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DOT HILL SYSTEMS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statement for Forward-Looking Information
Certain statements contained in this quarterly report on Form 10-Q, including,
statements regarding the development, growth and expansion of our business, our
intent, belief or current expectations, primarily with respect to our future
operating performance and the products we expect to offer, and other statements
regarding matters that are not historical facts, are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended and Section 21E of the Securities Exchange Act of 1934, as amended, or
the Exchange Act, and are subject to the "safe harbor" created by these
sections. Because such forward-looking statements are subject to risks and
uncertainties, many of which are beyond our control, actual results may differ
materially from those expressed or implied by such forward-looking statements.
Some of the factors that could cause actual results to differ materially from
those expressed or implied by such forward-looking statements can be found in
Part II, Item 1A, "Risk Factors" and in our reports filed with the Securities
and Exchange Commission, or SEC, including our Annual Report on Form 10-K for
the year ended December 31, 2011. Readers are cautioned not to place undue
reliance on forward-looking statements. The forward-looking statements speak
only as of the date on which they are made, and we undertake no obligation to
update such statements to reflect events that occur or circumstances that exist
after the date on which they are made.
The following discussion of our financial condition and results of operations
should be read in conjunction with our unaudited condensed consolidated
financial statements and notes thereto included in the preceding pages in this
quarterly report on Form 10-Q and our consolidated financial statements and
notes thereto included in our Annual Report on Form 10-K for the year ended
December 31, 2011.
Overview
We design, manufacture and market a range of software and hardware storage
systems for the entry and midrange storage markets. Beginning in the second half
of 2009, we began placing more emphasis on selling higher gross margin products
which includes appliance products and hardware products through indirect sales
channels.
Typical customers for our storage systems products, which includes our
AssuredSAN line of storage array products, include organizations requiring high
reliability, high performance networked storage and data management solutions in
an open systems architecture. Our storage solutions consist of integrated
hardware, firmware and software products employing a modular system that allows
end-users to add various protocol, performance, capacity or data protection
schemes as needed. Our broad range of products, from small capacity direct
attached to complete multi-hundred terabyte, or TB, storage area networks, or
SANs, provide end-users with a cost-effective means of addressing increasing
storage demands at compelling price-performance points. Our current product
family based on our AssuredSAN architecture provides high performance and large
disk array capacities for a broad variety of environments, employing Fibre
Channel, Internet Small Computer Systems Interface, or iSCSI or Serial Attached
SCSI, or SAS, interconnects to switches and/or hosts. In addition, our Assured
family of data protection software products provides additional layers of data
protection options to complement our line of storage disk
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arrays. Our current mainstream 2000 and 3000 series of entry-level storage
products and Just a Bunch of Disks, or JBOD, arrays are targeted primarily at
mainstream enterprise and small-to-medium business, or SMB, applications. Some
of our AssuredSAN products have been distinguished by certification as Network
Equipment Building System, or NEBS, Level 3 (a telecommunications standard for
equipment used in central offices) and are MIL-STD-810F (a military standard
created by the U.S. government) compliant based on their ruggedness and
reliability. In February 2010, we launched the latest AssuredSAN 3000 series of
storage arrays that provide high speed interface options including 8 gigabyte,
or GB, Fibre Channel, 1GB and 10GB iSCSI over Ethernet and 6GB SAS connectivity.
On August 22, 2012, we introduced AssuredSANTM Pro 5000 Series with RealStorTM
software that incorporates real-time data tiering. With RealStor, businesses
gain the advantage of very high performance SSDs, using them to their maximum
benefit, while storing less frequently accessed data on slower, but much less
expensive hard disk drives. On that same day, we also introduced our
AssuredSAN(TM) 4000 Series next-generation, high performance storage solution
designed to deliver best-in-class price performance, 99.999 percent
availability, and exceptional streaming throughput. The Series 4000 shares the
same architecture as the Series 5000. Our Series 2000 and 3000 products are
characterized by IDC as Band 2 and Band 3 products. With the announcement of our
Series 4000 and 5000 products, we now have products characterized as Bands 4 and
5 products and we have thus increased our total available market as measured by
end-user sales price from $4.0 billion to $10.6 billion.
In September 2008, we acquired certain assets, namely RAIDCore from Ciprico
Inc., or Ciprico. These products are marketed to OEM accounts as the AssuredVRA
product line. This acquisition opened up new markets for us in the enterprise
server and workstation markets for data protection internal to the servers and
workstations. In particular, the RAIDCore acquisition allows us to broaden our
product portfolio in the redundant array of independent disks, or RAID, market
while allowing us to sell into the Band 1 market, and to pursue opportunities at
current and target OEM customers. We signed our first customer agreement
relating to RAIDCore products in May 2009 and began selling to this customer
during the third quarter of 2009. Sales of AssuredVRA products were not
significant in 2011 or in 2012. Although sales of our AssuredVRA products
increased in 2011, such sales do not represent a significant percentage of our
total net revenue for the three and nine months ended September 30, 2012.
We have decided to expand our routes to market beyond our focus on OEMs, and in
October of 2009, we launched a Dot Hill channel program targeted at selling
through distributors and open storage partners, or OSPs. We continued to expand
our channel program in 2011 and we believe this will provide Dot Hill with
additional sales channels for all of our products. The majority of sales to our
channel partners were represented by our AssuredSAN line of products in 2011 and
in the first nine months of 2012.
Our agreements with our customers do not contain any minimum purchase
commitments and may be terminated at any time upon notice from the applicable
customer. Our ability to achieve and maintain profitability will depend on,
among other things, the level and mix of orders we actually receive from such
customers, the actual amounts we spend on marketing support, the actual amounts
we spend for inventory support and incremental internal investment, our ability
to reduce product cost, our product lead time, our ability to meet delivery
schedules required by our customers and the economic environment.
Our products and services are sold worldwide to facilitate server and SAN
storage implementations, primarily through OEMs, and supplemented by system
integrators, or SIs, distributors and value added resellers, or VARs. Our
storage system products' OEM partners currently include, among others,
Hewlett-Packard, or HP, Sony Ericsson, or Ericsson, Motorola, Inc., or Motorola,
General Dynamics Government Systems Corporation, or General Dynamics, Lockheed
Martin Corporation, or Lockheed Martin, NEC Corporation, or NEC, Tektronix Inc.,
or Tektronix, Samsung Electronics, or Samsung, Stratus Technologies, or Stratus,
and Fujitsu Technology Solutions GmbH, or FTS, and Concurrent Computer
Corporation, or Concurrent. Our standalone storage software products' OEM
partners currently include, among others, Dell Inc., or Dell. Although our
products and services are sold worldwide, the majority of our net revenue is
derived from our U.S. operations.
We began shipping products to HP in the fourth quarter of 2007. In January 2008,
we amended our agreement with HP to allow for sales of additional products to
additional divisions within HP. Our products are primarily sold as HP's MSA
2000/P2000 product family. Sales to HP increased significantly during 2008 and
increased again in 2009 primarily as a result of the successful launch and
market acceptance of the HP MSA 2000 products. HP launched its third generation
product line, now called the P2000 product line, in February 2010. Sales to HP
increased again in 2010 as we began selling our next generation host interfaces
across the HP P2000 product line. The agreement with HP does not contain any
minimum purchase commitments. In October 2011, we extended our supply agreement
with HP by five years to expire in October 2016 and also extended the expiration
of 1.6 million warrants granted to HP in March 2008 to expire concurrently with
the supply agreement in October 2016. Net revenue from HP approximated 74% of
our total net revenue in 2011 and 67% of our total net revenue for the nine
months ended September 30, 2012. We expect sales to HP to continue to represent
a substantial percentage of our total
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net revenue in 2012. We expect to generate additional revenue from our indirect
channel as well as new and potential new OEM customers.
In addition, the demand for our products has been affected in the past, and may
continue to be affected in the future, by various factors, including, but not
limited to, the following:
• our ability to maintain and enhance relationships with our customers,
in particular our OEM customers, as well as our ability to win new
business;
• our ability to source critical components such as integrated circuits,
hard disk drives, memory and other components on a timely basis;
• the amount of field failures resulting in product replacements or recalls;
• our ability to launch new products in accordance with OEM
specifications, schedules and milestones;
• our ability to sell Dot Hill branded products through Resellers;
• our ability to win new OEM customers;
• general economic and political conditions and specific conditions in
the markets we address, including the continuing volatility in the
technology sector, current general economic volatility and trends in
the data storage markets in various geographic regions;
• the timing, rescheduling or cancellation of significant customer orders
and our ability, as well as the ability of our customers, to manage
inventory; and
• the inability of certain of our customers who depend on credit to have
access to their traditional sources of credit to finance the purchase
of products from us, particularly in the current global economic
environment, which may lead them to reduce their level of purchases or
to seek credit or other accommodations from us.
For these and other reasons, our net revenue and results of operations for the
three and nine months ended September 30, 2012 and prior periods may not
necessarily be indicative of future net revenue and results of operations.
Our manufacturing strategy includes outsourcing substantially all of our
manufacturing to third-party manufacturers in order to reduce sales cycle times
and manufacturing infrastructure, enhance working capital and improve margins by
taking advantage of the third parties' manufacturing and procurement economies
of scale. In September 2008, we entered into a manufacturing agreement with
Foxconn Technology Group, or Foxconn. Under the terms of the agreement, Foxconn
supplies us with manufacturing, assembly and test services from its facilities
in China and final integration services including final assembly, testing and
configure-to-order services, through its worldwide facilities. In November 2011,
we amended our agreement with Foxconn to extend the manufacturing agreement for
a period of three years. In addition, Foxconn agreed to waive the requirement
for a letter of credit and improved our payment terms. Foxconn began
manufacturing products for us in July 2009 and we began shipping products for
general availability under the Foxconn agreement during the second half of 2009.
The majority of our products sold in 2011 and in the three and nine months ended
September 30, 2012 were manufactured by Foxconn. We expect Foxconn to
manufacture substantially all of our products for the remainder of 2012.
We derive the majority of our net revenue primarily from sales of our Series
2000 and 3000 family of products, which are included in our AssuredSAN product
line.
Cost of goods sold includes costs of materials, subcontractor costs, salary and
related benefits for the production and service departments, depreciation and
amortization of equipment and intangible assets used in the production and
service departments, production facility rent and allocation of overhead as well
as manufacturing variances and freight.
Research and development expenses consist primarily of project-related expenses,
consulting charges and salaries for employees directly engaged in research and
development.
Sales and marketing expenses consist primarily of salaries and commissions,
marketing related costs, advertising, customer-related evaluation unit expenses,
promotional costs and travel expenses.
General and administrative expenses consist primarily of compensation to
officers and employees performing administrative functions, as well as
expenditures for legal, accounting and other administrative services and
fluctuations in currency valuations.
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Other income (expense), net is comprised primarily of interest income earned on
our cash and cash equivalents and other miscellaneous income and expense items.
In the first quarter of 2012, our management approved, committed to, and
initiated a restructuring and cost reduction plan or the 2012 Plan that is
associated with the closure of our Israel Technology Development Center. The
2012 Plan is designed to re-align our software investments to focus on
accelerating the development of embedded software features, in order to launch a
competitive set of mid-range storage array products in 2012, and to provide more
differentiated entry-level products for both OEM and channel customers.
Substantially all of our 2012 Plan workforce reductions were completed by July
31, 2012. The closure of our Israel Technology Development Center is now
recorded in discontinued operations, since we have ceased all ongoing
operational activities as of September 30, 2012.
Critical Accounting Policies and Estimates
An accounting policy is deemed to be critical if it requires an accounting
estimate to be made based on assumptions about matters that are highly uncertain
at the time the estimate is made, if different estimates reasonably could have
been used, or if changes in the estimate that are reasonably likely to occur
could materially impact the unaudited condensed consolidated financial
statements. Except as noted below, management believes that there have been no
significant changes during the three and nine months ended September 30, 2012,
to the items that we disclosed as our critical accounting policies and estimates
in Management's Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2011.
Warranty and Related Obligations
Our standard warranty provides that if our systems do not function to published
specifications, we will repair or replace the defective component or system
without charge generally for a period of approximately three years. We generally
extend to our customers the warranties provided to us by our suppliers, and
accordingly, the majority of our warranty obligations to customers are typically
intended to be covered by corresponding supplier warranties. For warranty costs
not covered by our suppliers, we provide for estimated warranty costs in the
period the revenue is recognized. There can be no assurance that our suppliers
will continue to provide such warranties to us in the future or that our
warranty obligations to our customers will be covered by corresponding
warranties from our suppliers, the absence of which could have a material effect
on our financial statements. Estimated liabilities for product warranties are
included in accrued expenses.
In October 2009, we discovered a quality issue associated with certain power
supply devices provided by a long-term component supplier, which resulted in a
higher than expected level of power supply failures to us and our customers.
While we were able to promptly identify and resolve the cause of the failures,
we are required to provide replacement products or make repairs to the affected
power supply units that had been sold between March and October 2009. Through
June 30, 2011, our component supplier had repaired all of the faulty power
supplies at no cost to us and reimbursed us for our out-of-pocket costs which
has constituted a reimbursement to customers for certain out-of-pocket costs
they incurred in connection with these power supply failures. The total amount
reimbursed to us by our component supplier approximated $1.0 million through
June 30, 2011.
In the second and third quarters of 2011, a material customer provided us with a
framework estimating the potential claims precipitated by the power supply
failures. As previously disclosed, the customer's preliminary framework of
potential claims provided to us included additional costs related to the
customer's internal overhead for other internal indirect costs, in addition to
third-party direct costs. Based on preliminary discussions for settlement and
our analysis of the framework provided by the customer, including future
potential claims through the warranty period, we estimated that we had incurred
a probable loss of approximately $2.8 million. Consequently, in addition to the
$1.3 million previously recognized as of June 30, 2011, we recorded an estimated
liability of $1.5 million as of September 30, 2011 within "Accrued expenses" on
our condensed consolidated balance sheet.
Negotiations continued with our customer throughout the fourth quarter of 2011
into the first half of 2012. Based on the results of ongoing negotiations with
the material customer, we increased our estimated liability at December 31, 2011
to $5.5 million, resulting in a charge of $2.7 million during the fourth quarter
of 2011 within "Accrued expenses" on our condensed consolidated balance sheet,
gross of any third-party recoveries.
A final settlement with this material customer was reached during the second
quarter of 2012. The terms of the agreement required an immediate payment of
$2.0 million and an estimated remaining liability of approximately $2.7 million
as of September 30, 2012 related to a combination of future price concessions
and rebates to be paid quarterly based on sales
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volumes through December 31, 2012. While our estimated liability relating to
failed power supply units is subject to some uncertainty until final settlement,
based on our current expectation of sales volumes with this material customer,
we do not believe the incurrence of an additional loss is either probable or
reasonably possible at this time.
During the second quarter of 2011, based on the advice of legal counsel, we
established that our component supplier is contractually obligated to reimburse
us for fair and reasonable costs we incur with our customers associated with
these power supply failures. Our component supplier had continued to re-work and
distribute to our customer the affected population of power supplies at no cost
to us. In addition, at the time, our collection experience with similar amounts
already reimbursed to us by our supplier and our belief that our component
supplier and its parent companies had the financial ability to continue to
reimburse us for any additional costs we may incur, we recorded a current asset
within "Prepaid expenses and other assets" on our consolidated balance sheet of
$1.3 million as of June 30, 2011.
During the third quarter of 2011, as the claims from our customer became
clearer, we commenced negotiations with our component supplier for fair and
reasonable costs that we have and are likely to incur through the warranty
period associated with this component failure. Originally we determined that the
supplier was unlikely to make an up-front cash payment for the original
settlement amount of $1.3 million, but it indicated a willingness to provide
some form of reimbursement for costs incurred, in the form of cash and/or note
receivable of $0.5 million plus future product rebates. Based on our judgment at
the time, we reduced the previously recorded current asset of $1.3 million
within "Prepaid expenses and other assets" to $0.5 million as of September 30,
2011. We continued to negotiate this settlement with our supplier and during the
second quarter of 2012, the supplier signed a final settlement agreement
providing for additional reimbursements above what was recognized as of
September 30, 2011. Pursuant to the settlement, the supplier agreed to cash
consideration of $1.2 million, of which we received $0.7 million subsequent to
the signing of the settlement agreement, with the remaining $0.5 million to be
received in installments over the next three quarters. Additionally, our
supplier committed to product rebates and/or price concessions on product orders
for a period of 39 months from the execution of the settlement agreement, in
return for our agreement to release our supplier from all obligations relating
to the power supply failures known by us to date. This agreement is not subject
to any required future purchases.
In addition, we have commenced discussions with our General Liability and Errors
and Omissions Insurance and underwriters and will continue to pursue our rights
to cover any damages we incur and that are not reimbursed by our supplier. The
insurance company has issued a reservation of rights letter to us and at this
time, it is not possible to estimate to what extent the residual amounts, if
any, we will be covered by our carrier. As of September 30, 2012 we have not
assumed or recorded any insurance reimbursement.
To the extent our settlement agreements with our customer and our component
supplier are not on mutually beneficial terms, or our component supplier does
not continue to reimburse us for the expenses incurred by us or our customers,
and we are unsuccessful in recovering such expenses from our insurance provider,
we could incur additional expenses which could potentially have a material
effect on our financial statements and liquidity.
Long-lived Asset Impairment
We periodically review the recoverability of the carrying value of long-lived
assets for impairment whenever events or changes in circumstances indicate that
their carrying value may not be recoverable. An impairment in the carrying value
of an asset group is recognized whenever anticipated future undiscounted cash
flows from an asset group are estimated to be less than its carrying value. The
amount of impairment recognized is the difference between the carrying value of
the asset group and its fair value. Fair value estimates are based on
assumptions concerning the amount and timing of estimated future cash flows and
assumed discount rates, reflecting varying degrees of perceived risk.
As of September 30, 2011, we identified a change in circumstances that indicated
the carrying amount of our long-lived assets may not be recoverable, as our
primary AssuredUVS customer informed us that the AssuredUVS software would no
longer be a component of its business strategy, which would result in a
significant decline in revenues for the Company. Our long-lived assets consisted
of the intangible assets associated with our acquisition of certain identified
Cloverleaf Communications, Inc., or Cloverleaf, assets acquired in January 2010
with an original carrying value of $5.0 million and property and equipment of
$1.2 million.
Since we did not have an immediate replacement for our AssuredUVS customer,
management's forecasted undiscounted cash flows indicated that the assets were
potentially not recoverable, and proceeded to estimate the fair value of each
long-lived asset. Property and equipment consisted of mostly machinery and
equipment used for testing and development of our AssuredUVS technology.
Management determined that carrying value approximated fair value, as property
was either acquired
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in the 2010 acquisition of Cloverleaf, had been purchased subsequently, or could
be re-deployed, establishing recent evidence of fair value. It was depreciated
over a 3 - 5 year estimated useful life.
Intangible assets consisted primarily of acquired software of $4.9 million and a
trade name of $0.1 million. We determined the fair value of the acquired
software by estimating the replacement cost of the software, taking into account
both the software as acquired and subsequent development work, as well as the
business alternatives we were considering and the corresponding value of the
software in these alternative approaches. We estimated the value of the software
based on the probabilities of each of the business alternatives. We determined
the fair value of the trade name using an income approach and considered the
fact that the software's trade name at the time of acquisition was no longer
being used. All estimates were based on management using appropriate assumptions
and projections.
Our impairment analysis at September 30, 2011 identified $2.9 million of
impaired long-lived assets, consisting entirely of intangible assets recognized
as part of the Cloverleaf acquisition in 2010. Long-lived asset impairment
charges are recorded consistent with our treatment of related amortization
expense specific to each acquired intangible assets. We recorded $2.8 million of
impaired acquired software and $0.1 million of impaired acquired trade name as a
component of cost of goods sold for the year ended December 31, 2011.
In February 2012, our Board of Directors approved a plan to exit our AssuredUVS
business and close down our Israel Technology Development Center (see Note 7),
at which time it was determined that the valuations at that date were
appropriate. During the second quarter of 2012, we explored the potential sale
of the AssuredUVS business, but were unsuccessful in locating a buyer and ended
efforts to sell the business or its component assets as of June 30, 2012.
Accordingly, we recognized an impairment of $0.2 million of property, plant and
equipment and $1.6 million for the remaining value of acquired software as a
component of cost of goods sold as of June 30, 2012. The AssuredUVS business is
now recorded in discontinued operations, since we have ceased all ongoing
operational activities as of September 30, 2012.
Valuation of Goodwill
We review goodwill for impairment on an annual basis at November 30 and whenever
events or changes in circumstances indicate the carrying value of an asset may
not be recoverable.
Current accounting standards require that a two-step impairment test be
performed on goodwill. In the first step, we compare the fair value of our
reporting unit to its carrying value. We determine the fair value of our
reporting unit using a combination of the income approach and market
capitalization approach. If the fair value of the reporting unit exceeds the
carrying value of the net assets, goodwill is not impaired, and we are not
required to perform further testing. If the carrying value of the net assets
exceeds the fair value of the reporting unit, then we must perform the second
step in order to determine the implied fair value of the reporting unit's
goodwill and compare it to the carrying value of the reporting unit's goodwill.
If the carrying value of the reporting unit's goodwill exceeds its implied fair
value, then we must record an impairment charge equal to the difference.
Under the income approach, we calculate the fair value of a reporting unit based
on the present value of estimated future discounted cash flows. Under the market
capitalization approach, valuation multiples are calculated based on operating
data from publicly traded companies within our industry. Multiples derived from
companies within our industry provide an indication of how much a knowledgeable
investor in the marketplace would be willing to pay for a company. These
multiples are applied to the operating data for the reporting unit to arrive at
an indicated fair value. Significant management judgment is required in the
forecasts of future operating results that are used in the estimated future
discounted cash flow method of valuation. The estimates we have used are
consistent with the plans and estimates that we use to manage our business. We
base our fair value estimates on forecasted revenue and operating costs along
with business plans. Our forecasts consider the effect of a number of factors
including, but not limited to, the current future projected competitiveness and
market acceptance of the product, technological risk, the ease of use and ease
of implementation of the product, the likely outcome of sales and marketing
efforts and projected costs associated with product development, customer
support and selling, general and administrative costs. It is possible, however,
that the plans may change and that actual results may differ significantly from
our estimates.
During September 2011, our primary AssuredUVS customer became delinquent on the
settlement of its payables to us and upon our investigation it became evident
that its financial resources were limited. It also informed us that they were
changing their strategy which would result in a significant decline in revenue
for the Company, and we determined it was "more-likely-than-not" that the
reporting unit was less than its carrying value. The impairment of the goodwill
related to the reporting unit is now reported in discontinued operations (see
Note 3), since we have ceased all ongoing operational activities as of September
30, 2012.
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Results of Operations
The following table sets forth certain items from our statements of operations
as a percentage of net revenue for the periods indicated (percentages may not
aggregate due to rounding):
Three Months Ended Nine Months Ended
September 30, September 30,
2011 2012 2011 2012
Net revenue 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold 76.1 74.6 75.5 73.1
Gross profit 23.9 25.4 24.5 26.9
Operating expenses:
Research and development 17.5 19.4 15.5 18.8
Sales and marketing 7.6 7.4 6.6 6.9
General and administrative 4.0 4.4 4.2 4.7
Restructuring charge 1.4 (0.4 ) 0.4 (0.2 )
Total operating expenses 30.5 30.8 26.7 30.2
Operating loss (6.6 ) (5.4 ) (2.2 ) (3.3 )
Other income (expense), net - - - -
Loss before income taxes and discontinued
operations (6.6 ) (5.4 ) (2.2 ) (3.3 )
Income tax (benefit) expense 0.2 0.3 0.1 0.3
Loss from continuing operations (6.8 ) (5.7 ) (2.3 ) (3.6 )
Loss from discontinued operations (18.7 ) (0.6 ) (7.9 ) (2.9 )
Net loss (25.5 )% (6.3 )% (10.2 )% (6.5 )%
Three and Nine Months Ended September 30, 2011 Compared to the Three and Nine
Months Ended September 30, 2012
Net Revenue
Three Months Ended September 30,
2011 2012 Increase % Change
(in thousands, except percentages)
Net Revenue $ 47,805 $ 48,223 $ 418 0.9 %
Nine Months Ended September 30,
2011 2012 Increase % Change
(in thousands, except percentages)
Net Revenue $ 148,806 $ 150,529 $ 1,723 1.2 %
Net revenues increased approximately $0.4 million from $47.8 million for the
three months ended September 30, 2011 to $48.2 million for the three months
ended September 30, 2012. The increase in net revenue was primarily due to a
$2.5 million increase in sales to other OEM customers, offset by a $2.1 million
decrease in revenue from HP from $35.0 million for the three months ended
September 30, 2011 to $32.9 million for the three months ended September 30,
2012. However, we expect sales to HP to continue to represent a substantial
portion of our net revenue during 2012. Sales to HP approximated 73% of our net
revenue for the three months ended September 30, 2011 compared to 68% of our net
revenue for the three months ended September 30, 2012.
Net revenues for the nine months ended September 30, 2011 to September 30, 2012
increased approximately $1.7 million from $148.8 million to $150.5 million,
respectively. However, there were significant customer fluctuations within this
period. Revenues from HP decreased from $113.3 million for the nine months ended
September 30, 2011 compared to $100.4 million
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for the nine months ended September 30, 2012, a decline of $12.9 million. There
were additional revenue changes which contributed to the fluctuation in the nine
months ended September 30, 2012. Sales of our AssuredVRA products decreased from
$2.1 million to $1.7 million for the nine months ended September 30, 2011 and
September 30, 2012. Other OEM revenue increased $13.3 million for the nine
months ended September 30, 2012 and was a result of adding new OEM partners and
increased sales as our OEM customers responded to the global hard drive supply
constraints earlier in 2012. Sales to our channel partners increased from $4.8
million for the nine months ended September 30, 2011 to $6.5 million for the
nine months ended September 30, 2012. This was due to an increase in resellers
that were better qualified to resell our products.
Cost of Goods Sold and Gross Profit
Three Months Ended Three Months Ended Increase %
September 30, 2011 September 30, 2012 (Decrease) Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Cost of Goods Sold $ 36,364 76.1 % $ 35,955 74.6 % $ (409 ) (1.1 )%
Gross Profit $ 11,441 23.9 % $ 12,268 25.4 % $ 827 7.2 %
Nine Months Ended Nine Months Ended Increase %
September 30, 2011 September 30, 2012 (Decrease) Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Cost of Goods Sold $ 112,322 75.5 % $ 110,035 73.1 % $ (2,287 ) (2.0 )%
Gross Profit $ 36,484 24.5 % $ 40,494 26.9 % $ 4,010 11.0 %
Cost of goods sold decreased for the three and nine months ended September 30,
2012 compared to the three and nine months ended September 30, 2011 primarily as
a result of a more favorable mix of sales revenue and cost reductions, which
were partially offset by increased warranty related costs.
Gross profit margin increased from 23.9% for the three months ended
September 30, 2011 to 25.4% for the three months ended September 30, 2012. Gross
profit margin benefited from manufacturing cost reductions, component cost
reductions and a more favorable product and customer mix, which were partially
offset by increased warranty related costs. Gross profit and gross margins for
the three months ended September 30, 2012 were also positively impacted by
decreased manufacturing overhead costs which decreased from $6.0 million for the
three months ended September 30, 2011 to $4.5 million for the three months ended
September 30, 2012.
Gross profit margin increased from 24.5% for the nine months ended September 30,
2011 to 26.9% for the nine months ended September 30, 2012. Gross profit margins
benefited from manufacturing cost reductions, component cost reductions and a
more favorable product and customer mix, which were partially offset by
increased warranty related costs. Furthermore, gross profit and gross margins
for the nine months ended September 30, 2012 were positively impacted by
decreased manufacturing support costs which decreased from $13.9 million for the
nine months ended September 30, 2011 to $9.8 million for the nine months ended
September 30, 2012.
Research and Development Expenses
Three Months Ended Three Months Ended %
September 30, 2011 September 30, 2012 Increase Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Research and
Development Expenses $ 8,384 17.5 % $ 9,368 19.4 % $ 984 11.7 %
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Nine Months Ended Nine Months Ended %
September 30, 2011 September 30, 2012 Increase Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Research and Development
Expenses $ 23,125 15.5 % $ 28,226 18.8 % $ 5,101 22.1 %
Research and development expense increased $1.0 million to $9.4 million for the
three months ended September 30, 2012 compared to $8.4 million for the three
months ended September 30, 2011. The increase was primarily due to a $0.7
million increase in salaries and payroll expense and a $0.6 million increase in
project materials expense. These increases were partially offset by a $0.2
million decrease in depreciation expense and a $0.1 million decrease in other
miscellaneous expenses. The increase in salaries and payroll expense and project
materials expense is the result of the acquisition of materials and additions to
staff to support customizations for newer OEM customers, the launch of the
company's Series 4000 and 5000 mid-range products and next generation product
development. The net decrease in depreciation expense is due to $0.4 million of
depreciation expense on certain software licenses in 2011, versus an increase in
2012 of $0.2 million in depreciation expense resulting from the acquisition of
materials to support strategic development projects.
Research and development expense increased $5.1 million to $28.2 million for the
nine months ended September 30, 2012 compared to $23.1 million for the nine
months ended September 30, 2011. This increase was due to an increase in
salaries and payroll related expenses for research and development personnel of
$2.7 million, an increase in project materials and depreciation expense of $1.4
million, an increase in allocated costs of $0.6 million, and an increase in
consulting expense of $0.4 million. The increase in salaries and payroll related
expense is the result of the 2012 reinstatement of salary reductions which were
in effect throughout 2011. The increase in salaries expense is also the result
of increased headcount focused on customizations for newer OEM customers, the
launch of the company's Series 4000 and 5000 mid-range products and next
generation product development. The increase in project materials expense and
depreciation expense is the result of an increase in capital assets and project
supplies required to support new customer wins, the launch of our mid-range
products, and the development of our next generation storage products due to be
released in 2013.
The increase in allocated costs is due to increased headcount and equipment
necessary to support the research and development function. The increase in
consulting expense is primarily the result of an increased reliance on domestic
and foreign engineering consultants to assist certain engineering functions with
strategic development projects.
We expect that the timing of our engineering material purchases and additional
headcount requirements to support new product releases will affect the amount of
research and development expenses in future periods.
Sales and Marketing Expenses
Three Months Ended Three Months Ended %
September 30, 2011 September 30, 2012 Decrease Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Sales and Marketing
Expenses $ 3,623 7.6 % $ 3,558 7.4 % $ (65 ) (1.8 )%
Nine Months Ended Nine Months Ended %
September 30, 2011 September 30, 2012 Increase Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Sales and Marketing Expenses $ 9,889 6.6 % $ 10,415 6.9 % $ 526 5.3 %
Sales and marketing expense decreased approximately $0.1 million to $3.6 million
for the three months ended September 30, 2012 compared to $3.6 million for the
three months ended September 30, 2011. This decrease was primarily due to a
decrease in salaries and payroll related expenses of $0.1 million due to the
timing of replacing an employee.
Sales and marketing expense increased approximately $0.5 million to $10.4
million for the nine months ended September 30, 2012 compared to $9.9 million
for the nine months ended September 30, 2011. This increase was primarily due to
an increase in evaluation unit expenses of $0.4 million and an increase in trade
show expenses of $0.1 million. The increase
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in evaluation unit expenses was due to an increase in customer interest in new
products. The increase in trade show expenses is primarily due to promoting our
new product offerings.
General and Administrative Expenses
Three Months Ended Three Months Ended %
September 30, 2011 September 30, 2012 Increase Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
General and
Administrative Expenses $ 1,922 4.0 % $ 2,101 4.4 % $ 179 9.3 %
Nine Months Ended Nine Months Ended %
September 30, 2011 September 30, 2012 Increase Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
General and Administrative
Expenses $ 6,267 4.2 % $ 7,146 4.7 % $ 879 14.0 %
General and administrative expenses increased approximately $0.2 million to $2.1
million for the three months ended September 30, 2012 compared to $1.9 million
for the three months ended September 30, 2011. The increase was primarily due to
a $0.2 million increase in salaries and payroll related expenses for the hiring
of key administrative personnel.
General and administrative expenses increased approximately $0.9 million to $7.1
million for the nine months ended September 30, 2012 compared to $6.3 million
for the nine months ended September 30, 2011. This increase was due to $0.6
million realized and unrealized foreign currency net losses, a $0.4 million
increase in salaries and payroll related expenses, and a $0.3 million increase
in recruiting and consultant fees. These increases were partially offset by a
$0.3 million decrease in stock-based compensation. The realized and unrealized
foreign currency net losses resulted from an unfavorable change in unrealized
foreign currency losses of $1.1 million, partially offset by realized foreign
currency gains of $0.5 million related to transactions reflecting changes in the
value of the Euro, British Pound, and Japanese Yen in relation to the United
States Dollar. The increase in salaries and payroll related expense is the
result of the 2012 reinstatement of salary reductions which were in effect
throughout 2011 combined with the hiring of key administrative personnel. The
decline in stock-based compensation was due to an increased emphasis on the use
of stock options versus restricted stock awards, reducing the overall value of
more recent grants.
Restructuring Charge (Recovery)
Three Months Ended Three Months Ended %
September 30, 2011 September 30, 2012 Decrease Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Restructuring Charge
(Recovery) $ 659 1.4 % $ (183 ) (0.4 )% $ (842 ) (127.8 )%
Nine Months Ended Nine Months Ended %
September 30, 2011 September 30, 2012 Decrease Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Restructuring Charge (Recovery) $ 655 0.4 % $ (228 ) (0.2 )% $ (883 ) (134.8 )%
Restructuring expenses decreased to a recovery of $0.2 million for the three and
nine months ended September 30, 2012 compared to an expense of $0.7 million for
the three and nine months ended September 30, 2011. These expenses relate to our
2008 and 2010 Restructuring Plans, for which there are no significant expenses
remaining to be incurred in 2012. See Note 7 of Notes to Unaudited Condensed
Consolidated Financial Statements for more details regarding our restructuring
activities.
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Other Income (Expense), net
Three Months Ended Three Months Ended %
September 30, 2011 September 30, 2012 Decrease Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Other Income (Expense), net $ (15 ) - % $ (5 ) - % $ (10 ) (66.7 )%
Nine Months Ended Nine Months Ended %
September 30, 2011 September 30, 2012 Decrease Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Other Income (Expense), net $ (22 ) - % $ 8 - % $ (30 ) (136.4 )%
Other income (expense), net consists of interest income on our cash and cash
equivalents, interest expense related to our note payable and other
miscellaneous items. Other income (expense), was slightly lower for the three
and nine months ended September 30, 2012 compared to the three and nine months
ended September 30, 2011.
Income Taxes
We recorded an income tax provision of $0.2 million and $0.5 million for the
three and nine months ended September 30, 2012 and an income tax provision of
$0.1 million and $0.2 million for the three and nine months ended September 30,
2011. Our provision primarily relates to estimated liabilities relating to
certain tax positions involving our foreign subsidiaries that have not been
concluded on with the relevant taxing authority.
Loss From Discontinued Operations
Three Months Ended Three Months Ended %
September 30, 2011 September 30, 2012 Decrease Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Loss From Discontinued
Operations $ (8,945 ) (18.7 )% $ (280 ) (0.6 )% $ (8,665 ) (96.9 )%
Nine Months Ended Nine Months Ended %
September 30, 2011 September 30, 2012 Decrease Change
% of Net % of Net
Amount Revenue Amount Revenue
(in thousands, except percentages)
Loss From Discontinued
Operations $ (11,734 ) (7.9 )% $ (4,411 ) (2.9 )% $ (7,323 ) (62.4 )%
Loss from discontinued operations decreased $8.7 million to $0.3 million for the
three months ended September 30, 2012 compared to $8.9 million for the three
months ended September 30, 2011. The decline in losses was primarily driven by
the Company's decision in the first quarter of 2012 to close down our Israel
Technology Center and exit out of our AssuredUVS business. This decrease was due
to an increase in gross profit of $3.4 million, primarily driven by a decrease
of $0.2 million in revenue and a decrease of $3.6 million cost of goods sold.
Additionally, there was a decline in operating expenses from discontinued
operations of $5.3 million. The decrease in cost of goods sold was primarily a
result of a $2.9 million intangible impairment charge in 2011. The decrease in
operating expenses primarily consisted of a decrease in research and development
expense of $1.1 million, a decrease in sales and marketing expense of $0.2
million, an impairment of goodwill of $4.1 million recorded in 2011, partially
offset by an increase in general and administrative expense of $0.1 million.
Operating expenses from discontinued operations decreased primarily due to a
$0.9 million decrease in salaries and payroll related expenses, a $0.2 million
decrease in depreciation expense, a $0.1 million decrease in stock-based
compensation expense, a $0.1 million decrease in facility expense and an
impairment of goodwill of $4.1 million recorded in 2011 and a $0.2 million
decrease in other operating expenses. These decreases were partially offset by
an increase in professional service fees of $0.3 million.
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Loss from discontinued operations decreased $7.3 million to $4.4 million for the
nine months ended September 30, 2012 compared to $11.7 million for the nine
months ended September 30, 2011. The decline in losses was primarily driven by
the Company's decision in the first quarter of 2012 to close down our Israel
Technology Center and exit out of our AssuredUVS business. This decrease was due
to an increase in gross profit of $1.0 million, primarily driven by a decrease
of $1.4 million in revenue and a decrease of $2.4 million cost of goods sold.
Additionally, there was a decline in operating expenses from discontinued
operations of $6.3 million. The decrease in cost of goods sold was primarily a
result of a $2.9 million intangible impairment charge in 2011. The decrease in
operating expenses from discontinued operations consisted of a decrease in
research and development expense of $2.6 million, a decrease in sales and
marketing expense of $0.5 million, and an impairment of goodwill of $4.1 million
recorded in 2011, partially offset by an increase in general and administrative
expense of $0.1 million, in addition to restructuring charges of $0.8 million
recorded in 2012. Operating expenses from discontinued operations decreased
primarily due to a $2.3 million decrease in salaries and payroll related
expenses, a $0.3 million decrease in depreciation expense, a $0.3 million
decrease in stock-based compensation expense, a $0.2 million decrease in
facility expense, an impairment of goodwill of $4.1 million recorded in 2011 and
a $0.2 million decrease in insignificant other operating expenses, offset by an
increase in restructuring charges of $0.8 million. These decreases were offset
by an increase in professional service fees of $0.3 million.
All of the above are a result of activity related to our plan to exit our
AssuredUVS business and close down our Israel Technology Development Center. See
Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements for
more details regarding our discontinued operations.
Liquidity and Capital Resources
The primary drivers affecting cash and liquidity are net losses, working capital
requirements and capital expenditures. Historically, the payment terms we have
had to offer our customers have been relatively similar to the terms received
from our creditors and suppliers. We typically bill customers on an open account
basis subject to our standard credit quality and payment terms ranging between
net 30 and net 45 days. If our net revenue increases, it is likely that our
accounts receivable balance will also increase. Conversely, if our net revenue
decreases, it is likely that our accounts receivable will also decrease. Our
accounts receivable could increase if customers, such as large OEM customers,
delay their payments or if we grant them extended payment terms. Our accounts
payable also increase or decrease in connection with changes in volumes as well
as our cash conservation strategies.
As of September 30, 2012, we had $40.5 million of cash and cash equivalents and
$37.9 million of working capital compared to $46.2 million of cash and cash
equivalents and $41.4 million of working capital as of December 31, 2011. The
decrease in cash and cash equivalents is further described below.
Cash equivalents include highly liquid investments purchased with an original
maturity of 90 days or less and consist principally of money market funds.
Operating Activities
Net cash used by operating activities for the nine months ended September 30,
2012 was $4.7 million compared to $1.1 million of cash provided by operations
for the nine months ended September 30, 2011. The operating activities that
affected cash consisted primarily of a net loss, which totaled $9.9 million for
the nine months ended September 30, 2012 compared to a net loss of $15.4 million
for the nine months ended September 30, 2011. The decrease in our net loss for
the nine months ended September 30, 2012 was primarily attributable to our exit
from our AssuredUVS business, including the closing of our Israel Technology
Center and we improved margins due to changes in product mix. These savings were
offset by increased operating costs, the majority of which were due to increased
engineering costs as we continue to invest in our next generation technologies
and in our mid-range storage array products launched in 2012, and to provide
more differentiated entry-level products for both OEM and channel customers.
The adjustments to reconcile net loss to net cash used by operating activities
for the nine months ended September 30, 2012 for items that did not affect cash
consisted of depreciation and amortization of $2.8 million, loss on the
write-off of intangible assets of $1.6 million, loss on the write-off of
property and equipment of $0.3 million, stock-based compensation expense of $3.0
million and an insignificant provision for bad debt expense.
Cash flows from operations reflects the positive impact of $3.4 million related
to a decrease in accounts receivable, which was primarily due to a decrease in
the number of days sales outstanding, which decreased from 62 days at the end of
the fourth quarter of 2011 to 54 days at the end of the third quarter of 2012.
Additionally, accounts receivable at December 31, 2011 increased due to seasonal
year end demand. Cash flows from operations also reflects the positive impact of
$1.1 million
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related to an overall decrease in prepaid expenses and other assets at
September 30, 2012, which was primarily due to payments received from a material
component supplier in relation to certain failed power supply units. Deferred
revenue had a $0.4 million positive impact to cash from operations due to an
increase in prepaid maintenance agreements sold through our Channel partners.
Cash flows from operations also reflect the impact of $1.0 million related to an
overall increase in other long-term liabilities, primarily due to increased
deferred rents on our facility leases in Longmont, CO and Carlsbad, CA.
Cash flows from operations reflect a negative impact of $0.2 million due to a
slight increase in inventories from December 31, 2011 to September 30, 2012.
Cash flows from operations also reflect a negative impact of $4.7 million due to
the pay down of our accounts payable balance, which is also reflected in our
days payable outstanding which decreased from 75 days at the end of the fourth
quarter 2011 to 69 days at the end of the third quarter of 2012. Accrued
compensation and other expenses negatively impacted the cash from operations by
$2.6 million due to settling a large invoice for software licenses and payments
on a settlement with a material customer related to failed power supply units.
Cash flows from operations also include a decrease in our restructuring accrual
of $0.8 million which is due primarily to expense payments related to shutting
down the Israel Technology Development Center and continued reductions in our
2008 Plan and 2010 Plan contractual commitments.
Investing Activities
Cash used in investing activities for the nine months ended September 30, 2012
was approximately $2.9 million compared to $2.1 million for the nine months
ended September 30, 2011. Cash used in investing activities for the nine months
ended September 30, 2012 was due to purchases of property and equipment
primarily associated with test and other equipment used by our contract
manufacturing partners in the production of our products and for equipment used
in our Longmont, Colorado engineering laboratories.
Financing Activities
Cash provided by financing activities for the nine months ended September 30,
2012 was approximately $1.9 million compared to $0.9 million for the nine months
ended September 30, 2011. Cash provided by financing activities for the nine
months ended September 30, 2012 was primarily due to $1.8 million of borrowings
under the Silicon Valley Bank line of credit and the sale of stock to employees
under our employee stock plans of approximately $0.7 million, which was offset
by tax liability payments of $0.5 million made by Dot Hill associated with
employee equity awards and $0.1 million for the ongoing pay down of our note
payable associated with our 2008 acquisition of certain intangible assets from
Ciprico.
Based on current macro-economic conditions and conditions in the state of the
data storage systems markets, our own organizational structure and our current
outlook, we presently expect our cash and cash equivalents will be sufficient to
fund our operations, working capital and capital requirements for at least the
next 12 months. However, our capital resources could be negatively impacted by
unforeseen future events.
Our standard warranty provides that if our systems do not function to published
specifications, we will repair or replace the defective component or system
without charge generally for a period of approximately three years. We generally
extend to our customers the warranties provided to us by our suppliers, and
accordingly, the majority of our warranty obligations to customers are intended
to be covered by corresponding supplier warranties. For warranty costs not
covered by our suppliers, we provide for estimated warranty costs in the period
the revenue is recognized. There can be no assurance that our suppliers will
continue to provide such warranties to us in the future or that our warranty
obligations to our customers will be covered by corresponding warranties from
our suppliers, the absence of which could have a material effect on our
financial statements. Estimated liabilities for product warranties are included
in accrued expenses.
In October 2009, we discovered a quality issue associated with certain power
supply devices provided by a long-term component supplier, which resulted in a
higher than expected level of power supply failures to us and our customers.
While we were able to promptly identify and resolve the cause of the failures,
we are required to provide replacement products or make repairs to the affected
power supply units that had been sold between March and October 2009. Through
June 30, 2011, our component supplier had repaired all of the faulty power
supplies at no cost to us and reimbursed us for our out-of-pocket costs, which
has constituted a reimbursement to customers for certain out-of-pocket costs
they incurred in connection with these power supply failures. The total amount
reimbursed to us by our component supplier approximated $1.0 million through
June 30, 2011.
In the second and third quarters of 2011, a material customer provided us with a
framework estimating the potential claims precipitated by the power supply
failures. As previously disclosed, the customer's preliminary framework of
potential claims provided to us included additional costs related to the
customer's internal overhead for other internal indirect costs, in
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addition to third-party direct costs. Based on preliminary discussions for
settlement and our analysis of the framework provided by the customer, including
future potential claims through the warranty period, we estimated that we had
incurred a probable loss of approximately $2.8 million. Consequently, in
addition to the $1.3 million previously recognized as of June 30, 2011, we
recorded an estimated liability of $1.5 million as of September 30, 2011 within
"Accrued expenses" on our condensed consolidated balance sheet.
Negotiations continued with our customer throughout the fourth quarter of 2011
into the first half of 2012. Based on the results of ongoing negotiations with
the material customer, we increased our estimated liability at December 31, 2011
to $5.5 million, resulting in a charge of $2.7 million during the fourth quarter
of 2011 within "Accrued expenses" on our condensed consolidated balance sheet,
gross of any third-party recoveries.
A final settlement with this material customer was reached during the second
quarter of 2012. The terms of the agreement required an immediate payment of
$2.0 million, and an estimated remaining liability of approximately $2.7 million
as of September 30, 2012 related to a combination of future price concessions
and rebates to be paid quarterly based on sales volumes through December 31,
2012. While our estimated liability relating to failed power supply units is
subject to some uncertainty until final settlement, based on our current
expectation of sales volumes with this material customer, we do not believe the
incurrence of an additional loss is either probable or reasonably possible at
this time.
During the second quarter of 2011, based on the advice of legal counsel, we
established that our component supplier is contractually obligated to reimburse
us for fair and reasonable costs we incur with our customers associated with
these power supply failures. Our component supplier had continued to re-work and
distribute to our customer the affected population of power supplies at no cost
to us. In addition, at the time, our collection experience with similar amounts
already reimbursed to us by our supplier and our belief that our component
supplier and its parent companies had the financial ability to continue to
reimburse us for any additional costs we may incur, we recorded a current asset
within "Prepaid expenses and other assets" on our consolidated balance sheet of
$1.3 million as of June 30, 2011.
During the third quarter of 2011, as the claims from our customer became
clearer, we commenced negotiations with our component supplier for fair and
reasonable costs that we have and are likely to incur through the warranty
period associated with this component failure. Originally we determined that the
supplier was unlikely to make an up-front cash payment for the original
settlement amount of $1.3 million, but it indicated a willingness to provide
some form of reimbursement for costs incurred, in the form of cash and/or note
receivable of $0.5 million plus future product rebates. Based on our judgment at
the time, we reduced the previously recorded current asset of $1.3 million
within "Prepaid expenses and other assets" to $0.5 million as of September 30,
2011. We continued to negotiate this settlement with our supplier and during the
second quarter of 2012, the supplier signed a final settlement agreement
providing for additional reimbursements above what was recognized as of
September 30, 2011. Pursuant to the settlement, the supplier agreed to cash
consideration of $1.2 million, of which we received $0.7 million subsequent to
the signing of the settlement agreement, with the remaining $0.5 million to be
received in installments over the next three quarters. Additionally, our
supplier committed to product rebates and/or price concessions on product orders
for a period of 39 months from the execution of the settlement agreement, in
return for our agreement to release our supplier from all obligations relating
to the power supply failures known by us to date. This agreement is not subject
to any required future purchases.
In addition, we have commenced discussions with our General Liability and Errors
and Omissions Insurance and underwriters and will continue to pursue our rights
to cover any damages we incur and that are not reimbursed by our supplier. The
insurance company has issued a reservation of rights letter to us and at this
time, it is not possible to estimate to what extent the residual amounts, if
any, we will be covered by our carrier. As of September 30, 2012 we have not
assumed or recorded any insurance reimbursement.
To the extent our settlement agreements with our customer and our component
supplier are not on mutually beneficial terms, or our component supplier does
not continue to reimburse us for the expenses incurred by us or our customers,
and we are unsuccessful in recovering such expenses from our insurance provider,
we could incur additional expenses which could potentially have a material
effect on our financial statements and liquidity.
In July 2012, a technology partner notified us of a dispute regarding royalties
paid to it for the right to include their technology in certain products sold by
us under an intellectual property licensing agreement. This claim relates to
certain sales during the period from June 2006 to August 2011. We are reviewing
this claim, but cannot at this stage in the process determine the likelihood of
the outcome. Our initial estimate of our potential exposure ranges between $0.0
million and $1.9 million.
During September 2011, our primary AssuredUVS customer became delinquent on the
settlement of its payables to us and upon our investigation it became evident
that its financial resources were limited. It informed us that the AssuredUVS
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software would no longer be a component of its business strategy, which would
result in a significant decline in revenues for the Company, and we determined
it was "more-likely-than-not" that the reporting unit was less than its carrying
value.
The actual amount and timing of working capital and capital expenditures that we
may incur in future periods may vary significantly and will depend upon numerous
factors, including the timing and extent of net revenue and expenditures from
our core business and strategic investments, the overall level of net profits or
losses, our ability to manage our relationships with our contract manufacturers,
the potential growth or decline in inventory to support our customers, costs
associated with product quality issues and the recovery, if any, of such costs
from a supplier, the status of our relationships with key customers, partners
and suppliers, the timing and extent of the introduction of new products and
services, growth in operations and the economic environment. In addition, the
actual amount and timing of working capital will depend on our ability to
maintain payment terms with our suppliers consistent with the credit terms of
our customers. For example, if Foxconn, our major contract manufacturing
partner, were to shorten our payment terms with them, or if HP were to lengthen
their payment terms with us, our financial condition could be harmed.
We maintain a credit facility with Silicon Valley Bank for cash advances and
letters of credit of up to an aggregate of $30 million based upon an advance
rate dependent on certain concentration limits within eligible accounts
receivable. These limitations exclude certain eligible customer receivables if
an individual customer account balance exceeds 25, 50 or 85 percent of the total
eligible accounts receivable, depending on the customer, as defined by our Loan
and Security Agreement with Silicon Valley Bank. Borrowings under the credit
facility bear interest at the prime rate and are secured by substantially all of
our accounts receivable, deposit and securities accounts. The agreement provides
for a negative pledge on our inventory and intellectual property, subject to
certain exceptions, and contains usual and customary covenants for an
arrangement of its type, including an obligation that we maintain at all times a
net worth, as defined in the agreement, of $50 million (subject to certain
increases). The agreement also includes provisions to increase the financing
facility by $20 million subject to our meeting certain requirements, including
$40 million in borrowing base for the immediately preceding 90 days, and Silicon
Valley Bank locating a lender willing to finance the additional facility. In
addition, if our cash and cash equivalents net of the total amount outstanding
under the credit facility fall below $20 million (measured on a rolling
three-month basis), the interest rate will increase to prime plus 1% and
additional restrictions will apply. Our credit facility also provides for a cash
management services sublimit under the revolving credit line of up to $300,000.
During the second quarter of 2012, we amended our credit agreement with Silicon
Valley Bank. The amendment extends the maturity date to July 21, 2015 and
amended certain other terms of the credit agreement, which we do not believe
materially impacts our financial position. As of September 30, 2012 we had no
outstanding letters of credit and there was $1.8 million outstanding under the
Silicon Valley Bank line of credit.
At September 30, 2012, our long-term commitments had not materially changed from
those disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2011.
Off - Balance Sheet Arrangements
At September 30, 2012, we did not have any relationship with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance variable interest, or special purpose entities, which would
have been established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes. In addition, we
did not engage in trading activities involving non-exchange traded contracts. As
a result, we are not exposed to any financing, liquidity, market or credit risk
that could arise if we had engaged in such relationships. We do not have
relationships and transactions with persons and entities that derive benefits
from their non-independent relationship with us or our related parties except as
disclosed herein.
We enter into indemnification agreements with third parties in the ordinary
course of business that generally require us to reimburse losses suffered by the
third party due to various events, such as lawsuits arising from patent or
copyright infringement. These indemnification obligations are considered
off-balance sheet arrangements under accounting guidance. It is not possible to
determine the maximum potential amount under these indemnification agreements
due to the limited history of prior indemnification claims and the unique facts
and circumstances involved in each particular agreement. Such indemnification
agreements may not be subject to maximum loss clauses. Historically, we have not
incurred material costs as a result of obligations under these agreements.
Recent Accounting Pronouncements
Please see Note 1 of the Notes to Unaudited Condensed Consolidated Financial
Statements.
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