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EX-32.2 - EXHIBIT 32.2 - Gigamon Inc.ex322201710-q.htm
EX-32.1 - EXHIBIT 32.1 - Gigamon Inc.ex321201710-q.htm
EX-31.2 - EXHIBIT 31.2 - Gigamon Inc.ex312201710-q.htm
EX-31.1 - EXHIBIT 31.1 - Gigamon Inc.ex311q2201710-q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 (Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 1, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934                 
For the transition period from ______to______.    
Commission File Number 001-35957
gigalogoa02a07.jpg 
 
Gigamon Inc.
(Exact name of Registrant as specified in its Charter)
 
Delaware
 
26-3963351
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
3300 Olcott Street, Santa Clara, California 95054
(Address of principal executive offices and Zip Code)
 
 
 
(408) 831-4000
(Registrant's telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  ý NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES  ý NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.:
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
 
 
 
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Emerging growth company ¨
 
  If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES  ¨ NO  ý
As of July 22, 2017, there were 37,419,506 shares of the registrant’s common stock outstanding.




Gigamon Inc.
Form 10-Q
For the Quarterly Period Ended July 1, 2017

TABLE OF CONTENTS
 
 
Page No.
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 




PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Gigamon Inc.
Condensed Consolidated Balance Sheets
(In thousands, except par value)
(Unaudited)
 
July 1, 2017
December 31, 2016
ASSETS
 
 
CURRENT ASSETS:
 
 
Cash and cash equivalents
$
151,106

$
148,926

Short-term investments
107,722

109,238

Accounts receivable, net of allowance for doubtful accounts and sales returns of $925 and $979, as of July 1, 2017 and December 31, 2016, respectively
63,519

75,522

Inventories
14,301

11,347

Prepaid expenses and other current assets
12,176

9,909

Total current assets
348,824

354,942

Property and equipment, net
14,299

11,809

Deferred tax assets, net
48,866

33,094

Other assets, non-current
1,379

1,154

TOTAL ASSETS
$
413,368

$
400,999

LIABILITIES AND STOCKHOLDERS’ EQUITY

 
CURRENT LIABILITIES:
 
 
Accounts payable
$
4,063

$
5,208

Accrued liabilities
24,768

34,649

Deferred revenue
65,652

68,997

Total current liabilities
94,483

108,854

Deferred revenue, non-current
31,021

28,785

Deferred and other tax liabilities, non-current
475

201

Other liabilities, non-current
510

499

TOTAL LIABILITIES
126,489

138,339

Commitments and Contingencies (Note 5)


STOCKHOLDERS’ EQUITY
 
 
Preferred stock—$0.0001 par value; 20,000 shares authorized, no shares issued or outstanding as of July 1, 2017 and December 31, 2016, respectively.


Common stock—$0.0001 par value; 1,000,000 shares authorized, 36,924 and 36,303 shares issued and outstanding as of July 1, 2017 and December 31, 2016, respectively.
4

4

Additional paid-in capital
287,145

256,774

Accumulated other comprehensive income (loss)
(104
)
(17
)
Retained earnings (accumulated deficit)
(166
)
5,899

TOTAL STOCKHOLDERS’ EQUITY
286,879

262,660

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
413,368

$
400,999

The accompanying notes are an integral part of these condensed consolidated financial statements.


1



Gigamon Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Revenue:
 
 
 
 
Product
$
43,192

$
51,308

$
87,202

$
95,970

Service
25,945

23,795

51,502

46,344

Total revenue
69,137

75,103

138,704

142,314

Cost of revenue:




Product
10,424

11,510

21,028

22,217

Service
2,894

2,339

5,600

4,421

Total cost of revenue
13,318

13,849

26,628

26,638

Gross profit
55,819

61,254

112,076

115,676

Operating expenses:




Research and development
20,519

17,250

40,668

32,608

Sales and marketing
36,892

28,843

70,333

56,500

General and administrative
10,281

9,147

19,336

17,142

Total operating expenses
67,692

55,240

130,337

106,250

Income (loss) from operations
(11,873
)
6,014

(18,261
)
9,426

Interest income
477

219

833

426

Other expense, net
(75
)
(173
)
(192
)
(242
)
Income (loss) before income tax benefit
(11,471
)
6,060

(17,620
)
9,610

Income tax benefit (provision)
4,133

27,899

8,045

27,320

Net income (loss)
$
(7,338
)
$
33,959

$
(9,575
)
$
36,930

Net income (loss) per share:
 
 




Basic
$
(0.20
)
$
0.97

$
(0.26
)
$
1.06

Diluted
$
(0.20
)
$
0.91

$
(0.26
)
$
1.00

Weighted average shares used in computing net income (loss) per share:








Basic
36,890

35,146

36,728

34,878

Diluted
36,890

37,262

36,728

36,792

The accompanying notes are an integral part of these condensed consolidated financial statements.


2



Gigamon Inc.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands) 
(Unaudited)
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Net income (loss)
$
(7,338
)
$
33,959

$
(9,575
)
$
36,930

Other comprehensive income (loss):
 
 
 
 
Unrealized gain (loss) on available-for-sale investments, net
(54
)
30

(87
)
114

Comprehensive income (loss)
$
(7,392
)
$
33,989

$
(9,662
)
$
37,044

The accompanying notes are an integral part of these condensed consolidated financial statements.


3



Gigamon Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
Six Months Ended
 
July 1, 2017
July 2, 2016(1)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
Net income (loss)
$
(9,575
)
$
36,930

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
Depreciation and amortization
4,197

3,173

Stock-based compensation expense
29,018

18,780

Deferred income taxes
(8,357
)
(30,891
)
Inventory write-down
931

272

Other
142

312

Changes in operating assets and liabilities:
 
 
Accounts receivable
11,893

3,362

Inventories
(4,173
)
(3,593
)
Prepaid expenses and other assets
(2,022
)
(1,238
)
Accounts payable
(1,225
)
(515
)
Accrued liabilities and other liabilities
(10,574
)
(5,890
)
Deferred revenue
(1,109
)
(2,275
)
Net cash provided by (used in) operating activities
9,146

18,427

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
Purchase of short-term investments
(69,158
)
(63,831
)
Proceeds from maturities of short-term investments
70,712

61,247

Purchase of property and equipment
(5,202
)
(4,478
)
Net cash provided by (used in) investing activities
(3,648
)
(7,062
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
Proceeds from employee stock purchase plan
4,956

3,368

Proceeds from exercise of stock options
943

4,126

Shares repurchased for tax withholdings on vesting of restricted stock units
(8,404
)
(3,829
)
Net cash provided by (used in) financing activities
(2,505
)
3,665

NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH
2,993

15,030

CASH, CASH EQUIVALENTS AND RESTRICTED CASH — Beginning of period
148,926

120,212

CASH, CASH EQUIVALENTS AND RESTRICTED CASH — End of period
$
151,919

$
135,242

 
 
 
Reconciliation to cash and cash equivalents and Other assets, non-current
 
 
Current assets - Cash and cash equivalents
$
151,106

$
135,242

Other assets, current - restricted cash
813


Total cash, cash equivalents and restricted cash
$
151,919

$
135,242

 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

 
Income taxes paid during the period
$
1,003

$
811

NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
Unpaid property and equipment purchases
$
1,968

$
121

(1)Reflects the impact of the adoption of the accounting standard update related to Improvements to Employee Share-Based Payment Accounting, which amends Compensation - Stock Compensation.

The accompanying notes are an integral part of these condensed consolidated financial statements.


4



Gigamon Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Description of the Company
The Company
Gigamon Inc. (the “Company”) designs, develops and sells products and services that together provide customers visibility and control of network traffic. The Company serves global enterprises, governments and service providers that seek to maintain and improve the security, reliability and performance of their network infrastructure.
2. Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
The Company prepared its condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. As such, the unaudited information included in this Quarterly Report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
There have been no changes to the Company’s significant accounting policies described in the Annual Report on Form 10-K that have had a material impact on the Company’s condensed consolidated financial statements and related notes except for the adoption of the accounting standard update related to Improvements to Employee Share-Based Payment Accounting, which amends Compensation - Stock Compensation and the accounting standard update related to restricted cash, which affected the presentation in the condensed consolidated statements of cash flows.
Certain prior periods’ amounts were reclassified to conform to the current year’s presentation. None of these reclassifications impacted the reported net income (loss) or earnings per share for any of the periods presented.
The Company's fiscal year is 52 or 53 weeks and ends on the last Saturday in December. Fiscal 2016 was a 53-week fiscal year ending on December 31, 2016; the first quarter was a 14-week quarter ended on April 2, 2016 and each subsequent quarter was a 13-week quarter. Fiscal 2017 is a 52-week fiscal year ending on December 30, 2017, with each quarter therein being a 13-week quarter.
Unaudited Interim Financial Statements
The accompanying unaudited interim condensed consolidated financial statements have been prepared on a basis consistent with the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include normal recurring adjustments, necessary to fairly state the Company’s financial position as of July 1, 2017, its results of operations and comprehensive income (loss) for the three and six months ended July 1, 2017 and July 2, 2016, respectively, and cash flows for the six months ended July 1, 2017 and July 2, 2016, respectively. The financial data and the other financial information disclosed in the accompanying notes to the condensed consolidated financial statements related to these three and six month periods are also unaudited. The fiscal year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. The condensed consolidated statements of operations for the three and six months ended July 1, 2017 is not necessarily indicative of the results to be expected for the full fiscal year or any other future periods.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods. On an ongoing basis, the Company evaluates its estimates, including but not limited to those related to revenue recognition, allowance for doubtful accounts, warranty reserve, excess and obsolete inventory write-downs, stock-based compensation expense, depreciable useful lives and income taxes. The Company bases its estimates on historical experience, projections for future performance and other assumptions that it believes to be reasonable under the circumstances. Actual results could differ materially from those estimates.

5



Concentrations
The Company operates in highly competitive and rapidly changing markets that could negatively impact the Company’s operating results. A number of components that meet the Company’s manufacturing requirements are available only from single source suppliers. In addition, the Company relies on two contract manufacturers to manufacture a substantial majority of its products. The inability of its single source suppliers and contract manufacturers to provide the Company with adequate supplies of high-quality components and products could cause a delay in order fulfillment, which could adversely affect the Company’s revenue, cost of revenue and operating results.
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents, short-term investments and accounts receivable. The majority of the Company's cash, cash equivalents and short-term investments are held in, or managed by a limited number of major financial institutions in the United States that management believes are creditworthy. Such deposits may exceed the insured limits provided on them. The Company mitigates credit risk associated with its accounts receivable by performing ongoing credit evaluations of its customers and determines if it needs to establish an allowance for doubtful accounts for estimated losses based on management’s assessment of the collectability of customer accounts.
The following customers represented more than 10% or more of total revenue or accounts receivable:
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Percent of Revenue:
 
 
 
 
Customer A (distributor)
20
%
32
%
22
%
34
%
Customer B (distributor)
33
%
27
%
26
%
26
%
Customer C (end user)
*

13
%
11
%
13
%
* Represents less than 10% of total revenue
 
As of
 
July 1, 2017
December 31, 2016
Percent of Accounts Receivable:
 
 
Customer A (distributor)
14
%
32
%
Customer B (distributor)
37
%
16
%
Customer C (end user)
10
%
10
%

Recent Accounting Pronouncements
New Accounting Updates Recently Adopted
The Company has adopted the accounting standard update related to Improvements to Employee Share-Based Payment Accounting, which amends Compensation – Stock Compensation during the first quarter of fiscal 2017. Specifically, the Company elected to account for forfeitures as they occur, rather than estimate expected forfeitures. The net cumulative effect of the change was recognized as a $3.6 million reduction to retained earnings as of January 1, 2017. Stock-based excess tax benefits or shortfalls are now reflected in the results of operations as a component of the income tax benefit (provision), whereas they previously were recognized in equity. The cumulative impact of this change was recorded as a deferred tax asset of $7.6 million for the previously unrecognized excess tax benefits with an adjustment of $7.1 million and $0.5 million to retained earnings and a valuation allowance for a certain jurisdiction, respectively. Additionally, the Company's condensed consolidated statements of cash flows now includes excess tax benefits as an operating activity with the prior period adjusted accordingly.
The Company has adopted the restricted cash guidance, which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods presented in the condensed consolidated statements of cash flows in the first quarter of fiscal 2017 using a retrospective transition method for each period presented.

6



Recent Accounting Updates Not Yet Effective
In May 2014, the Financial Accounting Standards Board (the "FASB") issued an accounting standard update related to revenue from contracts with customers, which supersedes the revenue recognition requirements in the current Accounting Standards Codification. This standard is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This standard also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB voted to defer the effective date of this standard by one year. Additionally, in March 2016 the FASB issued additional information that clarifies the implementation guidance on principal versus agent considerations. The new standard permits adoption either by using (i) a full retrospective approach for all periods presented in the period of adoption or (ii) a modified retrospective approach with the cumulative effect of initially applying the new standard recognized at the date of initial application and providing certain additional disclosures. The new standard is effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted for annual reporting periods beginning after December 15, 2016. The Company did not elect to early adopt, and accordingly, it will adopt the new standard effective for its fiscal year 2018.
The Company is evaluating the impact of the new standard on its accounting policies, processes, and system requirements and currently plans to adopt using the full retrospective approach. However, a final decision regarding the adoption method has not been finalized at this time. The Company's final determination will depend on a number of factors, such as the significance of the impact of the new standard on our financial results, system readiness, including that of software procured from third-party providers, and its ability to accumulate and analyze the information necessary to assess the impact on prior period financial statements, as necessary.
Revenue recognition for non-essential software is currently accounted for under the Software Revenue Recognition guidance, which entails allocating the arrangement consideration to deliverables that have established vendor specific objective evidence value (“VSOE”) or fair value and the residual to other deliverables based on third party evidence or best estimates of selling prices. Revenue from each deliverable is then recognized when all requirements are met for that specific deliverable. As the new standard does not retain the concept of VSOE, the Company preliminarily believes it will use the Standalone Selling Price to determine the appropriate amount to be allocated to each separate performance obligation using the Relative Selling Price approach. As part of the Company's preliminary evaluation, it has also considered the impact of the guidance relating to Other Assets and Deferred Costs; Contracts with customers, and the interpretations of the FASB Transition Resource Group for Revenue Recognition ("TRG") from their November 7, 2016 meeting with respect to capitalization and amortization of incremental costs of obtaining a contract. As a result of this new guidance, the Company preliminarily believes that it will capitalize certain costs of obtaining a contract, including additional sales commissions, as the new cost guidance, as interpreted by the TRG, requires the capitalization of all incremental costs that the Company incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained, provided it expects to recover the costs. Under the Company's current accounting policy, it expenses the commission costs immediately as incurred.
While the Company continues to assess the potential impacts of the new standard, it anticipates this standard could have a material impact on its consolidated financial statements. However, the Company cannot reasonably estimate quantitative information related to the impact of the new standard on its consolidated financial statements at this time.
In February 2016, the FASB issued an accounting standard update which amends the existing accounting standards for leases. Consistent with current guidance, the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification. Under the new guidance, a lessee will be required to recognize assets and liabilities for all leases with lease terms of more than 12 months. The effective date of this update will be for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 using a modified retrospective transition method with early adoption permitted. The Company expects the standard to have a material impact on its assets and liabilities for the addition of right-of-use assets and lease liabilities, but the Company does not expect it to have a material impact on its results of operations or liquidity.
In June 2016, the FASB issued new guidance that changes the accounting for recognizing impairments of financial assets. Under the new guidance, credit losses for certain types of financial instruments will be estimated based on expected losses. The new guidance also modifies the impairment models for available-for-sale debt securities and for purchased financial assets with credit deterioration since their origination. The effective date of this standard will be for annual periods ending after December 15, 2019, and interim periods within that reporting period. Early adoption is permitted starting in annual periods ending after December 15, 2018. The Company is evaluating the impact of this guidance on its consolidated financial statements.

7



In October 2016, the FASB issued new guidance that requires a reporting entity to recognize the tax expense from intra-entity asset transfers of assets other than inventory in the selling entity’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. Any deferred tax asset that arises in the buying entity’s jurisdiction would also be recognized at the time of the transfer. The new guidance will likely impact reporting entities’ effective tax rates. The new guidance is effective for interim and annual periods beginning after December 15, 2017 and early adoption is permitted. The amendment should be adopted using the modified retrospective approach with a cumulative-effect adjustment recorded in retained earnings as of the beginning of the period of adoption. The Company is evaluating the impact of this guidance on its consolidated financial statements.
3. Fair Value Measurements
The inputs used in the valuation methodologies in measuring fair value are defined in the fair value hierarchy as follows:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The carrying value of the Company’s accounts receivable, accounts payable and accrued liabilities approximates their fair value due to the short-term nature of these instruments.
Cash Equivalents and Short-Term Investments
The components of the Company’s cash equivalents and short-term investments are as follows (in thousands):
 
 
Fair Value Measured Using
 
July 1, 2017
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Cash equivalents:
 
 
 
Money market funds
$
91,544

$
91,544

$

Commercial papers
9,995


9,995

Total cash equivalents
$
101,539

$
91,544

$
9,995

 
 
 
 
Short-term investments:
 
 
 
Corporate debt securities
$
24,037

$

$
24,037

Commercial papers
10,274


10,274

U.S. agency debt securities
7,990


7,990

U.S. government securities
65,421


65,421

Total short-term investments
$
107,722

$

$
107,722



8



 
 
Fair Value Measured Using
 
December 31, 2016
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Cash equivalents:
 
 
 
Money market funds
$
99,992

$
99,992

$

Commercial papers
1,999


1,999

Total cash equivalents
$
101,991

$
99,992

$
1,999

 
 
 
 
Short-term investments:
 
 
 
Corporate debt securities
$
10,110

$

$
10,110

Commercial papers
12,956


12,956

U.S. agency debt securities
21,697


21,697

U.S. government securities
64,475


64,475

Total short-term investments
$
109,238

$

$
109,238

The Company considers all highly liquid investments with maturity of three months or less at the time of purchase to be cash equivalents. The Company holds money market funds that invest primarily in high-quality short-term money-market instruments, and these funds are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Company presents available-for-sale investments as current assets as they are available for the Company's current operations.
Money market funds have been classified as Level 1 because these securities are valued based upon quoted prices in active markets. The Company’s Level 2 assets are priced using quoted market prices for similar instruments or non-binding market prices that are corroborated by observable market data. The Company uses inputs such as actual trade data, benchmark yields, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency which are obtained from quoted market prices, independent pricing vendors or other sources, to determine the ultimate fair value of these assets. The Company has no assets classified as Level 3. The Company’s policy is to recognize transfers among Level 1, Level 2 and Level 3 classifications as of the actual date of the events or change in circumstances that caused the transfers. The Company did not have any transfers between Level 1 and Level 2 in the six months ended July 1, 2017.
As of July 1, 2017 and December 31, 2016, the Company had no liabilities measured at fair value.
Financial assets measured at amortized cost, gross unrealized gains, gross unrealized losses and fair value by significant investment categories are summarized as follows (in thousands):
 
As of July 1, 2017
 
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Cash equivalents:
 
 
 
 
Money market funds
$
91,544

$

$

$
91,544

Commercial papers
9,995



9,995

Total cash equivalents
$
101,539

$

$

$
101,539

Short-term investments:
 
 
 
 
Corporate debt securities
$
24,052

$
2

$
(17
)
$
24,037

Commercial papers
10,274



10,274

U.S. agency debt securities
7,997


(7
)
7,990

U.S. government securities
65,503


(82
)
65,421

Total short-term investments
$
107,826

$
2

$
(106
)
$
107,722


9



 
As of December 31, 2016
 
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Cash equivalents:
 
 
 
 
Money market funds
$
99,992

$

$

$
99,992

Commercial papers
1,999



1,999

Total cash equivalents
$
101,991

$

$

$
101,991

Short-term investments:
 
 
 
 
Corporate debt securities
$
10,119

$

$
(9
)
$
10,110

Commercial papers
12,956



12,956

U.S. agency debt securities
21,698

1

(2
)
21,697

U.S. government securities
64,482

8

(15
)
64,475

Total short-term investments
$
109,255

$
9

$
(26
)
$
109,238

The Company had no realized gains from sales of securities in the six months ended July 1, 2017. There were no securities in a material continuous loss position for 12 months or longer as of July 1, 2017 and December 31, 2016.
The contractual maturity date of the cash equivalents and short-term investments at estimated fair value was as follows (in thousands):
 
As of
 
July 1, 2017
December 31, 2016
Due within one year
$
185,952

$
205,250

Due between one and five years
23,309

5,979

Total
$
209,261

$
211,229

4. Balance Sheet Components
Inventories
Inventories are comprised of the following (in thousands):
 
As of
 
July 1, 2017
December 31, 2016
Raw materials
$
82

$
50

Finished goods
14,219

11,297

Total inventories
$
14,301

$
11,347

Inventory is valued at the lower of cost computed on a first-in, first-out basis, or net realizable value.

10



Property and equipment, net
Property and equipment, net, are comprised of the following (in thousands):
 
As of
 
July 1, 2017
December 31, 2016
Equipment and machinery
$
23,512

$
20,611

Furniture and fixtures
676

654

Leasehold improvements
5,220

3,367

Software
2,898

2,519

Total property and equipment
32,306

27,151

Less accumulated depreciation and amortization
(18,007
)
(15,342
)
Total property and equipment, net
$
14,299

$
11,809

Depreciation and amortization expense was $3.3 million and $5.3 million for six months ended July 1, 2017 and fiscal 2016, respectively.
Accrued Liabilities
Accrued liabilities are comprised of the following (in thousands):
 
As of
 
July 1, 2017
December 31, 2016
Accrued employee related costs
$
14,005

$
25,468

Accrued inventory and other purchases
2,994

1,778

Accrued taxes payable
1,276

1,977

Accrued professional services
961

667

Other accruals
5,532

4,759

Total accrued liabilities
$
24,768

$
34,649

Accrued Warranty
Warranty activity and accrued warranty is comprised of the following (in thousands):
 
Six Months Ended
 
July 1, 2017
July 2, 2016
Accrued warranty balance at beginning of period
$
960

$
807

Accrual for warranty during the period
764

982

Actual costs incurred
(855
)
(809
)
Accrued warranty balance at end of period
$
869

$
980

 
As of
Accrued warranty reported as:
July 1, 2017
December 31, 2016
Accrued liabilities, current
$
599

$
653

Other liabilities, non-current
270

307

Total accrued warranty
$
869

$
960








11



Deferred Revenue
Deferred revenue is comprised of the following (in thousands):
 
As of
 
July 1, 2017
December 31, 2016
Deferred service revenue
$
96,646

$
97,646

Deferred product revenue
27

136

Total deferred revenue
$
96,673

$
97,782

Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss consists of unrealized gains and losses from available-for-sale securities. The following summarizes the activity within accumulated other comprehensive loss (in thousands):
Accumulated Other Comprehensive Loss

Balance as of December 31, 2016
$
(17
)
Available-for-sale securities:

Unrealized loss
(87
)
Total other comprehensive loss
(87
)
Balance as of July 1, 2017
$
(104
)
There was no material tax impact on the unrealized gains or losses and total other comprehensive income.
There were no material reclassifications out of accumulated other comprehensive loss into the condensed consolidated statements of operations in the six months ended July 1, 2017 and July 2, 2016.
5. Commitments and Contingencies
Lease Commitments
The Company leases office space for its current headquarters in Santa Clara, California and its United Kingdom subsidiary under non-cancelable operating leases that expire at various dates through fiscal 2025. The Company has also entered into lease agreements for additional office space in India and Sweden. The Company recognizes rent expense on a straight-line basis over the lease period.
Rent expense related to the Company’s operating leases was $1.3 million and $1.0 million for the three months ended July 1, 2017 and July 2, 2016, respectively, and $2.3 million and $1.9 million for the six months ended July 1, 2017 and July 2, 2016, respectively.
No material change in the future minimum lease payments under non-cancelable operating leases has occurred in the six months ended July 1, 2017 and as reported in the Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Purchase Commitments
The Company has agreements with two contract manufacturers for the manufacture of its products. The agreement with its primary contract manufacturer allows the contract manufacturer to procure components on the Company’s behalf based upon a production forecast provided by the Company. The Company also purchases raw materials directly from suppliers to be used by the contract manufacturers in the production of the Company’s products. The Company may be obligated to purchase component inventory that is non-cancelable. As of July 1, 2017 and December 31, 2016, the Company’s non-cancelable purchase commitments for such component inventory were $20.4 million and $15.7 million, respectively.
Legal Proceedings
On January 27, 2017, a purported shareholder class action was filed in the United States District Court for the Northern District of California against the Company and three of its current and former officers. The plaintiff alleges that the Company made false and misleading statements about the Company’s business, operations, and prospects, including statements about the Company’s guidance, for the fourth quarter of 2016. The complaint seeks unspecified monetary damages, attorneys' fees and costs and other relief. The Company believes this lawsuit is without merit and intends to defend against it vigorously. The matter is still in the very early stages and the Company will defend against

12



the allegations accordingly. Due to the current early stage of the proceedings, the Company cannot reasonably estimate the loss or the range of possible losses, if any.
Indemnification Obligations
Under the indemnification provisions of its standard sales related contracts, the Company agrees to defend its customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks, or trade secrets, and to pay judgments entered on such claims. The Company’s exposure under these indemnification provisions is generally limited to the total amount paid by its customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose the Company to losses in excess of the amount received under the agreement. The Company has not incurred any costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in its condensed consolidated financial statements. In addition, the Company indemnifies its officers, directors and certain key employees while they are serving in good faith in the company capacities. To date, there have been no claims under any indemnification provisions.
6. Stockholders’ Equity
Equity Award Plans
2013 Equity Incentive Plan
In May 2013, the Company adopted the 2013 Equity Incentive Plan (the “2013 Equity Plan”). All authorized but unissued shares of the Company’s 2012 Unit Option Plan (the “2012 Plan”) were added to the 2013 Equity Plan’s authorized pool in June 2013. The Company is authorized to issue up to a maximum of 2,929,481 shares of common stock for future issuance, plus up to an additional 4,967,172 shares upon termination of awards under the 2012 Plan. In addition, the 2013 Equity Plan is subject to increase annually on the first day of each of the Company’s fiscal years beginning with fiscal 2014, by an amount equal to the least of (i) 1,464,740 shares, (ii) 5% of the outstanding shares of common stock as of the last day of the immediately preceding fiscal year, or (iii) such other amount as determined by the Company's board of directors. Vested but unexercised options, under the 2013 Equity Plan, expire three months after termination of service with the Company. An additional 1,464,740 shares were authorized during the six months ended July 1, 2017. As of July 1, 2017, outstanding awards under the 2013 Equity Plan and the 2012 Plan covered 3,841,840 shares and 345,951 shares of the Company's common stock, respectively.
The 2013 Equity Plan permits the granting of stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs"), performance units and performance shares to employees, directors and consultants of the Company.
Employee Stock Purchase Plan
In conjunction with the completion of its initial public offering in June 2013 (the "IPO"), the Company adopted the 2013 Employee Stock Purchase Plan (the “ESPP”). A maximum of 439,422 shares were initially authorized for future issuance. In addition, the ESPP is subject to increase annually on the first day of each of the Company’s fiscal years beginning with fiscal 2014, by an amount equal to the least of (i) 439,422 shares, (i) 1.5% of the outstanding shares of common stock as of the last day of the immediately preceding fiscal year, or (iii) such other amount as determined by the Company’s board of directors. Eligible employees can purchase shares of the Company’s common stock at a discount through payroll deductions of up to 15% of their eligible compensation, subject to plan limitations. Employees are able to purchase shares at 85% of the lower of the fair market value of the Company’s common stock (i) at the date of commencement of the offering period or (ii) at the last day of the purchase period. The ESPP provides for a 24-month offering period comprised of four purchase periods of approximately six months. The offering periods are scheduled to start on the first trading day on or after February 15 and August 15 of each year, except for the first offering period, which commenced on the first trading day upon the completion of the Company’s IPO, or June 12, 2013, and ended on August 17, 2015.
In accordance with the terms of the ESPP, an additional 439,422 shares were authorized for future issuance during the six months ended July 1, 2017. The Company recorded stock-based compensation expense for its ESPP of $1.7 million and $3.9 million for the three and six months ended July 1, 2017, respectively, and $0.5 million and $1.4 million for the three and six months ended July 2, 2016, respectively. For the six months ended July 1, 2017 there was one purchase period that resulted in the issuance of 192,107 shares of the Company's common stock at a weighted average purchase price of $25.96 per share.



13



Stock Options
Stock options granted under the 2013 Equity Plan and formerly under the 2012 Plan (together, the “Equity incentive Plans”), are generally subject to a four-year vesting period whereby stock options become 25% vested on the first anniversary of the grant date and then ratably monthly thereafter through the end of the vesting period. Vested stock options may be exercised up to ten years from the vesting commencement date. Under the 2012 Plan, vested but unexercised stock options expire 30 days after termination of service with the Company.
The following table summarizes the stock option activity under the Company’s Equity Incentive Plans:
 
Number of
Stock
Options
Outstanding
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Life (Years)
Aggregate
Intrinsic
Value
(in Thousands)
Balance — December 31, 2016
1,391,171

$
21.19

6.39
$
35,076

Options granted
67,777

$
36.30



Options exercised
(73,137
)
$
12.89



Options forfeited/canceled
(112,087
)
$
25.28



Balance — July 1, 2017
1,273,724

$
22.11

6.11
$
23,766

Exercisable — July 1, 2017
885,131

$
17.45

5.95
$
19,386

Aggregate intrinsic value represents the difference between the exercise price of the awards and the Company’s fair value per share of $39.35 and $45.55 as of July 1, 2017 and December 31, 2016, respectively, for the total number of underlying options.
Restricted Stock Unit Activity
RSUs generally vest over a period of one to four years. RSU vesting dates are determined by the Company. The vesting is subject to the employee’s continuing service with the Company over that period. Until vested, RSUs do not have the voting or dividend participation rights of the Company’s common stock and the shares of the Company’s common stock underlying the awards are not considered issued and outstanding. The cost of RSUs is determined using the fair value of the Company’s common stock on the date of the grant.
The following table summarizes the RSU activity under the Company’s Equity Incentive Plans:
 
Number of
RSUs
Outstanding
Weighted-
Average
Grant Date
Fair Value
Weighted-
Average
Remaining
Contractual
Life (Years)
Aggregate
Intrinsic
Value
(in Thousands)
December 31, 2016
2,466,049

$
26.66

1.39
$
112,329

RSUs awarded
1,363,714

$
35.23



RSUs released
(617,645
)
$
25.06



RSUs forfeited
(301,495
)
$
25.36



As of July 1, 2017
2,910,623

$
31.15

1.43
$
114,533

 Aggregate intrinsic value for RSUs represents the Company’s fair market value per share of $39.35 and $45.55, as of July 1, 2017 and December 31, 2016, respectively, for the total number of underlying RSUs. The Company withheld shares totaling $8.4 million in value as a result of employee withholding taxes based on the value of the RSUs on their vesting dates for the six months ended July 1, 2017. The total payments for the employees’ tax obligations to the taxing authorities are reflected as financing activities within the condensed consolidated statements of cash flows.
Performance-Based Restricted Stock Units
During the fiscal year ended December 31, 2016, the Company awarded 193,000 shares of performance-based RSUs. The vesting conditions of these awards were tied to the Company's fiscal 2016 revenue and operating income performance. These performance-based RSUs could have vested from 0% to 200% of the target grant, based on attainment of the performance goals. The target achievement percentage became known as of December 31, 2016. On December 31, 2016, the Company concluded that 149% of the target grants were likely to vest. If the achievement

14



of such performance goals is not probable, no compensation expense would be recognized. For the three and six months ended July 1, 2017, the Company recorded $0.4 million and $1.1 million, respectively, on a graded-vesting basis in stock-based compensation expense related to these performance-based RSU awards. As of July 1, 2017, there were 73,563 RSUs subject to performance-based vesting criteria.
Restricted Stock Award Activity
During the three months ended July 1, 2017, the Company awarded 254,397 shares of restricted stock awards ("RSAs") at a weighted average grant date fair value of $30.72, of which 10,408 RSAs with a weighted average grant date fair value of $34.35 vested in the quarter.
RSA vesting dates are determined by the Company. The vesting is subject to the employee’s continuing service with the Company over that period. RSAs have the voting and dividend participation rights of the Company’s common stock. The cost of RSAs is determined using the fair value of the Company’s common stock on the date of the grant.
Performance-Based Restricted Stock Awards
During the second quarter of fiscal 2017, the Company awarded 211,945 shares of performance-based RSAs at a weighted average grant date fair value of $32.09. The vesting conditions of these awards are tied to the Company's fiscal 2017 revenue and operating income performance. These performance-based RSAs could vest from 0% to 200% of the target grant, based on attainment against the performance goals.
Stock-Based Compensation Expense
The fair value of the option awards and ESPP purchase rights granted and the assumptions used in the Black-Scholes option pricing model are summarized as follows:
 
Three Months Ended
Six Months Ended
 
July 1,
2017
July 2,
2016
July 1,
2017
July 2,
2016
Stock option awards:
 
 
 
 
Expected term (in years)
4.6
4.6
4.6
4.6
Risk-free interest rate
1.9%
1.4%
1.9%
1.4%
Expected volatility
62.02%
76.1%
62.02%
76.1%
Expected dividend rate
—%
—%
—%
—%
Grant date fair value per award
$18.67
$18.62
$18.67
$18.62
 
 
 
 
 
ESPP purchase right:
 
 
 
 
Expected term (in years)
0.50 - 2.0
0.50 - 2.0
0.50 - 2.0
0.50 - 2.0
Risk-free interest rate
0.67% - 1.26%
0.42% - 0.74%
0.67% - 1.26%
0.42% - 0.74%
Expected volatility
58.2% - 68.6%
55.8% - 67.2%
58.2% - 68.6%
55.8% - 67.2%
Expected dividend rate
—%
—%
—%
—%
Grant date fair value per share
$11.94 - $16.42
$7.75 - $12.26
$11.94 - $16.42
$7.75 - $12.26


15



The following table summarizes the stock-based compensation expense recorded in the Company’s condensed consolidated statements of operations (in thousands):
 
Three Months Ended
Six Months Ended
 
July 1,
2017
July 2,
2016
July 1,
2017
July 2,
2016
Cost of revenue
$
792

$
538

$
1,469

$
1,008

Research and development
$
5,705

3,457

10,413

6,403

Sales and marketing
$
6,088

3,448

9,945

5,740

General and administrative
$
3,879

3,162

7,191

5,629

Total stock-based compensation expense
$
16,464

$
10,605

$
29,018

$
18,780

As of July 1, 2017 and December 31, 2016, there was $0.4 million and $0.2 million of capitalized stock-based compensation costs, respectively, within the Company's inventory balance.
As of July 1, 2017, unrecognized compensation expense related to stock options, RSUs, RSAs, PSUs, and ESPP purchase rights was $3.5 million, $55.1 million, $4.4 million, $1.7 million and $4.5 million, respectively.

7. Defined Contribution Plans
The Company’s contributions to its 401(k)-defined contribution plan, which are expensed immediately as compensation costs, were $0.8 million and $0.5 million for the three months ended July 1, 2017 and July 2, 2016, respectively and $1.9 million and $1.3 million for the six months ended July 1, 2017 and July 2, 2016, respectively.
8. Income Tax
The Company recorded an income tax benefit of $4.1 million and $8.0 million for the three and six months ended July 1, 2017, respectively, and an income tax benefit of $27.9 million and $27.3 million for the three and six months ended July 2, 2016, respectively. The income tax benefit for the three and six months ended July 1, 2017 was primarily related to the Company's year-to-date pre-tax loss and a tax benefit related to stock-based compensation. As of July 1, 2017, the Company considered all positive and negative evidence in making a determination that the Company will more likely than not be able to utilize its U.S. deferred tax assets. Such evidence included, among others, the Company's history of profitability, jurisdictional income recognition trends, forecasted income by jurisdiction and maintaining three years of cumulative taxable income in the U.S. federal tax jurisdiction as of July 1, 2017. Therefore, the Company determined that there is sufficient positive evidence to conclude that it is more likely than not that it will utilize its U.S. deferred tax assets. Included in the net deferred tax asset balance is a $6.7 million valuation allowance that relates to research and development credits in a jurisdiction with a history of credits in excess of taxable profits.
The Company adopted the accounting standard update related to Improvements to Employee Share-Based Payment Accounting, which amends Compensation – Stock Compensation in the first quarter of fiscal 2017. As a result, the Company recorded a deferred tax asset of $7.6 million for the previously unrecognized excess tax benefits with an adjustment of $7.1 million and $0.5 million to retained earnings and a valuation allowance for a certain jurisdiction, respectively, on the accompanying condensed consolidated balance sheet. Additionally, the adoption resulted in net excess tax benefits in the Company's provision for income taxes of $3.1 million on its condensed consolidated statements of operations for the six months ended July 1, 2017.
The Company files annual income tax returns in multiple tax jurisdictions worldwide. A number of years may lapse before an uncertain tax position is audited and finally resolved. While it is typically difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, the Company believes its reserves for income taxes reflect the most likely outcomes. The Company adjusts these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular position would likely require the use of cash.
As of July 1, 2017, changes to the Company's uncertain tax positions in the next 12 months that are reasonably possible are not expected to have a material impact on the Company's financial position or results of operations. The Company recognizes interest and penalties related to uncertain tax positions as part of the income tax provision. To date, no such interest and penalties have been accrued.

16



9. Net Income (Loss) per Share
Basic net income (loss) per share is computed using the weighted average number of common shares outstanding for the period, excluding unvested restricted stock.
Due to the net loss incurred in the three and six months ended July 1, 2017, potential dilutive securities were excluded from the calculation of diluted net loss per share attributable to common stockholders for such periods as their effect was anti-dilutive. 
Diluted net income (loss) per share is computed based upon the weighted average common shares outstanding for the period plus dilutive potential common shares, including unvested restricted stock and stock options using the treasury stock method.
The following table presents the computation of basic and diluted net income (loss) per share attributable to common stockholders (in thousands, except per share data):
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Numerator:
 
 
 
 
Net income (loss)
(7,338
)
33,959

(9,575
)
36,930

Denominator:
 
 


Weighted average shares used for basic net income (loss) per share computation
36,890

35,146

36,728

34,878

Weighted average effect of dilutive securities:
 
 
 
 
Stock options

668


639

RSUs

1,172


1,045

Performance-based units

93


53

ESPP purchase rights

183


177

Weighted average shares used for diluted net income (loss) per share computation
36,890

37,262

36,728

36,792

Net income (loss) per share attributable to common stockholders:
 
 


Basic
$
(0.20
)
$
0.97

$
(0.26
)
$
1.06

Diluted
$
(0.20
)
$
0.91

$
(0.26
)
$
1.00

The weighted average number of shares outstanding used in the computation of diluted net income (loss) per share does not include the effect of the following shares of potentially outstanding common stock because the effect would have been anti-dilutive for the periods presented (in thousands):
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Equity awards to purchase common stock
302

202

365

278


17



10. Segment Information
The Company currently has one operating segment. The Company considers operating segments to be components of the Company’s business for which separate financial information is available that is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company has determined that the chief operating decision maker is its chief executive officer. The chief executive officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. Accordingly, the Company has determined that it has a single operating and reportable segment.
The following table summarizes the Company’s revenue by geographic region, based on shipment location (in thousands):
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
United States
$
51,977

$
60,027

$
106,408

$
112,474

Rest of Americas
2,036

1,807

4,761

4,823

Europe, Middle East and Africa
7,923

6,896

16,551

13,979

Asia Pacific
7,201

6,373

10,984

11,038

Total
$
69,137

$
75,103

$
138,704

$
142,314

The Company’s long-lived assets by geographic region are summarized as follows (in thousands):
 
As of
 
July 1, 2017
December 31, 2016
United States
$
12,027

$
9,907

India
1,620

1,271

Other
652

631

Total
$
14,299

$
11,809


18



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, as filed with the Securities and Exchange Commission. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements contained in this Quarterly Report on Form 10-Q, other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, as filed with the Securities and Exchange Commission and in Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for us to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Unless expressly indicated or the context requires otherwise, the terms “Gigamon,” “Company,” “we,” “us” and “our” in this document refer to Gigamon Inc., a Delaware corporation, and, where appropriate, its wholly owned subsidiaries. The term “Gigamon” may also refer to our products, regardless of the manner in which they are accessed.
Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:
our expectations regarding our results of operations and financial condition;
anticipated trends and challenges in our business and in the markets in which we operate;
the impact of seasonality on our business;
our anticipated growth strategies;
maintaining and expanding our end-user customer base and our relationships with our channel partners;
our ability to anticipate market needs and develop new and enhanced products and services to meet those needs;
our ability to manage the introduction of new products, including products jointly developed with third-party joint development and original design manufacturing partners and the effects of such new product introductions on our existing product portfolio;
our sales cycles and the results of our sales efforts;
our relationships with our third-party manufacturers and suppliers;
our management of inventory and backlog;
the evolution of technology affecting our products, services and markets;
our ability to retain and hire necessary employees and to staff our operations appropriately;

19



our liquidity and working capital requirements;
our need to obtain additional funding and our ability to obtain future funding on acceptable terms;
our remaining valuation allowance on deferred tax assets and the assumptions and estimates underpinning our determination;
our ability to stay abreast of new or modified laws and regulations that currently apply or become applicable to our business both in the United States and internationally; and
the estimates and estimate methodologies used in preparing our condensed consolidated financial statements.
We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.
Overview
We have developed innovative solutions that deliver pervasive, dynamic and intelligent visibility and control of data-in-motion traversing enterprise, federal and service provider networks. Our Visibility Platform consists of a distributed system of nodes (that in combination establish a Visibility Fabric) that enable an advanced level of visibility, modification and control of network traffic. Our Visibility Platform is comprised of physical appliances and virtual nodes that can be deployed in data centers, central offices, remote sites, virtual environments, private clouds, public clouds and hybrid clouds. We believe our Visibility Platform enables organizations to significantly improve their ability to secure, manage and understand critical data-in-motion traversing their infrastructure. Enterprise and Federal organizations can enhance their cyber-security posture by leveraging the power of network visibility to a pervasive view within the perimeter of their IT infrastructure. Furthermore, IT departments can significantly increase the effectiveness, efficiency and performance of their network management, analysis and compliance tools. Using our Visibility Platform, mobile service providers can gain subscriber-level awareness across their infrastructure enabling them to improve services, increase revenue generating opportunities and reduce operational costs.
We generate product revenue primarily from sale of perpetual software licenses installed on purpose-built physical Visibility Fabric appliances through channel partners, including distributors and resellers, as well as directly to end-user customers. We provide our channel partners with marketing assistance, technical training and support. Typically, we derive 80% or more of our revenue through channel partners.
We generate service revenue primarily from the sales of maintenance and support services for our products. Starting in the quarter ended September 26, 2015, we began to sell first-year maintenance and support as an additional offering. Prior to that time, the first year of maintenance and support services was generally bundled with the initial contract to purchase our products. Following expiration of this one-year contract, our end-user customers typically purchase maintenance and support contracts that generally have one-year terms.
Our revenue decreased to $69.1 million in the three months ended July 1, 2017 from $75.1 million in the three months ended July 2, 2016. As of July 1, 2017, we had increased our cumulative customer count to over 2,500, as compared to over 2,100 as of July 2, 2016. Our net loss was $7.3 million for the three months ended July 1, 2017 compared to net income of $34.0 million, which included a one time tax benefit of $30.5 million for the three months ended July 2, 2016. We generated cash from operations of $9.1 million for the six months ended July 1, 2017 compared to $18.4 million for the six months ended July 2, 2016. We operate as a single reportable segment.
Fiscal year 2016 was a 53-week fiscal year, with the first quarter being a 14-week quarter and each subsequent quarter being a 13-week quarter. Fiscal 2017 is a 52-week fiscal year ending on December 30, 2017, with all quarters being 13 weeks.

20



Key Performance Indicators of Our Business
We monitor a variety of key performance indicators to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies. These key performance indicators include (dollars in thousands):
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Key Performance Indicators:
 
 
 
 
Revenue
$
69,137

$
75,103

$
138,704

$
142,314

Gross margin
81
%
82
%
81
%
81
%
Income (loss) from operations
$
(11,873
)
$
6,014

$
(18,261
)
$
9,426

 
 
 
 
 
 
 
 
As of July 1, 2017
As of July 2, 2016
Deferred service revenue
 
 
$
96,646

$
79,854

Revenue. We monitor our revenue to assess the acceptance of our products and services by our end-user customers and growth in the markets we serve.
Gross margin. We monitor our gross margin to assess the impact on our current and forecasted financial results from any changes to the pricing and mix of products we are selling to our customers.
Income from operations. We monitor our income from operations to assess how effectively we are conducting our operations as well as controlling our expenses, which are primarily driven by headcount because we have an outsourced production model.
Deferred service revenue. Our deferred service revenue consists of the unamortized portion of service revenue from maintenance and support contracts. We monitor our deferred service revenue balance because it represents a significant portion of the revenue we will recognize in future periods. We assess the annual change in our deferred service revenue balance which, taken together with revenue, is an indication of sales activity year over year.
Financial Overview
Revenue
We generate revenue from the sale of products and related services, including maintenance and support. We present revenue net of discounts, rebates and sales taxes. Our revenue is comprised of the following:
Product revenue. We generate product revenue primarily from sales of perpetual software licenses installed on purpose-built physical appliances that establish a Visibility Fabric. We generally recognize product revenue at the time of product delivery, provided all other revenue recognition criteria have been met. As a percentage of revenue, we expect our product revenue to vary from quarter-to-quarter based on, among other things, the timing of orders, the delivery of products, and seasonal and cyclical factors discussed under the section titled “Results of Operations.”
We have experienced seasonality in the sale of our products. The first quarter of each year is usually our lowest revenue quarter during the year and product revenue typically declines sequentially from the prior fourth quarter. We generally expect and normally experience an increase in sales in the second half of the year relative to the first half, primarily due to the buying habits of many of our end-user customers as budgets for annual capital purchases are being fully utilized. The fiscal year-ending September 30 of the U.S. Federal government can also result in increased selling momentum for certain transactions in our third quarter.
Over time we expect our product revenue to increase as we continue to extend our product portfolio, add new end-user customers and expand the volume of shipments to our current end-user customers.
Service revenue. We generate service revenue primarily from sales of maintenance and support contracts, which may be bundled with sales of products, and from sales and subsequent renewals of maintenance and support contracts. We offer tiered maintenance and support services under our renewable, fee-based maintenance and support contracts, which include technical support, bug fixes, patches and unspecified upgrades on a when-and-if-available basis. We recognize service revenue ratably over the duration of the contract, which is typically one year and can be for multiple years depending on the customer contract. As a result, the impact on service revenue will lag any shift in product revenue because product revenue is recognized when a product is sold and revenue criteria are satisfied, whereas

21



service revenue is recognized ratably over the contract term. We expect our service revenue to increase as we expand our installed base by selling more products and support contracts, and adding more end-user customers.
Cost of revenue
Our cost of revenue consists of the following:
Cost of product revenue. Cost of product revenue is comprised primarily of the costs associated with manufacturing our products, including third-party hardware manufacturing costs; personnel costs for salary, benefits, bonuses and stock-based compensation expense; shipping costs; allocated costs of facilities and information technology; any inventory write-downs; warranty costs and other related expenses. We expect cost of product revenue to increase in connection with the anticipated increase in product revenue.
Cost of service revenue. Cost of service revenue is comprised primarily of personnel costs for salary, benefits, bonuses and stock-based compensation expense related to our customer support organization, as well as allocated costs of facilities, information technology and engineering. We expect cost of service revenue to increase in connection with the anticipated increase in service revenue.
Gross profit and gross margin
Gross profit has been and will continue to be affected by a variety of factors including shipment volumes, changes in the mix of products and services sold, changes in our product costs including any inventory write-downs, new product introductions and upgrades to existing products, changes in customer mix, changes in pricing and the extent of customer rebates and incentive programs. We expect our gross margin to fluctuate over time depending on a variety of factors, including those described above.
Operating expenses
Operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel costs comprise a significant component of our operating expenses, and consist of salaries, benefits, bonuses and stock-based compensation expense; and with respect to our sales organization, personnel costs also include sales commissions. The number of employees attributable to our operating expenses increased to 743 employees as of July 1, 2017, compared to 554 employees as of July 2, 2016. We expect to continue to hire new employees to support our anticipated growth, particularly with respect to an anticipated increase in sales and marketing and research and development efforts.
Research and development
Our research and development efforts consist primarily of software development and are focused on technical research, new product development and additional functionality for our existing products, and on-going activities to sustain previously developed products. Research and development expenses consist primarily of personnel costs, and to a lesser extent, prototype materials, allocated costs of facilities and information technology and product certification. We expense research and development costs as incurred.
Sales and marketing
Sales and marketing expenses are the largest component of our operating expenses and consist primarily of personnel costs, as well as travel expenses, trade shows, marketing and promotional activities, and allocated costs of facilities and information technology. We sell our products through our global sales organization, which is divided into three geographic regions: (i) the Americas (which includes the United States, Canada and Latin America), (ii) Europe, the Middle East and Africa (EMEA) and (iii) Asia Pacific. We expect our sales and marketing expenses to increase as we expand our sales and marketing efforts internationally and domestically to help drive increased revenue.
General and administrative
General and administrative expenses consist of personnel costs and allocated costs of facilities and information technology related to our executive, finance, human resources and legal functions, as well as professional services costs. Professional services costs consist primarily of outside legal and accounting services. We have incurred and expect to continue to incur expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a national securities exchange and costs related to compliance and reporting obligations.
Interest income and other income (expense), net
Interest income consists primarily of income earned on our invested cash, cash equivalents and short-term investments. Historically, interest income has not been material, and is not expected to be material despite our increased level of invested cash.

22



Other income (expense), net consists primarily of foreign currency exchange gains (losses) related to transactions denominated in currencies other than the U.S. dollar, which have not been material to date.
Income Tax (Provision) Benefit
Our Income tax benefit was $4.1 million and $8.0 million for the three and six months ended July 1, 2017, respectively, and $27.9 million and $27.3 million for the three and six months ended July 2, 2016, respectively. The income tax benefit for the three and six months ended July 1, 2017 was primarily related to our year-to-date pre-tax loss and a tax benefit related to stock-based compensation. As of July 1, 2017, we concluded that it is more likely than not that we will be able to realize our deferred tax assets in the foreseeable future except for research and development credits in a jurisdiction with a history of credits in excess of taxable profits. We will continue to assess the need for the valuation allowance on a quarterly basis.
Stock-based compensation expense and other compensation charges
Stock-based compensation expense was $16.5 million and $29.0 million for the three and six months ended July 1, 2017, respectively, as compared to $10.6 million and $18.8 million for the three and six months ended July 2, 2016, respectively. The increase in expense is primarily due to headcount increases and our election to account for forfeitures as they occur under the recently adopted accounting guidance. As of July 1, 2017, total unrecognized stock-based compensation costs were $69.2 million (see Note 6 "Stockholders' Equity" included in Part I, Item I).

23



Results of Operations
The following tables set forth our results of operations for the periods presented in dollars and as a percentage of our revenue (dollars in thousands):
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Condensed Consolidated Statements of Operations Data:
 
 
 
 
Revenue:
 
 
 
 
Product
$
43,192

$
51,308

$
87,202

$
95,970

Service
25,945

23,795

51,502

46,344

Total revenue
69,137

75,103

138,704

142,314

Cost of revenue:




Product
10,424

11,510

21,028

22,217

Service
2,894

2,339

5,600

4,421

Total cost of revenue
13,318

13,849

26,628

26,638

Gross profit
55,819

61,254

112,076

115,676

Operating expenses:


 
 
Research and development
20,519

17,250

40,668

32,608

Sales and marketing
36,892

28,843

70,333

56,500

General and administrative
10,281

9,147

19,336

17,142

Total operating expenses
67,692

55,240

130,337

106,250

Income (loss) from operations
(11,873
)
6,014

(18,261
)
9,426

Interest income
477

219

833

426

Other expense, net
(75
)
(173
)
(192
)
(242
)
Income (loss) before income tax benefit
(11,471
)
6,060

(17,620
)
9,610

Income tax benefit (provision)
4,133

27,899

8,045

27,320

Net income (loss)
$
(7,338
)
$
33,959

$
(9,575
)
$
36,930

 
 
 
 
 
Net income (loss) includes stock-based compensation and related payroll tax expenses allocated as follows:
 
 
 
 
Stock-based compensation and related payroll tax expenses:
 
 
 
 
Cost of revenue
$
821

$
558

$
1,529

$
1,044

Research and development
5,863

3,587

10,776

6,669

Sales and marketing
6,177

3,520

10,182

5,887

General and administrative
3,932

3,214

7,367

5,737

Total stock-based compensation and related payroll tax expenses
$
16,793

$
10,879

$
29,854

$
19,337


24



 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
July 1, 2017
July 2, 2016
Percentage of Revenue:
 
 
 
 
Revenue:
 
 
 
 
Product
62
 %
68
%
63
 %
67
%
Service
38
 %
32
%
37
 %
33
%
Total revenue
100
 %
100
%
100
 %
100
%
Cost of revenue
19
 %
18
%
19
 %
19
%
Gross margin
81
 %
82
%
81
 %
81
%
Operating expenses:
 
 
 
 
Research and development
30
 %
23
%
29
 %
23
%
Sales and marketing
53
 %
38
%
51
 %
39
%
General and administrative
15
 %
12
%
14
 %
12
%
Total operating expenses
98
 %
74
%
94
 %
74
%
Income (loss) from operations
(17
)%
8
%
(13
)%
7
%
Interest income
1
 %
%
1
 %
%
Income (loss) before income tax benefit
(17
)%
8
%
(13
)%
7
%
Income tax benefit (provision)
6
 %
37
%
6
 %
19
%
Net income (loss)
(11
)%
45
%
(7
)%
26
%

Comparison of Three and Six Months Ended July 1, 2017 and July 2, 2016
Revenue
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
$ Increase (Decrease)
% Increase (Decrease)
July 1, 2017
July 2, 2016
$ Increase (Decrease)
% Increase (Decrease)
 
(dollars in thousands)
 
(dollars in thousands)
 
Revenue:
 
 
 
 
 
 
 
 
Product
$
43,192

$
51,308

$
(8,116
)
(16)%
$
87,202

$
95,970

$
(8,768
)
(9)%
Service
25,945

23,795

2,150

9%
51,502

$
46,344

5,158

11%
Total revenue
$
69,137

$
75,103

$
(5,966
)
(8)%
$
138,704

$
142,314

$
(3,610
)
(3)%
Product revenue decreased $8.1 million and $8.8 million in the three and six months ended July 1, 2017, respectively as compared to the same prior year periods, driven primarily by decreases in North American revenue, partially offset by revenue increases in the EMEA region.
Service revenue increased $2.2 million and $5.2 million in the three and six months ended July 1, 2017 as compared to the same prior year periods, primarily due to the growth in our installed base of end-user customers under maintenance and support contracts.



25



Cost of revenue and gross margin
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
$ Increase (Decrease)
% Increase (Decrease)
July 1, 2017
July 2, 2016
$ Increase (Decrease)
% Increase (Decrease)
 
(dollars in thousands)
 
(dollars in thousands)
 
Cost of revenue:
 
 
 
 
 
 
 
 
Product
$
10,424

$
11,510

$
(1,086
)
(9)%
$
21,028

$
22,217

$
(1,189
)
(5)%
Service
2,894

2,339

555

24%
5,600

4,421

1,179

27%
Total cost of revenue
$
13,318

$
13,849

$
(531
)
(4)%
$
26,628

$
26,638

$
(10
)
—%
Gross margin:
 
 
 
 
 
 
 
 
Product
76
%
78
%
 
 
76
%
77
%
 
 
Service
89
%
90
%
 
 
89
%
90
%
 
 
Total gross margin
81
%
82
%
 
 
81
%
81
%
 
 
 
 
 
 
 
 
 
 
 
Stock-based compensation and related payroll tax expense included in cost of revenue
$
821

$
558

$
263

47%
$
1,529

$
1,044

$
485

46%
Three Months Ended July 1, 2017 Compared to Three Months Ended July 2, 2016
Total gross margin was 81% in the three months ended July 1, 2017 compared to 82% in the three months ended July 2, 2016. The slight decline in gross margin is primarily due to product discounting, largely offset by a more favorable mix shift to high margin service and software.
Product gross margin was 76% in the three months ended July 1, 2017 compared to 78% gross margin in the six months ended July 2, 2016, primarily due to discounting in the three months ended July 1, 2017.
Service gross margin was 89% in the three months ended July 1, 2017 compared to 90% in the three months ended July 2, 2016. The primary reason was due to increased investment to support our top customer accounts that are under maintenance and support contracts.
Six Months Ended July 1, 2017 Compared to Six Months Ended July 2, 2016
Total gross margin was 81% in the six months ended July 1, 2017, compared to 81% in the six months ended July 2, 2016. The consistent gross margin was a result of a higher proportion of service revenue at a higher gross margin which offset lower product gross margin.
Product gross margin was 76% in the six months ended July 1, 2017 compared to 77% gross margin in the six months ended July 2, 2016, primarily due to discounting in the six months ended July 1, 2017.
Service gross margin was 89% in the six months ended July 1, 2017 compared to 90% in the six months ended July 2, 2016. The primary reason for this decrease was the increased investment to support our top customer accounts that are under maintenance and support contracts.



26



Operating expenses
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
$ Increase
% Increase
July 1, 2017
July 2, 2016
$ Increase
% Increase
 
(dollars in thousands)
 
(dollars in thousands)
 
Operating expenses:
 
 
 
 
 
 
 
 
Research and development
$20,519
$17,250
$3,269
19%
$
40,668

$
32,608

$
8,060

25%
Sales and marketing
36,892
28,843
8,049
28%
70,333

56,500

13,833

24%
General and administrative
10,281
9,147
1,134
12%
19,336

17,142

2,194

13%
Total operating expenses
$67,692
$55,240
$12,452
23%
$
130,337

$
106,250

$
24,087

23%
 
 
 
 
 
 
 
 
 
Stock-based compensation and related payroll tax expense included in:
 
 
 
 
 
 
 
 
Research and development
5,863

3,587

5,863

163%
10,776

6,669

10,776

162%
Sales and marketing
6,177

3,520

6,177

175%
10,182

5,887

10,182

173%
General and administrative
3,932

3,214

3,932

122%
7,367

5,737

7,367

128%
Total stock-based compensation and related payroll tax expense
$15,972
$10,321
$15,972
155%
$
28,325

$
18,293

$
28,325

155%
 
Three Months Ended July 1, 2017 Compared to Three Months Ended July 2, 2016
Research and development expenses increased $3.3 million in the three months ended July 1, 2017 as compared to the same prior year period. This increase was primarily driven by $2.8 million of additional personnel costs, which were primarily comprised of increased stock-based compensation and related payroll tax expenses of $2.3 million, increased payroll related expenses of $1.7 million, partially offset by a $1.0 million reduction in bonus expense. The remaining research and development expense increase was primarily driven by IT, depreciation, and facilities-related expenses required to support a larger research and development team.
Sales and marketing expenses increased $8.0 million in the three months ended July 1, 2017 as compared to the same prior year period. This increase was primarily driven by $6.6 million of additional personnel costs, which were primarily comprised of increased payroll, payroll tax and contractor-related expenses of $4.4 million, and increased stock-based compensation and related payroll tax expenses of $2.7 million, partially offset by $0.4 million of decreased commission expense. The remaining sales and marketing expense increase was primarily driven by a $0.8 million increase in IT and facilities related costs to support a larger sales and marketing team, a $0.7 million related to internal sales events, and a $0.4 million increase in travel expense, partially offset by a $0.6 million decrease in use taxes.
General and administrative expenses increased $1.1 million in the three months ended July 1, 2017 as compared to the same prior year period. This increase was primarily driven by $0.9 million of additional personnel costs, which were primarily comprised of $0.9 million of increased payroll and payroll tax, and increased stock-based compensation and related payroll tax expenses of $0.7 million, partially offset by a $0.7 million reduction in bonus expense.
Six Months Ended July 1, 2017 Compared to Six Months Ended July 2, 2016
Research and development expenses increased $8.1 million in the six months ended July 1, 2017 as compared to the same prior year period. This increase was primarily driven by $6.1 million of additional personnel costs, which were primarily comprised of increased stock-based compensation and related payroll tax expenses of $4.1 million, and increased payroll, payroll tax and contractor-related expenses of $3.3 million, partially offset by $1.0 million of reduced bonus expense. The remaining research and development expense increase was primarily driven by a $1.4 million increase in facilities-related and IT-related expenses required to support a larger research and development team, and a $0.5 million increase in depreciation expense.
Sales and marketing expenses increased $13.8 million in the six months ended July 1, 2017 as compared to the same prior year period. This increase was primarily driven by $10.0 million of additional personnel costs, which were primarily comprised of increased payroll, payroll tax and contractor-related expenses of $7.9 million, and increased stock-based compensation and related payroll tax expenses of $4.3 million, partially offset by a $2.1 million decrease in commission expense. The remaining sales and marketing expense increase was primarily driven by a $1.2 million increase in internal sales events, a $1.6 million in IT and facilities related costs to support a larger sales and marketing team, and a $0.9 million of travel expense.
General and administrative expenses increased $2.2 million in the six months ended July 1, 2017 as compared to the same prior year period. This increase was primarily driven by $2.0 million of additional personnel costs, which

27



were primarily comprised of a $1.7 million increase in payroll and payroll tax, and a $1.6 million increase in stock-based compensation and related payroll tax expenses, partially offset by a $0.9 million reduction in bonus expense and a $0.6 million reduction in contractor-related expenses.
Income Tax (Provision) Benefit
 
Three Months Ended
Six Months Ended
 
July 1, 2017
July 2, 2016
$ Change
% Change
July 1, 2017
July 2, 2016
$ Change
% Change
 
(dollars in thousands)
 
(dollars in thousands)
 
Income tax (provision) benefit
$
4,133

$
27,899

$
(23,766
)
(85
)%
$
8,045

$
27,320

$
(19,275
)
(71
)%
We account for income taxes under the asset and liability approach. This process involves estimating the actual current tax exposure, including assessing the risks associated with tax audits, and assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance. Significant judgment is required in determining whether the valuation allowance should be recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence including past operating results and estimates of future forecasted taxable income or losses.
We had an income tax benefit of $4.1 million and $8.0 million for the three and six months ended July 1, 2017, respectively, compared to a tax benefit of $27.9 million and $27.3 million for the three and six months ended July 2, 2016, respectively. The income tax benefit recorded in the three and six months ended July 1, 2017 was primarily related to our year-to-date pre-tax loss and a tax benefit related to stock-based compensation. The income tax benefit for the three and six months ended July 2, 2016 represents the release of $30.5 million of existing valuation allowance against our U.S. deferred tax assets and additional foreign income tax expense. 
In making a determination whether to set up a valuation allowance or not, we considered all available evidence, both positive and negative. Such evidence included, but was not limited to, our history of profitability and losses, jurisdictional income recognition trends, pre-tax losses adjusted for certain other items, and forecasted income by jurisdiction. Based on the above evidence, we determined that it is more likely than not that we will utilize our U.S. deferred tax assets except for research and development credits in a jurisdiction with a history of credits in excess of taxable profits.
Liquidity and Capital Resources
As of July 1, 2017, our principal sources of liquidity, which consisted of cash, cash equivalents and short-term investments of $258.8 million, were held primarily in the United States. Our liquidity requirements are primarily to fund our working capital and operating expenses. As of July 1, 2017, we had no material commitments for capital expenditures.
Our future capital requirements will depend on many factors, including our results of operations and the expansion of our research and development, sales and marketing and general and administrative functions. Based on our current operating plan, we believe our existing cash, cash equivalents and investments, combined with cash generated from operations, will be sufficient to fund our working capital and operating expenses for at least the next 12 months. If we require additional capital resources to grow our business internally or to acquire complementary technologies and businesses at any time in the future, we may seek to sell additional equity, or raise funds through debt financing or other sources. The sale of additional equity could result in additional dilution to our stockholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility, and would also require us to incur cash interest expense. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain financing on terms favorable to us.







28



Cash flows
The following table summarizes our cash flows for the periods indicated (in thousands):
 
Six Months Ended
 
July 1, 2017
July 2, 2016(1)
Net cash provided by (used in) operating activities
$
9,146

$
18,427

Net cash provided by (used in) investing activities
$
(3,648
)
$
(7,062
)
Net cash provided by (used in) financing activities
$
(2,505
)
$
3,665

(1)Reflects the impact of the adoption of the accounting standard update related to Improvements to Employee Share-Based Payment Accounting, which amends Compensation - Stock Compensation.
Cash flows from operating activities
Our cash provided by operating activities is generated from sales of our products and, to a lesser extent, by upfront payments from customers under maintenance and support contracts. Our primary uses of cash from operating activities have been for personnel-related expenses, manufacturing costs, expenses related to marketing and promotional activities and costs related to our facilities. Our cash flows from operating activities will continue to be affected principally by our working capital requirements and increased spending on personnel, facilities and sales and marketing activities to meet our anticipated business growth.
In the six months ended July 1, 2017, our operating activities provided cash of $9.1 million. This was primarily due to timing of collection of our accounts receivable and a higher concentration of service bookings with upfront payment from customers.
Cash flows from investing activities
Net cash used in investing activities of $3.6 million for the six months ended July 1, 2017 was primarily attributable to maturities of short-term investments of $70.7 million which were partially offset by $69.2 million used for purchases of short-term investments and $5.2 million used for capital expenditures for property and equipment to support the growth of our business.
Cash flows from financing activities
Net cash used in financing activities of $2.5 million for the six months ended July 1, 2017 was primarily due to proceeds of $5.0 million from the issuance of common stock pursuant to our ESPP and $0.9 million from stock option exercises, offset by $8.4 million of tax payments upon vesting of restricted stock units.
Contractual Obligations
As of July 1, 2017, we had not entered into any material additional contractual obligation beyond those disclosed in the Annual Report on Form 10-K as of December 31, 2016. As of July 1, 2017, we had no material changes in tax liabilities recorded related to uncertainty in income tax positions beyond those disclosed in the Annual Report on Form 10-K as of December 31, 2016.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance 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.
Indemnification Obligations
Under the indemnification provisions of our standard sales related contracts, we agree to defend our customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks, or trade secrets, and to pay judgments entered on such claims. Our exposure under these indemnification provisions is generally limited to the total amount paid by our customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under the agreement. We have not incurred any costs as a result of such indemnifications and have not accrued any liabilities related to such obligations in our consolidated financial statements. In addition, we indemnify our officers, directors, and certain key employees while they are serving in good faith in the company capacities. To date, there have been no claims under any indemnification provisions.


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Recent Accounting Pronouncements
See Note 2, Summary of Significant Accounting Policies, in Notes to Condensed Consolidated Financial Statements in Part I - Item 1 - Financial Statements (unaudited) of this Report, for a full description of recent accounting pronouncements, including the expected dates of adoption and effects on the consolidated financial statements, which is incorporated herein by reference.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these condensed financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, operating expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows would be affected.
An accounting policy is considered to be critical if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and the effect of the estimates and assumptions on financial condition or operating performance is material. The accounting policies we believe to reflect our more significant estimates, judgments, and assumptions and are most critical to understanding and evaluating our reported financial results are as follows:
Revenue Recognition;
Stock-Based Compensation;
Inventory Valuation;
Warranty Reserves; and
Income Taxes and the release of our Valuation Allowance (see Note 8 Income Tax included in Part I, Item I).
There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risks in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. We do not hold or issue financial instruments for trading purposes.
Foreign currency exchange rate sensitivity
Our functional currency is the U.S. dollar. Most of our revenue, cost of revenue and operating expenses are denominated in U.S. dollars, and therefore our revenue is not currently subject to significant foreign currency risk. Our operating expenses are transacted in the currencies of the countries in which our operations are located, which are primarily in the Americas, Europe, the Middle East, Africa, and the Asia-Pacific region. Our condensed consolidated statements of operations, comprehensive income (loss) and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. To date, we have not entered into any hedging arrangements with respect to foreign currency risk or other derivative financial instruments. In the six months ended July 1, 2017 and July 2, 2016, the effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have had a material impact on our condensed consolidated financial statements.
Interest rate sensitivity
We had cash, cash equivalents and short-term investments of $258.8 million as of July 1, 2017. We hold our cash, cash equivalents and short-term investments for working capital purposes. Our cash and cash equivalents are primarily held in cash deposits and money market funds. We have invested a portion of our funds in short-term investments that are focused on preservation of capital and supporting our liquidity requirements. Our short-term investments are held in U.S. Treasury securities, U.S. agency debt securities and corporate debt securities. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future

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interest income. For the six months ended July 1, 2017 and July 2, 2016, the effect of a hypothetical 10% increase or decrease in overall interest rates would not have had a material impact on the fair value of our available-for-sale securities or our interest income.

Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The phrase “disclosure controls and procedures” refers to controls and other procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended, or the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the U.S. Securities and Exchange Commission, or the SEC. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer, or the CEO, and our Chief Financial Officer, or the CFO, as appropriate to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our CEO and CFO, we carried out an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of July 1, 2017, the end of the fiscal period covered by this Quarterly Report on Form 10-Q, or the Evaluation Date. Based on this evaluation, our CEO and CFO concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective such that the information required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting identified in connection with our evaluation required by paragraph (d) of rules 13a-15 and 15d-15 under the Exchange Act that occurred during the second quarter of fiscal 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On January 27, 2017, a purported shareholder class action was filed in the United States District Court for the Northern District of California against us and three of our current and former officers, Rodriguez v. Gigamon Inc., et al., Case No. 17-cv-00434 (N.D. Cal. filed Jan. 27, 2017). The plaintiff alleges that we made false and misleading statements about our business, operations and prospects, including statements about our guidance for the fourth quarter of 2016. The complaint asserts claims for violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended and SEC Rule 10b-5 on behalf of all persons and entities who acquired our securities between October 27, 2016 and January 17, 2017. The complaint seeks unspecified monetary damages, attorneys' fees and costs and other relief. We believe this lawsuit is without merit and intend to defend against it vigorously.
In addition, we may, from time to time, be subject to various legal proceedings, claims and litigation arising in the ordinary course of business. Other than that disclosed above, we do not believe we are a party to any currently pending legal proceedings the outcome of which would be expected to have a material adverse effect on our financial position, results of operations or cash flows.
There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our financial position, results of operations or cash flows.
Item 1A. Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below together with all of the other information in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K, before making a decision to invest in our common stock. The risks and uncertainties described below may not be the only ones we face. If any of the risks actually occur, our business, financial condition, operating results and prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline, and you could lose part or all of your investment.

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Risks Related to Our Business
The network traffic visibility market is rapidly evolving and difficult to predict. If the network traffic visibility market does not evolve as we anticipate or if our target end-user customers do not adopt our Visibility Platform or our Security Delivery Platform, our sales will not grow as quickly as anticipated and our stock price could decline.
We are in a new, rapidly evolving category within the network infrastructure industry that focuses on providing organizations with enhanced visibility and control over their networks through the efficient collection and analysis of network traffic. As such, it is difficult to predict important market trends, including how large the network traffic visibility market will be, or when and what products end-user customers will adopt. For example, organizations that currently use traditional approaches may believe that these approaches already provide them with sufficient visibility and control to secure and manage their network traffic. Therefore, they may continue spending their network infrastructure budgets on these products and may not adopt our Visibility Platform or Security Delivery Platform in addition to or in lieu of such products.
If the market for network traffic visibility does not evolve in the way we anticipate, if organizations do not recognize the benefits of our solution, if we are unable to sell our family of products to end-user customers, or if we are not able to effectively expand into new or adjacent markets, then our revenue may not grow as expected or may decline, and our stock price could decline.
New or existing technologies that are perceived to address network traffic visibility or address the need for network traffic visibility in different ways could gain wide adoption and supplant our products, thereby weakening our sales and our financial results.
The introduction of products and services embodying new technologies could render our existing products obsolete or less attractive to end-user customers. Other network traffic visibility technologies exist and could be developed in the future, and our business could be materially negatively affected if such technologies are widely adopted. We may not be able to successfully anticipate or adapt to changing technology or customer requirements on a timely basis, or at all. If we fail to keep up with technological changes, do not effectively adapt our technology to next generation network infrastructure deployments or fail to convince our end-user customers and potential end-user customers of the value of our solution even in light of new technologies, our business, operating results and financial condition could be materially and adversely affected.
If we are unable to introduce new products successfully and to make enhancements to existing products, our growth rates would likely decline and our business, operating results and competitive position could suffer.
Our continued success depends on our ability to identify and develop new products and to enhance and improve our existing products, and the acceptance of those products by our existing and target end-user customers. Our growth would likely be adversely affected if: 
we fail to correctly anticipate technology trends and introduce new products or product enhancements to address those trends;
our new products or product enhancements are not timely introduced or do not function as expected;
we fail to successfully manage the transition to new products from the products they are replacing;
we do not invest our development efforts in appropriate products or enhancements for markets in which we now compete and expect to compete;
we fail to predict the demand for new products following their introduction to market;
these new products or enhancements do not address existing or target end-user customer needs or do not attain broad market acceptance; or
lower cost products negatively impact sales of other existing products.
We invest substantial amounts of time and resources in researching and developing new products and enhancing existing products by incorporating additional features, improving functionality and adding other improvements to meet end-user customers’ rapidly evolving demands in our highly competitive industry. Our research and development expenses were $40.7 million, or 29% of our revenue in the six months ended July 1, 2017, and $32.6 million, or 23% of revenue in the six months ended July 2, 2016.
Our future plans contemplate significant investments in research and development and related product opportunities. In addition, we plan to increasingly use third-party joint development and original design manufacturing

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partners for the development of future products in our road map. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts and increase our investment in joint development relationships to maintain our competitive position. We have limited experience in joint development of products and our increasing use of third-party joint development and original design manufacturers reduces our control over the design, as well as the timing and delivery, of products to the market. If we do not manage these joint design relationships successfully, future products may be delayed or the features and quality of the products may not meet our expectations or that of our customers. We have invested and continue to invest in our internal research and development capabilities and other internal research and development efforts as well as third-party design and manufacturing relationships without being certain that they will result in products that the market will accept or that will expand our share of those markets.
The introduction of new products or product enhancements may shorten the life cycle of our existing products, or replace sales of some of our current products, thereby offsetting the benefit of even a successful product introduction, and may cause end-user customers to defer purchasing our existing products in anticipation of the new products.
Failure to successfully introduce new products to our portfolio could harm our operating results by decreasing sales, increasing our inventory levels of older products and exposing us to greater risk of product obsolescence. We have also experienced, and may in the future experience, delays in developing and releasing new products and product enhancements. This has led to, and may in the future lead to, delayed sales, deferred revenue, increased expenses and lower than anticipated quarterly revenue. In addition, complexity and difficulties in managing product transitions at the end-of-life stage of a product can create excess inventory of components associated with the outgoing products that can lead to increased expenses. Any or all of the above problems could materially harm our business and operating results.
Our quarterly and annual operating results may vary significantly and be difficult to predict, which may cause our stock price to fluctuate.
Our quarterly and annual operating results have varied historically from period to period, and we expect that they will continue to fluctuate due to a variety of factors, many of which are outside of our control, including: 
fluctuations in demand for our products and services, the timing of orders from our channel partners and end-user customers, and our ability to accurately forecast end-user customer demand;
the timing of our product shipments, which may depend on many factors such as inventory and logistics and our ability to ship new products on schedule and accurately forecast inventory requirements;
the budgeting cycles and internal purchasing priorities of our end-user customers;
seasonal buying patterns of our end-user customers;
changes in end-user customer or channel partner requirements or market needs;
dependence on key customers or large sales to individual customers;
the mix of products sold and the mix of revenue between products and services;
changes in the growth rate of the network traffic visibility market, the cyber-security market and related markets, such as the network infrastructure market, and the market for network management, analysis, compliance and security tools;
our ability to control costs, including operating expenses, the costs of hardware and software components, and other manufacturing costs;
our ability to timely develop, introduce and gain market acceptance for new products, technologies and services;
price competition;
any significant changes in the competitive environment, including the entry of new competitors, and any related discounting of products or services;
the timing and execution of product transitions or new product introductions, and related inventory costs;
deferral of orders from end-user customers in anticipation of new products or product enhancements announced by us or our competitors;

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decisions by potential end-user customers to purchase alternative network traffic visibility solutions or cyber-security solutions from their existing network infrastructure and security vendors or other third parties;
our ability to establish and manage our distribution channels, and the effectiveness of any changes we make to our distribution model;
the ability of our suppliers and contract manufacturers to provide component parts and finished products in a timely manner;
changes in end-user customer renewal rates for our services and our ability to up-sell additional products;
general economic conditions, both domestically and in our foreign markets; and
future accounting pronouncements or standards changes or changes in our accounting policies and accounting standards including, but not limited to, changes in the revenue recognition standard scheduled to take place in 2018.
Any one of the factors above or the cumulative effect of some of the factors referred to above may result in significant fluctuations in our quarterly and annual operating results, including fluctuations in our key performance indicators. This variability and unpredictability could result in our failure to meet our internal operating plan or the expectations of securities analysts or investors for any period. In addition, a significant percentage of our operating expenses are fixed in nature in the short term and based on forecasted revenue trends. Accordingly, in the event of revenue shortfalls, we are generally unable to mitigate the negative impact on margins in the short term. For example, the market price of our shares fell substantially when we announced financial results for the fourth quarter of fiscal 2016 which included revenue results below our expectations and the expectations of securities analysts. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our shares could fall substantially and we could face costly lawsuits, including securities class action suits.
Our revenue growth rate in recent periods may not be indicative of our future performance.
Our revenue growth rates have been highly variable in recent periods. We experienced annual revenue growth rates of 40% and 41% in fiscal 2016 and fiscal 2015, respectively, followed by revenue decline of 8% and 3% when comparing the three months ended July 1, 2017 to the three months ended July 2, 2016 and the six months ended July 1, 2017 to the six months ended July 2, 2016, respectively. Our revenue growth rates in future periods may be increasingly difficult to predict, especially as we enter new markets and expand our cloud-focused solutions. For example, we are seeing the public cloud cause a shift in deployment architectures across the industry. To the extent customers delay their purchasing decisions as they consider new deployment architectures or if they do not adopt our cloud-focused solutions at a rate sufficient to maintain our revenue growth, our operating results would be adversely impacted. You should not rely on our revenue for any prior quarterly or annual period as any indication of our future revenue or revenue growth. If we are unable to maintain consistent revenue or revenue growth, our business, financial condition, results of operations and prospects could be materially and adversely affected and our stock price could decline.
We compete in highly competitive markets, and competitive pressures from existing and new companies may adversely impact our business and operating results.
The markets in which we compete are highly competitive. We expect competition to intensify in the future as existing competitors bundle new and more competitive offerings with their existing products and services, and as new market entrants introduce new products into our markets. This competition could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and our failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results and financial condition. We also expect that competition will continue to increase as a result of advancements in networking technology and architecture. If we do not keep pace with product and technology advances and otherwise keep our product offerings competitive, there could be a material and adverse effect on our competitive position, revenue and prospects for growth.
We compete either directly or indirectly with certain large Ethernet switch vendors, such as Cisco Systems Inc., and Arista Networks, Inc., and network management, analysis, compliance and security tool vendors, including Ixia (which was recently acquired by Keysight Technologies, Inc.) and NetScout Systems, Inc., that offer solutions that address a portion of the issues that we solve. The principal competitive factors in our markets include functionality and performance, price and total cost of ownership, ease of use, flexibility and scalability of deployment, brand awareness, breadth of portfolio, product reliability and quality, interoperability with other products, the extent and speed of user adoption and quality of service, support and fulfillment.

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Many of our current and potential competitors are substantially larger and have greater financial, technical, research and development, sales and marketing, manufacturing, distribution and other resources and greater name recognition. We could also face competition from new market entrants, including current technology partners. In addition, many of our existing and potential competitors enjoy substantial competitive advantages, such as: 
longer operating histories;
the capacity to leverage their sales efforts and marketing expenditures across a broader portfolio of products;
broader distribution and established relationships with channel partners;
access to larger customer bases;
greater resources to make acquisitions;
larger intellectual property portfolios;
the ability to bundle competitive offerings with other products and services; and
greater customer support.
As a result, increased competition could result in fewer or delayed customer orders, price reductions, reduced operating margins and loss of market share. Our competitors also may be able to provide end-user customers with capabilities or benefits different from or greater than those we can provide in areas such as technical qualifications or geographic presence, or to provide end-user customers a broader range of products, services and prices. Some of our larger potential competitors have substantially broader product offerings and could leverage their relationships based on other products or incorporate functionality into existing products to gain business in a manner that discourages users from purchasing our products, including through selling at zero or negative margins, product bundling or closed technology platforms. These larger potential competitors may also have more extensive relationships within existing and potential end-user customers that provide them with an advantage in competing for business with those end-user customers. In addition, to the extent that one of our competitors establishes or strengthens a cooperative relationship with, or acquires, one or more of the network management, analysis, compliance and security tool vendors that we have relationships with, it could adversely affect our ability to compete. Our ability to compete will depend upon our ability to provide a better solution than our competitors at a competitive price. To remain competitive, we may be required to make substantial additional investments in research, development, marketing and sales in order to respond to competition, and there is no assurance that these investments will achieve any returns for us or that we will be able to compete successfully in the future.
We also expect increased competition if our market continues to expand. Conditions in our market could change rapidly and significantly as a result of technological advancements or other factors. In addition, current or potential competitors may be acquired by third parties that have greater resources available. For example, our competitor, Ixia was recently acquired by Keysight Technologies. As a result of these acquisitions, our current or potential competitors, such as Ixia, might take advantage of the greater resources of the larger organization to compete more aggressively against us.
We depend on growth in markets relating to network security, management and analysis, and lack of growth or contraction in one or more of these markets could have a material adverse effect on our sales and financial condition.
Demand for our products is linked to, among other things, growth in the size and complexity of network infrastructures and the demand for networking technologies addressing the security, management and analysis of such infrastructures. If this demand declines or if we do not effectively adapt our technology to next generation network infrastructure deployments, our sales, profitability and financial condition would be materially adversely affected. Segments of the network infrastructure industry have in the past experienced significant economic downturns. The occurrence of any of these factors in the markets relating to network security, management and analysis could materially adversely affect our sales, profitability and financial condition. Furthermore, these markets are dynamic and evolving. Our future financial performance will depend in large part on continued growth in the number of organizations investing in their network infrastructure and the amount they commit to such investments. The market for network infrastructure may not continue to grow at historic rates, or at all. If this market fails to grow, or grows more slowly than we currently anticipate, our sales and profitability could be adversely affected.

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If our end-user customers do not continue to purchase our products or expand deployment of our technologies, our ability to grow our business and improve our operating results and financial condition may be adversely affected.
A significant portion of our revenues come from new or recurring purchases of products from our installed base of end-user customers. Our future success depends, in part, on our ability to increase the adoption of our products within and across our existing end-user customers and future end-user customers. If we fail to expand existing deployments or sell additional products to our customers, our ability to grow our business and improve our operating results and financial condition would be adversely affected.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense.
We have experienced difficulty managing lengthening and increasingly unpredictable sales cycles in the past. Our sales efforts involve educating our end-user customers about the use and benefits of our solutions, including their technical capabilities. End-user customers often undertake an evaluation and testing process that can result in a lengthy sales cycle. Also, as our distribution strategy typically leverages a channel model, utilizing distributors, the level of variability in the length of sales cycles across transactions has increased and made it more difficult to predict the timing of many of our sales transactions. We spend substantial time and resources on our sales efforts without any assurance that our efforts will produce any sales or a material amount of revenue from such sales. In addition, product purchases are frequently subject to budget constraints, multiple approvals and unplanned administrative, processing and other delays. These factors, among others, have in the past led to, and could continue to result in, long and unpredictable sales cycles.
We sell our products primarily to enterprise IT departments and service providers. Our sales cycles typically range from three to six months and are generally longer for larger transactions. Often times, our larger transactions are part of larger data center projects or upgrades by our customers and we have little ability to influence the timing of these transactions. As a result, our sales cycles can often be more than six months, with sales cycles involving service providers taking significantly longer to complete. To the extent that the mix of our future sales shifts to include relatively more revenue from service providers, the average length of our sales cycles will likely increase. Furthermore, our sales to federal, state and local governmental agency end-user customers have increased in recent periods, and we may in the future increase sales to governmental entities. Selling to governmental entities can be highly competitive, expensive and time consuming, often requiring significant upfront time and expense without any assurance that some of these efforts will generate a sale. As a result of these lengthy and uncertain sales cycles and the increasing size of our transactions, it is difficult for us to predict when end-user customers may purchase solutions and accept products from us. If we are unable to effectively manage the sales cycle or if we fail to close a large transaction or multiple smaller transactions that we expect to close in a given period, our operating results may vary significantly from period to period and may be materially adversely affected.
Our limited operating history makes it difficult for you to evaluate our current business and future prospects, and may increase the risk of your investment.
We were founded in 2004 and sold our first products commercially in 2005. We have experienced rapid growth since our inception, and we have been increasing the breadth and scope of our product offerings. The majority of our revenue growth, however, has occurred over the past six years. This limited operating history, as well as the early stage of our relationships with many of our channel partners, makes financial forecasting and evaluation of our business difficult. Furthermore, because we depend in part on the market’s acceptance of our products, it is difficult to evaluate trends that may affect our business. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries. If we do not address these risks successfully, our business and operating results would be adversely affected, and our stock price could decline.
Some of the components and technologies used in our products are purchased and licensed from a single source or a limited number of sources. The loss of any of these suppliers might cause us to incur additional transition costs, result in delays in the manufacturing and delivery of our products, or cause us to carry excess or obsolete inventory and could require us to redesign our products.
Although supplies of our components are generally available from a variety of sources, we currently depend on a single source or a limited number of sources for some components included in our products. For example, processors that we use in our products are manufactured by Broadcom Corp., Freescale Semiconductor. Ltd., Intel Corporation and Cavium, Inc. and are currently available only from a limited number of sources, and neither we nor, to our knowledge our manufacturers have entered into supply agreements with such sources. As there are no other sources for identical components and technologies, if we lost any of these suppliers or were unable to acquire enough of these components or license these technologies, we would not be able to sell our products for a significant period of time, and we could

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incur significant costs to redesign our hardware and software to incorporate components or technologies from alternative sources or to qualify alternative suppliers. Our reliance on a single source or a limited number of suppliers involves a number of additional risks, including risks related to: 
supplier capacity constraints;
price increases;
timely delivery;
component quality;
failure of a key supplier to remain in business and adjust to market conditions;
delays in, or the inability to execute on, a supplier roadmap for components and technologies; and
natural disasters.
In addition, for certain components for which there are multiple sources, we are subject to potential price increases and limited availability as a result of market demand for these components. In the past, unexpected demand for computer and network products has caused worldwide shortages of certain electronic parts. If similar shortages occur in the future, our business would be adversely affected. Although we carry some finished goods inventory of our products, we and our manufacturers rely on our suppliers to deliver necessary components in a timely manner. We and our manufacturers rely on purchase orders rather than long-term contracts with these suppliers. As a result, we or our manufacturers might not be able to secure sufficient components, even if they were available, at reasonable prices or of acceptable quality to build products in a timely manner and, therefore, might not be able to meet end-user customer demands for our products, which would have a material and adverse effect on our business, operating results and financial condition.
We rely on third-party channel partners for a substantial portion of our revenue. If our partners fail to perform, our ability to sell our products and services would be limited. Further, if we fail to optimize our channel partner model going forward, our operating results would be harmed.
Our revenue is primarily generated through sales by our channel partners, which include distributors and resellers. We depend upon our channel partners to assist with the sales process through introduction to accounts and the distribution of our products. In North America we principally rely on two distributors, Global Convergence Inc., or GCI, and Arrow Enterprise Computing Solutions, Inc. or Arrow. GCI accounted for 20% and 22% of our revenue for the three and six months ended July 1, 2017, respectively and 33% of our revenue for the fiscal year 2016. Arrow accounted for 33% and 26% of our revenue for the three and six months ended July 1, 2017, respectively and 26% of our revenue for the fiscal year 2016. To the extent our channel partners are unable to generate an increasing amount of our sales opportunities, are unsuccessful in selling our products, or we are unable to enter into arrangements with, and retain, a sufficient number of high quality channel partners in each of the regions in which we sell products, and keep them motivated to sell our products, our ability to sell our products and operating results would be harmed. The termination of our relationship with any significant channel partner may adversely impact our sales, operating results and revenue growth. If we fail to optimize our channel partner model or fail to manage existing sales channels, our business and operating results could be materially and adversely affected.
Managing inventory of our products and product components is complex. Insufficient inventory may result in lost sales opportunities or delayed revenue, while excess inventory may harm our gross margins.

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Managing inventory of our products and product components is complex with many critical components requiring long lead times from the component manufacturer. These long lead times place added importance on our ability to effectively forecast end-user customer demand so that we have the right amount of product or product components available. Managing inventory is further complicated as our channel partners may increase orders during periods of product shortages, cancel orders, return product or take advantage of price protection (if any) or delay orders in anticipation of new products. They also may adjust their orders in response to the supply of our products and the products of our competitors that are available to them and in response to seasonal fluctuations in end-user customer demand. Furthermore, if the time required to manufacture certain products or ship products increases for any reason, this could result in inventory shortfalls. Managing our inventory depends significantly on our ability to accurately forecast end-user customer demand for our products. Our inventory management and demand planning systems and related supply chain visibility tools may be inadequate to enable us to effectively manage inventory. Inventory management remains an area of focus as we balance the need to maintain inventory levels that are sufficient to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology and customer requirements. If we ultimately determine that we have excess inventory, we may have to reduce our prices or write-down inventory, which in turn could result in lower gross margins. Alternatively, insufficient inventory levels may lead to shortages that result in delayed revenue or loss of sales opportunities altogether as potential end-user customers turn to competitors’ products that are readily available. If we are unable to effectively manage our inventory, our operating results could be adversely affected.
We currently rely on third-party contract manufacturers to our products, and our failure to manage our relationship with our contract manufacturers successfully could negatively impact our business.
We outsource the manufacturing, systems assembly, testing and order fulfillment of our hardware products to third-party contract manufacturers, original design manufacturers and third party logistics providers. Jabil Circuit, Inc., or Jabil and Delta Networks, Inc., or DNI, manufacture and, through joint design arrangements with us, develop substantially all of our hardware products. We also contract with Expeditors International to provide warehousing, packaging, order fulfillment and light manufacturing services for our products. We rely on Jabil and, to a lesser extent, DNI to manufacture a substantial majority of our products.   
Our reliance on these third parties reduces our control over the assembly and order fulfillment process, exposing us to risks, including reduced control over quality assurance, production costs and product supply. If we fail to effectively manage our relationship with our contract manufacturers, or if they experience delays, disruptions, capacity constraints or quality control problems in their operations, our ability to ship products to our end-user customers could be impaired and our competitive position and reputation could be harmed. Furthermore, Jabil manufactures our products in their facility in Guadalajara, Mexico. As such, these manufacturing operations may be subject to changes in the economic, security and political conditions in Mexico, or to changes in Mexico's trade relations with the United States, which might interrupt or impact manufacturing operations. For example, the political climate in the United States has created some uncertainty whether the United States might impose tariffs or other restrictions on foreign imports, including imports from Mexico. If any such tariffs are imposed on products or components that we import, including those manufactured by Jabil, our costs could increase or our gross margins could be negatively impacted. Furthermore, any adverse change in the financial or business condition or our third party contract manufacturers could disrupt our ability to supply quality products to our end-user customers. If we are required to change our contract manufacturers and cannot find a suitable alternative in a timely manner, we may lose revenue, incur increased costs and damage our relationships with our channel partners and end-user customers. In addition, qualifying a new contract manufacturer and commencing production can be an expensive and lengthy process. If we experience increased demand that our contract manufacturers are unable to fulfill, or if they are unable to provide us with an adequate supply of high-quality products for any reason, we could experience a delay in our order fulfillment, and our business, operating results and financial condition would be adversely affected.

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Defects, errors or vulnerabilities in our products, or the failure of our solution to improve network security, could harm our reputation and business.
Our products are complex and have contained and may contain undetected defects or errors, especially when first introduced or when new versions are released. Defects in our products may impede or block network traffic or cause our products to fail to provide network traffic visibility as intended. Further, defects in our products may impair the functionality or performance of the appliances and applications that rely on the data provided by our products. Defects in our products may lead to product returns and require us to implement design changes or software updates. Additionally, defects or vulnerabilities in our products or services may cause the networks of our end-user customers to be vulnerable to security attacks, cause them to fail to help secure networks, or temporarily interrupt the networking traffic of our end-user customers. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques and provide a solution in time to fix the defect or vulnerability in our products or services. Furthermore, as we increasingly design and market our products with specific security-related features, our networks, products, and services could be targeted by attacks specifically designed to disrupt our business and harm our reputation. Any successful security attack on our network or on the network of one of our end-user customers that could be traced to a defect or vulnerability in one of our products or services could lead to significant liability or reputational harm that could have a material adverse impact on our operating results.
Any defects or errors in our products, or the perception of such defects or errors, could result in:
expenditure of significant financial and product development resources in efforts to analyze, correct, eliminate or work around errors or defects;
loss of existing or potential end-user customers or channel partners;
delayed or lost revenue;
delay or failure to attain market acceptance;
delay in the development or release of new products or services;
negative publicity, which will harm our reputation;
warranty claims against us, which could result in an increase in our provision for warranty reserve;
an increase in collection cycles for accounts receivable or the expense and risk of litigation; and
harm to our operating results.
Although we have limitation of liability provisions in our standard terms and conditions, they may not fully or effectively protect us from claims as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the United States or other countries. The sale and support of our products also entail the risk of product liability claims. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover any claim asserted against us. In addition, even claims that ultimately are unsuccessful could result in our expenditure of funds in litigation and divert management’s time and other resources.
We rely on the availability of licenses to third-party software and other intellectual property.
Many of our products and services include software or other intellectual property licensed from third parties, and we otherwise use software and other intellectual property licensed from third parties in our business. This exposes us to risks over which we may have little or no control. For example, a licensor may have difficulties keeping up with technological changes or may stop supporting the software or other intellectual property that it licenses to us. Also, it will be necessary in the future to renew certain licenses, expand the scope of certain existing licenses or seek new licenses, relating to various aspects of these products and services, or otherwise relating to our business, which may result in increased license fees. There can be no assurance that the necessary licenses will be available on acceptable terms, if at all. In addition, a third-party may assert that we or our end-user customers, are in breach of the terms of a license, which could, among other things, give such third-party the right to terminate a license, seek damages from us, or both. The inability to obtain or maintain certain licenses or other rights or to obtain or maintain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could result in delays in releases of products and services, and could otherwise disrupt our business, until equivalent technology can be identified, licensed, developed and integrated (if at all). Any of these events could have a material adverse effect on our business, operating results and financial condition. Moreover, the inclusion in our products and services of software or other intellectual property licensed from third parties on a non-exclusive basis may limit our ability to differentiate our products from those of our competitors.

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Furthermore, we have a license and services agreement with Tall Maple Systems, Inc., or Tall Maple, pursuant to which we have been granted a perpetual, non-exclusive, worldwide license to certain software code of Tall Maple, which we integrate into the software components of our H Series products and certain additional products and which can be integrated into our other products and applications. In return, we paid Tall Maple a license fee. The agreement can only be terminated for cause upon written notice of a material breach and if the other party does not cure such breach within 30 days of such notice. We were notified in 2013 that the assets of Tall Maple were acquired by a third party. If our agreement with Tall Maple is terminated as a result of a material breach by us that we do not timely cure, we may need to identify, license or develop equivalent software, and integrate such replacement software into the software component of our H Series products, which could impede our ability to sell our H Series products until equivalent software is identified, licensed or developed, and integrated. These delays, if they occur, could adversely affect our business, operating results and financial condition.
Failure to protect our proprietary technology and intellectual property rights could substantially harm our business and operating results.
The success of our business depends on our ability to protect and enforce our trade secrets, trademarks, copyrights, patents and other intellectual property rights. We attempt to protect our intellectual property under patent, trademark, copyright and trade secret laws, and through a combination of confidentiality procedures, contractual provisions and other methods, all of which offer only limited protection.
As of July 1, 2017, we had 37 issued patents in the United States, but this number may be relatively small in comparison to some of our competitors and potential competitors. Additionally, as of July 1, 2017, we had 36 pending U.S. patent applications. Internationally, as of July 1, 2017, we had 10 issued patents and a number of pending patent applications. We may file additional patent applications in the future. The process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. We may choose not to seek patent protection for certain innovations and may choose not to pursue patent protection in certain jurisdictions. Furthermore, it is possible that our patent applications may not issue as granted patents, that the scope of our issued patents will be insufficient or not have the coverage originally sought, that our issued patents will not provide us with any competitive advantages, and that our patents and other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. In addition, issuance of a patent does not guarantee that we have an absolute right to practice the patented invention, or that we have the right to exclude others from practicing the claimed invention. As a result, we may not be able to obtain adequate patent protection or to enforce our issued patents effectively.
In addition to patented technology, we rely on our unpatented proprietary technology and trade secrets. Despite our efforts to protect our proprietary technology and trade secrets, unauthorized parties may attempt to misappropriate, reverse engineer or otherwise obtain and use them. The contractual provisions that we enter into with employees, consultants, partners, vendors and customers may not prevent unauthorized use or disclosure of our proprietary technology or intellectual property rights and may not provide an adequate remedy in the event of unauthorized use or disclosure of our proprietary technology or intellectual property rights. Moreover, policing unauthorized use of our technologies, products and intellectual property is difficult, expensive and time-consuming, particularly in foreign countries where the laws may not be as protective of intellectual property rights as those in the United States and where mechanisms for enforcement of intellectual property rights may be weak. For example, the laws of India, where we have established a research and development facility, do not protect our proprietary rights to the same extent as the laws of the United States. We may be unable to determine the extent of any unauthorized use or infringement of our products, technologies or intellectual property rights.
From time to time, we may need to take legal action to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the intellectual property rights of others or to defend against claims of infringement, misappropriation or invalidity. Such litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results, financial condition and cash flows. If we are unable to adequately protect our intellectual property rights, we may find ourselves at a competitive disadvantage to others who need not incur the additional expense, time and effort required to create the innovative products that have enabled us to be successful to date.
Assertions by third parties of infringement or other violations by us of their intellectual property rights, or other lawsuits asserted against us, could result in significant costs and substantially harm our business and operating results.
Patent and other intellectual property disputes are common in the network infrastructure industry. Some companies in the network infrastructure industry, including some of our competitors, own large numbers of patents, copyrights, trademarks and trade secrets, which they may use to assert claims against us. Third parties may in the future assert

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claims of infringement, misappropriation or other violations of intellectual property rights against us. They may also assert such claims against our end-user customers or against channel partners whom we indemnify against claims that our products violate the intellectual property rights of third parties. As the number of products and competitors in our market increase and overlaps occur, claims of infringement, misappropriation and other violations of intellectual property rights may increase. Any claim of infringement, misappropriation or other violation of intellectual property rights by a third party, even those without merit, could cause us to incur substantial costs defending against the claim and could distract our management from our business.
The patent portfolios of our most significant competitors and potential competitors may be larger than ours. Any disparity between our patent portfolio and the patent portfolios of our most significant competitors or potential competitors may increase the risk that they may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses. In addition, future assertions of patent rights by third parties, and any resulting litigation, may involve patent holding companies or other adverse patent owners who have no relevant product revenue and against whom our own patents may therefore provide little or no deterrence or protection. We cannot assure you that we are not infringing or otherwise violating any third-party intellectual property rights.
An adverse outcome of a dispute may require us to, among other things; pay substantial damages, including treble damages, if we are found to have willfully infringed a third party’s patents or copyrights; cease making, licensing or using solutions that are alleged to infringe or misappropriate the intellectual property of others; expend additional development resources to attempt to redesign our products or services or otherwise to develop non-infringing technology, which may not be successful; enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies or intellectual property rights; and indemnify our partners and other third parties. Any damages or royalty obligations we may become subject to, and any third-party indemnity we may need to provide, as a result of an adverse outcome could harm our operating results. Royalty or licensing agreements, if required or desirable, may be unavailable on terms acceptable to us, or at all, and may require significant royalty payments and other expenditures. In addition, some licenses may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. Any of these events could seriously harm our business, financial condition and operating results.
Under the indemnification provisions of our standard channel contracts and certain additional sales contracts, we agree to defend against third-party claims asserting infringement of certain intellectual property rights, which typically include patents, copyrights and trademarks, and to pay judgments entered on, and certain damages and costs in connection with, such claims. Our exposure under the channel indemnification provisions is generally limited to the total amount paid under the agreement (i) for the12 months preceding the claim or (ii) for the products at issue. However, certain agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under the agreement. We have not incurred any material costs in the past as a result of such indemnification obligations, and have not accrued any liabilities related to such obligations in our consolidated financial statements.
In addition, we may, from time to time, be a party to other lawsuits in the normal course of our business. Litigation in general, and intellectual property and securities litigation in particular, can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. Responding to lawsuits is likely to be expensive and time consuming for us, and could divert our management’s attention from our business. An unfavorable resolution of any lawsuit could adversely affect our business, operating results or financial condition.
Our use of open source and third-party technology could impose limitations on our ability to commercialize our software.
We use open source software in our products, and although we monitor our use of open source software to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. courts. As a result, there is a risk that these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In such an event, or if we fail to adequately monitor our use of open source software, we could be required to seek licenses from third parties to continue offering our products, to make our proprietary code generally available in source code form, to re-engineer our products or to discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.

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We are dependent on a single product family comprised of a limited number of products.
Our product offering is limited to a single product family comprised of our GigaVUE, GigaSECURE, GigaSMART, Gigamon Visibility Platform for Amazon Web Services (AWS) and G-TAP products. Historically, we have derived a substantial portion of our revenue from sales of our GigaVUE appliances and related services, and we expect to continue to derive a significant portion of our revenue from sales of our GigaVUE appliances and related services for the foreseeable future. A decline in the price of these products and related services, whether due to competition or otherwise, or our inability to increase sales of these products, would harm our business and operating results more seriously than it would if we derived significant revenue from a variety of product lines and services. We expect that this concentration of revenue from a single product family comprised of a limited number of products will continue for the foreseeable future. As a result, our future growth and financial performance will depend heavily on our ability to develop and sell enhanced versions of our GigaVUE appliances and the related family of products and services. If we fail to deliver product enhancements, new releases or new products that end-user customers want, it will be more difficult for us to succeed.
Adverse economic conditions or reduced information technology and network or security infrastructure spending may adversely impact our business and operating results.
Our business depends on the overall demand for information technology, network or security infrastructure and the market for network security analysis, compliance and monitoring tools. In addition, the purchase of our products and services is often discretionary and may involve a significant commitment of capital and other resources. Weak global economic conditions, or a reduction in information technology and network infrastructure spending even if economic conditions improve, could adversely impact our business, financial condition and operating results in a number of ways, including longer sales cycles, lower prices for our products and services, higher default rates among our distributors, reduced unit sales and lower or no growth. As global or regional economic conditions continue to be volatile or economic uncertainty remains, trends in information technology and network infrastructure spending also remain unpredictable and subject to reductions due to credit constraints and uncertainties about the future. Unfavorable economic conditions may lead end-user customers to delay or reduce purchases of our solution. Demand for our solution may not reach our sales targets, or may decline, when there is an economic downturn or economic uncertainty. Our sensitivity to economic cycles and any related fluctuation in demand may have a material adverse effect on our business, financial condition and operating results.
The market for cloud-based and cloud-focused solutions has been accelerating. If the market does not continue to develop or develops more slowly than we expect, or our cloud-focused solutions are not adopted or adopted more slowly than we anticipate, our business could be harmed.
We recently introduced our first Visibility Platform offering addressing the public cloud (Gigamon Visibility Platform for AWS) and expect to expand the range of our cloud-focused offerings in the future. Many factors may affect the market acceptance of cloud-based and cloud-focused solutions, including: 
perceived security capabilities and reliability;
perceived concerns about the ability to scale operations for large enterprise customers;
concerns with entrusting a third party to store and manage critical data; and
the level of configurability or customizability of the solution.
If this market does not continue to accelerate as we anticipate, if organizations that establish a presence in the cloud do not perceive the benefits of our cloud-focused solutions, or if our competitors or new market entrants are able to develop cloud-focused solutions that are or are perceived to be more effective than ours, this portion of our business may not grow further or may develop more slowly than we expect, either of which would adversely affect our business and operating results.
The average selling price of our products has decreased from time to time, and may decrease in the future, which may negatively impact gross profits.
From time to time, the average selling price of our products has decreased. In the future, it is possible that the average selling prices of our products will decrease in response to competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors or other factors. Such pricing pressures may also be dependent upon the mix of products sold, the mix of revenue between products and services and the degree to which products and services are bundled and sold together for a package price. Therefore, in order to maintain our profitability, we must develop and introduce new products and product enhancements on a timely basis and continually reduce our product costs. Our failure to do so would likely cause our revenue and gross profits to decline, which would harm

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our business and operating results. In addition, we may experience substantial period-to-period fluctuations in future operating results in the event we experience an erosion of our average selling prices.
We rely on revenue from support services which may decline, and because we recognize revenue from support services over the term of the relevant service period, downturns or upturns in sales of support services are not immediately reflected in full in our operating results.
Our service revenue has become a more meaningful part of revenue in recent periods. Starting in the quarter ended September 26, 2015, we began to sell first year maintenance and support as an additional offering. Prior to that time, the first year of maintenance and support was bundled as part of the initial contract to purchase our products. Sales of new or renewal services contracts may decline and fluctuate as a result of a number of factors, including end-user customers’ level of satisfaction with our products and services, the prices of our products and services, the prices of products and services offered by our competitors or reductions in our end-user customers’ spending levels. If our sales of new or renewal services contracts decline, our revenue and revenue growth may decline and our business will suffer. In addition, we recognize service revenue over the term of the relevant service period, which is typically 12 months. As a result, some of the revenue we report each quarter is the recognition of deferred revenue from services contracts entered into during previous quarters. Consequently, a decline in new or renewed service contracts in any one quarter will not be fully reflected in revenue in that quarter but will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in new or renewed sales of our services is not reflected in full in our operating results until future periods. Our service revenue also makes it difficult for us to rapidly increase our revenue through additional service sales in any period, as revenue from new and renewal service contracts must be recognized over the applicable service period. Furthermore, increases in the average term of services contracts would result in revenue for services contracts being recognized over longer periods of time.
Seasonality may cause fluctuations in our revenue and operating results.
We have experienced seasonality in our product revenue and operating results in the past, and we believe that we will continue to experience such seasonality in the future. The first quarter of each year is usually our lowest revenue quarter during the year and product revenue typically declines sequentially from the prior fourth quarter. We believe that this results in part from the procurement, budgeting and deployment cycles of many of our end-user customers. We generally expect a relative increase in sales in the second half of each year as budgets of our end-user customers for annual capital purchases are being fully utilized. We expect that seasonality will continue to affect our revenue and operating results in the future.
Our business and operations have experienced rapid growth, and if we do not appropriately manage any future growth, or are unable to improve our systems and processes, our operating results will be negatively affected.
We have experienced rapid growth over the last several years, which has placed a strain on our management, administrative, operational and financial infrastructure. In addition, some of the members of our current management team have only been working together for a short period of time. We also anticipate that additional investments in key channel partnerships and direct-sales personnel, as well as infrastructure, sales and marketing and research and development spending, will be required to: 
scale our operations and increase productivity;
address the needs of our end-user customers;
further develop and enhance our products and services;
develop new technology; and
expand our markets and opportunity under management, including into new industry verticals and geographic areas.
Our success will depend in part upon our ability to manage our growth effectively. To do so, we must continue to increase the productivity of our existing employees and to hire, train and manage new employees as needed. To manage domestic and international growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting processes and procedures, and implement more extensive and integrated financial and business information systems. These additional investments will increase our operating costs, which will make it more difficult for us to offset any future revenue shortfalls by reducing expenses in the short term. Moreover, if we fail to scale our operations successfully, our business and operating results could be materially and adversely affected.

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If we are unable to implement and maintain effective internal control over financial reporting, the accuracy and timeliness of our financial reporting may be adversely affected.
We must maintain effective internal control over financial reporting in order to accurately and timely report our results of operations and financial condition. In addition, the Sarbanes-Oxley Act requires, among other things, that we assess the effectiveness of our internal control over financial reporting and the effectiveness of our disclosure controls and procedures quarterly. If we are not able to comply with the requirements of the Sarbanes-Oxley Act in a timely manner, the market price of our stock could decline and we could be subject to sanctions or investigations by the New York Stock Exchange, the SEC or other regulatory authorities, which would diminish investor confidence in our financial reporting and require additional financial and management resources, each of which may adversely affect our business and operating results.
We have reported material weaknesses in our financial reporting in the past. Although prior material weaknesses have been remediated, including certain material weaknesses which our management determined were remediated in connection with their review of our internal control over financial reporting for fiscal 2015, there can be no assurance that control deficiencies or other significant deficiencies or material weaknesses in our financial reporting will not occur in the future. Any failure to maintain or implement required new or improved controls, or difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, or cause us to fail to meet our future reporting obligations. Internal control deficiencies could also result in a restatement of our financial statements in the future or cause investors to lose confidence in our reported financial information, which could cause a decline in the market price of our common stock.