IDENTIV : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

This Item 2, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations,” and other parts of this Quarterly Report on Form 10-Q
(“Quarterly Report”) contain forward-looking statements, within the meaning of
the safe harbor provisions under Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
that involve risks and uncertainties. Forward-looking statements reflect current
expectations of future events based on certain assumptions and include any
statement that does not directly relate to any historical or current fact.
Forward-looking statements can also be identified by words such as “will,”
“believe,” “could,” “should,” “would,” “may,” “anticipate,” “intend,” “plan,”
“estimate,” “expect,” “project” or the negative of these terms or other similar
expressions. Forward-looking statements are not guarantees of future performance
and our actual results may differ significantly from the results discussed in
the forward-looking statements. Factors that might cause such differences
include, but are not limited to, those discussed in Part I, Item 1A of our
Annual Report on Form 10-K for the year ended December 31, 2017 under the
heading “Risk Factors,” The following discussion should be read in conjunction
with the audited consolidated financial statements and notes thereto included in
Part II, Item 8 of our Annual Report on Form 10-K for the year ended December
31, 2017. We assume no obligation to revise or update any forward-looking
statements for any reason, except as required by law.

Each of the terms the “Company,” “Identiv,” “we” and “us” as used herein refers collectively to Identiv, Inc. and its wholly-owned subsidiaries, unless otherwise stated.Overview
Identiv is a global security technology company that secures and manages access
to physical places, things and information. Global organizations in government,
education, retail, transportation, healthcare and other markets rely upon our
solutions. We empower them to create secure and convenient experiences in
schools, government offices, factories, critical infrastructure, transportation,
hospitals and virtually every type of facility and for a wide range of products.

Our operating segments focus on the following solutions:• Physical security and customer insight solutions, securing buildings via an integrated access control system, included in our Premises segment.

• Information security solutions, securing enterprise information accessand secure transactions across PCs, networks, email, login, secure payments and printers via delivery of smart card reader products,
included in our Identity segment.

• Radio frequency identification (“RFID”) based solutions for use in awide range of applications from asset tracking to product authenticity,customer engagement, product instrumentation, transportation access and other applications sometimes included in the Internet of Things (“IoT”).
The RFID devices are embedded into access cards, transponders and otherembedded devices that enable frictionless access to and interaction with the physical world.

The foundation of our business is our deep technical expertise in RFID, smart card technology, and physical security technologies. Our close customer relationships and analytics platforms allow us to develop customer-relevant products and applications. This is underpinned by our core value of uncompromising quality.To deliver these solutions, we have organized our operations into four reportable business segments, principally by product families: Premises, Identity, Credentials, and All Other.Premises
The foundation of our physical security platform has been the Hirsch line of
controllers including the advanced MX line, Hirsch’s Velocity management
software and a wide range of integrations that provide Velocity/MX’s unique
flexibility across a wide range of industries and implementations. We have
further extended our physical access platform with our Identiv Connected
Physical Access Manager (“ICPAM”) software, derived from Cisco’s Physical Access
Manager (“CPAM”) system and available in partnership with Cisco. Additionally,
we sell either individual components or complete bundled solutions which can
include any or all among software, edge controllers, multi-door panels, access
readers, access cards and other components.

In February 2018, we acquired 3VR Security, Inc. (“3VR”), a video technology and
analytics company. With the acquisition, we have added the 3VR video security
and analytics platform, which is a natural complement to our Hirsch line. Nearly
all customers for access control are customers for video security, and vice
versa. Additionally, the events and data generated by both platforms combine to
create what we believe to be uniquely valuable information for our customers to
provide frictionless yet robust security. 3VR’s platform is architected as an
analytics system, proven across applications in the retail, banking, and other
vertical markets, and valuable to our traditional Hirsch and ICPAM markets in
government, education, critical infrastructure, transportation and
others. Additionally, we sell either individual components or complete bundled
solutions which can include any or all among software, edge controllers,
multi-door panels, access readers, access cards, 3VR appliances and other
components.

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Our modular Hirsch MX controllers are designed to be scalable, allowing
customers to start with a small system and expand over time. Hirsch MX
controllers can operate autonomously, whether as a single controller or as part
of a networked system with Velocity software. The Hirsch Velocity software
platform enables centralized management of access and security operations across
an organization, including control of doors, gates, turnstiles, elevators and
other building equipment, monitoring users as they move around a facility,
preventing unwanted access, maintaining compliance and providing a robust audit
trail.

To our price/performance/quality-leading commercial offerings, we have added
what we believe to be the highest performance, lowest per-door cost access
control system for the U.S. federal government security mandate known as the
Federal Identity, Credential and Access Management (“FICAM”) architecture. This
brings all of the advantages above into the next generation of physical security
for the U.S. government departments and agencies to achieve Federal Information
Processing Standard (“FIPS”) 201 compliance.

Our TouchSecure (“TS”) door readers provide unique features to support a wide
range of security standards. We support the majority of legacy card credentials
with a robust next-generation platform that can help companies migrate to more
secure credentials and technologies, including smart cards, near field
communication (“NFC”) and government-issued credentials including Common Access
Card (“CAC”), Personal Verification Identification (“PIV”), Personal
Verification Identification – Interoperable (“PIV-I”) and others. Additionally,
our Scramblepad readers employ numerical scrambling on the keypad to protect
access codes from being stolen as they are entered, and providing both secure
two-factor authentication and convenient alternative-factor access.

In addition to this solution offering, in 2017, we launched Identiv Global
Services (“IGS”), a service offering with a comprehensive catalog of end-to-end
services that facilitates customer success and drives deeper adoption of the
Identiv product portfolio. IGS supports customers throughout their premises
security lifecycle from system design, to deployment to managed services. IGS
experts enable customers to address today’s complex security and IT systems
interoperability requirements, and help them achieve a tailor-made set-up.

In addition to our core products, we have a range of product initiatives to
leverage leading technology advances across mobile, biometric, machine-learning
and other areas, to provide convenient, frictionless, low-cost yet highly secure
physical access. We invest independently and in partnership with other leading
technology companies in these emerging aspects of physical security and
analytics platforms.

Identity
Our Identity products include smart card readers, which includes a broad range
of contact, contactless, portable and mobile smart card readers, tokens and
terminals that are utilized around the world to enable logical access (i.e., PC,
network or data access) and security and identification applications, such as
national ID, payment, e-Health and e-Government.

With over 20 years of smart card reader, application and token experience, we
are known for our expertise in this complex ecosystem. We combine our deep
technical expertise with an optimized supply chain, to provide what we believe
to be the most optimal, cost-effective and high-quality smart card-based
products. Whether Identiv branded products, original equipment manufacturers
(“OEM”) branded, or embedded chips or modules, our position is as the trusted
business solution provider for users and issuers of smart cards and
embedded-chip applications.

Credentials
Our Credentials segment includes NFC and RFID products, including inlays,
inlay­based and other cards, labels, tags and stickers, as well as other radio
frequency (“RF”) and integrated circuits (“IC”) components and are generally
grouped into access cards and transponders. Our TS Cards product line, we
believe, is the first complete solution to allow customers to pay only for the
most basic low-frequency proximity access technology while having the ability to
evolve to the higher-security high-frequency and highest-security public key
infrastructure (“PKI”) based access credentials. This product line exemplifies
our values: we place no burden on our customers, instead providing the most
cost-effective solution to their basic needs; and then deliver within this
platform the ability for them to move to higher-level needs and capabilities,
when they want, when they are ready and when they will realize economic and
experience benefits.

Our transponder products span the full range of high frequency (“HF”) and
ultra-high frequency (“UHF”) technologies. Our differentiation is analogous to
application-specific integrated circuits (“ASICS”) in the semiconductor
market. We leverage our flexible platform, our deep technical expertise and our
infrastructure and supply chain to deliver solutions optimized for our
customers’ business goals. We believe we are more responsive, more flexible,
more experienced in business-optimized solutions and have a better track record
of sustained delivery of solution-specific, high-quality RFID devices than our
competitors. Our credentials products are manufactured in our state-of-the-art
facility in Singapore and are used in a diverse range of physical applications,
including electronic entertainment such as virtual reality (“VR”), games,
loyalty cards, mobile payment systems, transit and event ticketing, brand
authenticity from pharmaceuticals to consumer goods, hospital resource
management, cold-chain management and many others.

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Leveraging our expertise in RFID, physical access and physical authentication,
we are developing new solutions to extend our platforms across a wide variety of
physical use cases. The next major opportunity in our connected world is the
IoT, which fundamentally is about physical things. We believe our core strength
in physical access and physical instrumentation markets, our well-established
platforms and our deep knowledge of the relevant technologies, position us well
in this growth market.

All Other

The All Other segment included legacy product lines, such as Chipdrive and
Digital Media readers. No revenues from this segment were generated in 2018 and
nominal revenues were generated in 2017. No revenues are expected to be
generated in future periods. In the fourth quarter of 2016, we phased out our
Digital Media product lines and discontinued our Chipdrive product line.

We primarily conduct sales and marketing activities in each of the markets in
which we compete, utilizing our own sales and marketing organization to solicit
prospective channel partners and customers, provide technical advice and support
with respect to products, systems and services, and manage relationships with
customers, distributors and/or OEMs. We utilize indirect sales channels that may
include OEMs, dealers, systems integrators, value added resellers, resellers or
Internet sales, although we also sell directly to end users. In support of our
sales efforts, we participate in industry events and conduct sales training
courses, targeted marketing programs, and ongoing customer, channel partner and
third-party communications programs.

For a discussion of our net revenue by segment and geographic location, see Note
11, Segment Reporting and Geographic Information, in the accompanying notes to
our unaudited condensed consolidated financial statements.

Trends in Our Business
Geographic net revenue based on each customer’s ship-to location is as follows
(in thousands):

Six Months Ended
June 30,
2018 2017
Americas $ 29,137$ 18,603
Europe and the Middle East 4,831 3,996
Asia-Pacific 2,854 5,633
Total $ 36,822$ 28,232
Revenues:
Americas 79 % 66 %
Europe and the Middle East 12 % 14 %
Asia-Pacific 9 % 20 %
Total 100 % 100 %

Net Revenue Trends

Net revenue in the six months ended June 30, 2018 increased 30% compared with
the first six months of 2017. Approximately 44% of our net revenue in the six
months ended June 30, 2018 came from our Premises segment. Net revenue in the
Premises segment was $16.3 million and $11.1 million for the six months ended
June 30, 2018 and 2017, respectively. Net revenue in the Identity segment, which
represented approximately 16% of total net revenue, was $5.9 million in the six
months ended June 30, 2018 compared to $7.1 million in the prior year period.
Net revenue in our Credentials segment represented approximately 40% of our net
revenue. Net revenue in the Credentials segment was $14.6 million in the six
months ended June 30, 2018 compared to $9.9 million in the comparable period in
2017.

Net Revenue in the Americas

Net revenue in the Americas was approximately $29.1 million in the six months
ended June 30, 2018, accounting for 79% of total net revenue, and was up 57%
compared to $18.6 million in the six months of 2017. Net revenue from our
Premises solutions for security programs within various U.S. government agencies
and commercial customers for access control and video solutions, as well as
reader, controller and appliance products, represented approximately 50% of our
net revenue in the Americas region.

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Net revenue in our Premises segment for the six months ended June 30, 2018
increased 5% compared to the prior year period primarily due to additional sales
of video technology and analytics hardware and software products and related
support services following the acquisition of 3VR in February 2018, as well as
higher sales of physical access control solutions and products, higher sales
through our channel partners, and higher software product sales. Net revenue in
our Identity segment increased 78% in the six months ended June 30, 2018
compared to the comparable period of the previous year primarily due to higher
smart card reader sales. Net revenue in our Credentials segment increased 68% in
the six months ended June 30, 2018 compared with the same period of the prior
year primarily due to higher access card sales, partially offset by lower sales
of RFID and NFC transponder products.

As a general trend, U.S. Federal agencies continue to be subject to security
improvement mandates under programs such as Homeland Security Presidential
Directive-12 (“HSPD-12”) and reiterated in memoranda from the Office of
Management and Budget (“OMB M-11-11”). We believe that our solution for trusted
physical access is an attractive offering to help federal agency customers move
towards compliance with federal directives and mandates. To address our sales
opportunities in the United States in general and with our U.S. Government
customers in particular, we focus on a strong U.S. sales organization and our
sales presence in Washington D.C.Net Revenue in Europe, the Middle East, and Asia-Pacific
Net revenue in Europe, the Middle East, and Asia-Pacific was approximately $7.7
million in the six months ended June 30, 2018, accounting for 21% of total net
revenue and was down 20% compared to $9.6 million in the first six months of
2017 primarily as a result of lower sales in our Asia-Pacific region, partially
offset by higher sales in our Europe and the Middle East region. Net revenue in
these regions are very dependent on the completion of large projects and the
timing of orders placed by some of our customers. Sales of Identity readers and
RFID and NFC products and tags comprise a significant proportion of our net
revenue in these regions.

Net revenue from our Premises products increased 70% in the six months ended
June 30, 2018 from the prior year period due to higher sales of physical access
control solutions in the Europe and the Middle East region, partially offset by
a decrease in sales in the Asia-Pacific region. Net revenue from our Identity
products decreased by approximately 55% in the six months ended June 30, 2018
compared with the same period of the prior year primarily due to sales of smart
card readers for a government project in the Asia-Pacific region in the first
six months of 2017. Identity readers comprised approximately 30% of the net
revenue in both the Europe and the Middle East and the Asia-Pacific regions in
the first six months of 2018. Net revenue from our Credentials products, which
comprised approximately 47% of sales in both the Europe and the Middle East and
the Asia-Pacific regions in the first six months of 2018, was comparable with
the same period of the prior year primarily as a result of higher transponder
and access card product sales in Europe and the Middle East and the Asia-Pacific
regions, offset by lower access card product sales in the Asia-Pacific region.

Seasonality and Other Factors
In our business overall, we may experience significant variations in demand for
our offerings from quarter to quarter, and typically experience a stronger
demand cycle in the second half of our fiscal year. Sales of our physical access
control solutions and related products to U.S. Government agencies are subject
to annual government budget cycles and generally are highest in the third
quarter of each year. However, the usual seasonal trend can be negatively
impacted by actions such as government shutdowns and the passing of continuing
resolutions which can act to delay the completion of certain projects. Sales of
our identity reader chips, many of which are sold to government agencies
worldwide, are impacted by testing and compliance schedules of government bodies
as well as roll-out schedules for application deployments, both of which
contribute to variability in demand from quarter to quarter. Further, this
business is typically subject to seasonality based on differing commercial and
global government budget cycles. Lower sales are expected in the U.S. in the
first half, and in particular the first quarter of the year, with higher sales
typically in the second half of each year. In Asia-Pacific, with fiscal
year-ends in March and June, order demand can be higher in the first quarter as
customers attempt to complete projects before the end of the fiscal year.
Accordingly, our net revenue levels in the first quarter each year often depends
on the relative strength of project completions and sales mix between our U.S.
customer base and our international customer base.

In addition to the general seasonality of demand, overall U.S. Government
expenditure patterns have a significant impact on demand for our products due to
the significant portion of revenues that are typically sourced from U.S.
Government agencies. Therefore, any significant reduction in U.S. Government
spending could adversely impact our financial results and could cause our
operating results to fall below any guidance we provide to the market or below
the expectations of investors or security analysts.

30——————————————————————————–Operating Expense TrendsBase Operating Expenses
Our base operating expenses (i.e., research and development, selling and
marketing, and general and administrative spending) increased 26% in the first
six months of 2018 compared with the same period of 2017. Research and
development spending increased by 18% in the first six months of 2018 compared
with the same period of 2017 resulting from additional headcount and external
contractor costs associated with the acquisition of 3VR in the first quarter of
2018. Selling and marketing spending in the first six months of 2018 increased
by 23% compared with the same period of 2017, due to the additional headcount
and related costs associated with the acquisition of 3VR in the first quarter of
2018 and higher external contractor costs compared to the same period in the
prior year. General and administrative spending in the first six months of 2018
increased 37% from the same period in the prior year primarily due to higher
transaction related costs associated with the acquisition of 3VR in February of
2018, and the effect of reimbursements received in the first quarter of 2017
from our insurance provider for legal fees incurred in connection with matters
related to a complaint by a former employee, related investigations, the class
and derivative litigation and related proceedings, and reductions in our legal
accruals.

Results of Operations

The following table includes segment net revenue and segment net profit
information for our Premises, Identity, Credentials and All Other segments and
reconciles gross profit to results of continuing operations before income taxes
and noncontrolling interest (in thousands):

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
Premises:
Net revenue $ 8,821$ 5,778 53 % $ 16,327$ 11,142 47 %
Gross profit 4,818 3,045 58 % 8,973 6,144 46 %
Gross profit margin 55 % 53 % 55 % 55 %
Identity:
Net revenue 3,154 4,058 (22 %) 5,934 7,147 (17 %)
Gross profit 1,103 1,313 (16 %) 2,032 2,437 (17 %)
Gross profit margin 35 % 32 % 34 % 34 %
Credentials:
Net revenue 8,319 5,005 66 % 14,561 9,940 46 %
Gross profit 2,232 1,323 69 % 3,656 2,793 31 %
Gross profit margin 27 % 26 % 25 % 28 %
All Other:
Net revenue – (1 ) (100 %) – 3 (100 %)
Gross profit – 2 (100 %) – 6 (100 %)
Gross profit margin – N/A – N/A
Total:
Net revenue 20,294 14,840 37 % 36,822 28,232 30 %
Gross profit 8,153 5,683 43 % 14,661 11,380 29 %
Gross profit margin 40 % 38 % 40 % 40 %
Operating expenses:
Research and development 1,837 1,511 22 % 3,524 2,988 18 %
Selling and marketing 4,358 3,315 31 % 8,261 6,694 23 %
General and administrative 2,756 2,085 32 % 5,311 3,872 37 %
Restructuring and severance 258 – 100 % 368 – 100 %
Total operating expenses: 9,209 6,911 33 % 17,464 13,554 29 %
Loss from operations (1,056 ) (1,228 ) (14 %) (2,803 ) (2,174 ) 29 %
Non-operating income
(expense):
Interest expense, net (472 ) (678 ) (30 %) (948 ) (1,352 ) (30 %)
(Loss) gain on extinguishment
of debt, net (1,369 ) – N/A (1,369 ) 977 N/A
Foreign currency gains
(losses), net 192 1 N/A 154 (151 ) N/A
Loss before income taxes and
noncontrolling
interest $ (2,705 )$ (1,905 ) 42 % $ (4,966 )$ (2,700 ) 84 %

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——————————————————————————–Net Revenue
Total net revenue in the second quarter of 2018 was $20.3 million, up 37%
compared with $14.8 million in the second quarter of 2017. For the six months
ended June 30, 2018, total net revenue was $36.8 million, up 30% compared with
$28.2 million for the comparable period for 2017. Total net revenue was higher
in the second quarter of 2018 and the first six months of 2018, mainly driven by
higher sales in our Premises and Credentials segments. A more detailed
discussion of net revenue by segment follows below.

Net revenue in our Premises segment was $8.8 million in the second quarter of
2018, an increase of 53% from $5.8 million in the second quarter of 2017. In the
six months ended June 30, 2018, net revenue in our Premises segment was $16.3
million, an increase of 47% from $11.1 million in the six months ended June 30,
2017. The increases were primarily due to additional sales of video technology
and analytics hardware and software products and related support services
following the acquisition of 3VR in February 2018, as well as higher sales of
physical access control solutions, higher sales through our channel partners,
and higher software sales.

Net revenue in our Identity segment of $3.2 million in the second quarter of
2018 decreased 22% from $4.1 million in the second quarter of 2017. In the six
months ended June 30, 2018, net revenue in our Identity segment was $5.9
million, a decrease of 17% from $7.1 million in the six months ended June 30,
2017. The decreases were primarily due to sales of smart card readers for a
government project in the Asia-Pacific region in the first six months of 2017,
partially offset by higher smart card reader sales in the Americas region.

Net revenue in our Credentials segment was $8.3 million in the second quarter of
2018, an increase of 66% from $5.0 million in the second quarter of 2017. In the
six months ended June 30, 2018, net revenue in our Credentials segment was $14.6
million, an increase of 46% from $9.9 million in the six months ended June 30,
2017. The increases were primarily a result of higher access card product sales
in the Americas region, and higher RFID and NFC transponder product sales in the
Americas and Asia-Pacific regions.

Gross Profit
Gross profit for the second quarter of 2018 was $8.2 million, or 40% of net
revenue, compared with $5.7 million or 38% of net revenue in the second quarter
of 2017. In the six months ended June 30, 2018, gross profit was $14.7 million,
or 40% of net revenue, compared with $11.4 million, or 40% of net revenue in the
six months ended June 30, 2017. Gross profit represents net revenue less direct
cost of product sales, manufacturing overhead, other costs directly related to
preparing the product for sale including freight, scrap, inventory adjustments
and amortization, where applicable.

In our Premises segment, gross profit on sales of physical access control
solutions, including panels, controllers, and access readers, and sales of video
technology and analytics hardware and software products, and related support
services, was $4.8 million in the second quarter of 2018 and $3.0 million in the
second quarter of 2017, and $9.0 million and $6.1 million in the six months
ended June 30, 2018 and 2017, respectively. Gross profit margins in the Premises
segment of 55% were higher in the second quarter of 2018 compared to 53% in the
comparable period of 2017 primarily attributable to the impact of a higher
proportion of higher margin sales within the segment. Gross profit margins in
this segment for the six months ended June 30, 2018 were comparable to the same
period in the prior year.

In our Identity segment, gross profit on sales of information security readers,
smart card reader modules and reader chipsets was $1.1 million in the second
quarter of 2018 compared to $1.3 million in the second quarter of 2017, and $2.0
million and $2.4 million in the six months ended June 30, 2018 and 2017,
respectively. Gross profit margins in the Identity segment of 35% were higher in
the second quarter of 2018 compared to 32% in the comparable period of 2017
primarily due to product mix with a higher proportion of higher margin smart
card sales in 2018. Gross profit margins in this segment for the six months
ended June 30, 2018 were comparable to the same period in the prior year.

In our Credentials segment, gross profit on sales of physical access cards and
transponder related products for identification, authenticity and tracking
applications was $2.2 million in the second quarter of 2018 compared to $1.3
million in the second quarter of 2017, and $3.7 million and $2.8 million in the
six months ended June 30, 2018 and 2017, respectively. Gross profit margins in
the Credentials segment in the second quarter of 2018 were comparable to the
same period in the prior year. Gross profit margins in this segment for the six
months ended June 30, 2018 of 25% were lower compared to 28% in the comparable
period of 2017 primarily due to the impact of higher a proportion of lower
margin access card sales.

We expect there will be variation in our gross profit from period to period, as
our gross profit has been and will continue to be affected by a variety of
factors, including, without limitation, competition, product pricing, the volume
of sales in any given quarter, manufacturing volumes, product configuration and
mix, the availability of new products, product enhancements, software and
services, risk of inventory write-downs and the cost and availability of
components.

32——————————————————————————–Operating ExpensesInformation about our operating expenses for the three and six months ended June 30, 2018 and 2017 is set forth below (dollars in thousands).
Research and Development

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
Research and development $ 1,837$ 1,511 22 % $ 3,524$ 2,988 18 %
as a % of net revenue 9 % 10 % 10 % 11 %

Research and development expenses consist primarily of employee compensation and
fees for the development of hardware, software and firmware products. We focus
the bulk of our research and development activities on the continued development
of existing products and the development of new offerings for emerging market
opportunities.

Research and development expenses in the three and six months ended June 30, 2018 increased compared to the comparable prior year periods primarily attributable to the additional headcount and external contractor costs associated with the acquisition of 3VR in the first quarter of 2018.
Selling and Marketing

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
Selling and marketing $ 4,358$ 3,315 31 % $ 8,261$ 6,694 23 %
as a % of net revenue 21 % 22 % 22 % 24 %

Selling and marketing expenses consist primarily of employee compensation as
well as amortization expense of certain intangible assets, customer lead
generation activities, tradeshow participation, advertising and other marketing
and selling costs.

Selling and marketing expenses in the three and six months ended June 30, 2018
increased compared to the prior year periods primarily due to the additional
headcount and related costs associated with the acquisition of 3VR in the first
quarter of 2018 and higher external service and contractor costs compared to the
same period in the prior year.

General and Administrative

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
General and administrative $ 2,756$ 2,085 32 % $ 5,311$ 3,872 37 %
as a % of net revenue 14 % 14 % 14 % 14 %

General and administrative expenses consist primarily of compensation expense
for employees performing administrative functions as well as professional fees
arising from legal, auditing and other professional services.

General and administrative expenses in the three and six months ended June 30,
2018 were higher compared to the same periods of the prior year primarily due to
$0.5 million in transaction related costs associated with the acquisition of 3VR
in February of 2018, the impact of reimbursements received of $0.3 million in
the first quarter of 2017 from our insurance provider for legal fees incurred in
connection with matters related to a complaint by a former employee, related
investigations, the class and derivative litigation and related proceedings, and
reductions in our legal accruals of $0.4 million.

Restructuring and Severance Charges

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
Restructuring and severance $ 258 $ – 100 % $ 368 $ – 100 %

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Restructuring and severance expenses consist primarily of facility rental
related costs of $0.2 million and severance related costs of $0.2 million
associated with the acquisition of 3VR. In the first quarter of 2018, we engaged
a property management firm to actively market and search for a tenant to
sublease the newly acquired 3VR office facility in San Francisco, California. We
currently occupy only a small area of the leased space.

See Note 12, Restructuring and Severance, in the accompanying notes to our unaudited condensed consolidated financial statements for more information.Interest Expense, Net and (Loss) Gain on Extinguishment of Debt

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
Interest expense, net $ (472 )$ (678 )(30 %) $ (948 )$ (1,352 ) (30 %) (Loss) gain on extinguishment of debt $ (1,369 ) $ – N/A $ (1,369 )$ 977 N/A

Interest expense, net consists of interest on financial liabilities and interest
accretion expense for a liability on a long-term payment obligation arising from
our acquisition of Hirsch Electronics Corporation. The lower net interest
expense in the second quarter of 2018 and the first six months of 2018 is
primarily attributable to the $5.0 million principal pay down of our $10.0
million term loan in December 2017, and the subsequent payment of the remaining
principal amounts outstanding of $5.0 million in May 2018.

For the three and six months ended June 30, 2018, the loss on extinguishment of
debt represents the difference between the reacquisition price of the remaining
amounts outstanding under our term loan and its net carrying amount. See Note 9,
Financial Liabilities, in the accompanying notes to our unaudited condensed
consolidated financial statements for more information.

Foreign Currency Gains (Losses), Net

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
Foreign currency gains (losses), net $ 192$ 1 N/A $ 154$ (151 ) N/A

Changes in currency valuation in the periods mainly were the result of exchange
rate movements between the U.S. dollar and the Euro. Accordingly, they are
predominantly non-cash items. Our foreign currency gains and losses primarily
result from the valuation of current assets and liabilities denominated in a
currency other than the functional currency of the respective entity in the
local financial statements.

Income Taxes

Three Months Ended June 30, Six Months Ended June 30,
2018 2017 % Change 2018 2017 % Change
Income tax (provision) benefit $ (40 )$ 1 N/A $ (80 )$ 119 N/A
Effective tax rate (1 %) 0 % 2 % (4 %)

As of June 30, 2018, our deferred tax assets are fully offset by a valuation
allowance. Accounting Standards Codification, or ASC, 740, Income Taxes,
provides for the recognition of deferred tax assets if realization of such
assets is more likely than not. Based upon the weight of available evidence,
which includes historical operating performance, reported cumulative net losses
since inception and difficulty in accurately forecasting our future results, we
provided a full valuation allowance against all of our net U.S. and foreign
deferred tax assets. We reassess the need for our valuation allowance on a
quarterly basis. If it is later determined that a portion or all of the
valuation allowance is not required, it generally will be a benefit to the
income tax provision in the period such determination is made.

We recorded an income tax provision during the three and six months ended June
30, 2018. The effective tax rates for the six months ended June 30, 2018 and
2017 differ from the federal statutory rate of 21% (34% for June 30, 2017)
primarily due to a change in valuation allowance, a true-up of prior taxes,
changes to uncertain tax positions, and the provision or benefit in certain
foreign jurisdictions, which are subject to lower tax rates.

34——————————————————————————–Liquidity and Capital Resources
As of June 30, 2018, our working capital, which we define as current assets less
current liabilities, was $15.4 million, a decrease of $7.6 million compared to
$23.0 million as of December 31, 2017. As of June 30, 2018, our cash balance was
$17.9 million.

On February 8, 2017, we entered into Loan and Security Agreements (each, a “Loan
and Security Agreement”) with EWB and VLL7 and VLL8. The Loan and Security
Agreement with EWB provides for a $10.0 million revolving loan facility, and the
Loan and Security Agreement with VLL7 and VLL8 provides for a term loan in an
aggregate principal amount of $10.0 million. In connection with the closing of
both Loan and Security Agreements, we repaid all outstanding amounts under our
credit agreement with our previous lender. See Note 9, Financial Liabilities, in
the accompanying notes to our condensed consolidated financial statements for
more information.

On December 28, 2017, we paid down an aggregate principal amount of $5.0 million
of the $10.0 million outstanding principal balance of the term loan under the
Loan and Security Agreement with VLL7 and VLL8, and $0.9 million of accrued and
unpaid interest outstanding at the prepayment date, together with all the
scheduled interest that would have accrued and been payable through the stated
maturity of the term loan. On May 31, 2018, we repaid the remaining amounts
payable under the term loan of approximately $5.2 million, consisting of $4.6
million in outstanding principal, and $0.6 million of accrued and unpaid
interest outstanding at the prepayment date together with all the scheduled
interest that would have accrued and been payable through the stated maturity of
the term loan. See Note 9, Financial Liabilities, in the accompanying notes to
our condensed consolidated financial statements for more information.

On December 20, 2017, we entered into a Securities Purchase Agreement with each
of 21 April Fund, Ltd. and 21 April Fund, LP (collectively, the “Purchasers”),
in which we, through a private placement, agreed to issue and sell an aggregate
of up to 5,000,000 shares of Series B non-voting convertible preferred stock.
The Purchasers purchased an aggregate of 3,000,000 preferred shares at a price
of $4.00 per share in cash at the initial closing of the transaction. On May 30,
2018, we completed the second closing of the private placement of 2,000,000
preferred shares at a price of $4.00 per share. The total purchase price paid to
us was $20,000,000, of which $12,000,000 was paid at the initial closing and
$8,000,000 at the second closing. We are required to use the proceeds from the
issuance of the preferred shares to pay off existing debt obligations and to
fund future acquisitions of technology, business and other assets. See Note 5,
Stockholders’ Equity, in the accompanying notes to our condensed consolidated
financial statements for more information.

As our previously unremitted earnings have been subjected to U.S. federal income
tax, we expect any repatriation of these earnings to the U.S. would not incur
significant additional taxes related to such amounts. However, our estimates are
provisional and subject to further analysis. Generally, most of our foreign
subsidiaries have accumulated deficits and cash and cash equivalents that are
held outside the United States are typically not cash generated from earnings
that would be subject to tax upon repatriation if transferred to the United
States. We have access to the cash held outside the United States to fund
domestic operations and obligations without any material income tax
consequences. As of June 30, 2018, the amount of cash included at such
subsidiaries was $1.9 million. We have not, nor do we anticipate the need to,
repatriate funds to the United States to satisfy domestic liquidity needs
arising in the ordinary course of business, including liquidity needs associated
with our domestic debt service requirements.

We have historically incurred operating losses and negative cash flows from
operating activities, and we may continue to incur losses in the future. As of
June 30, 2018, we have a total accumulated deficit of $404.4 million. During the
six months ended June 30, 2018, we incurred a consolidated net loss of $5.0
million.

We believe our existing cash balance, together with cash generated from
operations and available credit under our Loan and Security Agreement, will be
sufficient to satisfy our working capital needs to fund operations for the next
twelve months. We may also use cash to acquire or invest in complementary
businesses, technologies, services or products that would change our cash
requirements. We may also finance our cash requirements through public or
private equity offerings, debt financings or other arrangements. However, there
can be no assurance that additional capital, if required, will be available to
us or that such capital will be available to us on acceptable terms. If we raise
funds by issuing equity securities, dilution to stockholders could result. Any
equity securities issued also may provide for rights, preferences or privileges
senior to those of holders of our common stock. The terms of debt securities
issued or borrowings could impose significant restrictions on our operations.
The incurrence of additional indebtedness or the issuance of certain equity
securities could result in increased fixed payment obligations and could also
result in restrictive covenants, such as limitations on our ability to incur
additional debt or issue additional equity, limitations on our ability to
acquire or license intellectual property rights and other operating restrictions
that could adversely affect our ability to conduct our business. Our Loan and
Security Agreement imposes restrictions on our operations, increases our fixed
payment obligations and has restrictive covenants. In addition, the issuance of
additional equity securities by us, or the possibility of such issuance, may
cause the market price of our common stock to decline. If we are not able to
secure additional funding when needed, we may have to curtail or reduce the
scope of our business or forgo potential business opportunities.

35——————————————————————————–The following summarizes our cash flows for the six months ended June 30, 2018
and 2017 (in thousands):

Six Months Ended June 30,
2018 2017Net cash used in operating activities $ (2,578 )$ (2,685 ) Net cash used in investing activities (1,601 ) (264 ) Net cash provided by financing activities 3,344 11,711 Effect of exchange rates on cash (295 ) 90 Net (decrease) increase in cash (1,130 ) 8,852 Cash, beginning of period 19,052 9,116
Cash, end of period $ 17,922$ 17,968Cash flows from operating activities
Cash used in operating activities for the six months ended June 30, 2018 was
primarily due to the net loss of $5.0 million and a decrease in cash from net
changes in operating assets and liabilities of $2.1 million, partially offset by
adjustments for certain non-cash items of $4.6 million, consisting primarily of
depreciation, amortization, amortization of debt issuance costs, loss on
extinguishment of debt, and stock-based compensation. For the six months ended
June 30, 2017, cash used in operating activities was primarily due to the net
loss of $2.6 million and a decrease in cash from net changes in operating assets
and liabilities of $2.4 million, partially offset by adjustments for certain
non-cash items of $2.3 million.

Cash flows from investing activities
Cash used in investing activities for the six months ended June 30, 2018 was
$1.6 million, of which $1.4 million related to the acquisition of 3VR net of
cash acquired, and $0.2 million related to capital expenditures. Cash used in
investing activities for the six months ended June 30, 2017 was $0.3 million and
related to capital expenditures.

Cash flows from financing activities
Cash provided by financing activities during the six months ended June 30, 2018
related to borrowings of debt, net of issuance costs, of $12.3 million, and
issuance of $7.9 million of Series B preferred stock, net of issuance costs,
offset by repayments of debt of $16.6 million and taxes paid related to net
share settlement of restricted stock units of $0.3 million. Cash provided by
financing activities during the six months ended June 30, 2017 was attributable
borrowings of debt, net of issuance costs, of $31.4 million, proceeds from the
sale of our common stock, net of issuance costs of $12.6 million, offset by
repayments of debt of $32.1 million and taxes paid related to net share
settlement of restricted stock units of $0.2 million.

Contractual Obligations
Significant commitments that will require the use of cash in future periods
include obligations under operating leases, our contractual payment obligation
assumed upon our acquisition of Hirsch, debt obligations, purchase commitments
and other obligations. Gross committed operating lease obligations are $4.8
million, our contractual payment obligation assumed upon our acquisition of
Hirsch is $3.2 million, the revolving loan facility and interest related
obligation is $13.7 million, notes payable of $2.0 million, and purchase
commitments and other obligations are $15.5 million at June 30, 2018. Total
commitments due within one year are $30.1 million and due thereafter are $9.1
million at June 30, 2018. These commitment levels are based on existing terms of
our operating leases, obligation with suppliers, our contractual payment
obligation and our existing loan agreements as of June 30, 2018.

Off-Balance Sheet ArrangementsWe have not entered into off-balance sheet arrangements, or issued guarantees to third parties.
36

——————————————————————————–Critical Accounting Policies and Estimates
Our condensed consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
(“U.S. GAAP”). The preparation of these financial statements requires management
to establish accounting policies that contain estimates and assumptions that
affect the amounts reported in the condensed consolidated financial statements
and accompanying notes. These policies relate to revenue recognition, inventory,
income taxes, goodwill, intangible and long-lived assets and stock-based
compensation. We have other important accounting policies and practices;
however, once adopted, these other policies either generally do not require us
to make significant estimates or assumptions or otherwise only require
implementation of the adopted policy and not a judgment as to the policy itself.
Management bases its estimates and judgments on historical experience and on
various other factors that we believe to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Despite our intention to establish accurate estimates and assumptions,
actual results may differ from these estimates under different assumptions or
conditions.

As a result of adopting ASC 606 as of January 1, 2018, and the acquisition of
3VR in the first quarter of 2018, there have been material changes in our
critical accounting policies during the three months ended June 30, 2018, as
described in Note 1, Organization and Summary of Significant Accounting
Policies, Note 2, Revenue, and Note 3, Business Combinations, to our condensed
consolidated financial statements included in Part I, Item I of this Form 10-Q.
With the exception of these changes, during the three months ended June 30,
2018, management believes there have been no significant changes to the items
that we disclosed within our critical accounting policies and estimates in
Management’s Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on Form 10-K for the year ended December 31,
2017.

Recent Accounting Pronouncements
See Note 1, Organization and Summary of Significant Accounting Policies, in the
accompanying notes to our unaudited condensed consolidated financial statements
in Item 1 of Part I of this Quarterly Report for a description of recent
accounting pronouncements, which is incorporated herein by reference.
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