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. This section of the Form 10-K generally discusses fiscal 2022 and 2021 items and year-to-year comparisons between fiscal 2022 and 2021. Discussions of fiscal 2020 items and year-to-year comparisons between fiscal 2021 and 2020 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed with the SEC on March 8, 2022. 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 two sources: (i) products revenue, which includes hardware, perpetual software license and subscription offerings, which include term-based license agreements and software-as-a-service; and (ii) services revenue, which includes post contract support (“PCS”), professional services, and training. Revenue for term-based license agreements is recognized at a point in time when the Company delivers the software license to the customer and the subscription term has commenced. For our software-as-a-service offerings, our customers do not take possession of the Company’s software but rather we provide access to the service via a hosting arrangement. Revenue in these arrangements is recognized ratably as the services are provided. A substantial portion of our revenue is from sales of our products and services through distribution channel partners, such as resellers and distributors. Our customers predominantly purchase PCS services in conjunction with purchases of our products. 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. We report two customer verticals: service providers and enterprises and we report customer revenues in three broad geographic regions: the Americas, APJ and EMEA regions. In the three months ended March 31, 2022, we changed the way we present revenue by geographic region. The Americas region comprises the United States and all other countries in America (excluding the United States). The APJ region comprises Japan and all other countries in APAC (excluding Japan). We believe this vertical and revised geographic view aligns with how we manage the business and maps our product portfolio to customer verticals. This change in the way we report revenue had no impact to our key metrics including operations, comprehensive income and accumulated deficit. 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, 2022, we had sold products to over 8,000 customers worldwide since our inception. 50 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 2022, (i) 53% of our total revenue was generated from the Americas region, of which 46% was generated from the United States, (ii) 32% was generated from the APJ region, of which 20% was generated from Japan, and (iii) 15% was generated from the EMEA region. During 2021, (i) 48% of our total revenue was generated from the Americas region, of which 40% was generated from the United States, (ii) 37% was generated from the APJ region, of which 25% was generated from Japan, and (iii) 15% was generated from the EMEA region. During 2020, (i) 43% of our total revenue was generated from the Americas region, of which 37% was generated from the United States, (ii) 43% was generated from the APJ region, of which 30% was generated from Japan, and (iii) 14% was generated from the EMEA region. Our enterprise customers accounted for 34%, 37% and 39% of our total revenue during 2022, 2021 and 2020, respectively. Our service provider customers accounted for 66%, 63% and 61% of our total revenue during 2022, 2021 and 2020, 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%, 39% and 41% of our total revenue for 2022, 2021 and 2020, 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, 2022, we had $68.0 million of cash and cash equivalents and $83.0 million of marketable securities. Cash provided by operating activities was $66.1 million in the year ended December 31, 2022 compared to $50.1 million of cash provided by operating activities in the year ended December 31, 2021. 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. 51 Results of Operations A summary of our consolidated statements of operations for the years ended December 31, 2022 and 2021 are as follows (dollars in thousands): Years Ended December 31, 2022 2021 Increase (Decrease) Amount Percent of Total Revenue Amount Percent of Total Revenue Amount Percent Revenue: Products $ 173,201 61.8 % $ 148,398 59.3 % $ 24,803 16.7 % Services 107,137 38.2 101,644 40.7 5,493 5.4 % Total revenue 280,338 100.0 250,042 100.0 30,296 12.1 % Cost of revenue: Products 40,135 14.3 32,620 13.0 7,515 23.0 % Services 16,697 6.0 20,885 8.4 (4,188) (20.1) % Total cost of revenue 56,832 20.3 53,505 21.4 3,327 6.2 % Gross profit 223,506 79.7 196,537 78.6 26,969 13.7 % Operating expenses: Sales and marketing 88,511 31.6 85,651 34.3 2,860 3.3 % Research and development 58,398 20.8 54,077 21.6 4,321 8.0 % General and administrative 23,518 8.4 23,421 9.4 97 0.4 % Total operating expenses 170,427 60.9 163,149 65.1 7,278 4.5 % Income from operations 53,079 18.8 33,388 13.4 19,691 59.0 % Non-operating income (expense): Interest income 1,304 0.5 409 0.2 895 218.8 % Interest and other income (expense), net (1,667) (0.6) (2,155) (0.9) 488 (22.6) % Total non-operating income (expense), net (363) (0.1) (1,746) (0.7) 1,383 (79.2) % Income before income taxes 52,716 18.7 31,642 12.7 21,074 66.6 % Provision for (benefit from) income taxes 5,808 2.1 (63,245) (25.3) 69,053 (109.2) % Net income $ 46,908 16.7 % $ 94,887 37.9 % $ (47,979) (50.6) % Revenue We derive revenue from two sources: (i) products revenue, which includes hardware, perpetual software license and subscription offerings, which include term-based license agreements and software-as-a-service; and (ii) services revenue, which includes post contract support (“PCS”), professional services, and training. 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. Additionally, currently a small portion of our products revenue comes from subscription revenue for our Cloud service offerings. We offer several products by subscription, primarily through either term-based license agreements or as a service through our cloud-based platform. With respect to sales of our hardware appliances, we recognize products revenue upon transfer of control, generally at the time of shipment, provided that all other revenue recognition criteria have been met. Revenue for term-based license agreements is recognized at a point in time when we deliver the software license to the customer and the subscription term has commenced. For our software-as-a-service offerings, our customers do not take possession of our software but rather we provide access to the service via a hosting arrangement. Revenue in these arrangements is recognized ratably as the services are 52 provided. 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 technical 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. A summary of our total revenue is as follows (dollars in thousands): Years Ended December 31, 2022 2021 Increase (Decrease) Amount Percent of Total Revenue Amount Percent of Total Revenue Amount Percent Revenue: Products $ 173,201 62 % $ 148,398 59 % $ 24,803 17 % Services 107,137 38 101,644 41 5,493 5 % Total revenue $ 280,338 100 % $ 250,042 100 % $ 30,296 12 % Revenue by geographic region: Americas $ 148,673 53 % $ 121,169 48 % $ 27,504 23 % United States 129,397 46 % 99,484 40 % 29,913 30 % Americas-other 19,276 7 % 21,685 8 % (2,409) (11) % APJ 89,702 32 % 90,374 37 % (672) (1) % APAC 32,986 12 % 28,674 12 % 4,312 15 % Japan 56,716 20 % 61,700 25 % (4,984) (8) % EMEA 41,963 15 % 38,499 15 % 3,464 9 % Total revenue $ 280,338 100 % $ 250,042 100 % $ 30,296 12 % Total revenue increased by $30.3 million, or 12%, in 2022 compared to 2021. This increase was due to a $24.8 million increase in products revenue and a $5.5 million increase in services revenue. Products revenue increased $24.8 million, or 17%, in 2022 compared to 2021 primarily driven by higher demand from our service provider customers in the Americas, APAC and EMEA regions, partially offset by lower demand from service provider customers in Japan. Services revenue increased $5.5 million, or 5%, in 2022 compared to 2021. The increase was primarily attributable to the increase in PCS sales in connection with our increased installed customer base in the Americas and EMEA regions. During 2022, $148.7 million, or 53% of total revenue, was generated from the Americas, which represents a 23% increase compared to 2021. The increase was primarily due to higher products revenue driven by an increase in demand from our service provider customers. During 2022, $89.7 million, or 32% of total revenue, was generated from APJ, which represents a 1% decrease compared to 2021. The decrease was mainly due to decreased revenue from our service provider customers. During 2022, $42.0 million, or 15% of total revenue, was generated from EMEA, which represented an 9% increase compared to 2021. The increase was primarily due to higher products revenue driven by an increase in demand from our service provider customers. 53 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. A summary of our cost of revenue is as follows (dollars in thousands): Years Ended December 31, Increase (Decrease) 2022 2021 Amount Percent Cost of revenue: Products $ 40,135 $ 32,620 $ 7,515 23 % Services 16,697 20,885 (4,188) (20) % Total cost of revenue $ 56,832 $ 53,505 $ 3,327 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, 2022 2021 Increase (Decrease) Amount Gross Margin Amount Gross Margin Amount Gross Margin Gross profit: Products $ 133,066 76.8 % $ 115,778 78.0 % $ 17,288 (1.2) % Services 90,440 84.4 % 80,759 79.5 % 9,681 4.9 % Total gross profit $ 223,506 79.7 % $ 196,537 78.6 % $ 26,969 1.1 % Products gross margin decreased by 1.2% in 2022 compared to 2021 primarily driven by changes in product and geographic mix. Services gross margin increased by 4.9% in 2022 compared to 2021 primarily due to a decrease in 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, 54 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) 2022 2021 Amount Percent Operating expenses: Sales and marketing $ 88,511 $ 85,651 $ 2,860 3 % Research and development 58,398 54,077 4,321 8 % General and administrative 23,518 23,421 97 — % Total operating expenses $ 170,427 $ 163,149 $ 7,278 4 % 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. The $2.9 million increase in sales and marketing expenses in 2022 compared to 2021 was primarily due to increases of $1.6 million in travel and related expenses, $1.0 million in marketing activities and events and $0.3 million in consulting expense. In 2023, we expect sales and marketing expenses to increase from 2022 levels in line with overall revenue growth as we apply a disciplined approach to focus our investments in areas that offer the greatest opportunities. 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 $4.3 million increase in research and development expenses in 2022 compared to 2021 was primarily due to a $5.0 million increase in consulting expense as the Company transitions to using non-employee consultants for certain research and developments activities and a $0.8 million increase in software expenses. This increase was partially offset by a $1.4 million decrease in salary and benefit expenses as a result of a decrease in headcount. In 2023, we expect research and development expenses to increase from 2022 levels reflecting strategic investments in our growth priorities, including cybersecurity technology. 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 $0.1 million increase in general and administrative expenses in 2022 compared to 2021 was primarily due to a $2.8 million increase in consulting expense as the Company transitions to using non-employee consultants for certain general and administrative activities. Additionally, business expenses increased $1.7 million primarily related to an increase in property tax expense. These increases were partially offset by a decrease of $4.4 million in salary and benefit expenses as a result of a decrease in headcount. 55 In 2023, we expect general and administrative expenses to remain stable as we apply a disciplined approach to focus our investments in areas that offer the greatest opportunities. Non-Operating Income (Expense) - Interest Income Interest income consists primarily of interest income earned on our cash and cash equivalents and marketable securities. Interest income was $1.3 million and $0.4 million in the years ended December 31, 2022 and 2021, respectively. Non-Operating Income (Expense) - Interest and Other Income (Expense), Net Interest and other income (expense), net consists primarily of foreign currency exchange gains and losses. Interest and other income (expense), net, had a favorable change of $0.5 million, or 23%, in 2022 compared to 2021 primarily driven by a $1.5 million favorable change in foreign currency exchange gains and losses, partially offset by a $1.0 million impairment of an equity investment held by the Company. Provision for (Benefit from) Income Taxes We recorded an income tax provision of $5.8 million for the year ended December 31, 2022 and recorded an income tax benefit of $(63.2) million for the year ended December 31, 2021. The main component of our income tax benefit in the year ended December 31, 2021 is related to the valuation allowance release in the three months ended September 30, 2021. Prior to 2021 and since inception, the Company had maintained a full valuation. Since 2021, federal deferred tax assets are no longer subject to a valuation allowance. Certain state deferred tax assets continue to be subject to a valuation allowance. Our deferred tax assets primarily consist of U.S. net operating loss (“NOL”) and tax credit carryforwards. The Company’s income tax provision for the year ended December 31, 2022 primarily consisted of federal income taxes. Our income tax provision for the years ended December 31, 2021 primarily consisted of foreign income taxes. See Note 9 Income Taxes, of the notes 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, 2022, we had cash and cash equivalents of $68.0 million, including $2.9 million held outside the United States in our foreign subsidiaries, and $83.0 million of marketable securities. We currently do not have any plans to repatriate our earnings from our foreign operations. As of December 31, 2022, we had working capital of $138.7 million, accumulated deficit of $130.5 million and total stockholders’ equity of $181.0 million. We plan to continue to invest for long-term growth, and our investment may increase. We currently 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 and beyond. 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 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 September 8, 2022, we entered into a Common Stock Repurchase Agreement (the “Repurchase Agreement”) with Summit Partners Growth Equity Fund VIII-A, L.P., Summit Partners Growth Equity Fund VIII-B L.P., Summit Investors I, LLC and Summit Investors I (UK), L.P. (collectively, “Summit”). Pursuant to the Repurchase Agreement, we repurchased 3.5 million shares of common stock from Summit for approximately $44.6 million. The common shares repurchased are held in treasury and accounted for under the cost method. 56 On September 17, 2020, the Company’s Board of Directors authorized a stock repurchase program of up to $50 million of its common stock over a period of twelve months. This repurchase program was active for twelve months and expired in the second half of 2021. On October 28, 2021, the Company announced its Board of Directors authorized a new stock repurchase program of up to $100 million of its common stock over a period of twelve months. This repurchase program was also active for twelve months and expired in the second half of 2022. On November 1, 2022, the Company announced its Board of Directors authorized a new stock repurchase program of up to $50 million of its common stock over a period of twelve months (the “2022 Program”). As of December 31, 2022, the Company had $50.0 million available to repurchase shares under the 2022 Program. Under all programs, repurchased shares are held in treasury at cost. The Company’s stock repurchase programs do 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 these programs, other than the repurchase from Summit, have occurred in the open market. During the year ended December 31, 2022, the Company repurchased 6.1 million shares for a total cost of $79.3 million. During the year ended December 31, 2021, the Company repurchased 1.7 million shares for a total cost of $18.3 million. In October 2021, our Board approved the initiation of a regular quarterly cash dividend on our common stock. The first dividend, in the amount of $0.05 per share of common stock outstanding, was paid in December 2021 and was treated as a return of capital. In October 2022, our Board approved an increase in the amount of the quarterly cash dividend to $0.06 per share. We currently anticipate that we will continue to pay comparable quarterly cash dividends in the future. However, the payment, amount and timing of future dividends remain within the discretion of our Board and will depend upon our results of operations, financial condition, cash requirements, and other factors. In addition, as described in Note 6 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, 2022 2021 Cash provided by (used in): Operating activities $ 66,100 $ 50,097 Investing activities 11,087 (38,070) Financing activities (88,141) (16,383) Net decrease in cash and cash equivalents $ (10,954) $ (4,356) 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, 2022, cash provided by operating activities was $66.1 million, consisting of net income of $46.9 million, partially offset by a non-cash benefit of $21.5 million and an unfavorable net change in operating assets and liabilities of $2.3 million. Our non-cash benefit consisted primarily of non-cash charges of $13.3 million for stock-based compensation and $7.4 million of depreciation and amortization expense. The net change in our operating assets and liabilities primarily reflects cash outflows from changes in accounts receivable of $10.1 million and accrued and other liabilities of $1.3 million, partially offset by cash inflows from changes in deferred revenue of $5.4 million, inventory of $2.0 million and prepaid expenses and other assets of $1.6 million. The unfavorable change in accounts receivable was due to the timing of collections from our customers. The favorable change in deferred revenues was attributable to the timing of service contract bookings. 57 During the year ended December 31, 2021, cash provided by operating activities was $50.1 million, consisting of net income of $94.9 million, partially offset by a non-cash benefit of $39.8 million and an unfavorable net change in operating assets and liabilities of $5.0 million. Our non-cash benefit consisted primarily of a benefit of $64.2 million related to the release our of deferred tax asset valuation allowance plus other adjustments, and non-cash charges of $14.4 million for stock-based compensation and $8.9 million of depreciation and amortization expense. The net change in our operating assets and liabilities primarily reflects cash outflows from changes in accounts receivable of $10.4 million, accrued and other liabilities of $5.6 million, prepaid expenses and other assets of $2.1 million and inventory of $1.8 million, partially offset by cash inflows from changes in deferred revenue of $12.9 million and changes in accounts payable of $2.0 million. The unfavorable change in accounts receivable was due to the timing of collections from our customers. The favorable change in deferred revenues was primarily driven by increased bookings. Cash Flows from Investing Activities During the year ended December 31, 2022, cash used in investing activities was $11.1 million, consisting of purchases of marketable securities of $55.4 million and property and equipment of $10.8 million, partially offset by proceeds from maturities of marketable securities of $71.0 million and sales of marketable securities of $6.3 million. During the year ended December 31, 2021, cash used in investing activities was $38.1 million, consisting of purchases of marketable securities of $128.6 million and property and equipment of $5.2 million, partially offset by proceeds from sales and maturities of marketable securities of $95.7 million. Cash Flows from Financing Activities During the year ended December 31, 2022, cash used in financing activities was $88.1 million consisting primarily of $79.3 million of cash used to repurchase our common stock and $15.9 million used for the payments of cash dividends, partially offset by $7.0 million of cash proceeds from common stock issuances under our equity incentive plans. During the year ended December 31, 2021, cash used in financing activities was $16.4 million consisting primarily of $18.3 million of cash used to repurchase our common stock and $3.9 million used for the payments of cash dividends, partially offset by $5.8 million of cash proceeds from common stock issuances under our equity incentive plans. 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. 58 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. Revenue for term-based license agreements is recognized at a point in time when the Company delivers the software license to the customer and the subscription term has commenced. For our software-as-a-service offerings, our customers do not take possession of the Company’s software but rather we provide access to the service via a hosting arrangement. Revenue in these arrangements is recognized ratably as the services are provided. A substantial portion of our revenue is from sales of our products and services through distribution channel partners, such as resellers and distributors. Our customers predominantly purchase PCS services in conjunction with purchases of our products. 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 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 return rates applied against current-period shipments. Specific customer returns and allowances are considered when determining our sales return reserve estimate. 59 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. 60