A10 Networks, Inc. — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2014; comparative results are for the three and nine months ended September 30, 2013. The company provides application networking products and related support services, including ADC, CGN and DDoS protection solutions. It completed its IPO in March 2014.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $43.4 million | $39.8 million | $134.3 million | $99.5 million |
| Gross profit | $31.7 million | $31.1 million | $102.2 million | $77.3 million |
| Gross margin | 72.9% | 78.1% | 76.1% | 77.6% |
| Operating loss | $(11.4) million | $(1.1) million | $(16.4) million | $(18.0) million |
| Net loss | $(12.3) million | $(2.7) million | $(18.7) million | $(21.5) million |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $(13.5) million | $(20.7) million |
Q3 revenue rose 9.0%; services revenue increased 56.4% to $11.8 million, while product revenue declined 2.1% to $31.6 million. For the first nine months, revenue increased 34.9%, with product revenue up 30.0% and services up 53.6%. Q3 basic and diluted loss per share was $0.21, versus $0.38 a year earlier; nine-month loss per share was $0.45, versus $2.43.
Q3 gross margin fell 5.2 percentage points year over year, primarily reflecting geographic sales mix, yen depreciation and higher inventory reserves, including obsolete inventory associated with adoption of the Thunder Series. Operating expenses increased 33.8% in Q3, driven by sales and marketing, R&D and G&A investment. Nine-month operating expenses rose 24.4%; reported litigation benefit helped narrow the operating loss.
Liquidity, debt and cash flows
- At September 30, 2014, cash and cash equivalents were $107.1 million, working capital was $107.7 million, and total assets were $190.4 million.
- Total liabilities were $84.7 million; deferred revenue totaled $50.9 million. No borrowings were outstanding under the $35 million revolving facility, and the company reported compliance with its covenants. The facility is secured by substantially all assets, including intellectual property, and matures September 30, 2016.
- Nine-month operating cash use was $13.5 million; investing cash use was $5.4 million, primarily capital expenditures. Financing provided $105.2 million, mainly from $121.0 million of net IPO proceeds, partly offset by repayment of $20.0 million of credit-facility borrowings.
- Cash increased $86.3 million during the nine months. Management stated existing cash and operating cash inflows were expected to cover anticipated needs for at least 12 months. It anticipated approximately $2.7 million of additional capital expenditures in the remainder of 2014.
Material changes and management commentary
- Q3 North American revenue was below expectations due to longer sales cycles on large deals and lower service-provider spending. North American service-provider revenue fell 62% year over year; product revenue from those customers fell 78%. Management warned of a possible further slowdown in North American service-provider spending and continued near-term revenue fluctuations.
- Nine-month growth reflected Thunder Series adoption, expansion in international markets and the absence of the adverse effects of the previously settled Brocade litigation. Q3 growth was supported by services and international regions, while U.S. revenue declined 23% year over year.
- Management expects services revenue to increase sequentially as the installed base grows, and expects gross margin to be consistent with its historical average. It also expects continued investment in product development, sales and marketing, international expansion and public-company infrastructure, which may constrain near-term profitability. No specific revenue or earnings guidance was provided.
- In May 2014, a settlement with a legal-services provider reduced a previously accrued $12.0 million contractual liability: A10 paid $5.0 million and recorded a $7.0 million litigation benefit. Radware litigation was settled in August 2014; terms are confidential. A separate Parallel Networks patent case remained pending, with trial scheduled for June 2016; the company could not estimate a possible loss and recorded no reserve.
Risks, contingencies and other notable items
- Customer concentration and irregular large purchases create revenue volatility: the ten largest end-customers represented approximately 41% of nine-month revenue, and service providers represented approximately 45%. One customer accounted for 12% of gross receivables at quarter-end.
- Foreign-exchange exposure, particularly to the Japanese yen, affected revenue and margins. The company reported no currency hedging; nine-month foreign-exchange loss was approximately $0.7 million.
- The company reported net losses and an accumulated deficit of $165.8 million, and maintained a full valuation allowance against net federal and state deferred tax assets.
- Management concluded disclosure controls were effective at a reasonable-assurance level and reported no material quarterly change in internal control. Separately, the risk-factor discussion disclosed significant deficiencies concerning the design, documentation and execution of the financial close and reporting process, including account-reconciliation and tax-provision reviews, and stated remediation was ongoing.
- Other stated risks include intense competition, product and inventory obsolescence, reliance on third-party manufacturers and limited-source components, intellectual-property claims, product security or defect risks, and costs of operating as a public company.
Important facts for investors to verify
- Whether North American service-provider spending and large-deal sales cycles recover, and how they affect product revenue.
- Whether services growth and international expansion offset product-revenue volatility, and whether gross margin stabilizes after inventory and currency effects.
- Cash burn, working-capital requirements, planned investment and the company’s ability to sustain liquidity while operating at a loss.
- Progress remediating the disclosed financial-reporting control deficiencies, alongside management’s conclusion that disclosure controls were effective.
- Developments and potential financial exposure in the Parallel Networks litigation and any other legal claims.
- Effects of stock-based compensation and equity-plan dilution; the filing reported $8.3 million of stock-based compensation for the first nine months of 2014.