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TMCNet:  AEROHIVE NETWORKS, INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[August 12, 2014]

AEROHIVE NETWORKS, INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read together with our condensed consolidated financial statements and the other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements reflecting our current expectations and involves risks and uncertainties. The words "believe," "will," "may," "estimate," "continue," "anticipate," "intend," "should," "plan," "expect," "predict," "could," "potentially" and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results and the timing of events may differ materially from those discussed in our forward-looking statements as a result of various factors, including those discussed below and those discussed in the section entitled "Risk Factors" included in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.


These forward-looking statements include, but are not limited to, statements concerning the following: • our ability to predict our revenue, operating results and gross margin accurately; • our ability to maintain an adequate rate of revenue growth and remain profitable; • the length and unpredictability of our sales cycles with service provider end-customers; • any potential loss of or reductions in orders from our larger customers; • the effects of increased competition in our market; • our ability to continue to enhance and broaden our product offering; • our ability to maintain, protect and enhance our brand; • our ability to effectively manage our growth; • our ability to maintain proper and effective internal controls; • the quality of our products and services; • our ability to continue to build and enhance relationships with channel partners; • the attraction and retention of qualified employees and key personnel; • our ability to sell our products and effectively expand internationally; • our ability to protect our intellectual property; • claims that we infringe intellectual property rights of others; and • other risk factors included under the section titled "Risk Factors." These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including those described in "Risk Factors" included in Part II, Item 1A and elsewhere in this report. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make.

In light of these risks, uncertainties, and assumptions, the forward-looking events and circumstances discussed in this report 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.

Overview We have designed and developed a leading cloud-managed mobile networking platform that enables enterprises to deploy a mobile-centric network edge. The network edge is the point at which devices access the enterprise network.

Managing the network edge is becoming more complex because of the proliferation of mobile devices and the ways in which such devices are used in business.

Increasingly, employees and clients are using Wi-Fi-enabled smartphones, tablets, laptops and other mobile devices instead of desktop computers for mission-critical business applications. As the difficulty and complexity of managing the network edge expands, our platform offers cost-efficiency, scalability, reliability, manageability and ease-of- 18-------------------------------------------------------------------------------- Table of Contents deployment and use. Additionally, our platform gives end-customers context-based visibility and policy enforcement, providing a high level of intelligence to the network. Our hardware products include intelligent access points, routers and switches. These products are managed by our Cloud Services Platform which delivers cloud-based network management and mobility applications giving end-customers a single, unified and contextual view of the entire network edge.

We derive revenue by selling our hardware products and related software licenses or software subscriptions and services, which together comprise our cloud-managed networking platform. Our product revenue consists of revenue from sales of our hardware products, which includes wireless access points, branch routers and switches, all of which are embedded with our proprietary operating system, HiveOS, and perpetual licenses of our unified network management system, HiveManager, and other software applications, as well as related accessories.

Our software subscriptions and service revenue consists of revenue from sales of our service offerings that are delivered over a specified term. These offerings primarily include post-contract customer support, or PCS, related to our perpetual software licenses and subscriptions to HiveManager and other software applications delivered as a service, or SaaS, including related customer support.

We sell our products and software subscriptions and services to the licensees of our products and software subscriptions and services. We define end-customers as holding or having held licenses to our products and software subscriptions and services. When our end-customers purchase hardware products, they are generally required to purchase a software license for every hardware unit, either as a perpetual license with PCS or as a SaaS license with a one-, three- or five-year term. Both our PCS and SaaS offerings include updates and upgrades of our software applications and our HiveOS operating system that is embedded in our hardware.

We maintain a field sales force that works to develop sales with our channel partners, which include value-added distributors, or VADs, and value-added resellers, or VARs. Our channel partners purchase our products and services from us at a discount to our list prices and then resell them to our end-customers.

Substantially all of our sales within North America are made through VARs. Under this model, we sell our products and services to our VARs, which in turn sell our products and services to our end-customers. We sell to VARs upon identification of a specified end-customer. All of our sales outside of North America, as well as a portion of our sales within North America, are made through VADs. Under this model, we sell our products and services to our VADs, which in turn sell our products and services to either VARs, which then sell our products and services to our end-customers, or directly to end-customers. We typically sell to VADs upon identification of a specified end-customer. In some cases, however, our VADs purchase inventory from us for stocking and subsequently receive an order from an end-customer. Our agreements with our VADs allow for stocking of our products in their inventory, and for certain of our VADs provide related price protection or rebates, as well as limited rights of return for stock rotation.

We have experienced rapid revenue growth in recent periods. During the three months ended June 30, 2014, our revenue increased by $9.5 million or 34% to $37.6 million from $28.0 million for the three months ended June 30, 2013.

During the six months ended June 30, 2014, our revenue increased by $17.9 million or 37% to $65.8 million from $47.9 million for the six months ended June 30, 2013. The revenue growth reflects the increasing demand for our products and software subscriptions and service offerings. We experienced growth both in our domestic and international business. We primarily conduct business in three geographic regions: (1) Americas, (2) Europe, the Middle East and Africa ("EMEA"), and (3) Asia Pacific ("APAC"). Revenue generated from Americas, EMEA and APAC was 65%, 24% and 11% during the three months ended June 30, 2014, respectively, and was 64%, 25% and 11% during the six months ended June 30,2014, respectively.

We added over 1,600 new end-customers during the quarter, bringing our total end-customer count to more than 16,000 in over 40 countries as of June 30, 2014.

Our end-customers represent a broad range of industry verticals, including K-12 and higher education, healthcare, retail and distributed enterprises.

We outsource the manufacturing of all of our products to contract manufacturers.

We currently outsource the warehousing and delivery of our products to a third-party logistics provider for worldwide fulfillment. We perform quality assurance and testing at our third-party logistics provider facilities in Fremont, California.

We intend to continue to invest in the development of our innovative technologies and new product offerings to the marketplace, acquire new end-customers in new and existing geographies, and increase penetration within our existing end-customer base. We expect to continue growing our organization to meet the needs of our customers and to pursue opportunities in new and existing markets. We increased the number of our employees from 488 employees as of June 30, 2013 to 519 as of December 31, 2013 and to 557 as of June 30, 2014.

Due to our continuing investments to grow our business, including internationally, in advance of and in preparation for, our expected increase in sales and expansion of our customer base, we are continuing to incur expenses in the near term from which we may not realize any long-term benefit. As a result, we have never achieved profitability and we do not expect to be profitable for the foreseeable future. However, we believe that over the long 19-------------------------------------------------------------------------------- Table of Contents term, we will be able to leverage these investments in the form of a higher revenue growth rate compared to the growth rate of our operating expenses.

Opportunities and Challenges We believe that the growth of our business and our future success depend upon many factors, including our ability to continue to develop innovative technologies and provide new product offerings to the marketplace; acquire new end-customers, both in the geographies in which we currently operate as well as in new geographies; and increase penetration within our existing end-customer base.

We operate in the highly competitive wired and wireless network access products market. This market continues to evolve and is characterized by rapid technological innovation. We will need to continue to innovate in order to continue to achieve market adoption of our products and services. We also extended our product offering to include a family of Ethernet switches to complement our wireless offering and allow us to deliver a unified wired and wireless network edge. During the quarter ended June, 30, 2014, we continued the expansion of our product portfolio with three new solutions targeted toward physical retailers, including Payment Card Industry (PCI) 3.0 compliance, Aerohive Social Login and integrated LTE Branch on Demand solutions.

In addition, our market is currently in the midst of an evolution in related wireless technology standards and protocols. For example, wireless standards for our market currently are transitioning from 802.11n to the new 802.11ac standard, which uses new radio hardware to deliver substantially higher wireless performance. As these standards were being developed and finalized, we performed hardware and software development, both internally and with our original design manufacturers, or ODMs, to incorporate these standards into our product offerings. We also continue to develop new functionality in our product offerings to take advantage of the changes that these industry standards incorporated. For example, in April 2014, we announced the AP230, an 802.11ac Gigabit Wi-Fi access point and for the quarter ended June 30, 2014, we witnessed rapid adoption of this product (based on the increasing percentage of our product sold during the quarter). When we introduce such new product offerings, we must effectively manage the timing of such releases to minimize the disruption to our existing product offerings and revenue streams and manage the orderly transition of our end-customers to these new products and services to reduce the amount of inventory for products that may become obsolete or slow moving due to our new product introductions and to limit the disruption to our end-customers' ordering practices and the pricing environment for our legacy products and services. We will need to continue to react and respond to these changes through innovation in order for our business to succeed, and we will incur related research and development expenses as we do that.

We intend to target new end-customers within the industry verticals and geographies in which we currently operate, as well as through expansion into new verticals and geographies. For example, we previously announced new channel partnerships in both China and Japan to further our penetration in the APAC region. Additionally, we have partnered with software application providers to tailor our product offerings for specific verticals such as retail, and we intend to continue to pursue such opportunities in other applicable industry verticals. In addition, our ability to successfully expand our end-customer base in new industry verticals and geographies of new end-customers is critical to creating a larger and more diverse end-customer base to which we can offer our current and future products and services. In our quarter ended June 30, 2014 we saw progress in the retail vertical with wins and deployments, including a Mexican restaurant chain with over 1600 U.S locations, one of the China's most popular chains of Ramen restaurants, a U.S based retailer specializing in imported home furnishings and decor, and a $10B European grocery/retail group.

Beyond the retail vertical, we also saw wins in larger enterprise accounts with wins at a top 10 U.S. bank, one of the world's largest logistics companies, and a global auto manufacturer.

Our sales efforts take several quarters, and involve educating our potential end-customers about the applications and benefits of our products, including the technical capabilities of our products. Sales to the education vertical are an important sales channel for us and can involve an extended sales cycle. In addition, sales to our enterprise customers may involve an extended sales cycle and often initial purchases are small. We attempt to manage these sales cycles through continued diversification of our end-customer base by industry vertical and related purchasing seasonality, deployment maturity and visibility, and the ratio of business from new and existing end-customers. Given the buying cycle for K-12 schools in our education vertical, the second quarter is usually the strongest for our education vertical, which historically has driven our strong sequential growth in the second quarter. We continued to see this in our second quarter ended June 30, 2014.

After the initial sale to a new end-customer, we focus on expanding our relationship with the end-customer. In order for us to continue to grow our total revenue, our end-customers must make additional purchases of our products and services. Additional sales to our existing end-customer base can take the form of incremental sales of products and services, either to complete deployments already started or to deploy additional products into other areas of their business. Our opportunity to 20-------------------------------------------------------------------------------- Table of Contents expand our end-customer relationships through such follow-on sales will increase as we add new end-customers, broaden our product portfolio and enhance product performance and functionality. Follow-on sales lead to increased revenue over the lifecycle of an end-customer relationship and can significantly increase our return on our sales and marketing investments.

Our growth strategy also contemplates increased sales and marketing investments internationally. Newly hired sales and marketing personnel require several months to establish new relationships and become productive. In addition, sales teams in international regions will attempt to sell into industry verticals and to end-customers that may not be familiar with our products and services. All of these factors will affect sales productivity. We attempt to manage our overall sales productivity through the timing of the introduction of new territories or the splitting of existing territories, the number and timing of new vertical penetration and the allocation of related headcount and go-to-market resources.

Lastly, we expect to continue to derive the majority of our sales through our channel partners. Our channel partners will play a significant role in our future growth as they identify new end-customers and expand our sales to existing end-customers. We plan to continue to invest in our network of channel partners to increase sales to existing end-customers, enable our channel partners to reach new end-customers and provide services and support effectively. All of these efforts will require us to continue to make significant sales and marketing investments.

Key Components of Our Results of Operations and Financial Condition Revenue We generate revenue from the sales of our products and services, and recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured.

Our total revenue comprises the following: Product Revenue. Our product revenue consists of revenue from sales of our hardware products, which include wireless access points, branch routers, and switches, all of which are embedded with our proprietary operating system, HiveOS, and perpetual licenses of our unified network management system, HiveManager, and other software applications, as well as related accessories. We recognize product revenue at the time of shipment, provided that all other revenue recognition criteria have been met. For our VAD arrangements in which our VADs stock inventory, we recognize revenue when our VADs have shipped the products to our end-customers (or to VARs that have identified end-customers), provided that all other revenue recognition criteria have been met.

Software Subscriptions and Service Revenue. Our software subscriptions and service revenue consists of revenue from sales of our software subscriptions and service offerings that we deliver over a specified term. These offerings primarily include PCS related to our perpetual software licenses and subscriptions to HiveManager and other software applications delivered as SaaS, including related customer support, and from subsequent renewals of those contracts. Our PCS includes tiered maintenance and support services under renewable, fee-based maintenance and support contracts, which include technical support, bug fixes, access to priority hardware replacement service and unspecified upgrades on a when-and-if available basis. Our SaaS subscriptions include comparable maintenance and support services. The higher the percentage of our end-customers that purchase SaaS subscriptions as opposed to HiveManager and PCS, the higher our software subscriptions and service revenue will be as a percentage of our total revenue. We recognize software subscriptions and service revenue ratably over the term of the contract, which is typically one, three or five years. As a result, our recognition of software subscriptions and service revenue lags our recognition of related product revenue.

Our business has historically experienced seasonality. As a result, our total revenue typically fluctuates from quarter to quarter, which often affects the comparability of our results between periods. Our total revenue has historically increased significantly in the second quarter compared to the first quarter, primarily due to the impact of increased seasonal demand by end-customers in the education vertical, which seasonal demand has historically carried over to our third quarter. Demand in the education vertical tends to be weakest in the fourth quarter. We also historically have seen an increase in end-of-year purchases by enterprise customers in our fourth quarter, which we believe is mainly due to a desire to complete purchases within their calendar-year budget cycle. While we believe that these seasonal trends have affected and will continue to affect our quarterly results, our rapid growth has largely masked these seasonal trends to date. We believe that our business may become more seasonal in the future. Historical patterns in our business may not be a reliable indicator of our future sales activity or performance.

21-------------------------------------------------------------------------------- Table of Contents Cost of Revenue Our cost of revenue includes the following: Cost of Product Revenue. Our cost of product revenue primarily includes manufacturing costs of our products payable to third-party manufacturers. Our cost of product revenue also includes personnel costs, including stock-based compensation, shipping costs, third-party logistics costs, provisions for excess and obsolete inventory, warranty and replacement costs, the depreciation and amortization of testing and imaging equipment, inbound license fees, certain allocated facilities and information technology infrastructure costs, and other expenses associated with logistics and quality control.

Cost of Software Subscriptions and Service Revenue. Our cost of software subscriptions and service revenue primarily includes personnel costs, including stock-based compensation, certain allocated facilities information technology infrastructure costs and costs associated with our provision of PCS and SaaS.

Our cost of software subscriptions and service revenue also includes datacenter costs.

Gross Profit Our gross profit has been and will continue to be affected by a variety of factors, including product shipment volumes, average sales prices of our products, discounts offered to our VAR and VAD partners, the mix of revenue between products and software subscriptions and service, and the mix of hardware products sold, because our hardware products have varying gross margins depending on the product offering and the lifecycle of the product.

Historically, our software subscriptions and service gross margin has been lower than our product gross margin; however, we expect our software subscriptions and service gross margin to increase over the long term because we expect our software subscriptions and service revenue to increase more quickly than our cost of software subscriptions and service revenue. We expect our gross margin to increase modestly over the long term, but it may decrease over time in the event we experience additional competitive pricing pressure. We also expect that our gross margin will fluctuate from period to period depending on the factors described above.

Operating Expenses Our operating expenses include the following: Research and Development. Our research and development expenses consist primarily of personnel costs, including bonuses, stock-based compensation and travel expenses for employees engaged in research, design and development activities. Research and development expenses also include costs for prototype-related expenses, product certification, consulting services, depreciation and certain allocated facilities and information technology infrastructure costs. We believe that continued investment in research and development is important to attaining our strategic objectives. We expect our research and development expenses to continue to increase in absolute dollars for the foreseeable future as we continue to invest in the development of our products and services. However, we expect our research and development expenses to decrease modestly as a percentage of our total revenue over the long term, although our research and development expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our research and development expenses.

Sales and Marketing. Our sales and marketing expenses consist primarily of personnel costs, including commission costs, stock-based compensation, recruiting fees and travel expenses for employees engaged in sales and marketing activities. Commission expenses in any given period are based on completed contracts, which may not result in revenue in the period in which they are incurred. Sales and marketing expenses also include the cost of trade shows, marketing programs, promotional materials, demonstration equipment, consulting services, depreciation and certain allocated facilities and information technology infrastructure costs. We expect our sales and marketing expenses to continue to increase in absolute dollars as we increase the size of our sales and marketing organization and expand into new markets. However, we expect our sales and marketing expenses to decrease modestly as a percentage of our total revenue over the long term, although our sales and marketing expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our sales and marketing expenses.

General and Administrative. Our general and administrative expenses consist primarily of personnel costs, including bonuses, stock-based compensation and travel expenses for our executive, finance, human resources, legal and operations employees, as well as compensation for our Board. General and administrative expenses also include fees for outside consulting, legal, audit and accounting service and insurance, as well as depreciation and certain allocated facilities and information technology infrastructure costs. We expect our general and administrative expenses to continue to increase in absolute dollars following the completion of the IPO due to the additional legal, accounting, insurance, investor relations and other costs that we will incur as a public company, as well as other costs associated with growing our business.

However, we expect our general and administrative expenses to decrease modestly as a percentage of our total revenue over the long term, 22-------------------------------------------------------------------------------- Table of Contents although our general and administrative expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our general and administrative expenses.

Interest Expense Our interest expense consists primarily of interest on our indebtedness. See Note 4 of our condensed consolidated financial statements included elsewhere in this Form 10-Q for more information about our debt.

Other Income (Expense), Net Prior to our IPO, other income (expense), net consisted primarily of the impact of fair value adjustments for our convertible preferred stock warrants. Upon completion of the IPO in April 2014, all convertible preferred stock warrants converted to common stock warrants and no longer require fair value remeasurement at each balance sheet date. Other income (expense), net also consists of gains and losses from foreign currency exchange transactions.

Provision for Income Taxes Our provision for income taxes consists primarily of foreign tax expense due to our cost-plus agreements with our foreign entities, which guarantee foreign entities a profit, and to a lesser extent federal and state income tax expense.

As of June 30, 2014 and December 31, 2013, respectively, we maintained a full valuation allowance against our domestic deferred tax assets, including net operating loss carryforwards and research and development and other tax credits.

We expect our provision for income taxes to increase in absolute dollars in future periods.

23-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth our results of operations for the periods presented in dollars (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Revenue: Product $ 33,721 $ 25,883 $ 58,582 $ 43,920 Software subscriptions and service 3,833 2,149 7,204 3,939 Total revenue 37,554 28,032 65,786 47,859 Cost of revenue: Product 10,560 8,059 18,442 14,214Software subscriptions and service 1,639 1,010 3,005 1,845 Total cost of revenue 12,199 9,069 21,447 16,059 Gross profit 25,355 18,963 44,339 31,800 Operating expenses: Research and development 6,833 6,674 12,971 12,431 Sales and marketing 19,011 14,604 35,580 27,504 General and administrative 5,135 3,926 9,972 7,815 Operating loss (5,624 ) (6,241 ) (14,184 ) (15,950 ) Interest income 8 3 9 7 Interest expense (459 ) (101 ) (924 ) (201 ) Other income (expense), net (58 ) (485 ) 59 (868 ) Loss before income taxes (6,133 ) (6,824 ) (15,040 ) (17,012 ) Income tax provision (135 ) (155 ) (155 ) (285 ) Net loss and comprehensive loss $ (6,268 ) $ (6,979 ) $ (15,195 ) $ (17,297 ) 24-------------------------------------------------------------------------------- Table of Contents The following table sets forth our results of operations for the periods presented as a percentage of our total revenue: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Revenue: Product 90 % 92 % 89 % 92 % Software subscriptions and service 10 8 11 8 Total revenue 100 100 100 100 Cost of revenue: Product 28 29 28 30 Software subscriptions and service 4 3 5 4 Total cost of revenue 32 32 33 34 Gross profit 68 68 67 66 Operating expenses: Research and development 18 24 20 26 Sales and marketing 51 52 54 57 General and administrative 14 14 15 16 Operating loss (15 ) (22 ) (22 ) (33 ) Interest income - - - - Interest expense (1 ) - (1 ) - Other income (expense), net - (2 ) - (2 ) Loss before income taxes (16 ) (24 ) (23 ) (35 ) Income tax provision - (1 ) - (1 ) Net loss and comprehensive loss (17 )% (25 )% (23 )% (36 )% 25 -------------------------------------------------------------------------------- Table of Contents Revenues Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands) Revenues: Product $ 33,721 $ 25,883 $ 7,838 30 % $ 58,582 $ 43,920 $ 14,662 33 % Software subscriptions and service 3,833 2,149 1,684 78 % 7,204 3,939 3,265 83 % Total revenue $ 37,554 $ 28,032 $ 9,522 34 % $ 65,786 $ 47,859 $ 17,927 37 % Percentage of revenues: Product 90 % 92 % 89 % 92 % Software subscriptions and service 10 % 8 % 11 % 8 % Total 100 % 100 % 100 % 100 % Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands) Revenue by geographic region: Americas $ 24,487 $ 20,426 $ 4,061 20 % $ 41,865 $ 34,063 $ 7,802 23 % EMEA 8,996 6,068 2,928 48 % 17,004 10,445 6,559 63 % APAC 4,071 1,538 2,533 165 % 6,917 3,351 3,566 106 % Total revenue $ 37,554 $ 28,032 $ 9,522 34 % $ 65,786 $ 47,859 $ 17,927 37 % Percentage of revenue by geographic region: Americas 65 % 73 % 64 % 71 % EMEA 24 % 22 % 25 % 22 % APAC 11 % 5 % 11 % 7 % Total 100 % 100 % 100 % 100 % Total revenue increased $9.5 million, or 34%, during the three months ended June 30, 2014 compared to the comparable period in 2013, and increased $17.9 million, or 37%, during the six months ended June 30, 2014, compared to the comparable period in 2013, due to the increasing demand for our products and software subscriptions and service offerings.

The increase in product revenue was primarily the result of an aggregate increase in product unit shipments largely driven by sales of our intelligent access points and our unified network management system, HiveManager.

The increase in our software subscriptions and service revenue of $1.7 million and $3.3 million during the three and six months ended June 30, 2014, respectively, compared to the comparable period in 2013, was primarily driven by the increase in sales of PCS and SaaS in connection with increased sales of products and an increase in the number of our end-customers, and recognition of deferred revenue.

The Americas and EMEA accounted for the majority of the increase in our total revenue from period to period. Our total number of end-customers increased from over 10,000 as of June 30, 2013 to more than 16,000 as of June 30, 2014.

26-------------------------------------------------------------------------------- Table of Contents Cost of Revenues, Gross Profit and Gross Margin Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands)Cost of revenues: Product $ 10,560 $ 8,059 $ 2,501 31 % $ 18,442 $ 14,214 $ 4,228 30 % Software subscriptions and service 1,639 1,010 629 62 % 3,005 1,845 1,160 63 % Total cost of revenues $ 12,199 $ 9,069 $ 3,130 35 % $ 21,447 $ 16,059 $ 5,388 34 % Gross margin: Product 68.7 % 68.9 % 68.5 % 67.6 % Software subscriptions and service 57.2 % 53.0 % 58.3 % 53.2 % Total gross margin 67.5 % 67.6 % 67.4 % 66.4 % We primarily attribute the increase in our cost of product revenue to an increase in sales of our products. We primarily relate the increase in our cost of software subscriptions and service revenue to an increase in service and support personnel headcount in the three and six months ended June 30, 2014 as compared to the same periods in 2013, and an increase in datacenter costs. Our service and support personnel headcount increased from 20 as of June 30, 2013 to 26 as of June 30, 2014.

Our gross margin was 67.5% and 67.6% for the three months ended June 30, 2014 and 2013, respectively, and 67.4% and 66.4% for the six months ended June 30, 2014 and 2013, respectively.

Our product gross margin remained relatively unchanged for the three months ended June 30, 2014 as compared to the same period in 2013, as our margin profile based on product mix during the respective periods remained similar, even with the recent introduction of our new AP230 802.11ac Gigabit Wi-Fi access point.

Our product gross margin increased for the six months ended June 30, 2014 as compared to the same period in 2013, due to improvement in the six months ended June 30, 2014 in our margin profile based on product mix and due to continued efficiencies in our product costs due to product design and supply chain management.

Our software subscriptions and service gross margin increased from 53.0% to 57.2% for the three months ended June 30, 2014 as compared to the same period in 2013, and increased from 53.2% to 58.3% for the six months ended June 30, 2014 as compared to the same period in 2013. Such increases were primarily due to higher growth in our software subscriptions and service revenue than our related cost of delivering these software subscriptions and services.

Research and Development Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands)Research and development $ 6,833 $ 6,674 $ 159 2 % $ 12,971 $ 12,431 $ 540 4 % % of revenue 18 % 24 % 20 % 26 % Research and development expenses increased in the three and six months ended June 30, 2014 as compared to the same period in 2013, primarily due to the increase in personnel and related allocated costs of facilities and information technology infrastructure were partially offset by the capitalized development costs for our SaaS offerings under development.

For the three and six months ended June 30, 2014 as compared to the same period in 2013, personnel and related costs increased $1.4 million and $2.6 million, including bonuses and stock-based compensation expense of $0.5 million and $0.8 million, respectively, as we increased our research and development headcount to support continued investment in our future product and service offerings. The increase in personnel and related costs was partially offset by $1.1 million and $2.0 million, respectively, of personnel and related costs, including bonuses and stock-based compensation capitalized for development of our SaaS offerings.

The remaining increase was mainly due to higher costs related to prototype-related expenses and consulting services and certain allocated facilities and information technology infrastructure costs. Our research and development 27-------------------------------------------------------------------------------- Table of Contents headcount increased from 210 as of June 30, 2013 to 213 as of June 30, 2014. We expect our research and development costs to continue to increase in absolute dollars, as we continue to invest in developing new products and new versions of our existing products.

Sales and Marketing Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands) Sales and marketing $ 19,011 $ 14,604 $ 4,407 30 % $ 35,580 $ 27,504 $ 8,076 29 % % of revenue 51 % 52 % 54 % 57 % Sales and marketing expenses increased for the three and six months ended June 30, 2014, as compared to the same period in 2013, primarily due to increases in personnel and related costs of $2.9 million and $5.3 million, respectively, including increased headcount, bonus expenses and higher commissions of $1.1 million and $1.7 million, respectively. Our sales and marketing expenses also increased due to higher marketing program expenses of $0.9 million and $1.5 million, respectively, and increase in our other sales and marketing related activities. Our sales and marketing headcount increased from 199 as of June 30, 2013 to 230 as of June 30, 2014. We expect that sales and marketing expenses will continue to increase in absolute dollars as we continue to add sales personnel and continue marketing programs.

General and Administrative Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands) General and administrative $ 5,135 $ 3,926 $ 1,209 31 % $ 9,972 $ 7,815 $ 2,157 28 % % of revenue 14 % 14 % 15 % 16 % General and administrative expenses increased for the three and six months ended June 30, 2014, as compared to the same period in 2013, primarily due to increases in personnel and related costs of $0.9 million and $1.7 million, including bonuses and higher stock-based compensation, respectively. Our general and administrative headcount increased from 54 as of June 30, 2013 to 77 as of June 30, 2014. We expect that general and administrative expenses will continue to increase in absolute dollars due primarily to costs associated with being a public company and to support the growth in our business.

Interest Expense Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands) Interest expense $ (459 ) $ (101 ) $ (358 ) 354 % $ (924 ) $ (201 ) $ (723 ) 360 % Interest expense consists of interests from our loan credit facilities. We primarily attribute the increase in our interest expense to the $10.0 million we borrowed from TriplePoint Capital LLC in December 2013 under our term loan credit facility.

Other Income (Expense), Net Three Months Ended June 30, Six Months Ended June 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change (dollars in thousands) (dollars in thousands) Other income (expense), net $ (58 ) $ (485 ) $ 427 (88 )% $ 59 $ (868 ) $ 927 (107 )% Our other income (expense), net, consists of fair value remeasurement of our convertible preferred stock warrants. Upon completion of the IPO in April 2014, all convertible preferred stock warrants became exercisable for shares of common stock and are no longer subject to fair value remeasurement, resulting in decrease of other expense.

28-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Capital Resources As of June 30, 2014, we had cash and cash equivalents of $103.9 million, $102.9 million of which was held within the United States.

Prior to the second quarter of fiscal 2014, we funded our operations primarily through cash provided by financing activities, including private sales of equity securities and funds raised through debt financing. In April 2014, we completed our IPO which resulted in net proceeds of $80.2 million, after deducting underwriters' discounts and commissions. We plan to continue to invest for long-term growth. This investment in long-term growth will continue to increase in absolute dollars. We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated working capital and capital expenditure 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 our spending to support our research and development efforts, the expansion of our sales and marketing activities, the introduction of new and enhanced product and service offerings, the costs to ensure access to adequate manufacturing capacity, and the level of market acceptance of our products.

Cash Flows The following table summarizes our cash flows for the periods indicated: Six Months Ended June 30, 2014 2013 (in thousands) Net cash used in operating activities $ (6,346 ) $ (11,837 ) Net cash used in investing activities (3,147 ) (963 ) Net cash provided by financing activities 78,383 11,240 Net increase (decrease) in cash and cash equivalents $ 68,890 $ (1,560 ) Operating Activities We have historically experienced negative cash flows from operating activities as we continue to expand our business. Our largest uses of cash from operating activities are for employee-related expenditures and purchases of finished products from our contract manufacturers. Our primary source of cash flows from operating activities is cash receipts from our channel partners. Our cash flows from operating activities will continue to be affected principally by the extent to which we grow our total revenue and increase our headcount, primarily in our sales and marketing and research and development functions, in order to grow our business.

In the six months ended June 30, 2014, operating activities used $6.3 million of cash as a result of our net loss of $15.2 million, partially offset by non-cash charges of $4.5 million and a net change of $4.3 million in our net operating assets and liabilities. Non-cash charges consisted primarily of stock-based compensation of $3.5 million and depreciation and amortization expense of $1.0 million. The net change in our net operating assets and liabilities was primarily due to a $6.9 million increase in deferred revenue as a result of an increase in sales of PCS and SaaS, an increase of $7.6 million in accounts payable, partially offset by an increase of $6.1 million in accounts receivable and an increase in cash used for inventory purchases of 5.2 million. Our days sales outstanding, or DSO, which we define as the number of days it takes us to collect revenue after a sale has been made, based on a 90-day average, was 53 days as of June 30, 2014.

In the six months ended June 30, 2013, operating activities used $11.8 million of cash as a result of our net loss of $17.3 million, partially offset by non-cash charges of $3.0 million, and a net change of $2.4 million in our net operating assets and liabilities. Non-cash charges consisted primarily of stock-based compensation of $1.5 million, depreciation and amortization expense of $0.7 million, and remeasurement of the fair value of our convertible preferred stock warrants of $0.8 million. The net change in our net operating assets and liabilities was primarily due to a $7.2 million increase in deferred revenue as a result of an increase in sales of PCS and SaaS, partially offset by an increase of $6.6 million in accounts receivable. Our DSO was 56 days as of June 30, 2013.

Investing Activities Our investing activities have primarily consisted of purchases of property and equipment. In fiscal 2014, our investing activities also consisted of capitalized development costs of our SaaS offerings.

29-------------------------------------------------------------------------------- Table of Contents In the six months ended June 30, 2014, cash used in investing activities was $3.1 million, primarily attributable to capitalization of internal software development costs of $2.0 million, and purchase of property and equipment of $1.1 million, relating primarily to manufacturing, research and development lab equipment and purchased software.

In the six months ended June 30, 2013, cash used in investing activities was $1.0 million and was attributable to purchase of property and equipment, relating primarily to computer and other infrastructure equipment, testing and imaging equipment, and research and development lab equipment.

Financing Activities Our financing activities have primarily consisted of the private placements of convertible preferred stock, issuance of debt and proceeds from exercises of stock options, as well as proceeds from the sale of common stock in our IPO in April, 2014.

In the six months ended June 30, 2014, financing activities provided $78.4 million of cash, primarily as a result of net proceeds of $80.2 million from our IPO in April 2014 (net of the underwriters' discounts and commissions), $0.9 million increase in net proceeds from exercises of convertible preferred stock warrants and $1.1 million in proceeds from exercises of stock options, partially offset by $3.9 million payment of offering costs related to our IPO.

In the six months ended June 30, 2013, financing activities provided $11.2 million of cash, primarily as a result of net proceeds of $10.0 million from sale of our convertible preferred stock.

Debt Obligations In June 2012, we entered into a revolving credit facility with Silicon Valley Bank for an aggregate principal amount of up to $10.0 million, with a sublimit of $3.0 million for borrowings guaranteed by the Export-Import Bank of the United States. Our revolving credit facility is collateralized by substantially all of our property, other than our intellectual property. Our revolving credit facility bears monthly interest at a floating rate equal to the greater of (1) 4.00% or (2) prime rate plus 0.75%. The revolving loans may be borrowed, repaid and reborrowed until June 29, 2015, when all outstanding amounts must be repaid. As of June 30, 2014, we have drawn $10.0 million under our revolving credit facility.

In August 2013, we entered into a term loan credit facility with TriplePoint Capital that allows us, subject to certain funding conditions, including compliance with certain covenants and the absence of certain events or conditions that could be deemed to have a material adverse effect on our business, to borrow term loans in an aggregate principal amount of up to $20.0 million. We may request draws under the term loan credit facility through November 2015. The draw period is subject to extension.

Our term loan credit facility is collateralized by substantially all of our property, other than our intellectual property. For each draw under our term loan credit facility, we may choose one of four options: (1) a 24-month, interest-only loan bearing interest at the greater of the prime rate or 3.25%, plus 6.5%, along with an end of term payment that will vary from 4.5% to 7.25% of the amount borrowed depending on the portion of the credit facility utilized; (2) a 48-month loan that is interest-only for 24 months and fully amortizes in 24 equal payments thereafter, and which bears interest at the greater of the prime rate or 3.25%, plus 7.5%, along with an end of term payment that will vary from 6.75% to 9.25% of the amount borrowed depending on the portion of the credit facility utilized; (3) a 36-month, interest-only loan bearing interest at the greater of the prime rate or 3.25%, plus 8.25%, along with an end of term payment that will vary from 8.5% to 10.25% of the amount borrowed depending on the portion of the credit facility utilized; or (4) a 48-month, interest-only loan bearing interest at the greater of the prime rate or 3.25%, plus 8.75%, along with an end of term payment that will vary from 10% to 12% of the amount borrowed depending on the portion of the credit facility utilized. We may prepay loans under this term loan credit facility in whole at any time, but may be subject to early repayment fees. We may not re-borrow amounts we prepay under this term loan credit facility.

In December 2013, we drew $10.0 million under this term loan credit facility, which remained outstanding as of June 30, 2014. In April 2014, the stated rate of interest was reduced by one-half percent (0.5%) due to the effectiveness of our IPO on March 28, 2014. We may prepay these loans in whole at any time but are required to pay the end of term payment, plus an early repayment fee of 1% of the loan balance outstanding if repaid within twelve months. We may not re-borrow amounts we repay under this term loan credit facility.

We intend to use loans drawn under our revolving and term loan credit facilities for working capital and general corporate purposes. Both credit facilities contain customary affirmative and negative covenants that limit our ability to, among other things, incur additional indebtedness, grant liens, make investments, repurchase stock, pay dividends, transfer assets and merge or consolidate. Our revolving credit facility also requires us to maintain a liquidity ratio of not less than 1.25 to 1.00.

30-------------------------------------------------------------------------------- Table of Contents Both of our credit facilities contain customary affirmative covenants, including requirements to deliver audited financial statements. Both of our credit facilities contain customary events of default, including non-payment defaults, covenant defaults, material judgment defaults, bankruptcy and insolvency defaults, cross-defaults to certain other material indebtedness and inaccuracy of representations and warranties. Our revolving credit facility includes a default upon the occurrence of a material adverse change to our business. Upon an event of default, the lenders may declare all or a portion of our outstanding obligations payable to be immediately due and payable and exercise other rights and remedies provided for under the credit agreement. During the existence of an event of default, interest on the obligations under both of our credit facilities could be increased by 5.0%.

We were in compliance with all covenants under our revolving credit facility and term loan credit facility as of June 30, 2014.

Off-Balance Sheet Arrangements Through June 30, 2014, 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.

We have entered into agreements with some of our end-customers that contain indemnification provisions in the event of claims alleging that our products infringe the intellectual property rights of a third party. Under these agreements, we have, at our option and expense, the ability to resolve any infringement, replace our product with a non-infringing product that is equivalent-in-function, or refund the customers the total product price. Other guarantees or indemnification arrangements include guarantees of product and service performance. We have not recorded a liability related to these indemnification and guarantee provisions and our guarantees and indemnification arrangements have not had any impact on our consolidated financial statements to date.

Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable. Actual results could differ significantly from our estimates. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

We believe the critical accounting policies and estimates discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" in our Prospectus as filed on March 28, 2014, reflect our more significant judgments and estimates used in the preparation of the condensed consolidated financial statements.

There have been no significant changes to our critical accounting policies and estimates as filed in such report.

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