Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________
FORM 10-Q
_____________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period from               to
Commission File Number: 001-37927
____________________________________
QUANTENNA COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its charter)
_____________________________________
Delaware
 
33-1127317
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
1704 Automation Parkway
San Jose, California 95131
(Address of principal executive offices, including zip code)

(669) 209-5500
(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  x 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  x  No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, a smaller reporting company, or an emerging growth company.
See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
x 
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
x
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. x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

As of October 26, 2018, 37,394,790 shares of the registrant’s common stock, $0.0001 par value, were outstanding.

 



Table of Contents

TABLE OF CONTENTS
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about our products, technology, customers, business, operations, and market and industry developments.
You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.
The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law.

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Table of Contents

PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
 
Quantenna Communications, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
(Unaudited)
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
$
34,559

 
$
24,432

 
Marketable securities
97,471

 
94,195

 
Accounts receivable
20,081

 
26,786

 
Inventory
21,578

 
12,662

 
Prepaid expenses and other current assets
6,512

 
2,744

 
Total current assets
180,201

 
160,819

 
Deferred tax assets
37,443

 
35,422

 
Property and equipment, net
13,418

 
12,511

 
Intangible and other assets, net
3,571

 
3,952

 
Total assets
$
234,633

 
$
212,704

 
Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
$
10,255

 
$
3,754

 
Accrued liabilities and other current liabilities
23,220

 
21,065

 
Long-term debt, current portion

 
3,943

 
Total current liabilities
33,475

 
28,762

 
Other long-term liabilities
2,670

 
3,339

 
Total liabilities
36,145

 
32,101

 
Commitments and contingencies (see Note 7)

 

 
Stockholders’ equity

 

 
Common stock: $0.0001 par value, 1,000,000,000 shares authorized at September 30, 2018 and December 31, 2017, 37,346,536 and 35,528,880 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
3

 
3

 
Additional paid-in capital
324,931

 
308,023

 
Accumulated other comprehensive loss
(894
)
 
(207
)
 
Accumulated deficit
(125,552
)
 
(127,216
)
 
Total stockholders’ equity
198,488

 
180,603

 
Total liabilities and stockholders’ equity
$
234,633

 
$
212,704

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

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Table of Contents
Quantenna Communications, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)



 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
 
 
 
 
 
 
 
Revenue
$
59,349

 
$
50,108

 
$
157,893

 
$
135,084

Cost of revenue
29,859

 
25,591

 
79,774

 
68,212

Gross profit
29,490

 
24,517

 
78,119

 
66,872

Operating expenses:
 
 
 
 
 
 
 
Research and development
17,783

 
15,011

 
52,468

 
43,699

Sales and marketing
3,833

 
3,363

 
12,307

 
9,553

General and administrative
4,886

 
3,735

 
13,602

 
11,231

Total operating expenses
26,502

 
22,109

 
78,377

 
64,483

Income (loss) from operations
2,988

 
2,408

 
(258
)
 
2,389

Interest expense

 
(103
)
 

 
(442
)
Other income, net
243

 
223

 
807

 
610

Income before income taxes
3,231

 
2,528

 
549

 
2,557

Benefit (provision) for income taxes
648

 
274

 
1,115

 
(470
)
Net income
$
3,879

 
$
2,802

 
$
1,664

 
$
2,087

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.08

 
$
0.05

 
$
0.06

Diluted
$
0.10

 
$
0.07

 
$
0.04

 
$
0.05

Weighted average shares used to compute basic and diluted net income per share:
 
 
 
 
 
 
 
Basic
37,070

 
34,734

 
36,476

 
33,907

Diluted
40,026

 
38,525

 
39,425

 
38,419

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


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Table of Contents
Quantenna Communications, Inc.
Condensed Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)


 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
 
 
 
 
 
 
 
Net income
$
3,879

 
$
2,802

 
$
1,664

 
$
2,087

Other comprehensive gain (loss), net of tax:
 
 
 
 
 
 
 
Unrealized gains (losses) on available-for-sale marketable securities
105

 
12

 
(22
)
 
(20
)
Unrealized losses on derivative instruments
(247
)
 

 
(664
)
 

Other comprehensive gain (loss), net of tax
(142
)
 
12

 
(686
)
 
(20
)
Comprehensive income
$
3,737

 
$
2,814

 
$
978

 
$
2,067

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


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Table of Contents
Quantenna Communications, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)



 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
Cash flows from operating activities
(in thousands)
Net income
$
1,664

 
$
2,087

Adjustments to reconcile net income to net cash provided by operating activities:

 
 
Depreciation and amortization
3,467

 
1,566

Stock-based compensation expense
12,923

 
7,447

Deferred income taxes
(1,821
)
 

Other
705

 
347

Changes in assets and liabilities:

 
 
Accounts receivable
6,705

 
(8,340
)
Inventory
(8,916
)
 
(7,880
)
Prepaid expenses and other current assets
(3,768
)
 
(22
)
Deferred rent and other assets
159

 
(790
)
Accounts payable
6,498

 
5,119

Accrued liabilities and other current liabilities
2,075

 
14,660

Net cash provided by operating activities
19,691

 
14,194

Cash flows from investing activities

 
 
Purchase of property and equipment
(3,962
)
 
(6,961
)
Purchase of long-term investment
(590
)
 

Purchase of marketable securities
(47,917
)
 
(104,044
)
Proceeds from sales of marketable securities

 
3,670

Maturities of marketable securities
44,259

 
12,239

Net cash used in investing activities
(8,210
)
 
(95,096
)
Cash flows from financing activities

 
 
Proceeds from issuance of common stock, net
6,091

 
5,083

Payments of taxes withheld for vested stock awards
(2,428
)
 
(626
)
Payments related to intangible asset purchase
(815
)
 

Repayments of long-term debt
(3,943
)
 
(1,756
)
Net cash (used in) provided by financing activities
(1,095
)
 
2,701

Effect of exchange rates on cash and cash equivalents
(259
)
 

Net increase (decrease) in cash and cash equivalents
10,127

 
(78,201
)
Cash and cash equivalents

 
 
Beginning of period
24,432

 
117,045

End of period
$
34,559

 
$
38,844

Supplemental disclosure of cash flow information

 
 
Interest paid during the period
$

 
$
342

Income taxes paid during the period
$
180

 
$
746

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

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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)


 
1.    The Company and Summary of Significant Accounting Policies
Quantenna Communications, Inc. (the “Company”) was incorporated in the State of Delaware on November 28, 2005. The Company designs, develops and markets advanced high-speed wireless communication solutions enabling wireless local area networking. The Company’s solutions are designed to deliver leading-edge Wi-Fi performance to support an increasing number of connected devices accessing a rapidly growing pool of digital content. The Company applies its wireless systems and software expertise with high-performance radio frequency, mixed-signal and digital semiconductor design skills to provide highly integrated Wi-Fi solutions to its customers.
Reporting Calendar
The Company prepares financial statements on a 52- or 53-week fiscal year that ends on the Sunday closest to December 31. Fiscal 2018 will have 52 weeks and fiscal 2017 had 52 weeks. In a 52-week year, each fiscal quarter consists of 13 weeks. Fiscal 2018 will end on December 30, 2018.
Unaudited Interim Financial Information
The accompanying interim condensed consolidated financial statements and related disclosures are unaudited and in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair statement of the results of operations for the periods presented. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“US GAAP”). The condensed consolidated results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the full year or for any other future year or interim period. The accompanying condensed consolidated financial statements should be read in conjunction with the audited financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2018 (“2017 Annual Report on Form 10-K”).
Use of Estimates
Preparation of financial statements in conformity with US GAAP requires management to make 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 reported amounts of revenue and expenses during the reporting periods covered by the financial statements and accompanying notes. Among the significant estimates affecting the financial statements are those related to inventories, revenue recognition, stock-based compensation and income taxes. Actual results could differ from those estimates.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Significant Accounting Policies
During the three and nine months ended September 30, 2018, there have been no changes in our significant accounting policies as described in the 2017 Annual Report on Form 10-K, except as discussed below:
Revenue Recognition
The Company adopted Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) on January 1, 2018 which resulted in a change to our revenue policy relating to customer rebate arrangements. Revenue is recognized when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.

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Table of Contents
Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Company adopted Accounting Standard Codification (“ASC”) Topic 606 (“ASC Topic 606”) as of January 1, 2018 using the modified retrospective transition method. Based on the evaluation of its current contracts and revenue streams under the new standard, the Company identified a change in accounting relating to customer rebate arrangements. Under the new standard, the Company is required to account for customer rebate arrangements as variable consideration which requires an estimate of the variable consideration to be made when revenue is recognized. In order to estimate this amount, the Company used historical data to determine an estimate of breakage which was applied to the amount of customer rebate due under its contractual arrangements. The cumulative effect upon adoption of ASC Topic 606 was not material and did not have a material impact on the Company’s consolidated financial position or results of operations. The impact of the estimate of breakage for the three and nine months ended September 30, 2018 of $0.2 million and $0.6 million, respectively, recorded as a result of applying the new revenue standard is not considered material to revenue or any other affected financial statement line items.
The following table sets forth the Company’s revenue by geographic region, based on ship-to destinations (in thousands):
 
Three Months Ended
Three Months Ended
 
September 30, 2018
 
October 1, 2017
 
Amount
% of revenue
 
Amount
% of revenue
Asia-Pacific
$
54,832

92
%
 
$
46,864

94
%
Europe, Middle East and Africa
4,409

8

 
3,051

6

Americas
108


 
193


Total
$
59,349

100
%
 
$
50,108

100
%
 
Nine Months Ended
 
Nine Months Ended
 
September 30, 2018
 
October 1, 2017
 
Amount
% of revenue
 
Amount
% of revenue
Asia-Pacific
$
144,528

92
%
 
$
125,040

93
%
Europe, Middle East and Africa
13,221

8

 
9,789

7

Americas
144


 
255


Total
$
157,893

100
%
 
$
135,084

100
%
Derivative Financial Instruments
The Company uses derivative instruments to manage its exposure to changes in foreign currency exchange rates from forecasted cash flows associated with the operational expenses of its foreign subsidiaries. Derivative instruments are measured at their fair values and recognized as either assets or liabilities. The Company’s derivative forward contracts are designated as cash-flow hedges and their effectiveness is measured by comparing the cumulative forward-rate changes in the fair value of the hedge contract with the cumulative forward-rate change in the forecasted cash flows of the hedged item.
Refer to Note 2 to the condensed consolidated financial statements, Recent Accounting Pronouncements, and to Note 6 to the condensed consolidated financial statements, Derivative Instruments, for further details.
Reclassifications
Reclassifications of certain prior period amounts in the condensed consolidated financial statements have been made to conform to the current period presentation.

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Table of Contents
Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

2.    Recent Accounting Pronouncements
On February 14, 2018, the FASB released ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The guidance allows a company to elect to reclassify from accumulated other comprehensive income (“AOCI”) to retained earnings the stranded tax effects from the adoption of the newly enacted federal corporate tax rate as a result of the 2017 Tax Cuts and Jobs Act (the “Tax Act”). The amount of the reclassification is calculated as the difference between the amount initially charged to other comprehensive income at the time of the previously enacted tax rate that remains in AOCI and the amount that would have been charged using the newly enacted tax rate, excluding any valuation allowance previously charged to income. ASU 2018-02 is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, with early adoption permitted. The Company decided to early adopt ASU 2018-02 during the three months ended September 30, 2018 with no material impact to our condensed consolidated financial statements as a result of this adoption.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The new standard is intended to improve and simplify accounting rules around hedge accounting. The new standard refines and expands hedge accounting for both financial (e.g., foreign currency) and commodity risks. Its provisions create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes, for investors and analysts. The new standard takes effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted in any interim period or fiscal years before the effective date of the standard. The Company early-adopted ASU 2017-12 during the second quarter of fiscal 2018 when it commenced its hedging activities and which did not result in any adjustment to the Company’s condensed consolidated financial statements as of the beginning of the second quarter of fiscal 2018. Refer to Note 6 to the condensed consolidated financial statements, Derivative Instruments, for further details.
In February 2016, the FASB issued ASU 2016-02, Leases (“ASC 842”), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than twelve months regardless of their classification. Leases with a term of twelve months or less will be accounted for similar to existing guidance for operating leases today. ASC 842 supersedes the previous leases standard, ASC 840 Leases. The standard is effective on January 1, 2019, with early adoption permitted. The Company is evaluating the effect that the adoption of ASC 842 will have on its financial statements. The Company currently expects that most of its operating lease commitments will be subject to the new standard and recognized as right-of-use assets and operating lease liabilities upon the adoption of ASC 842, which will increase the total assets and total liabilities that it reports relative to such amounts prior to adoption.

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Table of Contents
Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

3.     Earnings Per Share
The following table summarizes the Company’s computation of basic and diluted net loss per share:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
(in thousands, except per share data)
Net income
$
3,879

 
$
2,802

 
$
1,664

 
$
2,087

 
 
 
 
 
 
 
 
Weighted-average shares outstanding - basic
37,070

 
34,734

 
36,476

 
33,907

Dilutive effect of stock options, ESPP and RSUs
2,956

 
3,791

 
2,949

 
4,512

Weighted average shares outstanding - diluted
40,026

 
38,525

 
39,425

 
38,419

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.08

 
$
0.05

 
$
0.06

Diluted
$
0.10

 
$
0.07

 
$
0.04

 
$
0.05

The following potentially dilutive securities outstanding at the end of the periods have been excluded from the computation of diluted shares outstanding as the effect would have been anti-dilutive:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
(in thousands)
Shares available for Employee Stock Purchase Plan (ESPP)
16

 

 
8

 

Restricted Stock Units (RSUs)
47

 
104

 
172

 
881

Options to purchase common stock
1,289

 
672

 
1,436

 
672

Total
1,352

 
776

 
1,616

 
1,553

4.     Balance Sheets Components
Marketable Securities
Marketable securities at September 30, 2018 consisted of the following:
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
(in thousands)
Corporate debt securities
$
91,438

 
$
6

 
$
(291
)
 
$
91,153

Government debt securities
6,339

 

 
(21
)
 
6,318

 
$
97,777

 
$
6

 
$
(312
)
 
$
97,471


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Table of Contents
Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The contractual maturities of marketable securities as of September 30, 2018 were as follows:
 
Amortized Cost
 
Fair Value
 
(in thousands)
Due in one year or less
$
79,848

 
$
79,668

Due after one year to five years
17,929

 
17,803

 
$
97,777

 
$
97,471

Marketable securities as of December 31, 2017 consisted of the following:
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
(in thousands)
Corporate debt securities
$
83,570

 
$
7

 
$
(250
)
 
$
83,327

Government debt securities
10,889

 

 
(21
)
 
10,868

 
$
94,459

 
$
7

 
$
(271
)
 
$
94,195


The contractual maturities of marketable securities as of December 31, 2017 were as follows:
 
Amortized Cost
 
Fair Value
 
(in thousands)
Due in one year or less
$
49,201

 
$
49,144

Due after one year to five years
45,258

 
45,051

 
$
94,459

 
$
94,195

Property and Equipment, Net
Property and equipment, net consisted of the following:
 
September 30,
2018
 
December 31,
2017
 
(in thousands)
Computer and lab equipment
$
16,950

 
$
14,295

Computer software
968

 
795

Furniture and fixtures
1,739

 
1,589

Leasehold improvements
4,363

 
3,977

Sub-total
24,020

 
20,656

Accumulated depreciation and amortization
(10,602
)
 
(8,145
)
Property and equipment, net
$
13,418

 
$
12,511

Depreciation and amortization expense related to property and equipment was $0.9 million and $0.5 million, respectively, for the three months ended September 30, 2018 and October 1, 2017, and $2.7 million and $1.6 million, respectively, for the nine months ended September 30, 2018 and October 1, 2017.

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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Inventory
Inventory consisted of the following:
 
September 30,
2018
 
December 31,
2017
 
(in thousands)
Raw materials
$
7,481

 
$
5,812

Work in progress
2,121

 
1,069

Finished goods
11,976

 
5,781

 
$
21,578

 
$
12,662

Accrued Liabilities and Other Current Liabilities
Accrued liabilities and other current liabilities consisted of the following:
 
September 30,
2018
 
December 31,
2017
 
(in thousands)
Accrued customer rebates
$
9,044

 
$
8,710

Accrued payroll and related benefits
5,683

 
3,411

Accrued expenses
2,688

 
4,507

Accrual for inventory purchases
980

 
2,124

ESPP employee contributions
2,261

 
706

Other
2,564

 
1,607

 
$
23,220

 
$
21,065

5.    Fair Value Measurements
The Company determines fair value measurements used in its consolidated financial statements based upon the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (i) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (ii) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
Level 1:
Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2:
Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
Level 3:
Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The Company obtains the fair value of our Level 1 investments in money market funds, at the expected market price. These investments are expected to maintain a net asset value of $1 per share.


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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Company determines the fair value of our Level 2 financial instruments from third-party asset managers, custodian banks, and the accounting service providers.

The Company classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable, either directly or indirectly. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. There were no assets or liabilities in Level 3 of the fair value hierarchy and there were no transfers between Level 1 and Level 2 categories during the year ended any of the periods presented.

The Company utilizes the market approach to measure the fair value of our fixed income securities. The market approach is a valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The fair value of our fixed income securities is obtained using readily-available market prices from a variety of industry standard data providers, large financial institutions and other third-party sources for the identical underlying securities.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The Company measures and reports certain assets at fair value on a recurring basis as shown below except for cash held at banks that are measured at historical cost and which are therefore not included in the tables below.

 
Fair Value as of September 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
(in thousands)
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
1,254

 
$

 
$

 
$
1,254

Commercial paper

 
2,499

 

 
2,499

Government debt securities

 
648

 

 
648

Total cash equivalents
1,254

 
3,147

 

 
4,401

Marketable Securities:
 
 
 
 
 
 

Corporate debt securities

 
91,153

 

 
91,153

Government debt securities

 
6,318

 

 
6,318

Total marketable securities

 
97,471

 

 
97,471

 
 
 
 
 
 
 
 
Total cash equivalents and marketable securities
$
1,254

 
$
100,618

 
$

 
$
101,872


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Table of Contents
Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)


 
Fair Value as of December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
(in thousands)
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
4,398

 
$

 
$

 
$
4,398

Corporate debt securities

 
2,000

 

 
2,000

Total cash equivalents
4,398

 
2,000

 

 
6,398

Marketable Securities:
 
 
 
 
 
 

Corporate debt securities

 
83,329

 

 
83,329

Government debt securities

 
10,866

 

 
10,866

Total marketable securities

 
94,195

 

 
94,195

 
 
 
 
 
 
 
 
Total cash equivalents and marketable securities
$
4,398

 
$
96,195

 
$

 
$
100,593


The Level 1 assets consist of money market funds. The Level 2 assets consist of available-for-sale investment portfolio, which are valued utilizing a market approach.

Foreign currency derivative forward contracts are measured at fair value based on market-based observable inputs including currency exchange spot and forward rates, interest rates, and credit-risk spreads, and are classified at Level 2 of the fair value hierarchy.
Total notional and net fair values for foreign exchange derivative contracts designated as hedging instruments as of September 30, 2018 were as follows:
Derivative Assets*
 
Derivative Liabilities*

Notional Amount
Fair Value
 

Notional Amount
Fair Value
(in thousands)
Current assets
$
309

$
3

 
Current liabilities
$
18,021

$
768

Non-current assets**
1,967

14

 
Non-current liabilities**
3,925

93

Total foreign exchange contracts
$
2,276

$
17

 
Total foreign exchange contracts
$
21,946

$
861

*
The Company recorded a net derivative liability of $0.8 million as of September 30, 2018. There were no derivative assets or liabilities recorded for the comparative periods in fiscal 2017.
**
Non-current derivative assets and liabilities were discounted at the prevailing risk-free interest rate.
Common Stock Warrants
There were no common stock warrants exercised during the three months ended September 30, 2018. During the nine months ended September 30, 2018, the remaining 58,006 common stock warrants of those originally issued in September 2015 were exercised at $2.50 per share. There were no outstanding common stock warrants as of September 30, 2018.

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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

As of December 31, 2017, warrants issued and outstanding were as follows:

Date of Issuance
 
Number of Warrants
 
Exercise Price
 
Expiration Date
 
 
 
 
 
 
 
 
Common stock warrants
September 2015
 
83,006

 
$
2.50

 
February 2019
6.     Derivative Financial Instruments
The Company uses foreign currency forward contracts to reduce the earnings impact that exchange rate fluctuations have on operating expenses denominated in currencies other than the U.S. dollar. For accounting purposes, foreign currency forward contracts are designated as hedging instruments and, accordingly, the Company will record the fair value of the effective portion of these contracts as of the end of its’ reporting period in its’ condensed consolidated balance sheets (as an asset or a liability) with changes in fair value recorded within “Accumulated other comprehensive loss” under “Total stockholders’ equity”. The fair values of the derivative financial instruments are combined together on the balance sheet whenever there is a master netting arrangement in place. The changes in fair value will remain in “Accumulated other comprehensive loss” until the costs are recognized, at which time the Company will reclassify the cumulative change of fair value relating to the hedges proportionately into the respective line items on the condensed consolidated income statements. Any changes in fair value of the ineffective portion of the forward contracts will be recognized immediately in the Company’s consolidated income statement under “Other income, net”.
In concurrence with the implementation of its hedging program, the Company early-adopted the provisions of ASU 2017-12 as of the beginning of the second quarter of fiscal 2018 on a prospective basis. The early-adoption of ASU 2017-12 did not result in any adjustment to the Company’s consolidated financial statements as of the beginning of the second quarter of fiscal 2018 as the Company did not enter into any hedge accounting activities in prior reporting periods.
The effects of derivative instruments and hedging activities on the condensed consolidated statement of operations and its effect on the condensed consolidated statement of comprehensive loss from changes in fair value for the three and nine months ended September 30, 2018 was as follows:
 
Location and Amount of Loss Recognized for Hedging Activities:
 
Condensed Consolidated Statement of Operations
Condensed Consolidated Statement of Comprehensive Loss (pre-tax)
 
Research and Development
Sales and Marketing
General and Administrative
Total
 
(in thousands)
Total expense from foreign currency hedging
$
189

$
39

$
13

$
241

$
314

Effects of foreign currency cashflow hedging:
 
 
 
 
 
Loss reclassified from condensed consolidated statement of comprehensive loss
$
(189
)
(39
)
(13
)
(241
)
$
241

Loss recognized in condensed consolidated statement of comprehensive loss
$

$

$

$

$
555

 
 
 
 
 
 
The Company did not enter into any hedging activities for the comparative periods in fiscal 2017.
7.    Commitments and Contingencies
Leases
The Company conducts its operations using leased office facilities in various locations. The following is a schedule of future minimum lease payments under operating leases as of September 30, 2018 (in thousands):

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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

2018 (remaining three months)
$
747

2019
2,819

2020
2,344

2021
1,900

2022 and beyond
4,055

Total minimum lease payments
$
11,865

The Company leases office space under arrangements expiring through 2026. Rent expense for the three months ended September 30, 2018 and October 1, 2017 was $0.7 million and $0.4 million, respectively, and $2.2 million and $1.2 million, respectively, for the nine months ended September 30, 2018 and October 1, 2017.
Purchase Commitments
The Company has purchase obligations of $16.9 million that are based on outstanding purchase orders as of September 30, 2018, related to the fabrication of certain wafers for which production has started. These purchase orders are cancellable at any time, provided that the Company pays all costs incurred through the cancellation date. Historically, the Company has rarely canceled these agreements once production has started. The Company did not otherwise have any outstanding non-cancellable purchase obligations as of September 30, 2018.
Indemnification
In connection with the sale of its semiconductor products, the Company executes standard software license agreements allowing customers to use its firmware. Under the indemnification clauses of these license agreements, the Company agrees to defend the licensee against third-party claims asserting infringement by the Company’s products of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to pay any judgments entered on such claims against the licensee, subject to certain restrictions and limitations. The Company has never incurred significant expense defending its licensees against third-party claims. Further, the Company has never incurred significant expense under its standard product or services performance warranties. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements at September 30, 2018.
Commitments
In April 2012, an agreement was entered into with Joint Stock Company “RUSNANO” (“RUSNANO”) (formerly Open Joint Stock Company “RUSNANO”), which required the Company to form a wholly-owned subsidiary in the Russian Federation and to provide funding to the subsidiary in the three years following April 16, 2012. This wholly-owned subsidiary performs research and development activities for the Company. Funding means cash transfers to the subsidiary for equity investments, reimbursements of subsidiary operating expenses and Company expenses related to the subsidiary. RUSNANO also requires participation in subsidiary financial decisions.
In July 2014, the Company entered into an amended and restated letter agreement with RUSNANO pursuant to which the Company agreed, among other matters, to operate and fund its Russian operations in an aggregate amount of $13.0 million over six annual periods beginning on December 31, 2014. The annual funding requirements in period one to period six are $2.2 million, $1.7 million, $2.0 million, $2.2 million, $2.4 million, and $2.5 million, respectively. In the event that the Company fails to meet its funding obligations for any period, it will be required to pay RUSNANO a penalty fee of 10% on 80% of the difference between the funding obligation and the actual funding for that period, subject to a cure period of one calendar quarter after the applicable period funding deadline. As of September 30, 2018, the Company had met the minimum funding requirements and no penalty had been incurred.
As of September 30, 2018, the Company’s non-cancellable obligations for its definite long-lived intangible assets which are comprised of software licenses were approximately $3.0 million, of which $0.3 million is due payable in fiscal 2018 and $2.7 million is due payable within the subsequent two years.


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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Legal Matters
From time to time, the Company is a party to litigation and subject to claims incident to the ordinary course of business, including intellectual property claims, labor and employment claims, breach of contract claims, and other matters. Significant judgment is required when we assess the likelihood of any adverse judgments or outcomes to a potential claim or legal proceeding, as well as potential ranges of probable losses, and when the outcomes of the claims or proceedings are probable and reasonably estimable. Because of uncertainties related to these matters, we base our estimates on the information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation, and may revise our estimates. Any revisions in the estimates of potential liabilities could have a material impact on the Company’s results of operations, financial position, and cash flows.
8.     Long-term Debt
Loan and Security Agreement
The Company’s Amended and Restated Loan and Security Agreement with Silicon Valley Bank (“SVB”) (the “SVB Loan and Security Agreement”) includes (i) term loans, (ii) a revolving line of credit, and (iii) a mezzanine loan. The mezzanine loan was canceled upon its expiration in fiscal 2017 and the revolving line of credit expired in May 2018.
On December 31, 2017, the Company sought to extinguish its term loans under the SVB Loan and Security Agreement of which approximately $3.9 million (including interest and early termination fees) remained outstanding. The Company reclassified the final $3.9 million payment on December 31, 2017 to “Long-term debt, current portion” in its condensed consolidated balance sheet as of that date. The payment for the extinguishment of the term loans was processed on January 2, 2018.
9.    Stockholders’ Equity
Common Stock
The Company’s Certificate of Incorporation, as amended, authorizes the Company to issue 1,000,000,000 shares of $0.0001 par value common stock. Each share of common stock is entitled to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legally available and when and if declared by the board of directors. The Company has never declared any dividends.
The Company had reserved shares of common stock for issuance, on an as-converted basis, as follows:
 
September 30, 2018
 
 
Options issued and outstanding
4,562,312

RSUs issued and outstanding
1,861,257

Shares available for ESPP
1,418,697

Shares available for future stock awards
2,580,091

 
10,422,357

During the nine months ended September 30, 2018, the Company granted 1,489,046 restricted stock units (“RSUs”) and 666,250 options to employees. During the nine months ended October 1, 2017, the Company granted 1,041,629 RSUs and 516,750 options to employees.
Options Subject to Repurchase
The Company has a right of repurchase with respect to unvested shares issued upon early exercise of options at an amount equal to the lower of (i) the exercise price of each restricted share being repurchased and (ii) the fair market value of such restricted share at the time the Company’s right of repurchase is exercised. The Company’s right to repurchase these shares lapses as to 1/36th of the total number of shares originally granted per month for 36 months. During the three months ended

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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

September 30, 2018, 22,000 unvested shares which were early-exercised were repurchased by the Company. As of September 30, 2018, there were no more unvested shares subject to the Company’s right of repurchase.
10.    Stock-based Compensation
Total stock-based compensation expense for employees and non-employees recognized in the condensed consolidated statements of operations was as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
(in thousands)
Cost of revenue
$
50

 
$
38

 
$
146

 
$
123

Research and development
2,248

 
1,367

 
7,170

 
3,986

Sales and marketing
541

 
416

 
2,118

 
1,179

General and administrative
1,163

 
948

 
3,489

 
2,159

Total stock-based compensation expense
$
4,002

 
$
2,769

 
$
12,923

 
$
7,447

The above stock-based compensation expense related to the following equity-based awards:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
(in thousands)
Stock options
$
1,010

 
$
858

 
$
3,186

 
$
2,539

RSU awards
2,753

 
1,603

 
8,269

 
3,553

ESPP shares
239

 
308

 
1,468

 
1,355

Total stock-based compensation expense
$
4,002

 
$
2,769

 
$
12,923

 
$
7,447

11. Income Taxes
The Company recorded an income tax benefit of $0.6 million and $0.3 million, for the three months ended September 30, 2018 and October 1, 2017, respectively, and an income tax benefit of $1.1 million and an income tax provision of $0.5 million for the nine months ended September 30, 2018 and October 1, 2017, respectively. The income tax benefit consists primarily of discrete excess stock based tax benefits. The provision for income taxes consists primarily of income taxes in the foreign jurisdictions in which we conduct business.
In the fourth quarter of fiscal 2017, management concluded that the valuation allowance for the Company's U.S. federal and state (with the exception of California) deferred tax assets was no longer needed primarily due to the emergence from cumulative losses over the previous three years.
As of September 30, 2018, based on the available objective evidence, management still believes it is more likely than not that the net deferred tax assets will be realized for federal and state purposes. We will continue to maintain a valuation allowance in those jurisdictions deemed necessary until sufficient positive evidence exists to support reversal. Such assessment may change in the future as further evidence becomes available.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Act. The Tax Act makes broad and complex changes to the U.S. tax federal and state tax laws that affected 2017, the current year and onwards, including, but not limited to, a reduction of the U.S. federal corporate tax rate from as high as 35% to 21%, a

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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

general elimination of U.S. federal income taxes on dividends from foreign subsidiaries, net operating loss deduction limitations, and 100% disallowance of entertainment expense.
The Tax Act adds new provisions relating to “foreign derived intangible income” (“FDII”) and “global intangible low-taxed income” (“GILTI”). The Company has completed an analysis for FDII and GILTI and due to the forecasted results of the Company, there is currently no impact on the provision.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740, Income Taxes (“ASC 740”) for the year ended December 31, 2017. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. The Company is still within the measurement period as of the third quarter of fiscal 2018 and no further conclusions have been made, as the Company reviews the law change and the impact to the Company.
Under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), our ability to utilize net operating loss carry-forwards (“NOLs”) or other tax attributes such as research tax credits, in any taxable year may be limited if we experience, or have experienced, an “ownership change.” A Section 382 “ownership change” generally occurs if one or more stockholders or groups of stockholders, who own at least 5% of our stock, increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. Similar rules may apply under state tax laws.
We have completed an analysis under Section 382 of the Code through December 31, 2017 and determined that there was no significant limitation to the utilization of NOL or tax credit carryforwards before they expire. We are in the process of updating the study through the current year and will update for any significant limitations to the utilization of NOL or tax credit carryforwards in the current year upon completion of the study.
12.    Employee Benefit Plans
Defined Contribution Plan
The Company adopted a 401(k) Plan that qualifies as a deferred compensation arrangement under Section 401 of the Code. Under the 401(k) Plan, participating employees may defer a portion of their pretax earnings not to exceed the maximum amount allowable. The 401(k) Plan permits the Company to make matching contributions and profit sharing contributions to eligible participants. The Company has made matching contributions of $0.4 million for the nine months ended September 30, 2018.
13.     Related Party Transactions
Purchases from Cadence Design Systems, Inc.
Lip-Bu Tan, a member of the Company’s board of directors since June 2015, resigned from the board in accordance with his previously announced intentions, effective June 5, 2018 in connection with the Company’s Annual Meeting of Stockholders. As a result, Mr. Tan ceased to be a related party to the Company during the second quarter of fiscal 2018 which ended on July 1, 2018. Mr. Tan is the President and Chief Executive Officer of Cadence Design Systems, Inc. (“Cadence”), an electronic design automation software and engineering services company.
Since 2012, the Company has paid licensing fees for digital and analog layout tools and simulation tools from Cadence in the ordinary course of business. In fiscal 2017, the Company entered into a software license contract with Cadence for the use of various EDA software tools used for its research and development efforts. The Company classified the software licenses as definite long-lived intangible assets in its condensed consolidated balance sheets amounting to approximately $2.4 million as of July 1, 2018, net of accumulated amortization of approximately $0.8 million. Under the terms of this arrangement, the Company amortized fees, in its condensed consolidated statements of operations, of approximately $0.5 million during the six months ended July 1, 2018, and approximately $2.0 million and $3.7 million during the three and nine months ended October 1, 2017, respectively.

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Quantenna Communications, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

During the six months ended July 1, 2018, the Company engaged Cadence for design and development services related to integrated circuits amounting to approximately $1.8 million.

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Item 2. 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 should be read in conjunction with our consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 28, 2018 (“2017 Annual Report on Form 10-K”) and the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, those discussed in the section titled “Risk Factors” and those included elsewhere in this Quarterly Report on Form 10-Q.
Our Management’s Discussion and Analysis is organized as follows:
Overview. Discussion of our business and overall analysis of financial and other highlights affecting our Company.
Results of Operations. Analysis of our financial results comparing the third quarter and first nine months of 2018 to the corresponding periods in 2017.
Liquidity and Capital Resources. Analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and sources of liquidity.
Contractual Commitments. Contractual obligations as of September 30, 2018.
Overview
We are a leader in the design, development, and marketing of advanced high-speed wireless communication solutions enabling wireless local area networking. Our solutions are designed to deliver leading-edge Wi-Fi performance to support an increasing number of connected devices accessing a rapidly growing pool of digital content. We apply our wireless systems and software expertise with high-performance radio frequency, mixed-signal and digital semiconductor design skills to provide highly integrated Wi-Fi solutions to our customers. Wi-Fi is a ubiquitous standard for wireless network connectivity, defined by the Institute of Electrical and Electronics Engineers (“IEEE”) 802.11 standardization body working group that is rapidly evolving to deliver continued performance improvements while maintaining backward compatibility.
We sell our Wi-Fi solutions directly to global original equipment manufacturers (“OEMs”), original design manufacturers (“ODMs”) and contract manufacturers (“CMs”) that serve the end markets we address. In addition, we sell our Wi-Fi solutions to third-party distributors who, in turn, resell to OEMs, ODMs and CMs. OEMs incorporate our solutions into their products, which are then sold to their own customers, such as service providers, retailers, enterprises, small and medium businesses, and retail consumers. To date, we have primarily addressed the service provider market for home networking applications, including home gateways, repeaters, and set-top boxes. We are also addressing additional end markets, with solutions for (i) retail OEMs for home networking as well as small and medium business applications (e.g., routers and repeaters), (ii) enterprise OEMs for enterprise networking applications (e.g., access points), and (iii) potential future opportunities from consumer electronics OEMs for consumer connected home applications, including wireless streaming of audio and video, wireless TVs, and wireless speakers. We believe the life cycles of our customers’ products can range from approximately one year to five years or more depending on the end market.
Some OEMs purchase our Wi-Fi solutions directly from us and use them in the design and manufacture (directly or through their third-party contract manufacturers) of their own products. Other OEMs utilize ODMs to design and build subsystem products incorporating our Wi-Fi solutions, which the OEMs then purchase from the ODM and incorporate into the OEM products. Accordingly, we ship our Wi-Fi solutions either directly to the OEM, its contract manufacturer, or its ODM, based on the requirements of each OEM. However, we maintain close relationships with the target OEM to monitor OEM end-market demand as the initial Wi-Fi solution design win is generally awarded by the OEM.
We derive the substantial majority of our revenue from the sale of our Wi-Fi solutions. In addition, historically we also derived a portion of our revenue from a limited number of licensing and non-recurring arrangements. While licensing and non-recurring arrangements are not part of primary focus, we may enter into such arrangements on an opportunistic basis from time to time.

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The following table shows OEM, ODM and third-party distributor customers from which we derived 10% or more of our revenue during the periods shown:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
(Percentage of revenue)
Customer:
 
 
 
 
 
 
 
A
34%
 
18%
 
28%
 
15%
B
*
 
10%
 
*
 
*
C
13%
 
*
 
*
 
*
Over 99% of our revenue was generated outside the United States for the three and nine months ended September 30, 2018 and October 1, 2017, based on ship-to destinations, and we anticipate that the vast majority of our shipments will continue to be delivered outside the United States. Although almost all shipments are delivered outside the United States, we believe that a significant number of the Wi-Fi products that include our semiconductors, such as access points, gateways, set-top boxes and repeaters, are ultimately sold by OEM customers to service providers in North America and Western Europe. To date, all of our revenue has been denominated in U.S. dollars. Refer to Note 1 to the condensed consolidated financial statements, The Company and Summary of Significant Accounting Policies, for further details of the Company’s revenue by geographic region.
We use a fabless semiconductor business model and rely on third-party contractors to fabricate, assemble, and test our chipset designs. We purchase silicon wafers from Taiwan Semiconductor Manufacturing Company Limited (“TSMC”), our foundry partner, which are then shipped to third-party contractors who assemble and test our chipsets. Our inventory is distributed from the third-party contractors and a contracted warehouse in Taiwan. We believe this outsourced manufacturing approach gives us access to the best available process technology, reduces our capital requirements, and allows us to focus our resources on the design, development, marketing, sales, and customer integration of our Wi-Fi solutions. We typically receive purchase orders 16 to 18 weeks ahead of our customers’ desired delivery date, and we build our inventory primarily on the basis of purchase orders from our customers.
Third Quarter 2018 and Recent Highlights
Revenue increased $9.2 million, or 18%, to $59.3 million for the three months ended September 30, 2018 and net income increased by $1.1 million, or 38% to $3.9 million for the same period when compared to the three months ended October 1, 2017. Revenue increased $22.8 million, or 17%, to $157.9 million for the nine months ended September 30, 2018 and net income decreased by $0.4 million, or 20%, to $1.7 million for the same period when compared to the nine months ended October 1, 2017.
Gross profit increased $5.0 million, or 20%, to $29.5 million in the three months ended September 30, 2018 and increased $11.2 million, or 17%, to $78.1 million in the nine months ended September 30, 2018 when compared to the corresponding periods in 2017. Gross margin decreased by 80 basis points, to 49.7%, in the three months ended September 30, 2018 and remained unchanged at 49.5%, in the nine months ended September 30, 2018 compared to the corresponding periods in 2017.
The increase in revenue and gross profit were primarily due to an increase in sales of our Wi-Fi solutions driven by higher unit volumes of our 11ac products. Changes in our gross margin were primarily due to changes in our product mix including an increased concentration of our higher cost 11ac Wave 3 (10G) product. Operating expenses increased $4.4 million, or 20%, to $26.5 million for the three months ended September 30, 2018 and increased $13.9 million, or 22%, to $78.4 million when compared to the corresponding periods in 2017, primarily due to the continued expansion of our operations.
We generated cash from operations of $19.7 million for the nine months ended September 30, 2018 and ended the third quarter of 2018 with cash and cash equivalents and marketable securities of $132.0 million, up 11% from December 31, 2017. See "Liquidity and Capital Resources" below for further details.
As of September 30, 2018, we had 410 employees, up 8% from 380 employees at the end of the fourth quarter of 2017, and up 10% from 372 employees at the end of the third quarter of 2017. We expect our headcount to continue to grow as we scale our business.

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In the third quarter of fiscal 2018, we publicly announced that we:
partnered with Aerial Technologies to bring the latest in Wi-Fi motion detection technology to the market;
demonstrated over 1Gbps of Wi-Fi throughput using Quantenna QSR10GU-AX PLUS and QSR10G, each independently communicating with commercially available mobile products from Intel Corp.;
powered Deutsche Telekom’s award-winning Speedport Pro gateway with Quantenna’s Wave 3 10G solution, using its full 12 stream capabilities;
released and sampled to customers the QSR5GU-AX PLUS, a dual-band, 9-stream 802.11ax solution;
Orange Poland launched their new dual-band dual-concurrent Wi-Fi repeater based on our QV860 chipset;
joined forces with SoftAtHome to accelerate the availability of Wi-Fi solutions based on the latest draft of IEEE 802.11ax standard; and
integrated Plume’s Adaptive WiFi™ AI driven mesh solution into our QSR5GU-AX PLUS solution to deliver whole-home mesh networking.
We plan to continue to introduce our Wi-Fi solutions and related technologies that increase our addressable market and expand our selling opportunities into the strategic customers which we serve.
Factors Affecting Our Performance
Design Wins with Existing and Prospective Service Providers
Existing and prospective service providers that we serve through our OEM and ODM customer partners tend to be global enterprises that are continuously working with their partners to deploy new products. We believe our Wi-Fi solutions enable service providers to differentiate their products and services and drive the next upgrade cycles in their end market to ultimately gain market share. We work closely with service providers to assist in the development of their product specifications and designs. We compete to secure service provider design wins through an extended sales cycle, which can often last six to 18 months. After a design win is achieved, we continue to work closely with the service providers to assist them and their OEMs and ODMs throughout their product development and early deployment, which can often last six to 18 months. We believe our design win performance is dependent on the investments we make in research and development and sales and marketing to bring innovative Wi-Fi solutions to our existing and new markets and develop close relationships with our customer partners and service providers. As a result, we expect our research and development and sales and marketing expenses to increase in absolute dollars as we continue to grow our business.
Because of this extended sales cycle, our revenue is highly dependent upon the ongoing achievement of service provider design wins, including our Wave 2 11ac, Wave 3 11ac and 11ax product solutions. We expect future revenue to depend upon sales to service providers with whom we have existing relationships as well as our ability to garner design wins with new service providers with whom we currently do not have relationships or sales. Further, because we expect revenue relating to our earlier generation solutions to decline in the future, we consider these design wins critical to our future success.
Product Life Cycle of our Customer Partners and Service Providers; Expanding into Other End Markets
In the service provider home networking market, once service providers select our Wi-Fi solutions for integration into their products, we work with our OEM and ODM customer partners to monitor all phases of the product life cycle, including the initial design phase, prototype production and volume production. Our service providers’ product life cycles typically range from three to five years or more, based on product features, size of subscriber base, and roll-out plans. In contrast, wireless products sold in the retail or consumer electronics end markets have shorter life cycles than those sold into the service provider home networking market. In the retail or consumer electronics markets, a wireless product typically has a product life cycle of one to two years.
Currently, the majority of our revenue is derived from sales to OEMs and ODMs serving the service provider home networking market, with relatively longer sales cycles, longer customer product development cycles and longer time to shipment,

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but also with longer product life cycles. However, as we expand into additional end markets, such as retail, small and medium business, enterprise or consumer electronics, we expect revenue from such markets to increase as a proportion of our revenue over time. The shorter product life cycles associated with such additional end markets typically require greater frequency of design wins, and they may also result in faster time to shipment of our Wi-Fi solutions.
Sales Volume and Customer Concentration
A typical design win can generate a wide range of sales volumes for our Wi-Fi solutions, depending on the end market demand for our customers’ products. Such demand depends on several factors, including end market size, size of the service providers, product price and features, and the ability of our customer partners to sell their products into their end markets. As such, some design wins result in orders and significant revenue shortly after the design win is awarded and other design wins do not result in significant orders and revenue for several months or longer after the initial design win, if at all. As a result, an increase or decrease in the number of design wins we achieve on a quarterly or annual basis does not necessarily correlate to a likely increase or decrease in revenue in the same or immediately succeeding quarter or year. Nonetheless, design wins are critical to our continued sales, and we believe that the collective impact of design wins correlates to our overall revenue growth over time.
Our customer partners often share their product development schedules with us, including the projected launch dates of their wireless product offerings. Once our customer partners are in production, they generally will provide nine to 12-month forecasts of expected demand. However, they may change their purchase orders and demand forecasts at any time with limited or no prior notice.
We derive a significant portion of our revenue from a small number of OEMs and ODMs, and substantially all of our revenue to date has been generated by sales of our solutions to OEMs and ODMs serving the service provider market for home networking. While we strive to expand and diversify our customer base and we expect our customer concentration to decline over time, we anticipate that sales to a limited number of customer partners will continue to account for a significant percentage of our revenue in the foreseeable future. In light of this customer partner concentration, our revenue is likely to continue to be materially impacted by the purchasing decisions of our largest customer partners.
Wi-Fi Solutions Pricing, Cost and Gross Margin
Our average selling price (“ASP”) can vary by product mix, customer mix and end market, due to end market-specific characteristics such as supply and demand, competitive landscape, the maturation of Wi-Fi solutions launched in prior years and the launch of new Wi-Fi solutions. Our gross margin depends on a variety of factors, including the sales volume, features, price, and manufacturing costs of our Wi-Fi solutions. We make continuous investments in our solutions to enhance existing and add new features, maintain our competitiveness, minimize ASP erosion, and reduce the cost of our solutions.
As we rely on third-party contractors for the fabrication, assembly and testing of our chipsets, we work closely with these third-parties to improve the manufacturability of our chipsets, lower wafer cost, enhance yields, lower assembly and test costs, and improve quality.
In general, our latest generation solutions have higher prices compared to our prior generation solutions. As is typical in the semiconductor industry and consistent with our historical trends, we expect the ASPs of our solutions to decline as those solutions mature and unit volumes increase. These ASP declines often occur with improvements in manufacturing yields and lower wafer, assembly and testing costs, which may offset some or all of the margin reduction that results from lower ASPs.
Components of Results of Operations
Revenue
Our revenue is generated primarily from sales of our Wi-Fi solutions to our customer partners, net of accruals for estimated sales rebates. In addition, we sell our Wi-Fi solutions to third-party distributors who in turn resell to OEMs and ODMs. Our Wi-Fi solutions are integrated into OEM products, such as gateways, set-top boxes, repeaters or routers, which are then sold primarily to service providers. Our sales have historically been made on the basis of purchase orders against our standard terms and conditions, rather than long-term agreements and revenue is recognized on a sell-in basis. We account for rebates to end-user customer partners based on the maximum amount of rebate contractually due under the terms of the arrangement. Claims for

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customer rebates are accrued upon shipment to the ODM and adjusted based on historical settlement data. These rebate claim estimates are adjusted based on actual experience over time.
Sales of our Wi-Fi solutions fluctuate primarily based on competition, sales volume, customer inventory and price. We expect our revenue to fluctuate from quarter to quarter due to a variety of factors, such as customer product development and deployment cycles and the purchasing patterns of our customer partners and third-party distributors.
Cost of Revenue, Gross Margin
We utilize third-party contractors for the production of the chipsets included in our Wi-Fi solutions. Cost of revenue primarily relates to the purchase of silicon wafers from our third-party foundry, and costs associated with assembly, testing and inbound and outbound shipping of our wafers and chipsets. After we purchase wafers from our third-party foundry, we bear the manufacturing yield risk related to assembling and testing these wafers into chipsets, which can result in benefit or expense recorded in cost of revenue. Cost of revenue also includes lower of cost or market adjustments to the carrying value of inventory, scrap and inventory obsolescence, royalty costs, and any accruals for warranty obligations, which we record when revenue is recognized. Additionally, cost of revenue includes manufacturing overhead expense, such as personnel cost which primarily consist of compensation costs related to employees, consultants and contractors, including salaries, sales commissions, bonuses, stock-based compensation and other employee benefits, depreciation expense, and allocated administrative costs associated with supply chain management and quality assurance activities as well as property insurance premiums.
We seek to negotiate price reductions, which historically has included rebates, from our third-party foundry on the purchase of silicon wafers upon achieving certain volume targets. Such rebates are recorded as a reduction of inventory cost and are recognized as a reduction of cost of revenue. Because we do not have long-term, fixed supply agreements, our wafer costs are subject to changes based on the cyclical demand for semiconductors.
We calculate gross margin as revenue less cost of revenue divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, including ASPs, sales volume, and wafer, assembly and testing costs. The recent trade disputes and tariff increases may also impact gross margins. We believe the primary driver of our gross margin is the ASPs negotiated between us and our customer partners, relative to the wafer, assembly and testing costs for our Wi-Fi solutions. As each of our Wi-Fi solutions matures and sales volumes increase, we expect ASPs to decline. Historically, such ASP declines have often coincided with lower wafer, assembly and testing costs, which have offset some or all of the gross margin reduction resulting from lower ASPs. In the future, we expect our gross margin to fluctuate as a result of changes in ASPs, introductions of new Wi-Fi solutions, changes in our product and customer mix, and changes in wafer, assembly and testing costs.
Operating Expenses
Our operating expenses consist of research and development (“R&D”), sales and marketing (“S&M”) and general and administrative (“G&A”) expenses. Personnel costs are the largest component of operating expenses and primarily consist of compensation costs related to employees, consultants and contractors, including salaries, sales commissions, bonuses, stock-based compensation and other employee benefits. As we continue to grow our business, we expect operating expenses to increase in absolute dollars.
Research and Development. Our R&D expenses consisted primarily of personnel costs to support our R&D activities, including silicon design, software development and testing, and customers partner’s product development support and qualification. R&D expenses also include tape-out costs, which include layout services, mask sets, prototype wafers, mask set revisions, intellectual property license fees, and system qualification and testing incurred before releasing new semiconductor designs into production. In addition, R&D expenses include design software and simulation tools licenses, depreciation expense, and allocated administrative costs. All R&D costs are expensed as incurred.
Sales and Marketing. Our S&M expenses consist primarily of personnel costs for our S&M activities, including pre-sales support. S&M expenses also included sales-based commissions we pay to independent sales representatives, public relations costs, trade show expenses, product marketing and communication, promotional activities, travel and entertainment costs and allocated administrative costs.
General and Administrative. Our G&A expenses consist primarily of personnel costs for our administrative personnel in support of our infrastructure functions such as general management, finance, human resources, legal, facilities and information

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technology. G&A expenses also include professional services fees, insurance premiums, office equipment and supplies, depreciation expense and allocated administrative costs.
Other Income, Net
Other income, net consists primarily of interest income from our cash and cash equivalents and marketable securities portfolio, and the effect of exchange rates on our foreign currency-denominated asset and liability balances.
Provision (Benefit) for Income Taxes
Provision for income taxes consists primarily of alternative minimum tax and income taxes in the foreign jurisdictions in which we conduct business. Income tax benefit consists primarily of discrete excess stock based tax benefits.
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:
 
Three Months Ended
 
September 30,
2018
 
October 1,
2017
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
 
 
 
 
(In thousands, except per share data)
Revenue
$
59,349

 
100.0
%
 
$
50,108

 
100.0
 %
Cost of revenue (1)
29,859

 
50.3

 
25,591

 
51.1

Gross profit
29,490

 
49.7

 
24,517

 
48.9

Operating expenses (1)
 
 
 
 
 
 
 
Research and development
17,783

 
30.0

 
15,011

 
30.0

Sales and marketing
3,833

 
6.5

 
3,363

 
6.7

General and administrative
4,886

 
8.2

 
3,735

 
7.4

Total operating expenses
26,502

 
44.7


22,109

 
44.1

Income from operations
2,988

 
5.0

 
2,408

 
4.8

Interest expense

 

 
(103
)
 
(0.2
)
Other income, net
243

 
0.4

 
223

 
0.4

Income before income taxes
3,231

 
5.4

 
2,528

 
5.0

Benefit for income taxes
648

 
1.1

 
274

 
0.5

Net income
$
3,879

 
6.5
%
 
$
2,802

 
5.5
 %
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.10

 
 
 
$
0.08

 
 
Diluted
$
0.10

 
 
 
$
0.07

 
 
Weighted average shares used to compute basic and diluted net income per share:
 
 
 
 
 
 
 
Basic
37,070

 
 
 
34,734

 
 
Diluted
40,026

 
 
 
38,525

 
 





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Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
 
 
 
 
(In thousands, except per share data)
Revenue
$
157,893

 
100.0
 %
 
$
135,084

 
100.0
 %
Cost of revenue (1)
79,774

 
50.5

 
68,212

 
50.5

Gross profit
78,119

 
49.5

 
66,872

 
49.5

Operating expenses (1)
 
 
 
 
 
 
 
Research and development
52,468

 
33.2

 
43,699

 
32.3

Sales and marketing
12,307

 
7.8

 
9,553

 
7.1

General and administrative
13,602

 
8.6

 
11,231

 
8.3

Total operating expenses
78,377

 
49.6

 
64,483

 
47.7

Income (loss) from operations
(258
)
 
(0.1
)
 
2,389

 
1.8

Interest expense

 

 
(442
)
 
(0.3
)
Other income, net
807

 
0.5

 
610

 
0.4

Income before income taxes
549

 
0.4

 
2,557

 
1.9

Benefit (provision) for income taxes
1,115

 
0.6

 
(470
)
 
(0.3
)
Net income
$
1,664

 
1.0
 %
 
$
2,087

 
1.6
 %
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.05

 
 
 
$
0.06

 
 
Diluted
$
0.04

 
 
 
$
0.05

 
 
Weighted average shares used to compute basic and diluted net income per share:
 
 
 
 
 
 
 
Basic
36,476

 
 
 
33,907

 
 
Diluted
39,425

 
 
 
38,419

 
 



________________________
(1)
Cost of revenue and operating expenses include stock-based compensation expense as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
 
(In thousands)
Cost of revenue
$
50

 
$
38

 
$
146

 
$
123

Research and development
2,248

 
1,367

 
7,170

 
3,986

Sales and marketing
541

 
416

 
2,118

 
1,179

General and administrative
1,163

 
948

 
3,489

 
2,159

Total stock-based compensation expense
$
4,002

 
$
2,769

 
$
12,923

 
$
7,447



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Comparison of the three and nine months ended September 30, 2018 and October 1, 2017
Revenue, Cost of Revenue, Gross Profit and Gross Margin
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
Change
 
% Change
 
September 30,
2018
 
October 1,
2017
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
 
 
Revenue
$
59,349

 
$
50,108

 
$
9,241

 
18
%
 
$
157,893

 
$
135,084

 
$
22,809

 
17
%
Cost of revenue
29,859

 
25,591

 
4,268

 
17
%
 
79,774

 
68,212

 
11,562

 
17
%
Gross profit
$
29,490

 
$
24,517

 
$
4,973

 
20
%
 
$
78,119

 
$
66,872

 
$
11,247

 
17
%
Gross margin
49.7
%
 
48.9
%
 
80
bps
 
 
 
49.5
%
 
49.5
%
 
—%

 
 
Revenue. Revenue increased $9.2 million, or 18%, to $59.3 million in the three months ended September 30, 2018 and increased $22.8 million, or 17%, to $157.9 million in the nine months ended September 30, 2018 compared to the corresponding periods in 2017, primarily due to higher unit volumes from increased sales of our new 11ac Wave 3 (10G) products and our 11ac Wave 2 products. This increase was partially offset by declining sales of our legacy 11n products. We expect revenue will increase in absolute dollars in the fourth quarter of fiscal 2018 compared to the third quarter of fiscal 2018 due to overall higher unit shipments of our 11ac Wi-Fi solutions.
Cost of Revenue, Gross Profit and Gross Margin. Cost of revenue increased $4.3 million, or 17%, to $29.9 million in the three months ended September 30, 2018 and increased $11.6 million, or 17%, to $79.8 million in the nine months ended September 30, 2018 compared to the corresponding periods in 2017, as a result of higher unit volumes and changes to the product mix including an increased concentration of our higher cost 10G product.
Gross profit increased $5.0 million, or 20%, to $29.5 million in the three months ended September 30, 2018 and increased $11.2 million, or 17%, to $78.1 million compared to the corresponding periods in 2017 due to the higher unit volumes and changes to the product mix including an increased concentration of our higher priced 10G product.
Gross margin decreased by 80 basis points to 49.7%, in the three months ended September 30, 2018 and remained unchanged at 49.5%, in the nine months ended September 30, 2018 compared to the corresponding periods in 2017, primarily due to changes in our product mix including an increased concentration of our higher cost 10G product. We expect gross margin to increase slightly in the fourth quarter of fiscal 2018 compared to the third quarter of fiscal 2018 due to cost improvements in our 10G and other products.
Operating Expenses
 
Three Months Ended
 
 
 
 
 
September 30,
2018
 
October 1,
2017
 
 
 
 
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
Change
 
% Change
 
(Dollars in thousands)
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
17,783

 
30.0
%
 
$
15,011

 
30.0
%
 
$
2,772

 
18
%
Sales and marketing
3,833

 
6.5

 
3,363

 
6.7

 
470

 
14

General and administrative
4,886

 
8.2

 
3,735

 
7.4

 
1,151

 
31

Total operating expenses
$
26,502

 
44.7
%
 
$
22,109

 
44.1
%
 
$
4,393

 
20
%


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Nine Months Ended
 
 
 
 
 
September 30,
2018
 
October 1,
2017
 
 
 
 
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
Change
 
% Change
 
(Dollars in thousands)
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
52,468

 
33.2
%
 
$
43,699

 
32.3
%
 
$
8,769

 
20
%
Sales and marketing
12,307

 
7.8

 
9,553

 
7.1

 
2,754

 
29

General and administrative
13,602

 
8.6

 
11,231

 
8.3

 
2,371

 
21

Total operating expenses
$
78,377

 
49.6
%
 
$
64,483

 
47.7
%
 
$
13,894

 
22
%
Research and Development Expenses.  R&D expenses increased $2.8 million, or 18%, to $17.8 million in the three months ended September 30, 2018 compared to the corresponding period in 2017. The increase was primarily due to a $2.4 million increase in personnel costs, including $0.9 million in stock-based compensation expense, resulting from a 6% increase in headcount to further develop and expand our solutions portfolio and support increased customer product development activities, $0.6 million in allocated administrative costs and $0.3 million in equipment related expenses to support and qualify new product platforms. This increase was partially offset by a decrease of $0.4 million in tape-out and lay-out expenses and $0.2 million in professional services. We expect that R&D expenses will increase in the fourth quarter of fiscal 2018 compared to the third quarter of fiscal 2018.
R&D expenses increased $8.8 million, or 20%, to $52.5 million in the nine months ended September 30, 2018 compared to the corresponding period in 2017. The increase was primarily due to a $7.6 million increase in personnel costs, including $3.2 million in stock-based compensation expense, resulting from a 10% increase in headcount to further develop and expand our solutions portfolio and support increased customer product development activities, $1.9 million in allocated administrative costs and $1.0 million in equipment related expenses to support and qualify new product platforms. This increase was partially offset by a decrease of $0.9 million in amortization expense, $0.4 million in tape-out and lay-out expenses and $0.4 million in professional services.
Sales and Marketing Expenses. S&M expenses increased $0.5 million, or 14%, to $3.8 million in the three months ended September 30, 2018 compared to the corresponding period in 2017, primarily due to an increase of $0.4 million in personnel related costs, including $0.1 million in stock based compensation expense to support our expanding business. We expect that S&M expenses will increase in the fourth quarter of fiscal 2018 compared to the third quarter of fiscal 2018.
S&M expenses increased $2.8 million, or 29%, to $12.3 million in the nine months ended September 30, 2018 compared to the corresponding period in 2017, primarily due to an increase of $2.3 million in personnel related costs, including $0.9 million in stock based compensation expense to support our expanding business and $0.3 million in allocated administrative costs.
General and Administrative Expenses.  G&A expenses increased $1.2 million, or 31%, to $4.9 million in the three months ended September 30, 2018 compared to the corresponding period in 2017, primarily due to a $0.9 million increase in personnel costs, including $0.2 million in stock-based compensation expense, as we grew our administrative headcount by 41% to support the growth of our business, $0.4 million in other general administrative expenses, $0.3 million in additional facility costs and $0.3 million in depreciation and amortization expense. This increase was partially offset by $0.8 million in lower allocated administrative costs. We expect that G&A expenses will increase in the fourth quarter of fiscal 2018 compared to the third quarter of fiscal 2018.
G&A expenses increased $2.4 million, or 21%, to $13.6 million in the nine months ended September 30, 2018 compared to the corresponding period in 2017, primarily due to a $3.0 million increase in personnel costs, including a $1.3 million increase in stock-based compensation expense, as we increased our administrative headcount by 41% to support the growth of our business, $1.4 million in additional facility costs and $0.9 million in depreciation and amortization expense. This increase was partially offset by $2.3 million in lower allocated administrative costs and $0.8 million in legal and professional services.

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Liquidity and Capital Resources
Since our inception in 2005, we have funded our operations primarily through sales of our common stock in conjunction with our initial public offering (“IPO”), private equity financing, gross profits generated from sales, technology licensing and debt financing arrangements. As of September 30, 2018 and December 31, 2017, we had cash and cash equivalents and marketable securities of $132.0 million and $118.6 million, respectively, and as of September 30, 2018, we had an accumulated deficit of $125.6 million. On November 2, 2016, we consummated our IPO and received net proceeds of approximately $97.4 million, after underwriting discounts, commissions and other offering expenses.
Credit Facilities
Our Amended and Restated Loan and Security Agreement with Silicon Valley Bank (“SVB”) (the “SVB Loan and Security Agreement”) includes (i) term loans, (ii) a revolving line of credit, and (iii) a mezzanine loan. The mezzanine loan was canceled upon its expiration in fiscal 2017 and the revolving line of credit expired in May 2018.
On December 31, 2017, we sought to extinguish our term loans under the SVB Loan and Security Agreement of which approximately $3.9 million (including interest and early termination fees) remained outstanding. The Company reclassified the final $3.9 million payment on December 31, 2017 to “Long-term debt, current portion” in its condensed consolidated balance sheet as of that date. The payment for the extinguishment of the term loans was processed on January 2, 2018.
Based on our current operating plan, we expect that our cash and cash equivalents and marketable securities will be sufficient to fund our operations through at least the next 12 months. However, our liquidity assumptions may prove to be incorrect, and we could utilize our available financial resources sooner than we currently expect.
In the event that additional capital is needed, we may not be able to raise such capital on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, results of operations, and financial condition would be adversely affected. We may also seek to raise capital opportunistically to support the anticipated growth of our business.
Cash Flows
The following table sets forth the primary sources and uses of cash and cash equivalents for each of the periods presented below:
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
(In thousands)
Net cash provided by (used in):
 
 
 
Operating activities
$
19,691

 
$
14,194

Investing activities
(8,210
)
 
(95,096
)
Financing activities
$
(1,095
)
 
$
2,701

Cash flows from Operating Activities.
Net cash provided by operating activities for the nine months ended September 30, 2018 and October 1, 2017 was $19.7 million and $14.2 million, respectively.
Net cash provided by operating activities for the nine months ended September 30, 2018 of $19.7 million resulted from a net income of $1.7 million, net cash inflow from changes in operating assets and liabilities of $2.7 million and non-cash expenses of $12.9 million in stock based compensation, $3.5 million of depreciation and amortization and $0.7 million of other non-cash expenses, partially offset by non-cash income of $1.8 million relating to non-cash deferred taxes. The $2.7 million net cash inflow from changes in operating assets and liabilities primarily consisted of a $6.7 million decrease in accounts receivable due to timing of collections, a $6.5 million increase in accounts payable due to timing of payments to our suppliers and a $2.1 million increase in accrued liabilities and other current liabilities, partially offset by $8.9 million in increased inventory due to timing

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of raw materials purchases and a $3.8 million increase in prepaid expenses and other assets required to support the growth of our business.
Net cash provided by operating activities for the nine months ended October 1, 2017 of $14.2 million resulted from net income of $2.1 million, net cash inflow from changes in operating assets and liabilities of $2.7 million and non-cash expenses of $7.4 million of stock based compensation, $1.6 million of depreciation and amortization, $0.3 million of non-cash interest expense and $0.1 million of accretion of discount on our marketable securities. The $2.7 million cash inflow from changes in operating assets and liabilities primarily consisted of an increase of $14.7 million in accrued liabilities and other current liabilities as a result of an increase in expenses consistent with the growth of our business and a $5.1 million increase in accounts payable due to timing of payments to our suppliers offset by a $8.3 million increase in accounts receivable due to increased sales and timing of collections, a $7.9 million increase in inventory due to timing of purchases of raw materials and an increase of $0.9 million of other assets.
Cash flows from Investing Activities.
Net cash used in investing activities was $8.2 million for the nine months ended September 30, 2018 compared to net cash used in investing activities for the nine months ended October 1, 2017 of $95.1 million. Cash used in investing activities for the nine months ended September 30, 2018 related to $47.9 million of marketable securities purchases, $4.0 million of property and equipment purchases and $0.6 million of long-term investment purchases, partially offset by maturities of $44.3 million in marketable securities.
Net cash used in investing activities for the nine months ended October 1, 2017 of $95.1 million related to $104.0 million of marketable securities purchases and $7.0 million of property and equipment purchases including $4.1 million related to our new corporate headquarters, partially offset by maturities and sales of $15.9 million in marketable securities.
Cash flows from Financing Activities.
Net cash used in financing activities was $1.1 million for the nine months ended September 30, 2018, compared to net cash provided by financing activities for the nine months ended October 1, 2017 of $2.7 million. Net cash flow used in financing activities during the nine months ended September 30, 2018 reflected the repayment of $3.9 million in outstanding debt, payment of $2.4 million of taxes withheld for vested stock awards and payments of $0.8 million related to intangible asset purchases, partially offset by $6.0 million in proceeds from the issuance of common stock
Net cash flow provided by financing activities during the nine months ended October 1, 2017 reflected $5.1 million in proceeds from issuance of common stock, net, partially offset by repayments of outstanding long-term debt of $1.8 million and payment of $0.6 million of taxes withheld for vested stock awards.
Contractual Obligations and Commitments
The following table summarizes our contractual commitments and obligations as of September 30, 2018:
 
Total
 
Less Than
1 Year
 
1-3 Years
 
3-5 Years
 
More Than
5 Years
 
(In thousands)
Operating lease obligations
$
11,865

 
$
1,451

 
$
6,840

 
$
3,334

 
$
240

Commitments(1)
4,900

 
2,400

 
2,500

 

 

Software license commitments
2,976

 
1,488

 
1,488

 

 

 
$
19,741

 
$
5,339

 
$
10,828

 
$
3,334

 
$
240

________________________

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(1)
In April 2012, we entered into a letter agreement with RUSNANO, pursuant to which we agreed, among other matters, to create a subsidiary to be incorporated in Russia and to fund such subsidiary in an aggregate amount of $20.0 million over three years. In July 2014, we amended and restated such letter agreement with RUSNANO, pursuant to which we agreed, among other matters, to operate and fund our Russian operations in an aggregate amount of $13.0 million over six annual periods beginning on December 31, 2014. The annual funding requirements in period one to period six are $2.2 million, $1.7 million, $2.0 million, $2.2 million, $2.4 million, and $2.5 million, respectively. In the event that we fail to meet our funding obligations for any period, we will be required to pay RUSNANO a penalty fee of 10% on 80% of the difference between the funding obligation and the actual funding for that period, subject to a cure period of one calendar quarter after the applicable period funding deadline. As of September 30, 2018, we had met the minimum funding requirements.
Obligations under contracts that we can cancel without a significant penalty are not included in the table above. As of September 30, 2018, we have purchase obligations of $16.9 million that are based on outstanding purchase orders related to the fabrication of silicon wafers for which production has started. These purchase orders are cancellable at any time, provided that we are required to pay all costs incurred through the cancellation date. Historically, we have rarely canceled these agreements once production has started.
Off-Balance Sheet Arrangements
As of September 30, 2018, we did not have any off-balance sheet arrangements.
JOBS Act Accounting Election
The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We are choosing to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.
Critical Accounting Policies, Significant Judgments and Use of Estimates
Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”). Our critical accounting policies are more fully described in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and Note 1, “The Company and Summary of Significant Accounting Policies” contained in the “Notes to Consolidated Financial Statements” of our 2017 Annual Report on Form 10-K. There were no changes to our significant accounting policies during the three and nine months ended September 30, 2018.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our condensed consolidated financial statements. Our critical accounting policies include our more significant estimates and assumptions used in the preparation of our condensed consolidated financial statements. Our critical accounting policies are described in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” of our 2017 Annual Report on Form 10-K.
On an ongoing basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, inventory valuation, stock-based compensation, common stock warrants, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Recent Accounting Pronouncements
See Note 2 contained in the “Notes to Condensed Consolidated Financial Statements” in Item 1 of Part I of this Quarterly Report on Form 10-Q for a full description of the recent accounting pronouncements and our explanation of their impact, if any, on our results of operations and financial condition.


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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have operations both within the United States and internationally, and we are exposed to market risks in the ordinary course of our business. We are primarily exposed to market risks related to changes in interest rates, foreign currency exchange rates and inflation, as well as risks relating to changes in the general economic conditions in the countries where we conduct business. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results.
Interest Rate Risk
We had cash and cash equivalents and marketable securities of $132.0 million and $118.6 million as of September 30, 2018 and December 31, 2017, respectively. We manage our cash and cash equivalents portfolio and marketable securities for operating and working capital purposes.
Our cash and cash equivalents are held in cash, short-term money market funds, agency securities and commercial paper with maturities of less than 90 days when purchased. 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 cash equivalents portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce our future interest income. During the nine months ended September 30, 2018, the effect of a hypothetical 100-basis point (one percentage point) increase or decrease in overall interest rates would not have had a material impact on our interest income.
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio comprising of marketable securities. We invest in a number of securities including U.S. agency notes, U.S. treasuries, commercial paper, corporate bonds, municipal bonds and money market funds. We attempt to ensure the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in high grade investment securities.
The fair market value of our fixed rate securities may be adversely impacted by increases in interest rates while income earned may decline as a result of decreases in interest rates. A hypothetical 100 basis-point (one percentage point) increase or decrease in interest rates compared to rates at September 30, 2018 would have affected the fair value of our investment portfolio by approximately $0.5 million.
Foreign Currency Exchange Risk
To date, all of our revenue and the majority of our operating expenses have been denominated in U.S. dollars. Some operating expenses, primarily associated with our international subsidiaries, are denominated in foreign currencies and are therefore exposed to fluctuations due to changes in foreign currency exchange rates, which may cause us to recognize transaction gains and losses in our consolidated statements of operations. During the second quarter of fiscal 2018, we established a currency risk management program to hedge against fluctuations and volatility of future cash flows caused by changes in currency exchange rates. Under this program, our strategy is to have increases or decreases in foreign currency exposures mitigated by gains or losses on the foreign currency forward derivative contracts in order to mitigate the risks and volatility associated with foreign currency transaction gains or losses. This strategy reduces, but does not always entirely eliminate, the impact of currency exchange rate movements. Refer to Note 6 to the condensed consolidated financial statements, Derivative Instruments, for further details.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2018, the last day of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), refers to controls and procedures that are designed to provide reasonable assurance that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to provide reasonable assurance that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act

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is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Because of the material weakness in our internal control over financial reporting as previously disclosed in our final prospectus, dated October 27, 2016, and in our Annual Reports on Form 10-K for the fiscal years ended January 1, 2017 and December 31, 2017, and as described below, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2018, our disclosure controls and procedures were not effective. Notwithstanding the material weakness in our internal control over financial reporting, our management, including our Chief Executive Officer and Chief Financial Officer, believes that the condensed consolidated financial statements in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with US GAAP.
During the course of the preparation of our 2015 consolidated financial statements, we identified a control deficiency in our internal control over financial reporting. This control deficiency did not result in a misstatement of the annual or interim financial statements, however, this control deficiency could result in a misstatement of the consolidated financial statements or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Accordingly, our management has determined that this control deficiency constitutes a material weakness.
The material weakness was a result of a lack of sufficient qualified personnel within the finance and accounting function who possessed an appropriate level of expertise to effectively perform the following functions commensurate with our structure and financial reporting requirements:
identify, select and apply US GAAP sufficiently to provide reasonable assurance that transactions were being appropriately recorded; and
assess risk and design appropriate control activities over financial and reporting processes necessary to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements.
Management’s Remediation Efforts
In response to the identified material weakness, we have taken a number of steps to remediate this material weakness and improve our internal control over financial reporting. Since the beginning of fiscal 2017 and through the third quarter of fiscal 2018, we have increased our dedicated finance and accounting personnel, including certified public accountants and several finance support team members. We have also implemented additional internal controls, including additional workflows relating to change management, review and approval processes, and account reconciliations. We further updated our internal controls process narratives and performed tests to ensure that our internal control processes performed as documented.
The additional resources added to the finance function have enabled us to further (i) allow separate preparation and review of reconciliations and other account analysis, (ii) enable us to develop a more structured close process, including enhancing our existing policies and procedures, to improve the completeness, timeliness and accuracy of our financial reporting, and (iii) identify and review complex or unusual transactions. We believe these individuals possess the appropriate knowledge and capacity to help fulfill our obligations to comply with the accounting and reporting requirements. Additionally, we have further significantly improved internal controls surrounding our financial reporting process and continued to validate and test the design and operating effectiveness of our internal controls.
While we believe that the foregoing actions have improved our internal control over financial reporting, the implementation of these measures is ongoing and will require validation and testing of the design and operating effectiveness of internal controls over a sustained period of financial reporting cycles. We also believe that our planned efforts to assess risk and identify, design and implement the necessary control activities to addre