A10 Networks, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Comparative periods are the corresponding 2014 periods; balance-sheet comparisons are with December 31, 2014. Dollar amounts below are in millions unless noted.
Business context
A10 sells application networking products—including application delivery controllers, carrier-grade network address translation and DDoS protection—on hardware and as virtual appliances. Services are primarily maintenance and support. The company reported one operating segment and approximately 4,500 customers across 73 countries.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $50.8 | $43.4 | $142.3 | $134.3 |
| Gross profit / margin | $38.1 / 75.0% | $31.7 / 72.9% | $107.2 / 75.3% | $102.2 / 76.1% |
| Operating loss | $(8.6) | $(11.4) | $(31.6) | $(16.4) |
| Net loss | $(9.0) | $(12.3) | $(32.7) | $(18.7) |
| Net loss per share | $(0.14) | $(0.21) | $(0.53) | $(0.45) |
- Q3 revenue grew 16.9%; product revenue rose 11% and services revenue rose 33%. For the first nine months, revenue grew 6.0%, with services up 35% but product revenue down 3%.
- Q3 gross margin improved 2.1 percentage points, while nine-month gross margin declined 0.8 points. Management cited Q3 product mix and lower inventory reserves as favorable; yen weakness and increased service-team costs were headwinds.
- Operating expenses increased 8% in Q3 and 17% year to date. Year-to-date operating loss widened, including because 2014 included a $7.0 million litigation-related benefit from settlement of a contractual liability.
- Nine-month operating cash flow was positive $7.6 million, versus cash used of $13.5 million in 2014. Investing used $2.6 million; financing provided $3.5 million. Cash increased $8.6 million to $100.5 million.
- At September 30, cash was $100.5 million, working capital $91.0 million, total assets $178.0 million and total liabilities $97.0 million. Deferred revenue totaled $66.3 million, up from $57.2 million at year-end 2014.
- No borrowings were outstanding on the $35 million revolving credit facility; the company reported compliance with its covenants. It also had $0.3 million in capital lease obligations. Management said available resources should meet anticipated needs for at least 12 months.
Material changes and management commentary
- Revenue growth was concentrated in services and in the U.S., EMEA and Asia Pacific excluding Japan. Nine-month Japan revenue fell 32%, which management attributed to lower product revenue, a high comparison-period backlog and adverse yen exchange rates.
- Enterprise customers accounted for 58% of nine-month revenue versus 51% in 2014; service providers accounted for 42% versus 49%. The ten largest end-customers represented approximately 30% of nine-month revenue, compared with 41% in 2014.
- Stock-based compensation was $13.2 million for the first nine months, up from $8.3 million; $26.6 million of related expense remained unrecognized, expected to be recognized over a weighted-average 2.6 years.
- Management expects sales and marketing and R&D expenses to continue rising as it invests in growth; G&A is expected to increase slightly. It cautioned that such investment may affect short-term profitability. No numerical revenue or earnings guidance was provided.
Risks, contingencies and unusual items
- Internal controls: Disclosure controls were deemed ineffective as of September 30 solely because of a material weakness in controls over stock-based compensation calculations for the 2014 Employee Stock Purchase Plan. Remediation work continued; management targeted remediation by year-end 2015, subject to testing.
- Litigation: A June 2015 settlement of the Parallel Networks patent case provided a fully paid-up license and dismissal. Securities class-action litigation related to the IPO and a shareholder derivative action remained pending; damages sought were unspecified and no reserve was recorded because potential loss could not be reasonably estimated.
- Foreign exchange: The company had no currency hedges. Yen movements affected revenue and margins; management expected foreign-exchange effects to remain relevant.
- Business risks: Results can fluctuate with large, irregular customer orders, long sales cycles, competition, product mix, customer spending, and third-party manufacturing and component supply. Management also cited the possibility of a North American service-provider spending slowdown.
- The company maintained a full valuation allowance against its U.S. federal and state deferred tax assets and recorded $2.4 million of unrecognized tax benefits.
Important facts for investors to verify
- Whether the stock-based compensation control weakness was remediated and operating effectively after the quarter.
- Progress and potential financial exposure from the pending securities class action and derivative litigation.
- Whether services growth can offset weaker product revenue, particularly in Japan, and how currency movements affect margins.
- Revenue concentration and the timing of purchases by large customers, alongside the company’s path toward profitability as expenses rise.
- Cash-flow sustainability, including the contribution from receivables collection and deferred-revenue growth, and continued compliance with credit-facility covenants.