A10 Networks, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations (“MD&A”) should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this document. In addition to historical information, the MD&A contains forward-looking statements that involve risks and uncertainties. These forward-looking statements include, but are not limited to, those matters discussed under the heading “Forward-looking Statements.” Our actual results could differ materially from those anticipated by these forward‑looking statements due to various factors, including, but not limited to, those set forth under Item 1A. Risk Factors of this Form 10-K and elsewhere in this document. Overview We are a leading provider of networking solutions that enable next-generation networks focused on reliability, availability, scalability and cybersecurity. Our portfolio supports customers operating in the cloud, on-premise or in hybrid environments providing rapid return on their investment as well as investment protection with best-in-class technical performance. As cyber-attacks increase in volume and complexity, we integrate security as a key attribute in our solutions that further enable our customers to continue to adapt to market trends in cloud, internet of things and the ever increasing need for more data, building upon our strong global footprint and leadership in application and network infrastructure. Our customers include leading service providers (cloud, telecommunications, multiple system operators, cable), government organizations, and enterprises. Our product portfolio seeks to address many of the cyber protection challenges and solution requirements. The portfolio consists of six secure application solutions; Thunder Application Delivery Controller (“ADC”), Lightning Application Delivery Controller (“Lightning ADC”), Thunder Carrier Grade Networking (“CGN”), Thunder Threat Protection System (“TPS”), Thunder SSL Insight (“SSLi”) and Thunder Convergent Firewall (“CFW”) and intelligent management, and automation tools; Harmony Controller and aGalaxy TPS. Our products are offered in a variety of form factors and payment models, including physical appliances and perpetual and subscription-based software licenses, as well as pay-as-you-go licensing models and FlexPool, a flexible consumption-based software model. We derive revenue from sales of products and related support services. Products revenue is generated primarily by sales of hardware appliances with perpetual licenses to our embedded software solutions. We also derive revenue from licenses to, or subscription services for, software-only versions of our solutions. We generate services revenue primarily from sales of maintenance and support contracts. Our customers predominantly purchase maintenance and support in conjunction with purchases of our products. In addition, we also derive revenue from the sale of professional services. We sell our products globally to service providers and enterprises that depend on data center applications and networks to generate revenue and manage operations efficiently. In 2019, we changed the way we present revenue by customer vertical. We now report two customer verticals: service providers and enterprises, compared to service providers, enterprises and web giants in prior years. Our previously reported revenue from web giants is primarily accounted for now in enterprise revenue. Additionally, we changed the way we present customer revenue by geographic region. We now report customer revenues in four geographic regions: the Americas, Japan, Asia Pacific (excluding Japan) and EMEA. Our previously reported customer revenues of our United States and Latin America regions are now included in the Americas geographic region. We believe this new geographic and vertical view aligns with how we manage the business and maps our product portfolio to customer verticals. The revenue by vertical percentages from prior years included in this report have been revised to conform with current year presentation. Our end-customers operate in a variety of industries, including telecommunications, technology, industrial, retail, financial, gaming, education and government. Since inception, our customer base has grown rapidly. As of December 31, 2020, we had sold products to more than 7,290 end-customers worldwide. We sell substantially all of our solutions through our high-touch sales organization as well as distribution channel partners, including distributors, value-added resellers and system integrators, and fulfill nearly all orders globally through such partners. We believe this sales approach allows us to obtain the benefits of channel distribution, such as expanding our market coverage, while still maintaining face-to-face relationships with our end-customers. We outsource the manufacturing of our hardware products to original design manufacturers. We perform quality assurance and testing at our San Jose, Taiwan and Japan distribution centers, as well as at our manufacturers’ locations. During 2020, 43% of our total revenue was generated from the Americas, 30% from Japan and 27% from other geographical regions. During 2019, 42% of our total revenue was generated from the Americas, 28% from Japan and 30% from 49 other geographical regions. During 2018, 48% of our total revenue was generated from the Americas, 24% from Japan and 28% from other geographical regions. Our enterprise customers accounted for 39%, 42% and 43% of our total revenue during 2020, 2019 and 2018, respectively. Our service provider customers accounted for 61%, 58% and 57% of our total revenue during 2020, 2019 and 2018, respectively. As a result of the nature of our target market and the current stage of our development, a substantial portion of our revenue comes from a limited number of large customers and service providers, in any period. Purchases from our ten largest end-customers accounted for 41%, 36% and 37% of our total revenue for 2020, 2019 and 2018, respectively. Sales to these large end-customers have typically been characterized by large but irregular purchases with long sales cycles. The timing of these purchases and the delivery of the purchased products are difficult to predict. Consequently, any acceleration or delay in anticipated product purchases by or deliveries to our largest customers could materially impact our revenue and operating results in any quarterly period. This may cause our quarterly revenue and operating results to fluctuate from quarter to quarter and make them difficult to predict. As of December 31, 2020, we had $83.3 million of cash and cash equivalents and $74.9 million of marketable securities. Cash provided by operating activities was $55.3 million in 2020 compared to $0.4 million of cash used in operating activities in 2019. We intend to continue to invest for long-term growth. We have invested and expect to continue to invest in our product development efforts to deliver new products and additional features in our current products to address customer needs. In addition, we may expand our global sales and marketing organizations, expand our distribution channel partner programs and increase awareness of our solutions on a global basis. Our investments in growth in these areas may affect our short-term profitability. 50 Results of Operations A summary of our consolidated statements of operations for the year ended December 31, 2020, 2019 and 2018 are as follows (dollars in thousands): Years Ended December 31, 2020 2019 Increase (Decrease) Amount Percent of Total Revenue Amount Percent of Total Revenue Amount Percent Revenue: Products $ 129,876 57.6 % $ 121,920 57.3 % $ 7,956 6.5 % Services 95,651 42.4 90,708 42.7 4,943 5.4 % Total revenue 225,527 100.0 212,628 100.0 12,899 6.1 % Cost of revenue: Products 29,109 12.9 29,816 14.0 (707) (2.4) % Services 21,039 9.3 19,065 9.0 1,974 10.4 % Total cost of revenue 50,148 22.2 48,881 23.0 1,267 2.6 % Gross profit 175,379 77.8 163,747 77.0 11,632 7.1 % Operating expenses: Sales and marketing 77,732 34.5 92,783 43.6 (15,051) (16.2) % Research and development 58,063 25.7 61,824 29.1 (3,761) (6.1) % General and administrative 21,851 9.7 23,704 11.1 (1,853) (7.8) % Restructuring expense — — 2,530 1.2 2,530 * Total operating expenses 157,646 69.9 180,841 85.0 (23,195) (12.8) % Income (loss) from operations 17,733 7.9 (17,094) (8.0) (34,827) 203.7 % Non-operating income (expense): Interest expense (1) — (237) (0.1) 236 (99.6) % Interest and other income, net 1,407 0.6 919 0.4 488 53.1 % Total non-operating income (expense), net 1,406 0.6 682 0.3 724 106.2 % Income (loss) before income taxes 19,139 8.5 (16,412) (7.7) 35,551 216.6 % Provision for income taxes 1,323 0.6 1,407 0.7 (84) (6.0) % Net income (loss) $ 17,816 7.9 % $ (17,819) (8.4) % $ 35,635 200.0 % * not meaningful 51 Years Ended December 31, 2019 2018 Increase (Decrease) Amount Percent of Total Revenue Amount Percent of Total Revenue Amount Percent Revenue: Products $ 121,920 57.3 % $ 144,682 62.3 % $ (22,762) (15.7) % Services 90,708 42.7 87,541 37.7 3,167 3.6 % Total revenue 212,628 100.0 232,223 100.0 (19,595) (8.4) % Cost of revenue: Products 29,816 14.0 34,066 14.7 (4,250) (12.5) % Services 19,065 9.0 17,830 7.6 1,235 6.9 % Total cost of revenue 48,881 23.0 51,896 22.3 (3,015) (5.8) % Gross profit 163,747 77.0 180,327 77.7 (16,580) (9.2) % Operating expenses: Sales and marketing 92,783 43.6 103,214 44.4 (10,431) (10.1) % Research and development 61,824 29.1 65,157 28.1 (3,333) (5.1) % General and administrative 23,704 11.1 39,635 17.1 (15,931) (40.2) % Restructuring expense 2,530 1.2 — — 2,530 * Total operating expenses 180,841 85.0 208,006 89.6 (27,165) (13.1) % Loss from operations (17,094) (8.0) (27,679) (11.9) 10,585 (38.2) % Non-operating income (expense): Interest expense (237) (0.1) (129) (0.1) (108) 83.7 % Interest and other income, net 919 0.4 1,273 0.6 (354) (27.8) % Total non-operating income (expense), net 682 0.3 1,144 0.5 (462) (40.4) % Loss before income taxes (16,412) (7.7) (26,535) (11.4) 10,123 (38.1) % Provision for income taxes 1,407 0.7 1,082 0.5 325 30.0 % Net loss $ (17,819) (8.4) % $ (27,617) (11.9) % $ 9,798 (35.5) % * not meaningful Revenue Our products revenue primarily consists of revenue from sales of our hardware appliances upon which our software is installed. Such software includes our ACOS software platform plus one or more of our ADC, CGN, TPS, SSLi or CFW solutions. Purchase of a hardware appliance includes a perpetual license to the included software. We recognize products revenue upon transfer of control, generally at the time of shipment, provided that all other revenue recognition criteria have been met. As a percentage of revenue, our products revenue may vary from quarter to quarter based on, among other things, the timing of orders and delivery of products, cyclicality and seasonality, changes in currency exchange rates and the impact of significant transactions with unique terms and conditions. We generate services revenue from sales of post contract support (“PCS”), which is bundled with sales of products and professional services. We offer tiered PCS services under renewable, fee-based PCS contracts, primarily including technical support, hardware repair and replacement parts, and software upgrades on a when-and-if-available basis. We recognize services revenue ratably over the term of the PCS contract, which is typically one year, but can be up to seven years. Our adoption of ASC 606, Revenue from Contracts with Customers, in January 2018 resulted in a $2.6 million increase in products revenue in 2018. See Note 2 Revenue, of the notes to consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for additional information. 52 A summary of our total revenue is as follows (dollars in thousands): Years Ended December 31, 2020 2019 Increase (Decrease) Amount Percent of Total Revenue Amount Percent of Total Revenue Amount Percent Revenue: Products $ 129,876 58 % $ 121,920 57 % $ 7,956 7 % Services 95,651 42 90,708 43 4,943 5 % Total revenue $ 225,527 100 % $ 212,628 100 % $ 12,899 6 % Revenue by geographic region: Americas $ 98,150 43 % $ 89,944 42 % $ 8,206 9 % Japan 67,050 30 59,454 28 7,596 13 % Asia Pacific, excluding Japan 29,760 13 35,689 17 (5,929) (17) % EMEA 30,567 14 27,541 13 3,026 11 % Total revenue $ 225,527 100 % $ 212,628 100 % $ 12,899 6 % Years Ended December 31, 2019 2018 Increase (Decrease) Amount Percent of Total Revenue Amount Percent of Total Revenue Amount Percent Revenue: Products $ 121,920 57 % $ 144,682 62 % $ (22,762) (16) % Services 90,708 43 87,541 38 3,167 4 % Total revenue $ 212,628 100 % $ 232,223 100 % $ (19,595) (8) % Revenue by geographic region: Americas $ 89,944 42 % $ 112,506 48 % $ (22,562) (20) % Japan 59,454 28 55,205 24 4,249 8 % Asia Pacific, excluding Japan 35,689 17 36,897 16 (1,208) (3) % EMEA 27,541 13 27,615 12 (74) — % Total revenue $ 212,628 100 % $ 232,223 100 % $ (19,595) (8) % 2020 Revenue Compared to 2019 Revenue Total revenue increased by $12.9 million, or 6%, in 2020 compared to 2019. This increase was due to a $8.0 million increase in products revenue and a $4.9 million increase in services revenue. Products revenue increased $8.0 million, or 7%, in 2020 compared to 2019 primarily driven by higher demand from our service provider and enterprise customers in the Americas, and from higher demand from service provider customers in Japan. Services revenue increased $4.9 million, or 5%, in 2020 compared to 2019. The increase was primarily attributable to the increase in PCS sales in connection with our increased installed customer base in Japan. During 2020, $98.2 million, or 43% of total revenue, was generated from the Americas, which represents a 9% increase compared to 2019. The increase was primarily due to higher products revenue driven by an increase in demand from our service provider customers. 53 During 2020, $67.1 million, or 30% of total revenue, was generated from Japan, which represents a 13% increase compared to 2019. The increase was mainly due to increased revenue from our service provider customers. During 2020, $29.8 million, or 13% of total revenue, was generated from the Asia Pacific region excluding Japan, which represents a 17% decrease compared to 2019. The decrease was driven by lower revenues from our service provider and enterprise customers. During 2020, $30.6 million, or 14% of total revenue, was generated from EMEA, which represented an 11% increase compared to 2019. The increase was primarily due to higher products revenue driven by an increase in demand from our enterprise customers. 2019 Revenue Compared to 2018 Revenue Total revenue decreased by $19.6 million, or 8%, in 2019 compared to 2018. This decrease was due to a $22.8 million decrease in products revenue, partially offset by a $3.2 million increase in services revenue. The decrease in products revenue was primarily driven by lower demand from our service provider and enterprise customers in the Americas, partially offset by an increase in product revenues in Japan. Products revenue decreased $22.8 million, or 16%, in 2019 compared to 2018 primarily driven by lower demand from our service provider and enterprise customers in the Americas, partially offset by increased revenues in Japan. Services revenue increased $3.2 million, or 4%, in 2019 compared to 2018. The increases were primarily attributable to the increase in PCS sales in connection with our increased installed customer base. During 2019, $89.9 million, or 42% of total revenue, was generated from the Americas, which represents a 20% decrease compared to 2018. The decrease was primarily due to lower product revenue driven by lower demand from our service provider and enterprise customers in the Americas. During 2019, $59.5 million, or 28% of total revenue, was generated from Japan, which represents a 8% increase compared to 2018. The increase was mainly due to increased revenue from our enterprise customers in Japan. During 2019, $35.7 million, or 17% of total revenue, was generated from the Asia Pacific region excluding Japan, which represents a 3% decrease compared to 2018. The decrease was driven primarily by lower revenues from our enterprise customers in Asia Pacific. During 2019, $27.5 million, or 13% of total revenue, was generated from EMEA, which remained relatively constant compared to 2018. Cost of Revenue, Gross Profit and Gross Margin Cost of Revenue Cost of products revenue is primarily comprised of cost of third-party manufacturing services and cost of inventory for the hardware component of our products. Cost of products revenue also includes warehouse personnel costs, shipping costs, inventory write-downs, certain allocated facilities and information technology infrastructure costs, and expenses associated with logistics and quality control. Cost of services revenue is primarily comprised of personnel costs for our technical support, training and professional service teams. Cost of services revenue also includes the costs of inventory used to provide hardware replacements to end- customers under PCS contracts and certain allocated facilities and information technology infrastructure costs. 54 A summary of our cost of revenue is as follows (dollars in thousands): Years Ended December 31, Increase (Decrease) 2020 2019 Amount Percent Cost of revenue: Products $ 29,109 $ 29,816 $ (707) (2) % Services 21,039 19,065 1,974 10 % Total cost of revenue $ 50,148 $ 48,881 $ 1,267 3 % Years Ended December 31, Increase (Decrease) 2019 2018 Amount Percent Cost of revenue: Products $ 29,816 $ 34,066 $ (4,250) (12) % Services 19,065 17,830 1,235 7 % Total cost of revenue $ 48,881 $ 51,896 $ (3,015) (6) % Gross Margin Gross margin may vary and be unpredictable from period to period due to a variety of factors. These may include the mix of revenue from each of our regions, the mix of our products sold within a period, discounts provided to customers, inventory write-downs and foreign currency exchange rates. Our sales are generally denominated in U.S. dollars, however, in Japan they are denominated in Japanese yen. Any of the factors noted above can generate either a favorable or unfavorable impact on gross margin. A summary of our gross profit and gross margin is as follows (dollars in thousands): Years Ended December 31, 2020 2019 Increase (Decrease) Amount Gross Margin Amount Gross Margin Amount Gross Margin Gross profit: Products $ 100,767 77.6 % $ 92,104 75.5 % $ 8,663 2.1 % Services 74,612 78.0 % 71,643 79.0 % 2,969 (1.0) % Total gross profit $ 175,379 77.8 % $ 163,747 77.0 % $ 11,632 0.8 % Years Ended December 31, 2019 2018 Increase (Decrease) Amount Gross Margin Amount Gross Margin Amount Gross Margin Gross profit: Products $ 92,104 75.5 % $ 110,616 76.5 % $ (18,512) (1.0) % Services 71,643 79.0 % 69,711 79.6 % 1,932 (0.6) % Total gross profit $ 163,747 77.0 % $ 180,327 77.7 % $ (16,580) (0.7) % 2020 Gross Margin Compared to 2019 Gross Margin Products gross margin increased by 2.1% in 2020 compared to 2019 primarily driven by changes in product and geographic mix. 55 Services gross margin decreased by 1.0% in 2020 compared to 2019 primarily due to higher personnel related support costs. 2019 Gross Margin Compared to 2018 Gross Margin Products gross margin decreased by 1.0% in 2019 compared to 2018 primarily driven by changes in product and geographic mix. Services gross margin decreased by 0.6% in 2019 compared to 2018 primarily due to higher personnel related support costs. Operating Expenses Our operating expenses consist of sales and marketing, research and development, general and administrative, and restructuring expenses. The largest component of our operating expenses is personnel costs which consist of wages, benefits, bonuses, and, with respect to sales and marketing expenses, sales commissions. Personnel costs also include stock-based compensation. A summary of our operating expenses is as follows (dollars in thousands): Years Ended December 31, Increase (Decrease) 2020 2019 Amount Percent Operating expenses: Sales and marketing $ 77,732 $ 92,783 $ (15,051) (16) % Research and development 58,063 61,824 (3,761) (6) % General and administrative 21,851 23,704 (1,853) (8) % Restructuring expense — 2,530 (2,530) * Total operating expenses $ 157,646 $ 180,841 $ (23,195) (13) % * not meaningful Years Ended December 31, Increase (Decrease) 2019 2018 Amount Percent Operating expenses: Sales and marketing $ 92,783 103,214 $ (10,431) (10) % Research and development 61,824 65,157 (3,333) (5) % General and administrative 23,704 39,635 (15,931) (40) % Restructuring expense 2,530 — 2,530 * Total operating expenses $ 180,841 $ 208,006 $ (27,165) (13) % * not meaningful Sales and Marketing Sales and marketing expenses are our largest functional category of operating expenses and primarily consist of personnel costs. Sales and marketing expenses also include the cost of marketing programs, trade shows, consulting services, promotional materials, demonstration equipment, depreciation and certain allocated facilities and information technology infrastructure costs. Prior to the adoption of ASC 606, we expensed sales commissions associated with the acquisition of customer contracts as incurred in the period the contract was acquired. Upon the adoption of ASC 606 in January 2018, $8.4 million of our sales commission expenses from prior periods has been deferred and will be recognized over an expected benefit 56 period as required by ASC 340-40, Other Assets and Deferred Costs - Contracts with Customers . See Note 2 Revenue, of the notes to consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for additional information. The $15.1 million decrease in sales and marketing expenses in 2020 compared to 2019 was primarily due to a 12% decrease in headcount, resulting in a $9.6 million decrease in salary and benefit expenses, a $4.1 million decrease in travel and entertainment and a $1.1 million decrease in marketing expenses. The $10.4 million decrease in sales and marketing expenses in 2019 compared to 2018 was primarily due to a 14% decrease in headcount, resulting in a $7.0 million decrease in salary and benefit expenses, a $0.9 million decrease in travel and entertainment and $0.8 million decrease in depreciation. In 2021, we expect sales and marketing expenses to remain at 2020 levels as we continue to actively control costs. Research and Development Research and development efforts are focused on new product development and on developing additional functionality for our existing products. These expenses primarily consist of personnel costs, and, to a lesser extent, prototype materials, depreciation and certain allocated facilities and information technology infrastructure costs. We expense research and development costs as incurred. The $3.8 million decrease in research and development expenses in 2020 compared to 2019 was primarily due to a decrease in salary and benefit expenses, partially offset by an increase in facility expense. The $3.3 million decrease in research and development expenses in 2019 compared to 2018 was primarily due to a decrease in salary and benefit expenses. In 2021, we expect research and development expenses to remain at 2020 levels as we continue to actively control costs. General and Administrative General and administrative expenses primarily consist of personnel costs, professional services and office expenses. General and administrative personnel costs include executive, finance, human resources, information technology, facility and legal related expenses. Professional services primarily consist of fees for outside accounting, tax, legal, recruiting and other administrative services. The $1.9 million decrease in general and administrative expenses in 2020 compared to 2019 was primarily due to a decrease in consulting and contractor fees, partially offset by an increase in business operations and facility expenses. The $15.9 million decrease in general and administrative expenses in 2019 compared to 2018 was primarily due to $10.1 million lower legal fees, $1.4 million lower audit-related costs, $1.7 million lower contractor and consultant expense (all related to the 2018 litigation settlement, investigation and restatement efforts), $1.0 million lower commission and bonus, $2.3 million reduction in general IT expenses and $0.4 million lower recruiting costs. In 2021, we expect general and administrative expenses to remain at 2020 levels as we continue to actively control costs. Restructuring Expense In October 2019, we began implementing a restructuring plan in our ongoing efforts to reduce operating costs and focus on advanced technologies. The restructuring plan resulted in a reduction of approximately 5% of our workforce and the closure and consolidation of certain U.S. and international office facilities. The restructuring was completed by the end of the second fiscal quarter of 2020. We recorded restructuring expenses of $2.5 million in the fourth quarter of 2019, which included the following (in thousands): 57 Cost of revenue Sales and marketing Research and development General and administrative Total restructuring expense Employee severance and related payroll taxes $ 28 $ 1,355 $ 340 $ 194 $ 1,917 Facilities closure expenses 435 89 524 Legal fees 89 89 $ 28 $ 1,790 $ 429 $ 283 $ 2,530 Interest Expense In the past, interest expense has primarily consisted of interest expense and amortization of debt issuance costs. We elected to allow our credit facility to expire in November 2019 without renewal. Should we seek additional sources of funding we may incur increased interest expense and amortization of debt issuance costs. Interest expense was immaterial in 2020, 2019 and 2018. Interest and Other Income, Net Interest income consists primarily of interest income earned on our cash and cash equivalents and marketable securities. Other income (expense), net consists primarily of foreign currency exchange gains and losses. Interest and other income, net, had a favorable change of $0.5 million, or 53%, in 2020 compared to 2019 primarily driven by a $1.4 million increase in foreign exchange gain, partially offset by a $0.9 million decrease in interest income. Interest and other income, net, had an unfavorable change of $0.4 million, or 28%, in 2019 compared to 2018 primarily driven by a $0.7 million increase in foreign exchange loss, partially offset by a $0.4 million increase in interest income. Provision for Income Taxes We recorded an income tax provision of $1.3 million, $1.4 million and $1.1 million for the years ended December 31, 2020, 2019 and 2018, respectively, which primarily consisted of foreign income taxes. We currently maintain a valuation allowance on federal and state deferred tax assets, and we will continue to maintain a valuation allowance against all of our U.S. and certain foreign deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of this allowance. See Note 11 Income Taxes, of the note to consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for further details regarding the Company’s taxes. Liquidity and Capital Resources As of December 31, 2020, we had cash and cash equivalents of $83.3 million, including $5.4 million held outside the United States in our foreign subsidiaries, and $74.9 million of marketable securities. We currently do not have any plans to repatriate our earnings from our foreign operations. As of December 31, 2020, we had working capital of $134.5 million, accumulated deficit of $272.2 million and total stockholders’ equity of $116.0 million. We plan to continue to invest for long-term growth, and our investment may increase. We believe that our existing cash and cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the expansion of sales and marketing activities, the timing and extent of spending to support development efforts, the introduction of new and enhanced 58 product and service offerings and the continuing market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition could be adversely affected. On May 17, 2020, we entered into a Common Stock Repurchase and Option Exchange Agreement (the “Repurchase Agreement”) with Lee Chen, the Company’s founder and its former Chairman, President and Chief Executive Officer. Pursuant to the Repurchase Agreement, we repurchased 2.2 million shares of common stock from Mr. Chen for approximately $13.3 million. The common shares repurchased are held in treasury and accounted for under the cost method. On September 17, 2020, we issued a press release announcing that our Board of Directors had approved a stock repurchase program of up to $50 million of its common stock over a period of twelve months. During the year ended December 31, 2020, we repurchased a total of 2.7 million shares for a total cost of $19.2 million under this program and as of December 31, 2020 we had $30.8 million available to repurchase shares. Our stock repurchase program does not obligate us to acquire any specific number of shares. Shares may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Exchange Act. To date, all repurchases under this program have occurred in the open market. In addition, as described in Note 8 Commitments and Contingencies, in the notes to consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K, we may be currently, or may be from time to time, involved in ongoing litigation. Any adverse settlements or judgments in any litigation could have a material adverse impact on our results of operations, cash balances and cash flows in the period in which such events occur. Statements of Cash Flows The following table summarizes our cash flow related activities (in thousands): Years Ended December 31, 2020 2019 2018 Cash provided by (used in): Operating activities $ 55,286 $ (426) $ (2,694) Investing activities 5,202 (251) (6,876) Financing activities (22,949) 5,798 3,624 Net increase (decrease) in cash and cash equivalents $ 37,539 $ 5,121 $ (5,946) Cash Flows from Operating Activities Our cash provided by operating activities is driven primarily by sales of our products and management of working capital investments. Our primary uses of cash from operating activities have been for personnel-related expenditures, manufacturing costs, marketing and promotional expenses and costs related to our facilities. Our cash flows from operating activities will continue to be affected principally by the extent to which we increase spending on our business and our working capital requirements. During the year ended December 31, 2020, cash provided by operating activities was $55.3 million, consisting of net income of $17.8 million, non-cash charges of $24.7 million and a favorable net change in operating assets and liabilities of $12.8 million. Our non-cash charges consisted primarily of stock-based compensation expense of $12.3 million and depreciation and amortization expenses of $11.3 million. The net change in our operating assets and liabilities primarily reflects cash inflows from the changes in deferred revenue of $7.5 million, accrued liabilities and other of $3.9 million, accounts receivable of $2.3 million and prepaid expenses and other assets of $1.1 million, partially offset by cash outflows from changes in accounts payable of $2.7 million. The unfavorable change in accounts payable was due to the timing of payments to our vendors. During the year ended December 31, 2019, cash used in operating activities was $0.4 million, consisting of net loss of $17.8 million, non-cash charges of $26.2 million and an unfavorable net change in operating assets and liabilities of $8.8 million. Our non-cash charges consisted primarily of stock-based compensation expense of $16.5 million and depreciation and 59 amortization expenses of $10.0 million. The net change in our operating assets and liabilities primarily reflects an outflow from the changes in accrued liabilities and other of $5.9 million and inventory of $5.6 million, partially offset by an inflow from changes in deferred revenue of $3.2 million. The unfavorable change in accrued liabilities and other was driven by an increase in lease liabilities associated with the lease of the San Jose corporate office. The unfavorable change in inventory was due to build up of inventory and timing of shipments, partially offset by increased reserves. The favorable change in deferred revenues was primarily driven by increased bookings. During the year ended December 31, 2018, cash used in operating activities was $2.7 million, consisting of net loss of $27.6 million which includes payments for our internal investigation costs of $8.6 million, non-cash charges of $25.0 million and an unfavorable net change in operating assets and liabilities of $0.1 million. Our non-cash charges consisted primarily of stock-based compensation expense of $17.0 million and depreciation and amortization expenses of $7.9 million. The net change in our operating assets and liabilities primarily reflects an inflow from the changes in deferred revenue of $7.3 million and accrued and other liabilities of $3.1 million, offset primarily by an outflow from the changes in accounts receivable of $6.1 million, prepaid expenses and other assets of $2.4 million and inventory of $1.5 million. The favorable change in deferred revenue was primarily driven by the increase in the sale of subscription and support. The favorable change in accrued and other liabilities was primarily due to higher accrued bonuses and commissions, increased value added tax accrual due to timing of payments, and an increase in legal fees accrual. The unfavorable change in accounts receivable was attributed to timing of billing and cash collections. The unfavorable change in prepaid and other assets was mainly driven by the increase in deferred sales commissions due to higher deferred revenue and higher average commission rate. The unfavorable change in inventory was due to the timing of shipments. Cash Flows from Investing Activities During the year ended December 31, 2020, cash provided by investing activities was $5.2 million, consisting of proceeds from sales and maturities of marketable securities of $66.8 million, partially offset by purchases of marketable securities of $58.0 million and property and equipment of $3.6 million. During the year ended December 31, 2019, cash used in investing activities was $0.3 million, consisting of purchases of property and equipment of $4.3 million, marketable securities of $71.6 million, partially offset by proceeds from sales and maturities of marketable securities of $75.7 million. During the year ended December 31, 2018, cash used in investing activities was $6.9 million, consisting of purchases of property and equipment of $2.8 million, marketable securities of $86.8 million and investment of $1.0 million, partially offset by proceeds from sales and maturities of marketable securities of $83.7 million. Cash Flows from Financing Activities During the year ended December 31, 2020, cash used in financing activities was $22.9 million consisting primarily of $32.5 million of cash used to repurchase our common stock, partially offset by $9.6 million of cash proceeds from common stock issuances under our equity incentive plans. During the year ended December 31, 2019, cash provided by financing activities was $5.8 million consisting primarily of proceeds from common stock issuances under our equity incentive plans. During the year ended December 31, 2018, cash used in financing activities was $3.6 million consisting primarily of proceeds from common stock issuances under our equity incentive plans. Contractual Obligations Our contractual obligations consist of operating leases. 60 The following table summarizes our contractual obligations as of December 31, 2020 (in thousands): Total Less Than 1 Year 1 to 3 Years 3 to 5 Years More than 5 years Operating leases $ 31,609 $ 6,064 $ 13,772 $ 9,359 $ 2,414 The contractual obligations table above excludes $4.6 million of tax liabilities related to uncertain tax positions because we are unable to make a reasonably reliable estimate of the timing of settlement, if any, of these future payments. Off-Balance Sheet Arrangements As of December 31, 2020, we did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities that are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements. Inventory Inventory consists primarily of finished goods and related component parts and is stated at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or estimated net realizable value. We evaluate inventory for excess and obsolete products, based on management’s assessment of future demand and market conditions. Inventory write-downs, once established, are not reversed as they establish a new cost basis for the inventory. Inventory write downs are included as a component of cost of products revenue in the consolidated statements of operations. Revenue Recognition We derive revenue from two sources: (i) products revenue, which includes hardware, perpetual software license and subscription revenue; and (ii) services revenue, which includes post contract support (“PCS”), professional services, and training. A substantial portion of our revenue is from sales of our products and services through distribution channel partners, such as resellers and distributors. Revenue is recognized, net of applicable taxes, upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to be entitled to receive in exchange for those products or services. We apply the following five-step revenue recognition model: • Identification of the contract, or contracts, with a customer • Identification of the performance obligations in the contract • Determination of the transaction price • Allocation of the transaction price to the performance obligations in the contract • Recognition of revenue when, or as, performance obligations are satisfied. PCS revenue includes arrangements for software support and technical support for our products. PCS is offered under renewable, fee-based contracts, which includes technical support, hardware repair and replacement parts, bug fixes, patches, and unspecified upgrades on a when-and-if available basis. Revenue for PCS services is recognized on a straight-line basis over 61 the service contract term, which is typically one year, but can be up to five years as there is no discernible pattern of transfer related to these promises. Billed but unearned PCS revenue is included in deferred revenue. Professional service revenue primarily consists of the fees we earn related to installation and consulting services. We recognize revenue from professional services upon delivery or completion of performance. Professional service arrangements are typically short term in nature and are largely completed within 30 to 90 days from the start of service. Revenue is recognized for training when the training course is delivered. Contracts with Multiple Performance Obligations Most of our contracts with customers, other than renewals of PCS, contain multiple performance obligations with a combination of products and PCS. Products and PCS generally qualify as distinct performance obligations. Our hardware includes embedded ACOS software, which together deliver the essential functionality of our products. For contracts which contain multiple performance obligations, we allocate revenue to each distinct performance obligation based on the standalone selling price (“SSP”). Judgment is required to determine the SSP for each distinct performance obligation. We use a range of amounts to estimate SSP for products and PCS sold together in a contract to determine whether there is a discount to be allocated based on the relative SSP of the various products and PCS. If we do not have an observable SSP, such as when we do not sell a product or service separately, then SSP is estimated using judgment and considering all reasonably available information such as market conditions and information about the size and/or purchase volume of the customer. We generally use a range of amounts to estimate SSP for individual products and services based on multiple factors including, but not limited to the sales channel (reseller, distributor or end-customer), the geographies in which our products and services are sold, and the size of the end-customer. We account for multiple contracts with a single partner as one arrangement if the contractual terms and/or substance of those agreements indicate that they may be so closely related that they are, in effect, parts of a single contract. We may occasionally accept returns to address customer satisfaction issues even though there is generally no contractual provision for such returns. We estimate returns for sales to customers based on historical returns rates applied against current-period shipments. Specific customer returns and allowances are considered when determining our sales return reserve estimate. Our policy applies to the accounting for individual contracts. However, we have elected a practical expedient to apply the guidance to a portfolio of contracts or performance obligations with similar characteristics so long as such application would not differ materially from applying the guidance to the individual contracts (or performance obligations) within that portfolio. Consequently, we have chosen to apply the portfolio approach when possible, which we do not believe will happen frequently. Additionally, we will evaluate a portfolio of data, when possible, in various situations, including accounting for commissions, rights of return and transactions with variable consideration. We report revenue net of sales taxes. We include shipping charges billed to customers in revenue and the related shipping costs are included in cost of product revenue. Recent Accounting Pronouncements Refer to Note 1 Description of Business and Summary of Significant Accounting Policies, in the notes to consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for information related to recent accounting pronouncements. 62