Intermolecular, Inc.
INTERMOLECULAR INC (Form: 10-Q, Received: 08/01/2014 08:18:47)
Table of Contents

 
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 June 30, 2014
Or  
o       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission File Number 001-35348  
Intermolecular, Inc.
(Exact Name of Registrant as Specified in its Charter)
Delaware
 
20-1616267
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
3011 N. First Street
San Jose, California
 
95134
(Address of Principal Executive Offices)
 
(Zip Code)
(408) 582-5700
(Registrant’s Telephone Number, Including Area Code)
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
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  o
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  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  o
 
Accelerated filer  x
 
 
 
Non-accelerated filer  o
 
Smaller reporting company  o
(Do not check if a smaller reporting company)
 
 

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o   No  x
Shares outstanding of the registrant’s common stock:
Class
 
Outstanding as of July 28, 2014
Common stock, $0.001 par value
 
47,787,338
 


Table of Contents

INTERMOLECULAR, INC.  
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2014
TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

PART I — FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
INTERMOLECULAR, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
(Unaudited)
 
June 30, 2014
 
December 31, 2013
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
41,785

 
$
72,083

Short-term investments
28,196

 

Accounts receivable, net of allowance for doubtful accounts of $0 as of June 30, 2014 and December 31, 2013
4,594

 
6,791

Accounts receivable, due from related parties
30

 
231

Prepaid expenses and other current assets
1,410

 
2,247

Total current assets
76,015

 
81,352

Inventory
7,331

 
6,510

Property and equipment, net
24,530

 
28,485

Intangible assets, net
8,080

 
7,855

Other assets
272

 
280

Total assets
$
116,228

 
$
124,482

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
1,128

 
$
2,157

Accrued liabilities
2,655

 
3,672

Accrued compensation and employee benefits
2,840

 
3,655

Deferred revenue
1,969

 
2,087

Related party deferred revenue
943

 
385

Note payable
2,000

 
2,000

Total current liabilities
11,535

 
13,956

Deferred revenue, net of current portion
2,073

 
830

Deferred rent, net of current portion
2,540

 
1,844

Note payable, net of current portion
22,000

 
23,000

Total liabilities
38,148

 
39,630

Commitments and contingencies (note 5)


 


Stockholders’ equity:
 

 
 

Preferred stock, $0.001 par value, 5,000,000 shares authorized, no shares issued and outstanding as of June 30, 2014 and December 31, 2013

 

Common stock, par value $0.001 per share—200,000,000 shares authorized; 47,787,338 and 46,486,372 shares issued and outstanding as of June 30, 2014 and December 31, 2013, respectively
48

 
46

Additional paid-in capital
198,884

 
194,930

      Accumulated other comprehensive loss
(18
)
 

Accumulated deficit
(120,834
)
 
(110,124
)
Total stockholders’ equity
78,080

 
84,852

Total liabilities and stockholders’ equity
$
116,228

 
$
124,482

 
See accompanying notes to unaudited condensed consolidated financial statements

3

Table of Contents

INTERMOLECULAR, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(In thousands, except share and per share data)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Revenue:
 

 
 

 
 

 
 

Collaborative development program and services revenue
$
6,865

 
$
12,799

 
$
15,751

 
$
23,702

Product revenue

 

 

 
3,104

Licensing and royalty revenue
3,069

 
3,809

 
10,088

 
7,235

Total revenue
9,934

 
16,608

 
25,839

 
34,041

Cost of revenue:
 

 
 

 
 

 
 

Cost of collaborative development program and services revenue
5,484

 
7,080

 
11,954

 
13,738

Cost of product revenue

 

 

 
1,133

Cost of licensing and royalty revenue
152

 
60

 
250

 
112

Total cost of revenue
5,636

 
7,140

 
12,204

 
14,983

Gross profit
4,298

 
9,468

 
13,635

 
19,058

Operating expenses:
 

 
 

 
 

 
 

Research and development
6,212

 
5,448

 
13,168

 
11,620

Sales and marketing
1,379

 
1,578

 
3,027

 
3,215

General and administrative
3,097

 
3,042

 
6,410

 
6,034

Restructuring charges
293

 

 
1,361

 

Total operating expenses
10,981

 
10,068

 
23,966

 
20,869

Loss from operations
(6,683
)
 
(600
)
 
(10,331
)
 
(1,811
)
Other income (expense):
 

 
 

 
 

 
 

Interest expense, net
(179
)
 
(231
)
 
(373
)
 
(481
)
Other income, net
5

 
87

 

 
68

Total other income (expense), net
(174
)
 
(144
)
 
(373
)
 
(413
)
Loss before provision for income taxes
(6,857
)
 
(744
)
 
(10,704
)
 
(2,224
)
Provision for income taxes
2

 

 
6

 
6

Net loss
$
(6,859
)
 
$
(744
)
 
$
(10,710
)
 
$
(2,230
)
Net loss per share of common stock, basic and diluted
$
(0.15
)
 
$
(0.02
)
 
$
(0.23
)
 
$
(0.05
)
Weighted-average number of shares used in computing net loss per share of common stock, basic and diluted
47,192,882

 
44,630,442

 
46,560,205

 
44,386,111

Related Party Transactions
The Condensed Consolidated Statements of Operations shown above include the following related party transactions:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Revenue:
 

 
 

 
 

 
 

Collaborative development program and services revenue
$
171

 
$
1,900

 
$
1,108

 
$
3,812

Licensing and royalty revenue
1,059

 
1,358

 
1,500

 
2,724

Total revenue
$
1,230

 
$
3,258

 
$
2,608

 
$
6,536

See accompanying notes to unaudited condensed consolidated financial statements

4

Table of Contents

INTERMOLECULAR, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Loss
(In thousands)
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(6,859
)
 
$
(744
)
 
$
(10,710
)
 
$
(2,230
)
Unrealized losses on available-for-sale-securities
(18
)
 

 
(18
)
 

Other comprehensive loss
(18
)
 

 
(18
)
 

Comprehensive loss, net of income tax
$
(6,877
)
 
$
(744
)
 
$
(10,728
)
 
$
(2,230
)

See accompanying notes to unaudited condensed consolidated financial statements


5

Table of Contents

INTERMOLECULAR, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)  
 
Six Months Ended June 30,
 
2014
 
2013
Cash flows from operating activities:
 

 
 

Net loss
$
(10,710
)
 
$
(2,230
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 

 
 

Depreciation and amortization
5,164

 
4,546

Stock-based compensation
2,793

 
2,764

Loss on disposal of property and equipment

 
6

Changes in operating assets and liabilities:
 

 
 

Prepaid expenses and other assets
845

 
139

Inventory
(497
)
 
(931
)
Accounts receivable
2,398

 
3,341

Accounts payable
(492
)
 
(155
)
Accrued and other liabilities
(525
)
 
(32
)
Deferred revenue
1,125

 
651

Related party deferred revenue
558

 
1,966

Net cash provided by operating activities
659

 
10,065

Cash flows from investing activities:
 

 
 

Purchase of short-term investments
(28,214
)
 
(1,001
)
Redemption of short-term investments

 
1

Purchase of property and equipment
(1,958
)
 
(6,457
)
Purchased and capitalized intangible assets
(948
)
 
(833
)
Net cash used in investing activities
(31,120
)
 
(8,290
)
Cash flows from financing activities:
 

 
 

Proceeds from debt

 
25,000

Payment of debt
(1,000
)
 
(26,514
)
Proceeds from exercise of common stock options
1,163

 
1,268

Net cash provided by (used in) financing activities
163

 
(246
)
Net (decrease) increase in cash and cash equivalents
(30,298
)
 
1,529

Cash and cash equivalents at beginning of period
72,083

 
78,283

Cash and cash equivalents at end of period
$
41,785

 
$
79,812

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 

Cash paid for interest
$
272

 
$
442

Cash paid for income taxes, net of refunds received
$
23

 
$

Noncash investing/operating activities:
 
 
 
Transfer of property and equipment to inventory
$
324

 
$
393

 
See accompanying notes to unaudited condensed consolidated financial statements

6

Table of Contents

INTERMOLECULAR, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying condensed consolidated financial statements of Intermolecular, Inc. and subsidiaries (the "Company") have been prepared without audit in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission ("SEC"). Accordingly, certain information and disclosures normally included in complete financial statements prepared in accordance with GAAP have been condensed or omitted. The information in this report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2013, as filed with the SEC on March 10, 2014.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. The operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for any other future interim period or full year. The condensed consolidated balance sheet as of December 31, 2013 is derived from the audited consolidated financial statements as of the year then ended. 
Use of Estimates  
The preparation of the accompanying condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenue and expenses. Management uses estimates and judgments in determining recognition of revenues, valuations of accounts receivable, inventories, intangible assets, debt, capital stock, warrants and assumptions used in the calculation of income taxes and stock-based compensation, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, and adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. 
Concentration of Credit Risk  
Financial instruments that potentially subject the Company to concentration of credit risk consist of cash, cash equivalents, short-term investments and accounts receivable. The Company’s cash, cash equivalents and short-term investments consist of demand deposits, money market accounts, certificates of deposit, corporate bonds and commercial paper maintained with high quality financial institutions. The Company's accounts receivable consist of non-interest bearing balances due from credit-worthy customers.
Cash, Cash Equivalents and Short-Term Investments

The Company holds its cash and cash equivalents in checking, money market and investment accounts with high credit quality financial institutions. The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents.

Short-term investments consist principally of corporate debt securities and commercial paper. If applicable, the Company considers marketable securities with remaining time to maturity greater than one year and that have been in a consistent loss position for at least nine months to be classified as long-term, as it expects to hold them to maturity. As of June 30, 2014, the Company did not have any such securities. The Company considers all other marketable securities to be short-term marketable securities. The short-term marketable securities are classified as current assets because they can be readily converted into securities with a shorter remaining time to maturity or into cash. The Company determines the appropriate classification of its marketable securities at the time of purchase and re-evaluates such designations as of each balance sheet date. All marketable securities and cash equivalents in the portfolio are classified as available-for-sale and are stated at fair value, with all the associated unrealized gains and losses reported as a component of accumulated other comprehensive income (loss). Fair value is based on quoted market rates or direct and indirect observable markets for these investments. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in interest income. The cost of securities sold and any gains and losses on sales are based on the specific identification method.


7


The Company reviews its investment portfolio periodically to assess for other-than-temporary impairment in order to determine the classification of the impairment as temporary or other-than-temporary, which involves considerable judgment regarding factors such as the length of the time and the extent to which the market value has been lower than the amortized cost, the nature of underlying assets, and the financial condition, credit rating, market liquidity conditions and near-term prospects of the issuer. If the fair value of a debt security is less than its amortized cost basis at the balance sheet date, an assessment would have to be made as to whether the impairment is other-than-temporary. If the Company considers it more likely than not that it will sell the security before it will recover its amortized cost basis, an other-than-temporary impairment will be considered to have occurred. An other-than temporary impairment will also be considered to have occurred if the Company does not expect to recover the entire amortized cost basis of the security, even if it does not intend to sell the security. The Company has recognized no other-than-temporary impairments for its marketable securities.
Inventory
Inventories are stated at the lower of cost or market value, with cost determined on an average cost basis. Current inventories consist of work-in-process for products that are expected to be sold in the next twelve months. Noncurrent inventories consist of raw materials in the amount of $6.8 million and $6.5 million as of June 30, 2014 and December 31, 2013 , respectively, and work-in-process for products that are not expected to be sold during the next twelve months in the amount of $0.5 million and zero as of June 30, 2014 and December 31, 2013 , respectively. Inventories in excess of salable amounts and spare parts inventories that are considered obsolete are recorded as a cost of revenue in the period in which they occur. The Company recorded inventory impairments of $0.3 million during the six months ended June 30, 2014 and no impairments during the six months ended June 30, 2013 .
Impairment of Long-Lived Assets
The Company evaluates its long-lived assets, which consist of property and equipment and intangible assets, for indicators of possible impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Impairment exists if the carrying amounts of such assets exceed the estimates of future net undiscounted cash flows expected to be generated by such assets. Should impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the estimated fair value of the asset. The Company had no impairment of long-lived assets during the three and six months ended June 30, 2014 and 2013.
Revenue Recognition
The Company derives its revenue from three principal sources: collaborative development programs and other services; product sales; and technology licensing and royalty fees. Revenue is recognized when all of the following criteria are met:
• Persuasive evidence of an arrangement exists;
• Delivery has occurred;
• The fee is fixed or determinable; and
• Collectability of the fee is probable.

Persuasive evidence of the arrangement represents a written contract signed by both the Company and the customer, or a customer purchase order. The Company assesses whether a price is fixed or determinable by, among other things, reviewing
contractual terms and conditions related to payment terms. The Company assesses collectability based on factors such as the
customer's creditworthiness and past collection history, if applicable. If collection is not probable, revenue recognition is deferred until receipt of payment.
Collaborative development programs and other services - The Company enters into collaborative development programs ("CDPs") and other research and development service agreements with customers under which the Company conducts research and development activities jointly with the customer. The agreements specify minimum levels of research effort required to be performed by the Company. Payments received under the agreements are not refundable if the research effort is not successful. The Company retains rights to certain elements of technology developed in the course of its performance, which the customer has an option to license in the future under the terms defined in the agreement. Most arrangements with customers have fixed monthly fees and requirements to provide regular reporting of research and development activities performed, and revenue is recognized in a manner consistent with the fixed monthly fee. Payments received prior to performance are deferred and recognized as revenue when earned over future performance periods. 
The Company considers arrangements that include specifically identified, dedicated equipment to contain a lease provision, as these arrangements convey the right to the customer to use specific equipment and provide the ability to the customer to direct the use of the equipment as well as control more than a minor amount of the output of the equipment. To date the Company has determined these arrangements to contain operating leases, with a lease term that corresponds to the term of the CDP arrangement. The amount of revenue allocated for the lease element is based on its relative fair value, but the

8


impact of the allocation does not change the amount of revenue recognized for the total arrangement as the lease term is consistent with the CDP term. Operating lease income recorded in CDP and services revenue during the six months ended June 30, 2014 and 2013 was $0.8 million and $4.3 million , respectively.
Future minimum operating lease payments associated with CDP arrangements that contain operating leases were zero and $0.8 million as of June 30, 2014 and December 31, 2013 , respectively. 
Product maintenance and support services - Included in CDP and other services revenue, these services entitle customers to receive product updates and enhancements or technical support and maintenance, depending on the offering. The related revenue is recognized ratably over the period the services are delivered. 
Product revenue - The Company recognizes revenue from the sale of products once delivery has occurred (title and risk of loss have passed to the customer), and customer acceptance, if required, has been achieved.
Licensing and royalty revenue - The Company recognizes revenue for licenses to intellectual property when earned pursuant to the terms of the agreements. Time-based license revenue is recognized ratably over the license term. Licensing and royalty revenue that becomes triggered by specific customer actions, such as exercise of a license option or by sales volume, is recognized when it occurs based on royalty reports or other information received from the licensee. Minimum and prepaid royalties and license fees are recognized ratably over the related periods. Revenue on the sale of intellectual property is recognized in full when title transfers if there are no remaining deliverables related to the intellectual property purchase.
Software - The Company includes software with product sales that is considered essential to the product's functionality. The Company also sells software with advanced features that can be used independent of products sold or in conjunction with products sold, which is considered non-essential to the product's functionality. Software related revenue is included in licensing and royalty revenue and is recognized ratably over the license period once delivered.
Multiple-element arrangements - Certain of the Company’s customer arrangements involve the delivery or performance of multiple products, services or licenses. Product sale arrangements include product maintenance and support. CDP and other research and development services include licenses of technology, and may also include sales of products. For multiple-element arrangements entered into after January 1, 2011 that include hardware products containing software essential to the hardware product’s functionality, undelivered software elements that relate to the hardware product’s essential software, and undelivered non-software services, the Company allocates revenue to all deliverables based on their relative selling prices. For multiple-element arrangements entered into prior to January 1, 2011 that included hardware products containing software essential to the hardware product’s functionality, undelivered software elements that related to the hardware product’s essential software, and undelivered non-software services, the Company assessed whether there was objective and reliable evidence of fair values of all undelivered elements. The Company could not establish vendor-specific objective evidence of selling price ("VSOE") for undelivered elements and recognized revenue once the last element of the multiple-element arrangement was delivered.
The Company evaluates whether a delivered element has value to the customer without the remaining undelivered elements by determining whether the delivered element could be sold by the Company, or resold by the customer, on a stand- alone basis. The Company concluded that all of its products and services deliverables have value to the customers on a stand-alone basis, as all these deliverables have been or could be sold and used by customers on a stand-alone basis. Intellectual property license arrangements have value on a stand-alone basis if the customer could purchase and use them without the remaining elements of the arrangement. In instances where software is considered essential to the functionality of the product, only the software portion and post contract support is evaluated under industry specific software accounting guidance. For transactions entered into prior to January 1, 2011, the Company assessed whether there was objective and reliable evidence of fair values of all undelivered elements. Fair values of such elements were determined by reference to the Company-specific objective evidence, such as pricing of these elements when sold separately, substantive renewal prices for product maintenance and support and time-based licenses, or other available evidence. If the fair value of any undelivered elements in a multiple-element arrangement could not be objectively determined, revenue was deferred until all elements were delivered. If product maintenance and support and time-based licenses were the only undelivered elements without objective and reliable evidence of fair value, all revenue from the arrangement was amortized over the longer of the product maintenance and support term or license period. For purposes of classification in the consolidated statements of operations, revenue is allocated between CDP and services revenue, product revenue and licensing and royalty revenue based on objective and reliable evidence of fair value for any elements for which it exists or based on the relative stated invoice amount for elements for which objective and reliable evidence of fair value does not exist.
For all transactions entered into on or after January 1, 2011, the Company recognizes revenue using estimated selling prices of the delivered goods and services based on a hierarchy of methods as required by GAAP. The Company has not established VSOE for the determination of estimated selling price of elements, and since third-party evidence ("TPE") is not available for those elements where vendor-specific objective evidence of selling price cannot be determined, the Company evaluates factors to determine its estimated selling prices ("ESP") for all other elements. In multiple-element arrangements

9


where hardware and software are sold as part of the solution, revenue is allocated to the hardware and software as a group using the relative selling prices of each of the deliverables in the arrangement based upon the aforementioned selling price hierarchy. 
Deferred Revenue - Deferred revenue represents amounts collected from customers for which the related revenue has not been recognized, because one or more of the revenue recognition criteria have not been met, net of the associated costs. The current portion of deferred revenue represents the amount that is expected to be recognized as revenue within one year from the balance sheet date. When deferred revenues are recognized as revenues, the associated deferred costs are also recognized as cost of revenues.
Accounts Receivable and Allowance for Doubtful Accounts
Trade accounts receivable are recorded at invoiced amounts and unbilled contractually obligated amounts. Trade accounts receivable are presented net of allowances for doubtful accounts, if applicable, and do not bear interest. The allowance for doubtful accounts is based on the Company's assessment of the collectability of its customer accounts. The Company reviews the allowance by considering certain factors such as historical experience, industry data, credit quality, age of balances and current economic conditions that may affect customers' ability to pay.
Concentration of Revenue and Accounts Receivable
Significant customers are those that represent more than 10% of the Company’s total revenue or accounts receivable. For each significant customer, including related parties, revenue as a percentage of total revenue and accounts receivable as a percentage of total accounts receivable are as follows:
 
Revenue
 
Accounts Receivable
 
Three Months Ended
 
Six Months Ended
 
As of
 
As of 
 
June 30,
 
June 30,
 
June 30,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Customer A
*

 
13
%
 
*

 
12
%
 
*

 
*

Customer B
%
 
22
%
 
20
%
 
22
%
 
%
 
13
%
Customer C (1)
%
 
15
%
 
%
 
16
%
 
%
 
%
Customer D
20
%
 
*

 
14
%
 
*

 
11
%
 
15
%
Customer E
10
%
 
*

 
*

 
17
%
 
*

 
14
%
Customer F (1)
42
%
 
*

 
32
%
 
*

 
63
%
 
41
%
 
 
*   less than 10%
(1) Customer C was acquired by Customer F as of July 31, 2013. Revenue and accounts receivable attributed to Customers C and F are combined under Customer F for periods after July 31, 2013.

Stock-Based Compensation
The Company applies the fair value recognition and measurement provisions of ASC 718 Compensation — Stock Compensation. Stock-based compensation is recorded at fair value as of the grant date, determined using the Black-Scholes option-pricing model, and recognized as an expense over the employee’s requisite service period (generally the vesting period), which the Company has elected to amortize on a straight-line basis.
The Company accounts for stock options issued to nonemployees based on the fair value of the options determined using the Black-Scholes option-pricing model. The fair value of stock options granted to nonemployees is remeasured each reporting period as the stock options vest and the resulting change in value, if any, is recognized in the Company’s consolidated statements of operations during the period the related services are rendered.
Recent Accounting Pronouncements  
In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09) "Revenue from Contracts with Customers." ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early

10


adoption is not permitted. The Company is currently in the process of evaluating the impact of the adoption of ASU 2014-09 on the consolidated financial statements.
2. Fair Value of Financial Instruments
The Company measures and reports its cash equivalents and short- and long-term investments at fair value on a recurring basis. There have been no transfers between fair values during the six months ended June 30, 2014 and six months ended June 30, 2013 . The Company does not have any financial liabilities that are measured and reported at fair value.
The following tables set forth the fair value of the Company’s cash equivalents by level within the fair value hierarchy (in thousands):
 
As of June 30, 2014
 
Fair Value
 
Level I
 
Level II
 
Level III
Assets:
 
 
 
 
 
 
 
Money market funds
$
31,541

 
$
31,541

 
$

 
$

  Corporate debt securities and commercial paper
28,196

 

 
28,196

 

Total assets measured at fair value
$
59,737

 
$
31,541

 
$
28,196

 
$

 
As of December 31, 2013
 
Fair Value
 
Level I
 
Level II
 
Level III
Assets:
 
 
 
 
 
 
 
Money market funds
$
49,117

 
$
49,117

 
$

 
$

Total assets measured at fair value
$
49,117

 
$
49,117

 
$

 
$


Cash equivalents and short-term investments are classified as "available-for-sale" and are carried at fair value based on quoted markets or other readily available market information. The Company's investment policy requires investments less than twenty four months and a minimum credit rating of A-. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive loss. Gains and losses are determined using the specific identification method. Cash, cash equivalents, and short-term investments consisted of the following as of June 30, 2014 (in thousands):
 
As of June 30, 2014
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Assets:
 
 
 
 
 
 
 
  Cash
$
10,244

 
$

 
$

 
$
10,244

  Money market funds
31,541

 

 

 
31,541

  Corporate debt securities and commercial paper

28,214

 

 
(18
)
 
28,196

Total cash, cash equivalents and short-term investments
$
69,999

 
$

 
$
(18
)
 
$
69,981


As of December 31, 2013 the Company did not have any unrealized gains or losses.









11


3. Property and Equipment
Property and equipment consist of the following (in thousands):
 
As of
 
As of
 
June 30, 2014
 
December 31, 2013
Lab equipment and machinery
$
52,957

 
$
49,264

Leasehold improvements
5,751

 
4,413

Computer equipment and software
3,722

 
3,563

Furniture and fixtures
195

 
182

Construction in progress
2,217

 
6,544

Total property and equipment
64,842

 
63,966

Less accumulated depreciation
(40,312
)
 
(35,481
)
Property and equipment, net
$
24,530

 
$
28,485


During 2013, the Company entered into a loan and security agreement ("Loan Agreement") with Silicon Valley Bank ("SVB") pursuant to which SVB made a term loan to the Company in the principal amount of $25.0 million . Under the Loan Agreement, and as of both June 30, 2014 and December 31, 2013 , SVB held a security interest in substantially all of the Company's assets, excluding all intellectual property.
The following table presents depreciation expense included in the Condensed Consolidated Statement of Operations and includes amortization of leasehold improvements (in thousands): 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Depreciation expense
$
2,550

 
$
2,193

 
$
4,834

 
$
4,244

 
The Company maintained dedicated equipment to support contractual customer capacity requirements as part of certain collaborative development programs that are classified as lab equipment and machinery, which had a net book value of zero and $1.8 million as of June 30, 2014 and December 31, 2013 , respectively.
4. Intangible Assets
Intangible assets consist of the following (in thousands):
 
As of
 
As of
 
June 30, 2014
 
December 31, 2013
Patents issued
$
5,413

 
$
4,893

Patents pending
4,259

 
4,224

Trademarks
40

 
40

Total intangible assets
9,712

 
9,157

Less patent amortization
(1,632
)
 
(1,302
)
Intangible assets, net
$
8,080

 
$
7,855


Amortization commences upon patent issuance. The useful life of the patents, once issued, will not exceed 20 years , and will depend on the nature of the patent. The average estimated amortization period of the Company's current portfolio is approximately 17 years from the date of patent issuance. The average estimated remaining amortization period of patents acquired as part of the Symyx asset purchase transaction is approximately 4 years .

12


The following table presents patent amortization expense included in the Condensed Consolidated Statement of Operations (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Amortization expense
$
164

 
$
152

 
$
330

 
$
302

 
5. Commitments and Contingencies
Leases
The Company entered into an operating lease agreement in October 2013 that expires in June 2025. Rent expense is being recognized on a straight-line basis over the lease term.
The following table presents rent expense included in the Condensed Consolidated Statement of Operations (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Rent expense
$
567

 
$
324

 
$
1,134

 
$
648


Future commitments and obligations under this operating lease to be satisfied as they become due over the term are as follows (in thousands):
As of June 30, 2014:
 

Six months ending December 31, 2014
$
854

The years ending December 31,
 

2015
1,757

2016
2,253

2017
2,399

2018
2,459

Thereafter
17,557

Total
$
27,279


During 2014 , the Company has made payments of $0.4 million related to this operating lease. The Company received free rent from December 2013 through March 2014 as part of the lease agreement.
Silicon Valley Bank Loan Agreement
During 2013, the Company entered into the Loan Agreement with SVB in the amount of $25.0 million that bears interest at a fixed rate equal to 3.25% . The Company is obligated to pay interest at the applicable rate and $0.5 million of principal on a quarterly basis. The term loan matures on November 30, 2016 and the Company is obligated to pay all outstanding principal and accrued and unpaid interest on that date. At the Company's option, the Company may pre-pay the outstanding principal balance of the term loan in full or in part, subject to a pre-payment fee of 0.25% if repaid before November 30, 2014.
The following table presents payments made during 2014 for interest and principal owed under the terms of the Loan Agreement (in thousands):
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
Principal
 
Interest
 
Total
 
Principal
 
Interest
 
Total
SVB payments
$
500

 
$
199

 
$
699

 
$
1,000

 
$
272

 
$
1,272





13


Litigation
On August 23, 2013, the Company received a copy of a complaint from the California Division of Labor Standards and Enforcement ("DLSE") filed by an employee in the Company’s research and development group claiming that the employee is owed back pay due to an incorrect classification as an exempt employee for overtime purposes. The Company commenced a review of the employee's claim as well as a review of the Company’s policies regarding classification of employees for overtime purposes. The Company also agreed to enter mediation with the attorney who represents the employee that filed the claim with the DLSE as well as fourteen other current and former employees who are similarly situated. This mediation did not result in a settlement of the subject claims, and on February 18, 2014, the claimants filed a lawsuit against the Company in the United States District Court for the Northern District of California (the "Court"). The claimants subsequently filed an amended lawsuit in the Court on March 11, 2014. On April 1, 2014, the Company filed with the Court the Company's answer to the amended lawsuit. Thereafter, without any admission of liability, the Company entered into settlement agreements with eleven of the fifteen claimants, including full releases of legal claims and dismissals of their claims in the lawsuit. Without any admission of liability, the Company subsequently made offers of judgment to the remaining four claimants, which have all been accepted. The Company believes it is in the final process of documenting appropriate settlement agreements with those claimants, after which time the lawsuit with all claimants will be dismissed and the matter will be concluded.

As of June 30, 2014 , the Company has accrued its best estimate of the amount of probable loss associated with the matter. While the Company cannot predict the outcome of this matter, or of any legal or administrative proceedings related to this matter that have commenced or may be commenced in the future, the Company believes the matter will not have a material adverse effect on its business, operating results, financial condition or cash flows.

6. Stockholders’ Equity
Stock-Based Compensation
The fair value of the employee stock options granted during the period was estimated on the respective grant date using a Black-Scholes option-pricing model with the following weighted-average assumptions: 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Expected term (in years)
5.7

 
6.0

 
5.8

 
6.0

Risk-free interest rate
1.9
%
 
1.0
%
 
1.9
%
 
1.1
%
Expected volatility
56
%
 
60
%
 
57
%
 
60
%
Expected dividend rate
%
 
%
 
%
 
%

Stock-based compensation expense, net of estimated forfeitures, was included in the following line items on the Condensed Consolidated Statements of Operations (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Cost of revenue
$
243

 
$
398

 
$
548

 
$
772

Research and development
257

 
289

 
580

 
684

Sales and marketing
315

 
277

 
660

 
557

General and administrative
490

 
400

 
1,005

 
751

Total stock-based compensation
$
1,305

 
$
1,364

 
$
2,793

 
$
2,764



14


The following table presents stock-based compensation expense, net of estimated forfeitures, by grant type (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Stock options
$
818

 
$
950

 
$
1,798

 
$
1,968

Restricted stock awards and restricted stock units (RSUs)
487

 
414

 
995

 
796

Total stock-based compensation
$
1,305

 
$
1,364

 
$
2,793

 
$
2,764


The following table presents unrecognized compensation expense, net of estimated forfeitures, related to the Company’s equity compensation plans as of June 30, 2014 , which is expected to be recognized over the following weighted-average periods, (in thousands, except for weighted-average period): 
 
Unrecognized
Compensation
Expense
 
Weighted-
Average Period
(in years)
Stock options
$
6,271

 
2.4
RSUs
$
5,825

 
2.0
 
The following table presents details on grants made by the Company for the following periods: 
 
Six Months Ended
 
Six Months Ended
 
June 30, 2014
 
June 30, 2013
 
Shares Granted
 
Weighted-
Average Grant
Date Fair Value
 
Shares Granted
 
Weighted-
Average Grant
Date Fair Value
Stock options
1,888,100

 
$
1.48

 
894,800

 
$
5.06

RSUs
1,410,450

 
$
2.78

 
644,000

 
$
9.26


The total intrinsic value of stock options exercised for the six months ended June 30, 2014 and 2013 was $0.7 million and $5.8 million , respectively.
RSUs that vested during the six months ended June 30, 2014 and 2013 had fair values of $1.5 million and $0.9 million , respectively, as of the vesting date.
Common Stock Warrants
As of June 30, 2014 and December 31, 2013 , the Company had 912,368 outstanding warrants to purchase shares of common stock. Of these outstanding warrants, 912,368 and 90,000 were exercisable as of June 30, 2014 and December 31, 2013 , respectively. During the year ended December 31, 2010, the Company issued warrants to purchase 822,368 shares of common stock in connection with a collaborative development agreement with an exercise price of $6.08 per share. These warrants vested and became exercisable during the three months ended June 30, 2014 , the fair value of these warrants measured on the date of vesting was not significant.








15


Common Stock  
As of June 30, 2014 and December 31, 2013 , the Company had reserved shares of common stock for issuance as follows:
 
June 30, 2014
 
December 31, 2013
Number of stock options outstanding
6,901,291

 
6,468,743

Number of RSUs outstanding
1,909,980

 
850,351

Shares available for future grant
5,083,666

 
5,238,699

Number of warrants outstanding
912,368

 
912,368

Total shares reserved
14,807,305

 
13,470,161

 
7. Net Loss per Share of Common Stock
The following table sets forth the computation of the Company’s basic and diluted net loss per share of common stock during the three and six months ended June 30, 2014 and 2013 (in thousands, except for share and per share amounts):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net loss attributable to common stockholders
$
(6,859
)
 
$
(744
)
 
$
(10,710
)
 
$
(2,230
)
Shares used in computing net loss per share of common stock, basic and diluted
47,192,882

 
44,630,442

 
46,560,205

 
44,386,111

Net loss per share of common stock, basic and diluted
$
(0.15
)
 
$
(0.02
)
 
$
(0.23
)
 
$
(0.05
)

The following outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been antidilutive:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Stock options to purchase common stock
6,901,291

 
7,133,921

 
6,901,291

 
7,133,921

RSUs
1,909,980

 
756,955

 
1,909,980

 
756,955

Common stock warrants
912,368

 
912,368

 
912,368

 
912,368

8. Income Taxes
Income tax expense for the six months ended June 30, 2014 was $6,000 , or 0.1% on a pre-tax loss of $10.7 million . The difference between the Company's effective tax rate and the federal statutory rate of 35% is primarily attributable to the differential in foreign taxes, non-deductible stock-based compensation expense, other currently non-deductible items and movement in its valuation allowance. The Company maintained a valuation allowance as of June 30, 2014 against all of its deferred tax assets.
 
The Company intends to maintain a full valuation allowance until sufficient positive evidence exists to support its reduction.
9. Related Party Transactions
In March 2013, the Company amended the CDP agreement that it had entered into in March 2010 with a related party and that it and the related party had amended in March 2012. Under the amended agreement, the two companies agreed to work together to conduct research and development and other activities. Depending on the output of the research and development, the primary rightholder will be the Company or the other party. However, if the other party is not the primary rightholder, it will be able to license the developed technology from the Company. The CDP development program between the parties ended during the three months ended March 31, 2014, although certain licensing and royalty elements continue. The other party and the Company each have an independent board member that serves on both companies’ boards of directors and the independent board member is also a managing member of a significant shareholder of the Company. As of June 30, 2014 , this shareholder was

16


a beneficial owner of approximately 9.0% of the Company’s common stock. As of June 30, 2014 and December 31, 2013 , the Company had accounts receivable in the amount of zero and $0.1 million , respectively, and had a deferred revenue balance in the amount of zero and zero , respectively, related to the amended agreement. The following table presents related party revenue included in the Condensed Consolidated Statement of Operations from this amended agreement (in thousands): 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Related party revenue
$
354

 
$
1,158

 
$
1,257

 
$
2,317


In November 2006, the Company entered into an Alliance Agreement with a related party that was a beneficial owner of approximately 5.4% of the Company’s common stock as of June 30, 2014 . The other party and the Company each have an independent board member that serves on both companies’ boards of directors. Since November 2006, the agreement has been amended numerous times with the last amendment signed in December 2013. The December 2013 amendment did not extend or renew CDP services and decreased workflow support and licenses. As of June 30, 2014 and December 31, 2013 , the Company had accounts receivable in the amount of $30,000 and $0.1 million , respectively, and had a deferred revenue balance in the amount of $0.9 million and $0.4 million , respectively, related to the amended agreement. The following table presents related party revenue and cost of revenue included in the Condensed Consolidated Statement of Operations from the amended agreement (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Related party revenue
$
876

 
$
2,100

 
$
1,351

 
$
4,219

10. Information about Geographic Areas
Revenue
Revenue by geography is based on the billing address of the customer. The following table sets forth revenue by geographic area (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
United States
$
9,054

 
$
11,822

 
$
23,271

 
$
24,844

Japan
354

 
3,746

 
1,257

 
7,807

APAC other
389

 
1,040

 
931

 
1,281

Europe and Middle East
137

 

 
380

 
109

Total
$
9,934

 
$
16,608

 
$
25,839

 
$
34,041


Long-Lived Assets  
Substantially all of the Company’s long-lived assets are located in the U.S. An insignificant amount of long-lived assets reside in the Company’s foreign subsidiaries and branches in Hong Kong, Japan and Taiwan.
11. Restructuring Charges
During each of February and May 2014, the Company initiated reductions in force as part of an overall plan to reduce the Company’s cost structure. The reductions in force constituted approximately 18% of the Company’s workforce in February 2014 and 10% in May 2014. As a result of the reductions in force, the Company recorded expenses related to employee severance and termination benefits of approximately $1.4 million , which was recognized during the six months ended June 30, 2014 . The following table presents severance and related expenses, payments, and accrual adjustments (in thousands) as of June 30, 2014 :
 
As of
 
 
 
 
 
 
 
As of
 
December 31, 2013
 
Charges
 
Cash Payments
 
Adjustments
 
June 30, 2014
Severance and related expenses
$

 
$
1,423

 
$
(1,296
)
 
(61
)
 
$
66



17


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is provided in addition to the accompanying consolidated condensed financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. Our MD&A is organized as follows:
Overview . Discussion of our business and overall analysis of financial and other highlights affecting the Company in order to provide context for the remainder of MD&A.
Strategy . Our overall strategy.
Basis of Presentation . A summary of the primary elements of our financial results.
Critical Accounting Estimates . Accounting estimates that we believe are most important to understanding the assumptions and judgments incorporated in our reported financial results and forecasts.
Results of Operations . An analysis of our financial results comparing the three and six months ended June 30, 2014 to the three and six months ended June 30, 2013 .
Liquidity and Capital Resources . An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition and potential sources of liquidity.
The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q (“Form 10-Q”) and in our Annual Report on Form 10-K (the “2013 Form 10-K”) and subsequent quarterly reports on Form 10-Q , as filed with the Securities and Exchange Commission. This Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “estimate,” or “continue,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” in Part II, Item 1A of this Form 10-Q and in our 2013 Form 10-K and subsequent quarterly reports on Form10-Q . Furthermore, such forward-looking statements speak only as of the date of this Form 10-Q. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. 
Overview
We have pioneered a proprietary approach to accelerate research and development ("R&D"), innovation and time-to-market for the semiconductor and clean energy industries. Through paid collaborative development programs ("CDPs") with our customers, we develop proprietary technology and intellectual property ("IP") for our customers focused on advanced materials, processes, integration and device architectures. This technology enables our customers to bring optimized, volume manufacturing-ready integrated devices to market faster and with less risk than conventional approaches to R&D. We provide our customers with proprietary technology through various fee arrangements and grant them rights to associated IP, primarily through royalty-bearing licenses. Through paid CDPs and our own development, we have established a portfolio of greater than 1,200 patents and patent applications. Our proprietary approach is broadly applicable to high-volume integrated device markets, which include the markets for semiconductors, flat-glass coatings and glass-based devices, solar cells, light-emitting diodes ("LEDs"), flat-panel displays, advanced batteries and other energy efficiency applications.
We were founded in 2004 and are headquartered in San Jose, California. Our total revenue decreased to $9.9 million and $25.8 million for the three and six months ended June 30, 2014 from $16.6 million and $34.0 million for the three and six months ended June 30, 2013 . Our net loss increased to $6.9 million for the three months ended June 30, 2014 , from a net loss of $0.7 million for the three months ended June 30, 2013 and increased to a net loss of  $10.7 million  during the six months ended June 30, 2014 from a net loss of  $2.2 million  during the six months ended June 30, 2013. Since inception, we have incurred net losses leading to an accumulated deficit of $120.8 million as of June 30, 2014 .
Strategy
Our mission is to drive our customers' success by transforming R&D and accelerating innovation in markets that

18

Table of Contents

derive competitive advantage from the interaction of materials science, processes, integration and device architecture. We currently target semiconductor and high-growth emerging clean energy markets, including DRAM, stand-alone non-volatile memory, embedded memory, complex logic, flat glass coatings and glass-based devices, solar cells, LEDs, displays, advanced batteries and energy-efficiency technologies. Within these broad markets, we target customers that have track records of technological innovation, deploy significant resources and are pursuing technical advancements that are critical to their success and strategy, including ATMI, Elpida (a wholly owned subsidiary of Micron Technology), First Solar, GLOBALFOUNDRIES, Guardian Industries, Micron Technology, SanDisk, Taiwan Semiconductor Manufacturing Company (“TSMC”), Toshiba, and the Ulyanovsk Center for Technology Transfer of the Russian Federation ("UCTT"). ATMI and Elpida have commenced shipping products incorporating technology developed through our CDPs and pay us licensing and royalty fees. To date, we have received the majority of our revenue from customers in DRAM, stand-alone non-volatile memory, complex logic, solar cells and energy-efficiency applications in flat-glass coatings and glass-based devices, and we have not yet received a material amount of revenue from customers in embedded memory, LEDs, displays and other energy-efficiency technologies.
Basis of Presentation
How We Generate Revenue  
Our customer engagement process generates revenue in three ways: CDP and services revenue; product revenue; and licensing and royalty revenue. CDPs are our primary engagement model with customers, and are structured to result in licensing and/or royalty revenue. When we initially engage with a customer, we generate revenue from micro-CDPs, CDPs and licensing of our high productivity combinatorial (“HPC”) platform. Our micro-CDPs are smaller, customer-paid programs that require significantly less investment from our customers but allow us to demonstrate the capabilities of our HPC platform to a customer without requiring them to commit to a multi-year agreement. We use these micro-CDPs to demonstrate the capabilities and value of our HPC platform to these new customers, with the objective of engaging with these customers in a full CDP. When technology developed through CDPs is incorporated in our customers' commercialized products, we generate licensing and/or royalty revenue. In certain cases, we sell HPC processing tools to our customers who pay a recurring license fee to operate those tools with our combinatorial processing capabilities.
CDP and services revenue.   CDP revenue may include payments for full time equivalent employees, milestone payments, subscription payments for dedicated and shared workflow tools used in the CDP and reimbursed payments for consumables and outside services from third parties. Individual CDPs typically range from one to three years. Services revenue outside of CDPs is substantially comprised of support and maintenance fees and extended warranty agreements. CDP and services revenue is recognized in a manner consistent with activities performed. During the year ending December 31, 2014, as a result of certain CDPs being completed in 2014, we expect a decrease in CDP and services revenue.
Product revenue.   Product revenue consists of sales of our workflow hardware and embedded software. In support of our business strategy, we selectively sell our proprietary tools to increase opportunities for CDPs and licensing fees and royalties. As our other revenue streams increase we expect our product revenue to decrease as a percentage of our overall revenue. Product revenue is recognized upon shipment (title and risk of loss passed to the customer), and customer acceptance, if required, is achieved.
Licensing and royalty revenue.   Licensing and royalty revenue consists of licensing fees and royalties for granting our customers rights to our proprietary technology and IP. Specifically, this includes licensing the HPC capabilities of our workflows, licensing our informatics and analysis software, and licensing fees and royalties on products commercialized by our customers that incorporate technology developed through our CDPs. In certain instances, minimum license fees and royalties may be guaranteed by customer contracts and are recognized as revenue ratably over the related periods. Over the long term, we expect licensing and royalty revenue to be an increasing and significant component of our revenue. During the three months ended March 31, 2014, we experienced an increase in licensing and royalty revenue attributable to an accelerated payment from a customer in connection with an amended CDP agreement.
Cost of Revenue
Our cost of revenue is variable and depends on the product mix and type of revenue earned in each period relating to our customer programs. As customers commercialize products that incorporate technology developed through our CDPs, we expect our cost of revenue to decrease as a percentage of total revenue when licensing and royalty revenue become an increasing component of our revenue.

Cost of CDP and services revenue.  Our cost of CDP and services revenue is primarily comprised of salaries and other personnel-related expenses (including stock-based compensation) for our collaborative research and development scientists, engineers and development fab process operations employees. Additionally, our cost of

19

Table of Contents

revenue includes costs of wafers, targets, materials, program-related supplies, third-party professional fees and depreciation of equipment used in CDPs.
Cost of product revenue.  Our cost of product revenue primarily includes our cost of products sold. Our cost of product revenue will fluctuate based on the type of product and configuration sold. Cost of product revenue is recognized upon product shipment and customer acceptance, if required. The variability in cost of product revenue as a percentage of revenue is related to the quantity and configuration of products sold during the period.
Cost of licensing and royalty revenue.  Our cost of licensing and royalty revenue is primarily comprised of the amortization of acquired patents and licensing obligations.
Research and Development
Our R&D expenses consist of costs incurred for development and continuous improvement of our HPC platform, expansion of software capabilities and application R&D that are not associated with customer programs. R&D costs include personnel-related expenses (including stock-based compensation expenses) for our technical staff as well as consultant costs, parts and prototypes, wafers, chemicals, supply costs, facilities costs, utilities costs related to laboratories and offices occupied by technical staff, depreciation on equipment used by technical staff, and outside services, such as machining and third-party R&D costs. Overhead costs that are not allocated to a customer program are recognized as expenses within R&D. We expect our R&D expense to increase modestly in absolute dollars in the near-term periods as resources are reallocated from customer CDPs to R&D and as we continue to develop and improve our HPC platform and extend the applicability of our platform to a broader set of applications within the industries we serve.
Sales and Marketing
Our sales and marketing expenses consist primarily of personnel-related costs (including stock-based compensation) for our sales and marketing employees, as well as payments of commissions to our sales employees, facility costs and professional expenses. Professional expenses consist of external website and marketing communication consulting costs and market research. We expect sales and marketing expense to remain relatively flat in absolute dollars in the near-term periods.
General and Administrative
General and administrative expenses consist primarily of personnel-related costs (including stock-based compensation) as well as professional services and facilities costs related to our executive, finance, legal, human resources, management information systems and information technology functions. Professional services consist of outside accounting, information technology, consulting and legal costs. We also incur significant accounting and legal costs related to compliance with rules and regulations enacted by the Securities and Exchange Commission, including the costs maintaining compliance with Section 404 of the Sarbanes-Oxley Act, as well as insurance, investor relations and other costs associated with being a public company. In addition to these expenses, we expect that our general and administrative expenses will continue to increase for the foreseeable future.
Restructuring Expenses
After experiencing a reduced level of CDP activity, we initiated reductions in force in February 2014 and May 2014 with respect to approximately 18% and 10% of our workforce at such times, respectively. These reductions in force were part of an overall plan to reduce our cost structure and were completed during the six months ended June 30, 2014. Restructuring expenses consist of personnel-related costs.
Interest Expense, net
Interest expense historically consisted of interest accrued on our note payable to Symyx in connection with the Symyx asset purchase transaction that closed in November 2011, which was paid in full in May 2013 with a credit facility from SVB. Interest expense after May 2013 consists primarily of interest accrued on our credit facility, which was converted in November 2013 to a three year note payable to SVB. Interest income represents interest earned on our cash, cash equivalents, and short-term investments. We expect interest income will vary each reporting period depending on our average investment balances during the period and market interest rates.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States and include our accounts and the accounts of our wholly-owned subsidiaries. The preparation of our consolidated financial statements requires our management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and disclosures for contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenue and expenses during the applicable periods. Management bases its estimates,

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assumptions and judgments on historical experience and on various other factors that management believed were reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements which, in turn, could change the results from those reported. Our management evaluates its estimates, assumptions and judgments on an ongoing basis.
There have been no material changes in the matters for which we make critical accounting estimates in the preparation of our condensed consolidated financial statements during the three and six months ended June 30, 2014 as compared to those disclosed in our 2013 Form 10-K. For further information on our critical and other significant accounting policies, see our 2013 Form 10-K.
Recent Accounting Pronouncements
See Note 1 of the Notes to Condensed Consolidated Financial Statements included in this Form 10-Q for recent accounting pronouncements that could have an effect on us.
Results of Operations
Comparison of the Three and Six Months Ended June 30, 2014 and 2013
 
Three Months Ended June 30,
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
 
(in thousands)
 
 
 
 
 
(in thousands)
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collaborative development program and services revenue
$
6,865

 
$
12,799

 
$
(5,934
)
 
(46
)%
 
$
15,751

 
$
23,702

 
$
(7,951
)
 
(34
)%
Product revenue

 

 

 
 %
 

 
3,104

 
(3,104
)
 
(100
)%
Licensing and royalty revenue
3,069

 
3,809

 
(740
)
 
(19
)%
 
10,088

 
7,235

 
2,853

 
39
 %
Total revenue
9,934

 
16,608

 
(6,674
)
 
(40
)%
 
25,839

 
34,041

 
(8,202
)
 
(24
)%
Cost of revenue:
5,636

 
7,140

 
(1,504
)
 
(21
)%
 
12,204

 
14,983

 
(2,779
)
 
(19
)%
Gross profit
4,298

 
9,468

 
(5,170
)
 
(55
)%
 
13,635

 
19,058

 
(5,423
)
 
(28
)%
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
6,212

 
5,448

 
764

 
14
 %
 
13,168

 
11,620

 
1,548

 
13
 %
Sales and marketing
1,379

 
1,578

 
(199
)
 
(13
)%
 
3,027

 
3,215

 
(188
)
 
(6
)%
General and administrative
3,097

 
3,042

 
55

 
2
 %
 
6,410

 
6,034

 
376

 
6
 %
Restructuring charges
293

 

 
293

 
100
 %
 
1,361

 

 
1,361

 
100
 %
Total operating expenses
10,981

 
10,068

 
913

 
9
 %
 
23,966

 
20,869

 
3,097

 
15
 %
Loss from operations
(6,683
)
 
(600
)
 
(6,083
)
 
 
 
(10,331
)
 
(1,811
)
 
(8,520
)
 
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense, net
(179
)
 
(231
)
 
52

 
 
 
(373
)
 
(481
)
 
108

 
 
Other income, net
5

 
87

 
(82
)
 
 
 

 
68

 
(68
)
 
 
Total other income (expense), net
(174
)
 
(144
)
 
(30
)
 
 
 
(373
)
 
(413
)
 
40

 
 
Loss before provision for income taxes
(6,857
)
 
(744
)
 
(6,113
)
 
 
 
(10,704
)
 
(2,224
)
 
(8,480
)
 
 
Provision for income taxes
2

 

 
2

 
 
 
6

 
6

 

 
 
Net loss
$
(6,859
)
 
$
(744
)
 
$
(6,115
)
 
 
 
$
(10,710
)
 
$
(2,230
)
 
$
(8,480
)
 
 

Revenue

Our revenue decreased by $6.7 million , or 40% , to $9.9 million during the three months ended June 30, 2014 , from $16.6 million during the three months ended June 30, 2013 , due to decreases in CDP and services revenue and licensing and royalty revenue primarily as a result of CDPs that ended during 2014, including our engagements with GLOBALFOUNDRIES and SanDisk and Toshiba.

Our revenue decreased by $8.2 million , or 24% , to $25.8 million during the six months ended June 30, 2014 , from $34.0 million during the six months ended June 30, 2013 , due to decreases in CDP and services revenue and product revenue offset by an increase in licensing and royalty revenue.


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CDP and services revenue decreased by $5.9 million , or 46% , to $6.9 million during the three months ended June 30, 2014 , from $12.8 million during the three months ended June 30, 2013 . This decrease was primarily attributable to $6.7 million in revenue from the scheduled completion and reduction of CDP and service agreements. This was partially offset by $0.6 million in revenue derived from the expansion of existing customer engagements and $0.2 million in revenue derived from new customer engagements.
    
CDP and services revenue decreased by $8.0 million , or 34% , to $15.8 million during the six months ended June 30, 2014 , from $23.7 million during the six months ended June 30, 2013 . This decrease was primarily attributable to $11.2 million decrease in revenue from the scheduled completion and reduction of CDP and service agreements. This was partially offset by $2.6 million in revenue derived from the expansion of existing customer engagements and $0.7 million in revenue derived from new customer engagements. Of the growth from new customer engagements, $0.6 million in revenue was derived from three CDPs.

There was no change to product revenue during the three months ended June 30, 2014 from the three months ended June 30, 2013 , as there were no workflow sales in either period.

Product revenue decreased by $3.1 million during the six months ended June 30, 2014 , as there were no workflow sales during the six months ended June 30, 2014.

Licensing and royalty revenue decreased by $0.7 million , or 19% , to $3.1 million during the three months ended June 30, 2014 , from $3.8 million during the three months ended June 30, 2013 . This decrease was primarily attributable to a $0.9 million decrease in scheduled minimum license fees guaranteed by customer contracts. This was partially offset by a $0.1 million increase in scheduled minimum license fees from existing customer contracts.

Licensing and royalty revenue increased by $2.9 million , or 39% , to $10.1 million during the six months ended June 30, 2014 , from $7.2 million during the six months ended June 30, 2013 . This increase was primarily attributable to a $4.2 million accelerated payment from a customer in connection with the suspension of CDP activities with them, and to a lesser extent a $0.2 million increase in scheduled minimum license fees from existing customer contracts. This was partially offset by a $1.1 million decrease in scheduled minimum license fees guaranteed by other customer contracts.

The following table presents revenue by geographic region (based on invoiced locations) during the three and six months ended June 30, 2014 and 2013 in dollars (in thousands) and as a percentage of revenue for the periods presented:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
Revenues
 
% of Revenues
 
Revenues
 
% of Revenues
 
Revenues
 
% of Revenues
 
Revenues
 
% of Revenues
United States
$
9,054

 
91
%
 
$
11,822

 
71
%
 
$
23,271

 
90
%
 
$
24,844

 
73
%
Japan
354

 
4
%
 
3,746

 
23
%
 
1,257

 
5
%
 
7,807

 
23
%
APAC other
389

 
4
%
 
1,040

 
6
%
 
931

 
4
%
 
1,281

 
4
%
Europe and Middle East
137

 
1
%
 

 
%
 
380

 
1
%
 
109

 
%
Total
$
9,934

 
100
%
 
$
16,608

 
100
%
 
$
25,839

 
100
%
 
$
34,041

 
100
%

Cost of Revenue

Cost of revenue decreased by $1.5 million , or 21% , to $5.6 million during the three months ended June 30, 2014 , from $7.1 million during the three months ended June 30, 2013 . This change was a result of a $1.6 million decrease in direct labor, materials and other costs associated with the scheduled completion and reduction of certain CDP and service agreements. This decrease is partially offset by a $0.1 million increase in licensing and royalty cost.

Cost of revenue decreased by $2.8 million , or 19% , to $12.2 million during the six months ended June 30, 2014 , from $15.0 million during the six months ended June 30, 2013 . This change is a result of a $1.1 million decrease in direct product costs consistent with decreased product revenue and a $1.7 million decrease in direct labor, materials and other costs associated with the scheduled completion and reduction of certain CDP and service agreements.




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Gross Margin

Our gross profit as a percentage of net revenues, or gross margin, has been and will continue to be affected by a variety of factors, including the mix of CDP and services revenue, product revenue, and licensing and royalty revenue recognized during the period. We achieve a higher gross margin on licensing and royalty revenue as compared to CDP and services and product revenue.

Gross margin was 43.3% during the three months ended June 30, 2014 compared to 57.0% for the three months ended June 30, 2013 . This decrease was primarily attributable to the decreases in licensing and royalty revenue, which are typically higher margin, and due to increased investments in customer CDPs.

Gross margin was 52.8% during the six months ended June 30, 2014 compared to 56.0% for the six months ended June 30, 2013 . This decrease was primarily attributable to increased investments in customer CDPs.

Research and Development

R&D expenses increased by $0.8 million , or 14% , to $6.2 million during the three months ended June 30, 2014 , from $5.4 million during the three months ended June 30, 2013 . The change was primarily attributable to an increase of $0.9 million in facility and depreciation expense due to assets utilized for R&D development previously assigned to customer CDPs and increased rent expense and $0.3 million increase in engineering parts and other expenses associated with application development, offset by decreases in employee and professional services related costs of $0.4 million. Research and development expense included stock-based compensation of $0.3 million during the three months ended June 30, 2014 and 2013.

R&D expenses increased by $1.5 million , or 13% , to $13.2 million during the six months ended June 30, 2014 , from $11.6 million during the six months ended June 30, 2013 . The change was primarily attributable to an increase of $1.2 million in facility and depreciation expense due to assets utilized for R&D development previously assigned to customer CDPs and increased rent expense and $0.4 million increase in engineering parts and other expenses associated with new application development, offset by decreases in employee related costs of $0.1 million. Research and development expense included stock-based compensation of $0.6 million and $0.7 million during the six months ended June 30, 2014 and 2013, respectively.

Sales and Marketing

Sales and marketing expenses decreased by $0.2 million , or 13% , to $1.4 million during the three months ended June 30, 2014 , from $1.6 million during the three months ended June 30, 2013 . This decrease is primarily related to decreases in employee and professional services related costs. Sales and marketing expense included stock-based compensation of $0.3 million during the three months ended June 30, 2014 and 2013.

Sales and marketing expenses decreased by $0.2 million , or 6% , to $3.0 million during the six months ended June 30, 2014 , from $3.2 million during the six months ended June 30, 2013 . This decrease is primarily related to decreases in employee and professional services related costs. Sales and marketing expense included stock-based compensation of $0.7 million and $0.6 million during the six months ended June 30, 2014 and 2013, respectively.

General and Administrative

General and administrative expenses increased by $0.1 million , or 2% , to $3.1 million during the three months ended June 30, 2014 , from $3.0 million during the three months ended June 30, 2013 . This increase is primarily attributable to $0.1 million in higher personnel costs related to increased wages, stock-based compensation and other related benefits. General and administrative expense included stock-based compensation of $0.5 million and $0.4 million during the three months ended June 30, 2014 and 2013, respectively.

General and administrative expenses increased by $0.4 million , or 6% , to $6.4 million during the six months ended June 30, 2014 , from $6.0 million during the six months ended June 30, 2013 . This increase is primarily attributable to $0.4 million in higher personnel costs related to increased wages, stock-based compensation and other related benefits. General and administrative expense included stock-based compensation of $1.0 million and $0.8 million during the six months ended June 30, 2014 and 2013, respectively.



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Restructuring Charges
Restructuring expenses were $0.3 million during the three months ended June 30, 2014 , compared to zero for the three months ended June 30, 2013 . In May 2014, our Board of Directors authorized a restructuring plan to reduce our workforce by 10%, pursuant to which charges of $0.3 million were incurred for severance and other personnel related costs.

Restructuring expenses were $1.4 million during the six months ended June 30, 2014 , compared to none for the six months ended June 30, 2013 . In January and May 2014, our Board of Directors authorized restructuring plans to reduce our workforce by 18% and 10%, respectively, pursuant to which charges of $1.1 million and $0.3 million were incurred for severance and other personnel related costs.

Loss from Operations

Our operating loss increased by $6.1 million , to an operating loss of $6.7 million during the three months ended June 30, 2014 , from an operating loss of $0.6 million during the three months ended June 30, 2013 . Our operating expenses increased by $0.9 million to $11.0 million , which includes $0.3 million in restructuring related expenses, during the three months ended June 30, 2014 , from $10.1 million during the three months ended June 30, 2013 .

Our operating loss increased by $8.5 million , to an operating loss of $10.3 million during the six months ended June 30, 2014 , from an operating loss of $1.8 million during the six months ended June 30, 2013 . Our operating expenses increased by $3.1 million to $24.0 million , which includes $1.4 million in restructuring related expenses, during the six months ended June 30, 2014 , from $20.9 million during the six months ended June 30, 2013 .

Interest Expense, net

On May 31, 2013, we entered into a loan and security agreement (the "Loan Agreement") with Silicon Valley Bank (“SVB”) and repaid the remaining principal and accrued interest under the secured promissory note that we issued to Symyx in November 2011.

Interest expense, net, remained unchanged at $0.2 million during the three months ended June 30, 2014 and 2013.

Interest expense, net, decreased by $0.1 million to $0.4 million during the six months ended June 30, 2014 , from $0.5 million during the six months ended June 30, 2013 and is primarily comprised of interest expense associated with the Loan Agreement with SVB during the six months ended June 30, 2014 and interest on our note payable to Symyx during the six months ended June 30, 2013.

Other Income, net

Other income, net, for the three and six months ended June 30, 2014 and 2013 consisted of municipal development grant proceeds and foreign exchange gains and losses that were not significant during these periods.

Provision for Income Taxes

Provision for income taxes during the three and six months ended June 30, 2014 and 2013 consisted of income taxes on our foreign entities and were not significant during these periods.

Net Loss

Our net loss increased by $6.1 million , to a net loss of $6.9 million during the three months ended June 30, 2014 , from a net loss of $0.7 million during the three months ended June 30, 2013 . The difference between operating loss and net loss during the three months ended June 30, 2014 and 2013 was primarily related to interest expense associated with the Loan Agreement with SVB and interest expense associated with our note payable to Symyx, respectively.

Our net loss increased by $8.5 million , to a net loss of $10.7 million during the six months ended June 30, 2014 , from a net loss of $2.2 million during the six months ended June 30, 2013 . The difference between operating loss and net loss during the six months ended June 30, 2014 and 2013 was primarily related to interest expense associated with the Loan Agreement with SVB and interest expense associated with our note payable to Symyx, respectively.

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Liquidity and Capital Resources
Prior to our initial public offering in November 2011, we substantially satisfied our capital and liquidity needs through private placements of redeemable convertible preferred stock and, to a lesser extent, cash flow from operations. As of June 30, 2014 we had $70.0 million of cash, cash equivalents and short-term investments and $64.5 million of net working capital.
As of June 30, 2014 , we had debt outstanding of $24.0 million related to the Loan Agreement with SVB. We are obligated to pay interest at a fixed rate of 3.25% and $0.5 million of principal on a quarterly basis. The term loan matures on November 30, 2016 and we are obligated to pay all outstanding principal and accrued and unpaid interest on that date. At our option, we may prepay the outstanding principal balance of the term loan in full or in part, subject to a pre-payment fee of 0.25% of the outstanding principal balance of the term loan if the term loan is repaid prior to November 30, 2014. Our obligations under the term loan require us to dedicate a substantial portion of our cash flow from operations to payments on interest and principal at or prior to maturity, thus reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts, execution of our business strategy and other general corporate purposes. Such limitations increase our vulnerability to adverse general economic and industry conditions and limit our flexibility in planning for, or reacting to, changes in the economy, our industry and new opportunities that may arise. In addition, our obligations under the term loan and the security interests granted in favor of SVB may make it more difficult for us to borrow funds in the future to fund working capital, capital expenditures and other purposes, which could materially and adversely affect our business, financial condition and results of operations.
To date, we have incurred significant losses. During the six months ended June 30, 2014 and 2013, we incurred net losses of $10.7 million and $2.2 million , respectively. As of June 30, 2014 , our accumulated deficit was $120.8 million .
We believe that we have the financial resources needed to meet business requirements for the next 12 months. However, our forecast of the period of time through which our financial resources will be adequate to meet business requirements are forward-looking statements and involve risks and uncertainties. Our future capital requirements will depend on many factors, many of which are set forth in greater detail under the caption “Risk Factors,” but generally include without limitation our rate of revenue growth, our expansion of our sales and marketing activities and overhead expenses, the timing and extent of our spending to support our R&D efforts and our ability to expand CDPs in the semiconductor and clean energy industries, whether we are successful in obtaining payments from customers, the financial stability of our customers, whether we can enter into additional collaborations in our target industries, the progress and scope of collaborative R&D projects performed by us and our customers, the effect of any acquisitions of other businesses or technologies that we may make in the future, the filing, prosecution and enforcement of patent claims, how much funding we may need to develop or enhance our solutions or HPC platform and any necessary responses to competitive pressures. To the extent that existing cash, cash equivalents, short-term investments and cash from operations are insufficient to fund our operations and repay our outstanding debt when it may become due, we may need to raise additional funds through public or private equity or debt financing. We may also seek to invest in or acquire complementary businesses, applications or technologies, any of which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. We maintain almost all of our cash and investments in the United States and therefore are not subject to restrictions or tax obligations as we access the cash.
Cash Flows
The following summary of our cash flows for the periods indicated has been derived from our condensed consolidated financial statements included elsewhere in this filing (in thousands):
 
Six Months Ended June 30,
 
2014
 
2013
Net cash provided by operating activities
$
659

 
$
10,065

Net cash used in investing activities
$
(31,120
)
 
$
(8,290
)
Net cash provided by (used in) financing activities
$
163

 
$
(246
)


Cash Flows from Operating Activities
We experienced positive cash flows from operating activities during the six months ended June 30, 2014 and 2013 of $0.7 million and $10.1 million , respectively.

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Net cash provided by operating activities during the six months ended June 30, 2014 of $0.7 million reflects a net loss of $10.7 million , non-cash charges of $5.2 million for depreciation and amortization, and $2.8 million for stock-based compensation. Depreciation and amortization increased by $0.6 million from the year ago period due to a larger fixed asset install base. Net operating assets and liabilities cash flow increased by $3.4 million primarily due to a $2.4 million increase of collections in accounts receivable as a result of timing of payments and an increase in deferred revenue of $1.7 million due to customer payments. Operating cash flow related to accounts payable and accrued liabilities decreased by $1.0 million due to declines in purchasing activity and employee related liabilities and cash flows related to inventory decreased by $0.5 million due to procurement of components of workflow elements to be used in future builds.
Cash Flows from Investing Activities
Our investing activities consist primarily of purchases and maturities of short-term investments, capital expenditures to purchase property and equipment, and our investments in intangible assets relating to our patents and trademarks. In the future, we expect we will continue to make modest capital expenditures to support our operations, and to incur costs to protect our investment in our developed technology and IP.
During the six months ended June 30, 2014 , cash used in investing activities was $31.1 million , primarily as a result of $28.2 million of purchased short-term investments. We also incurred $2.0 million in capital expenditures and $0.9 million in capitalized patent and trademark costs.
Cash Flows from Financing Activities
To date, we have financed our operations primarily with proceeds from the sale of our redeemable convertible preferred stock and proceeds received from our initial public offering. We have a term loan pursuant to the Loan Agreement with SVB with a remaining principal balance of $24 million as of June 30, 2014 .
During the six months ended June 30, 2014 , cash provided by financing activities of $0.2 million was primarily related to positive cash flow related to the issuance of common stock as a result of option exercises in the amount of $1.2 million , which was partially offset by cash used in financing activities of $1.0 million for scheduled principal payments on our SVB term loan.
Contractual Obligations and Commitments
The following summarizes our contractual obligations as of June 30, 2014 (in thousands):
 
Payments Due by Period
 
Total
 
Less Than
One Year
 
1 - 3 Years
 
3 - 5 Years
 
More Than
5 Years
Operating lease obligations
$
27,279

 
$
854

 
$
6,409

 
$
4,980

 
$
15,036

Term loan
24,000

 
1,000

 
23,000

 

 

Contractual interest payments on term loan
1,897

 
392

 
1,505

 

 

Purchase obligations(1)
308

 
308

 

 

 

Total
$
53,484

 
$
2,554

 
$
30,914

 
$
4,980

 
$
15,036

(1) Purchase obligations consist of firm, non-cancelable agreements to purchase property and equipment and inventory related items.

Operating lease agreements represent our obligations to make payments under our non-cancelable lease agreement for our facility in San Jose, California. During the six months ended June 30, 2014 , we made regular lease payments of $0.4 million under this operating lease agreement following a period of free rent from December 2013 through March 2014 in connection with the execution of the agreement in October 2013.
During 2013 we entered into a term loan pursuant to the Loan Agreement with SVB in the amount of $25.0 million that bears interest at a fixed rate equal to 3.25% . We are obligated to pay interest at the applicable rate and $0.5 million of principal on a quarterly basis. The term loan matures on November 30, 2016, and we are obligated to pay all outstanding principal and accrued and unpaid interest on that date. At our option, we may pre-pay the outstanding principal balance of the term loan in full or in part, subject to a pre-payment fee of 0.25% of the outstanding principal balance of the term loan if the term loan is repaid prior to November 30, 2014. As of June 30, 2014 , the remaining principal on the term loan was $24.0 million , with remaining interest payments of $1.9 million due over the term of the loan.


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Off-Balance Sheet Arrangements
As of June 30, 2014 , we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
  ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.
Interest Rate Sensitivity
The primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without exposing us to significant risk of loss. The securities we invest in are subject to market risk and a change in prevailing interest rates may cause the principal amount of our investments to fluctuate. We maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, corporate debt securities and money market funds. As of June 30, 2014 , our investments were primarily in commercial paper, corporate notes and bonds and money market funds. If overall interest rates fell 10% for the three and six months ended June 30, 2014 , our interest income would have decreased by an immaterial amount, assuming consistent investment levels.

During 2013 we entered into a Loan Agreement with SVB with a principal amount of $25.0 million that bears interest at a fixed rate equal to 3.25% . We are obligated to pay interest at the applicable rate and $0.5 million of principal on a quarterly basis. The term loan matures on November 30, 2016 and we are obligated to pay all outstanding principal and accrued and unpaid interest on that date. As the rates on the term loan are fixed, we do not have any further exposure to changes in our interest expense as a result of changes in rates. However, in the event we enter into other long-term debt arrangements, we could be subject to fluctuations in interest rates which could have a material impact on our future financial condition and results of operation. In addition, the Loan Agreement also includes several potential events of default such as payment default, material adverse change conditions and insolvency conditions that could cause interest to be charged at the rate that is otherwise applicable plus 5.0%. As of June 30, 2014 , we were in compliance with the covenants in the Loan Agreement. If we are ever unable to meet the covenants in the Loan Agreement, we could also be required to renegotiate the terms of credit under the Loan Agreement, including the interest rate, and there can be no assurance that any renegotiated terms of credit would not materially impact our earnings.
Foreign Currency Exchange Risk
As we expand internationally, our consolidated results of operations and cash flows will become increasingly subject to fluctuations due to changes in foreign currency exchange rates. Our revenue is denominated in U.S. dollars. Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the United States, with an insignificant portion of expenses incurred in the local currencies of our wholly-owned subsidiaries in Hong Kong and Japan and our wholly-owned branch in Taiwan. The effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have a material impact on our consolidated financial statements. To date, we have not entered into any material foreign currency hedging contracts, although we may do so in the future.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2014 . 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”), means controls and other procedures of a company that are designed to ensure 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’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of June 30, 2014 , our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.


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Changes in Internal Control over Financial Reporting
There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at the reasonable assurance level. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.

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PART II — OTHER INFORMATION  
ITEM 1. LEGAL PROCEEDINGS
On August 23, 2013, we received a copy of a complaint from the California Division of Labor Standards and Enforcement ("DLSE") filed by an employee in the company’s research and development group claiming that the employee is owed back pay due to an incorrect classification as an exempt employee for overtime purposes. We subsequently commenced a review of the employee's claim as well as a review of our policies regarding classification of employees for overtime purposes. On January 16, 2014, we participated in mediation with the attorney who represents the employee that filed the claim with the DLSE, as well as fourteen other current and former employees and contractors who are similarly situated. This mediation did not result in a settlement of the subject claims, and on February 18, 2014, the claimants filed a lawsuit against us in the United States District Court for the Northern District of California (the "Court"). The claimants subsequently filed an amended lawsuit in the Court on March 11, 2014. On April 1, 2014, we filed with the Court our answer to the amended lawsuit. Between May 19, 2014 and May 22, 2014, without any admission of liability, we entered into settlement agreements with eleven of the fifteen claimants, including full releases of legal claims and dismissals of their claims in the lawsuit. Without any admission of liability, we subsequently made offers of judgment to the remaining four claimants, which have all been accepted. We are in the final process of documenting appropriate settlement agreements with those claimants, after which time the lawsuit with these fifteen claimants will all have been dismissed and the matter will be concluded. We believe the amount of actual loss for the settled claims and probable loss for the claims remaining subject to final settlement agreement have not had and will not have a material adverse effect on our business, operating results, financial condition or cash flows.
From time to time, we may become involved in other legal proceedings and claims arising in the ordinary course of our business, including but not limited to legal proceedings and claims brought by employees or former employees relating to working conditions or other issues. We are not currently a party to any legal proceedings the outcome of which, if determined adversely to us, we believe would individually or in the aggregate have a material adverse effect on our business, operating results, financial condition or cash flows.
ITEM 1A.                 RISK FACTORS
We describe our business risk factors below. This description includes any material changes to and supersedes the description of the risk factors disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013 as filed with the Securities and Exchange Commission on March 10, 2014 ("2013 Form 10-K") and our Quarterly Report on Form 10-Q for the first quarter of 2014. You should carefully consider the risks described below together with the other information set forth in this Form 10-Q, which could materially affect our business, financial condition or future results. The risks described below are not the only risks facing our company. Risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and operating results.
We have marked with an asterisk (*) those risks described below that reflect material substantive changes from the risks described under “Risk Factors” included in our Quarterly Report on Form 10-Q for the first quarter of 2014.
Risks Related to Our Business, Financial Condition and Results of Operations

We have a limited operating history, which makes it difficult for investors to evaluate our current business and future prospects.*

We do not have a long history of operating results on which you can base your evaluation of our business. We are still proving our business model, and we have not yet demonstrated our ability to generate significant revenue, particularly licensing and royalty revenue (which represented 39% of total revenue in the six months ended June 30, 2014 and 22%, 24%, and 27% in fiscal years 2013, 2012 and 2011, respectively). As a result, it may be difficult for analysts and investors to evaluate our future prospects. If we do not generate significant licensing and royalty revenue, we may never achieve sustained profitability. Furthermore, because of our limited operating history and because the semiconductor and clean energy industries are rapidly evolving, we have limited experience in analyzing and understanding the trends that may emerge and affect our business. If we are unable to obtain significant licensing and royalty revenue from products that use or incorporate technology developed under our collaborative development programs ("CDPs"), our financial condition and results of operations would be materially and adversely affected.

Our operating results may fluctuate from quarter to quarter, which may make it difficult to predict our future performance.

Our revenue, expenses and operating results have fluctuated, and may in the future continue to fluctuate significantly from quarter to quarter due to a number of factors, many of which are outside our control. Factors that may contribute to these fluctuations include the following, as well as other factors described elsewhere in this Form 10-Q:

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our dependence on a limited number of customers;

the length of our sales cycles for CDPs, which makes it difficult to predict the timing of new or expanded CDPs;

the length of our development cycles for CDPs, which makes it difficult to predict the timeframe in which technology developed under CDPs will be available for commercialization;

fluctuations in the volume and prices of products manufactured and sold by our customers that use or incorporate technology developed under our CDPs ("CDP Products") and that generate licensing and royalty revenue for us;

our revenue mix, which may vary from quarter to quarter as (i) we enter into new CDPs and related customer arrangements; (ii) existing CDPs, particularly for significant customers, are completed, extended, or undergo a change in scope; (iii) licensing arrangements take effect; (iv) we enter into product sale transactions and/or (v) we enter into intellectual property ("IP") sale transactions;

the highly cyclical nature of and price volatility in the semiconductor industry;

the financial stability of any of our customers;

the timing and extent to which we enter into new CDPs or complete, extend the duration, expand the scope or reduce the duration or scope of existing CDPs;

one-time offsets to revenue associated with the vesting of contingent warrants issued to two of our customers that are currently outstanding;

non-cash charges relating to stock-based compensation, amortization of intangible assets, write-down expenses related to inventory, and impairment expenses related to long-lived assets;

any involvement in significant litigation, and in particular intellectual property litigation;

any payments resulting from our intellectual property indemnification policies and obligations;

any need for significant additional capital to finance our business;

any delay in shipments caused by shortages of components used or incorporated in products sold into the market, design errors, manufacturing problems, or difficulties or delays gaining required export licenses for such products;

warranty claims, product recalls and product liability for our HPC tools and for CDP Products; and

business interruptions such as earthquakes and other natural disasters.

You should not rely on quarter-to-quarter comparisons to predict our future performance. Unfavorable changes in any of these or other factors may adversely affect our business, financial condition and results of operations.

We have incurred operating losses since our inception and may not be able to achieve or maintain sustained profitability.*

We have generated net losses each year since our inception, including $10.7 million in the six months ended June 30, 2014, and $8.8 million, $0.8 million, and $30.0 million for the fiscal years ended December 31, 2013, 2012 and 2011, respectively. Our accumulated deficit as of June 30, 2014 was $120.8 million . We will need to significantly increase revenue and operating margins (through greater licensing revenue and other mechanisms) to achieve sustained profitability, which we may not be able to accomplish.

Our ability to achieve and maintain profitability will depend, in large part, on our success in addressing the following four challenges, as well as the other risk factors in this Item 1A:


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We may be unable to achieve broad customer acceptance of our HPC platform and approach as an alternative to conventional research and development activities.

Historically, semiconductor companies have conducted R&D activities internally using conventional research methods, and they have vigorously protected the confidentiality of their R&D activities. In order for us to increase revenue, we must convince these companies that our technology and capabilities justify collaborating with us on their basic R&D programs. A significant cultural transition is required for a customer's internal R&D team to embrace us as a collaborative partner. This contributes to the long sales cycles we experience, and may require us to make significant investments in the expansion of our sales and marketing efforts. We must also convince potential customers in the clean energy industry that our HPC platform and approach are useful tools in an emerging industry. We may not achieve the levels of customer acceptance necessary for us to maintain and grow a profitable business. Failure to achieve the necessary customer acceptance to extend or add current or new customer relationships would adversely affect our revenue and profitability.

We may be unable to successfully collaborate with all of our customers to achieve the technological innovations sought by our customers.

Even if we achieve sufficient levels of customer acceptance of our HPC platform as an effective tool for R&D, we will not achieve significant revenue or profitability from a CDP if a project to which we have devoted technology and significant resources fails to produce any measurable success or value to our customers in the form of differentiated technology and intellectual property. CDPs are extremely complex and time-consuming to implement and costly to maintain. We rely to some degree on the efforts and resources of the customer. Differences of opinion over the implementation and management of the program may occur, which could lead to material delays and/or a failure to achieve the successful development of technology. In addition, there are a limited number of CDPs to which we can commit our resources at any given time. For a variety of reasons, including but not limited to insufficient R&D budgets of our customers or us, we may fail to achieve the technological innovations sought by our customers in a reasonable amount of time or at all. We do not know whether our customers will have sufficient resources to maintain or increase the level of investment in R&D required for a successful CDP. If a customer reduces the scope of its CDP with us, it will result in a greater concentration of risk of success being placed upon the remaining scope of our engagement, and we cannot guarantee that the remaining scope of the engagement will lead to a successful result. If a CDP does not generate sufficient revenue to recover the upfront costs and cash we invested in the CDP, this would adversely affect our results of operations.

Our customers may not be successful in commercializing products that use or incorporate technology and IP developed under our CDPs with them.

If we are successful in developing valuable technology for our customers, they still face significant challenges in commercializing products that use or incorporate such technology. The markets for products related to our engagements are intensely competitive and are characterized by rapid technological change. These changes result in frequent product introductions, short product life cycles and the necessity of continually increasing product capabilities. We cannot assure you that our customers will dedicate the resources necessary to successfully execute their business strategies for these products. Our customers are not contractually obligated to us to make or sell any CDP Products. They may not have the financial strength to cost-effectively manufacture the CDP Products at high volume and in quantities sufficient to meet demand, or the competitiveness to price, market and sell the CDP Products in intensely competitive markets. They may experience delays in shipments caused by shortages of components incorporated in the CDP Products, design errors or other manufacturing problems associated with the CDP Products. A decline in demand or average selling prices in the end markets for CDP Products could result in declining sales revenue for our customers and could adversely affect our business and results of operations. Any failure of a customer to achieve market success for CDP Products could also negatively affect such customer's willingness to work with us on other collaborations and could more generally harm our reputation and business prospects. Even if a customer is able to successfully commercialize a CDP Product, there may be a significant delay before we receive any licensing or royalty revenue due to the complexities inherent in production and manufacturing in our customers' target markets.

Existing and potential customers may be resistant to paying license and royalty fees, and we may face challenges in monitoring and enforcing royalty agreements with existing customers.


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Our royalty-bearing licenses with our customers lay the framework for ongoing royalty revenue from CDP Products. Although our R&D activities under CDPs generate revenue for us, in order to achieve profitability we must be able to structure, negotiate and enforce agreements for the calculation and payment of higher-margin license and royalty revenue. Unless we adequately demonstrate the value of our platform to our customers and potential customers, we may face resistance to structuring royalty arrangements in the future that are acceptable to us, or our customers and our potential customers may not agree to enter into royalty-bearing licenses with us at all.

If we are able to negotiate appropriate agreements, we will need to rely on our customers to make those payments on a timely basis. Licensing and royalty revenue we may receive in the future may be based on sales of CDP Products. In order to accurately report our financial results on a timely basis, we will need to receive timely, complete and accurate information from our customers regarding their sales and resulting payments they owe us. If the information that we receive is not timely, complete or accurate, we may not receive the full amount of revenue to which we are entitled under these arrangements on a timely basis, which could result in adjustments to our financial results in a future period. Although we typically have audit rights with these parties, performing this type of audit could be harmful to our collaborative relationships, expensive and time-consuming and may not be sufficient to reveal any discrepancies in a timeframe consistent with our financial reporting requirements.

If a project to which we have devoted technology and significant resources fails to produce any measurable success or value to our customer in the form of differentiated technology and intellectual property that our customer can successfully commercialize, we may not earn licensing and royalty revenue sufficient to recover our upfront investment in the CDP, which could adversely affect our revenue and profitability.

In some cases, the revenue we receive from our customers during the development stage is not sufficient for us to fully recover our costs and cash invested in HPC platforms dedicated to customer engagements, and our business model relies on licensing and royalty revenue based on the sales by our customers in the end-markets of CDP Products. Our CDPs involve complex R&D, and our ability to develop the differentiated technology and intellectual property sought by our customers is inherently uncertain and difficult to predict. If a project fails to produce any measurable value to a customer, or if we are otherwise not successful in maintaining and managing a CDP, we may not receive sufficient amounts of licensing and royalty revenue to recover our upfront investment in the CDP.

We depend on a limited number of customers, and a loss of any of them, or a significant reduction in revenue from any of them, would adversely affect our business, financial condition and results of operations.*

Our customer base is highly concentrated. Revenue has historically come from a few customers, and we expect that revenue from a small number of customers will continue to account for a high percentage of our revenue for the foreseeable future. Our three largest customers accounted for 66% of revenue in the six months ended June 30, 2014, and our four largest customers accounted for 55% of our revenue in the fiscal year ended December 31, 2013. Our three largest customers during 2012 and 2011 (all of which are in the semiconductor industry), accounted for 67% and 64% of our revenue in the fiscal years ended December 31, 2012 and 2011, respectively. Our largest customer accounted for 32% , 17%, 28%, and 29% of our r