial reporting is effective, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our common stock to decline, and we may be subject to investigation or sanctions by the SEC.

We are required, pursuant to Section 404 of the Sarbanes-Oxley Act to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting as of the end of our fiscal year. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting.

 

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We are required to disclose changes made in our internal controls and procedures on a quarterly basis. However, our independent registered public accounting firm will not be required to report on the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until the later of the year following our first annual report required to be filed with the SEC, or the date we are no longer an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) if we take advantage of the exemptions contained in the JOBS Act. At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating. Our remediation efforts may not enable us to avoid a material weakness in the future.

Additionally, to comply with the requirements of being a public company, we may need to undertake various actions, such as implementing new internal controls and procedures and hiring accounting or internal audit staff, which may adversely affect our operating results and financial condition.

If our solutions do not interoperate with our end-customers’ infrastructure, sales of our solutions could be negatively affected, which would harm our business.

Our solutions must interoperate with our end-customers’ existing infrastructure, which often have different specifications, utilize multiple protocol standards, deploy products from multiple vendors, and contain multiple generations of products that have been added over time. As a result, when problems occur in a network, it may be difficult to identify the sources of these problems. Any delays in identifying the sources of problems or in providing necessary modifications to our software or hardware could have a negative impact on our reputation and our customers’ satisfaction with our solutions, and our ability to sell solutions could be adversely affected. In addition, customers may require our solutions to comply with certain security or other certifications and standards. If our solutions are late in achieving or fail to achieve compliance with these certifications and standards, or our competitors achieve compliance with these certifications and standards, we may be disqualified from selling our solutions to such end-customers, or at a competitive disadvantage, which would harm our business, operating results and financial condition.

If our solutions fail to help our customers achieve and maintain compliance with government regulations and industry standards, our business and operating results could be materially adversely affected.

We generate a portion of our revenues from our solutions because they help organizations achieve and maintain compliance with government regulations and industry standards. For example, many of our customers purchase our security and storage solutions to help them comply with the security standards developed and maintained by the Payment Card Industry Security Standards Council (the “PCI Council”), which apply to companies that process or store credit card information. Industry organizations like the PCI Council may significantly change their security standards with little or no notice, including changes that could make their standards more or less onerous for businesses. Governments may also adopt new laws or regulations, or make changes to existing laws or regulations, that could impact whether our solutions enable our customers to demonstrate, maintain or audit their compliance. If we are unable to adapt our solutions to changing regulatory standards in a timely manner, or if our solutions fail to expedite our customers’ compliance initiatives, our customers may lose confidence in our solutions and could switch to solutions offered by our competitors. In addition, if regulations and standards related to data security are changed in a manner that makes them less onerous, our customers may view government and industry regulatory compliance as less critical to their businesses, and our customers may be less willing to purchase our solutions. In either case, our business, financial condition and operating results may suffer.

Our sales to government entities are subject to a number of challenges and risks.

We sell to state and local governmental agency customers, particularly schools, and we may increase sales to government entities in the future. Sales to government entities are subject to a number of challenges and risks. Selling to government entities can be highly competitive, expensive and time consuming, often requiring significant upfront time and expense without any assurance that these efforts will generate a sale. Government certification requirements for solutions like ours may change and in doing so restrict our ability to sell into the federal government sector until we have attained the revised certification. Government demand and payment for our solutions may be impacted by public sector budgetary cycles and funding authorizations, with funding reductions or delays adversely affecting public sector demand for our solutions. Government entities may have statutory, contractual or other legal rights to terminate contracts with our distributors and resellers for convenience or due to a default, and any such termination may adversely impact our future operating results.

Our failure to generate the significant capital necessary to expand our operations and invest in new solutions could reduce our ability to compete and could harm our business.

        We may need to raise additional funds in the future, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests and the per share value of our common stock could decline. Furthermore, if we engage in debt financing, the holders of debt would have priority over the holders of our common stock, and we may be required to accept terms that restrict our ability to incur additional indebtedness. We may also be required to take other actions that would otherwise be in the interests of the debt holders and force us to maintain specified liquidity or other ratios, any of which could harm our business, operating results and financial condition. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

 

    develop or enhance our solutions;

 

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    continue to expand our sales and marketing and research and development organizations;

 

    acquire or invest in complementary businesses, solutions or technologies;

 

    expand operations in the United States or internationally;

 

    hire, train and retain employees; or

 

    respond to competitive pressures or unanticipated working capital requirements.

Our failure to do any of these things could adversely affect our business, financial condition and operating results.

We are exposed to the credit risk of some of our distributors, resellers and customers and to credit exposure in weakened markets, which could result in material losses.

Most of our sales are on an open credit basis. Although we have programs in place that are designed to monitor and mitigate these risks, and our broad customer base and channel partner network mitigate these risks, we cannot assure you these programs will be effective in reducing our credit risks, especially as we expand our business internationally. Additionally, as our accounts receivable continue to increase, these risks, including the risk of doubtful accounts, will be exacerbated. If we are unable to adequately control these risks, our business, operating results and financial condition could be adversely affected.

If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below expectations of securities analysts and investors, resulting in a decline in our stock price.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our operating results may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our operating results to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price. Significant assumptions and estimates used in preparing our condensed consolidated financial statements include those related to revenue recognition, stock-based compensation expense, valuation of inventory and accounting for income taxes.

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

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

 

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

 

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

 

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

 

    tax effects of stock-based compensation;

 

    costs related to intercompany restructurings;

 

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

 

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

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

Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.

Changes in financial accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our business and financial results.

 

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Our business is subject to the risks of earthquakes, fire, power outages, floods and other catastrophic events and to interruption by man-made problems such as terrorism.

A significant natural disaster, such as an earthquake, fire, flood or significant power outage could have a material adverse impact on our business, operating results and financial condition. Both our corporate headquarters and the location where our solutions are manufactured are located in the San Francisco Bay Area, a region known for seismic activity. In addition, natural disasters could affect our supply chain, manufacturing vendors, logistics providers’ or data center hosting providers’ ability to provide materials and perform services on a timely basis. In the event our or our service providers’ IT systems or manufacturing or logistics abilities are hindered by any of the events discussed above, shipments could be delayed, and our solutions could become unavailable resulting in missed financial targets, such as revenue and shipment targets, for a particular quarter. In addition, acts of terrorism and other geo-political unrest could cause disruptions in our business or the business of our supply chain, manufacturers, logistics providers, partners or customers or the economy as a whole. Any disruption in the business of our supply chain, manufacturers, logistics providers, data center hosting partners or customers that impacts sales at the end of a fiscal quarter could have a significant adverse impact on our quarterly results. All of the aforementioned risks may be further increased if the disaster recovery plans for us and our suppliers prove to be inadequate. To the extent that any of the above should result in delays or cancellations of customer orders, or the delay in the manufacture, deployment or shipment of our solutions, our business, financial condition and operating results would be adversely affected.

If we fail to comply with environmental requirements, our business, financial condition, operating results and reputation could be adversely affected.

We are subject to various environmental laws and regulations including laws governing the hazardous material content of our solutions and laws relating to the collection of and recycling of electrical and electronic equipment. Examples of these laws and regulations include the EU Restrictions of Hazardous Substances Directive (the “RoHS Directive”) and the EU Waste Electrical and Electronic Equipment Directive (the “WEEE Directive”), as well as the implementing legislation of the EU member states. Similar laws and regulations have been passed or are pending in China, South Korea, Norway and Japan and may be enacted in other regions, including in the United States, and we are, or may in the future be, subject to these laws and regulations.

The RoHS Directive and the similar laws of other jurisdictions ban the use of certain hazardous materials such as lead, mercury and cadmium in the manufacture of electrical equipment, including our solutions. Currently, we and other manufacturers of our hardware appliances and major component part suppliers comply with the RoHS Directive requirements. However, if there are changes to this or other laws (or their interpretation) or if new similar laws are passed in other jurisdictions, we may be required to re-engineer our solutions to use components compatible with these regulations. This re-engineering and component substitution could result in additional costs to us or disrupt our operations or logistics.

The WEEE Directive requires electronic goods producers to be responsible for the collection, recycling and treatment of such solutions. Changes in interpretation of the directive may cause us to incur costs or have additional regulatory requirements to meet in the future in order to comply with this directive, or with any similar laws adopted in other jurisdictions.

Our failure to comply with past, present and future similar laws could result in reduced sales of our solutions, inventory write-offs, reputational damage, penalties and other sanctions, any of which could harm our business and financial condition. We also expect that our solutions will be affected by new environmental laws and regulations on an ongoing basis. To date, our expenditures for environmental compliance have not had a material impact on our results of operations or cash flows, and although we cannot predict the future impact of such laws or regulations, they will likely result in additional costs and may increase penalties associated with violations or require us to change the content of our solutions or how they are manufactured, which could have a material adverse effect on our business, operating results and financial condition.

New regulations related to conflict minerals may cause us to incur additional expenses and could limit the supply and increase the costs of certain metals used in the manufacturing of our appliances.

As a public company, we are subject to certain requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) that require us to diligence, disclose and report whether or not our appliances contain conflict minerals. The implementation of these new requirements could adversely affect the sourcing, availability and pricing of the materials used in the manufacture of components used in our solutions. In addition, we will incur additional costs to comply with the disclosure requirements, including costs related to conducting diligence procedures to determine the sources of conflict minerals that may be used or necessary to the production of our appliances and, if applicable, potential changes to appliances, processes or sources of supply as a consequence of such verification activities. It is also possible that we may face reputational harm if we determine that certain of our appliances contain minerals not determined to be conflict free or if we are unable to alter our appliances, processes or sources of supply to avoid such materials.

 

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Risks Related to Ownership of Our Common Stock

Our actual operating results may differ significantly from our guidance.

From time to time, we have released, and may continue to release guidance in our quarterly earnings conference call, quarterly earnings releases, or otherwise, regarding our future performance that represents our management’s estimates as of the date of release. This guidance, which includes forward-looking statements, has been and will be based on projections prepared by our management. These projections are not prepared with a view toward compliance with published guidelines of the American Institute of Certified Public Accountants, and neither our registered public accountants nor any other independent expert or outside party compiles or examines the projections. Accordingly, no such person expresses any opinion or any other form of assurance with respect to the projections.

Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and are based upon specific assumptions with respect to future business decisions, some of which will change. We intend to state possible outcomes as high and low ranges which are intended to provide a sensitivity analysis as variables are changed but are not intended to imply that actual results could not fall outside of the suggested ranges. The principal reason that we release guidance is to provide a basis for our management to discuss our business outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by any such third parties.

Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the guidance furnished by us will not materialize or will vary significantly from actual results. Accordingly, our guidance is only an estimate of what management believes is realizable as of the date of release. Actual results may vary from our guidance and the variations may be material. We undertake no obligation to make revisions or publicly update our guidance in advance of actual results unless required by law. In light of the foregoing, investors are urged to consider all of the information we make publicly available in making an investment decision regarding our common stock and not rely solely upon our guidance.

Any failure to successfully implement our operating strategy or the occurrence of any of the events or circumstances set forth in this “Risk Factors” section could result in the actual operating results being different from our guidance, and the differences may be adverse and material.

Our share price has been and may continue to be volatile, and you may be unable to sell your shares at or above the price at which you purchased your stock.

Technology stocks have historically experienced high levels of volatility. The trading price of our common stock has been and is likely to continue to be highly volatile and subject to wide fluctuations in response to various factors, some of which are beyond our control and may not be related to our operating performance. Since shares of our common stock were sold in our initial public offering in November 2013 at a price of $18.00 per share, the reported high and low sales prices of our common stock have ranged from $18.63 to $46.78 through August 31, 2015. These fluctuations could cause you to lose all or part of your investment in our common stock. Factors that may cause the market price of our common stock to fluctuate include:

 

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

 

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

 

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

 

    whether our operating results meet the expectations of securities analysts or investors;

 

    actual or anticipated changes in the expectations of investors or securities analysts;

 

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

 

    developments or disputes concerning our intellectual property or other proprietary rights;

 

    litigation or investigations involving us, our industry or both;

 

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

 

    general economic conditions and trends;

 

    major catastrophic events;

 

    our stock repurchase program;

 

    sales of large blocks of our stock; or

 

    major changes in our board of directors or management or departures of key personnel.

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

 

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

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

If our existing stockholders sell, or indicate an intent to sell, substantial amounts of our common stock in the public market, the trading price of our common stock could decline. As of August 31, 2015, there were 53,347,890 shares of common stock outstanding. All outstanding shares are freely tradable, unless such shares are held by “affiliates,” as that term is defined in Rule 144 of the Securities Act of 1933, as amended.

In addition, we have filed registration statements on Form S-8 to register all shares subject to outstanding options and restricted stock units or reserved for future issuance under our equity compensation plans. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

We cannot guarantee that we will repurchase our common stock pursuant to our recently announced stock repurchase program or that our stock repurchase program will enhance long-term stockholder value. Stock repurchases could also increase the volatility of the price of our common stock and could diminish our cash reserves.

In September 2015, our board of directors authorized a stock repurchase program. Under the program, we are authorized to repurchase shares of our common stock for an aggregate purchase price not to exceed $50.0 million through September 30, 2017. Although our board of directors has authorized the stock repurchase program, the stock repurchase program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares. Stock will be purchased from time to time, in the open market or through private transactions, subject to market condition, in compliance with applicable state and federal securities laws. The timing and amount of repurchases, if any, will depend upon several factors, including market and business conditions, the trading price of our common stock and the nature of other investment opportunities. In addition, repurchases of our common stock pursuant to our stock repurchase program could affect the market price of our common stock or increase its volatility. For example, the existence of a stock repurchase program could cause our stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. Additionally, our stock repurchase program could diminish our cash reserves, which may impact our ability to finance future growth and to pursue possible future strategic opportunities and acquisitions. There can be no assurance that any stock repurchases will enhance stockholder value because the market price of our common stock may decline below the levels at which we determine to repurchase our stock. Although our stock repurchase program is intended to enhance long-term stockholder value, there is no assurance that it will do so and short-term stock price fluctuations could reduce the program’s effectiveness.

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

The trading market for our common stock could be influenced by any research and reports that securities or industry analysts publish about us or our business. In the event securities analysts who cover our company downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

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

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

The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain executive management and qualified board members.

As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of the New York Stock Exchange (the “NYSE”) and other applicable securities rules and regulations. Compliance with these rules and regulations will increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources, particularly after we are no longer an “emerging growth company,” as defined in the JOBS Act. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management’s attention may be diverted from other business concerns, which could adversely affect our business and operating results. Although we have already hired additional employees to comply with these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our costs and expenses.

In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us, and our business may be adversely affected.

However, for as long as we remain an “emerging growth company,” we may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not “emerging growth companies” including, but not limited to, not being

 

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required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We may take advantage of these reporting exemptions until we are no longer an “emerging growth company.”

We will cease to be an “emerging growth company” upon the earliest of: (i) the end of our fiscal year 2019, (ii) the beginning of our first fiscal year after our annual gross revenues are $1.0 billion or more, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities or (iv) as of the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year.

We also expect that these new rules and regulations will make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee and compensation committee, and qualified executive officers.

As a public company, our business and financial condition have become more visible, which we believe may result in threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business and operating results could be adversely affected, and even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and adversely affect our business and operating results.

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

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock, and our stock price may be more volatile.

We do not intend to pay dividends for the foreseeable future.

We anticipate that we will retain all of our future earnings for use in the development of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of our board of directors. In addition, our existing credit facility restricts and any future indebtedness may restrict our ability to pay dividends. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments. Investors seeking cash dividends should not purchase our common stock.

We have incurred and will continue to incur increased costs as a result of being a public company.

As a public company, we have incurred and will continue to incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, rules implemented by the SEC and the NYSE require certain corporate governance practices by public companies. These rules and regulations increase our legal and financial compliance costs and make some activities more time-consuming and costly. We also incur additional costs associated with our public company reporting requirements. These rules and regulations may also make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors or as executive officers.

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

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

 

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

 

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

 

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

 

    prohibit stockholders from calling a special meeting of our stockholders;

 

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

 

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

 

    provide that a state or federal court located within the State of Delaware will be the exclusive forum for any derivative action brought on our behalf, any action asserting a breach of fiduciary duty, any action asserting a claim against us arising under the Delaware General Corporation Law and certain other claims.

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

The provisions of our amended and restated certificate of incorporation and amended and restated bylaws may frustrate or prevent attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. The provisions of our amended and restated certificate of incorporation and amended and restated bylaws or Delaware law may also have the effect of delaying or deterring a change in control, which could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

a) Sale of Unregistered Securities

Not applicable.

b) Issuer Purchases of Equity Securities

Not applicable.

 

Item 3. Defaults Upon Senior Securities

Not applicable.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

Not applicable

 

Item 6. Exhibits

The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Quarterly Report on Form 10-Q.

 

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    BARRACUDA NETWORKS, INC.
Date: October 2, 2015     By:  

/s/ William D. Jenkins, Jr.

      William D. Jenkins, Jr.
     

Chief Executive Officer

(Principal Executive Officer)

Date: October 2, 2015     By:  

/s/ David Faugno

      David Faugno
     

Chief Financial Officer

(Principal Financial Officer)


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EXHIBIT INDEX

 

Exhibit

Number

  

Description

  31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
  31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
  32.1*    Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
  32.2*    Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

* The certifications attached as Exhibit 32.1 and 32.2 that accompany this Quarterly Report on Form 10-Q are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Barracuda Networks, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.