VA LINUX SYSTEMS INC (LNUX)
Quarterly Report (SEC form 10-Q)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
[VA Linux disclaimer]
Special Note Regarding Forward Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements, including, without limitation, statements regarding future financial performance and results of our operations; composition of revenues between our various product, support, OSDN and service offerings; the Company's sales strategy and anticipated benefits from such strategy; future growth of SourceForge.net(TM) and expected benefits of SourceForge Onsite; successful adoption of Open Source technologies by large corporations; the Company's ability to benefit from large corporation's adoption of Open Source technologies; demand for the Company's consulting services and OSDN(TM); anticipated benefits from cost-cutting and other restructuring actions; technological trends in the computer industry; our future product and service offerings, costs and features; the ultimate success of our product and service offerings; anticipated domestic and international revenue; future gross margin on products and services; sufficiency of the Company's existing cash balances and credit facilities to fund operations; management's strategy, plans and objectives for future operations; demand for our products and service plans; the future functionality, business potential, demand for and adoption of build-to-order software, the Build-to-Order Software Selector (BOSS), and OSDN; growth in adoption of and support for the Open Source development model; and the expansion of the range of Open Source software applications. Our actual results may differ materially from those projected in the forward-looking statements due to various factors set forth in this report, including as set out in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The following discussion and analysis should be read in conjunction with the section entitled "Risk Factors," as well as the condensed consolidated financial statements and the notes thereto included in Item 1 in this Quarterly Report, and our other filings with the SEC made from time to time.
[streetlawyer's own disclaimer] Although this anonymous website post discusses newsflow related to a publicly traded security, it does so in a purely journalistic manner and no opinion on the advisability of buying, selling or holding any traded security is given or implied. A certain amount of care has been taken to ensure accuracy of figures, but not anything approaching the level which might be expected of a paid professional and no statement of fact below should be relied upon for any decision purpose whatever unless independently verified.
..... and on with the 10-Q my friends ...
We are a leading provider of Linux-based solutions, integrating systems, software and services. Our broad-based technical expertise in systems and software design, as well as our focus on the Linux operating system and related Open Source solutions, enable us to provide high-quality Linux systems designed for optimal performance, reliability and scalability. To further expand our service offerings, we established a professional service organization in September 1999 and OSDN in June 2000.
[snip history and description of VA Linux' business] --SL
RESULTS OF OPERATIONS
The following table sets forth our operating results for the periods indicated as a percentage of net revenues, represented by selected items from the unaudited condensed consolidated statements of operations. This table should be read in conjunction with the condensed consolidated financial statements and the accompanying notes thereto included in this Quarterly Report.
[snip unwieldy table] -- SL
THREE AND NINE MONTHS ENDED APRIL 28, 2001 AND APRIL 28, 2000
The Company has two reportable business segments for revenue: Systems and Services; and OSDN. The Company allocates resources to and evaluates performance of its segments based on revenue.
Net revenues for the three months ended April 28, 2001 decreased by approximately $14.3 million or 41% to $20.3 million, compared to net revenues of $34.6 million for the three months ended April 28, 2000. The Systems and Services business segment and the OSDN business segment accounted for $17.0 million or 83.8% and $3.3 million or 16.2% of net revenues, respectively, for the three months ended April 28, 2001, compared to $34.6 million or 100% and $0 million or 0% of net revenues, respectively, for the three months ended April 28, 2000.
Net revenues for the nine months ended April 28, 2001 increased by approximately $49.3 million or 71% to $118.9 million, compared to net revenues of $69.6 million for the nine months ended April 28, 2000. The Systems and Services business segment and the OSDN business segment accounted for $106.5 million or 89.6% and $12.4 million or 10.4% of net revenues, respectively, for the nine months ended April 28, 2001, compared to $69.6 million or 100% and $0 million or 0% of net revenues, respectively, for the nine months ended April 28, 2000.
To summarise, sales are up nine-months on nine-months, but down 41% quarter on quarter. In other words, the stock market (which has been selling off VA like warm Ebola since January) saw this one coming.
The decrease in net revenues for the three months ended April 28, 2001, as compared to the three months ended April 28, 2000, was due primarily to a decrease in the sales volume of our Internet server products resulting from the general economic slowdown and lower pricing due to market competition, while being partially offset by the increased revenues from web-based advertising sales and professional services. The increase in net revenues for the nine months ended April 28, 2001, as compared to the nine months ended April 28, 2000, was due primarily to the increases in sales volume of our Internet server products and professional services and to the newly introduced web-based advertising sales.
Surely can't have much to do with advertising sales - half the ads on OSDN are "house ads" for other VA companies, or for Thinkgeek products, who can't pay too well. The increase is due to the launch of SourceForge Onsite, the product that lets you pretend you're doing "Open Source" while not actually doing so. Which isn't to say that SFOS is a bad product - it's very good. But will it save VA as an Open Source company?
For the third quarter in fiscal 2001, our top ten customers accounted for approximately 45.5% of net revenues, as compared to 44.4% of net revenues for the same period in fiscal 2000. The only customer to account for more than 10% of net revenue in the third quarter of fiscal 2001 was Akamai Technologies, which represented 26.2% of net revenues. For the first nine months in fiscal 2001, our top ten customers accounted for approximately 41.4% of net revenues, as compared to 34.0% of net revenues for the same period in fiscal 2000. Akamai Technologies, which represented 23.9% and 16.1% of net revenues, was the only customer to account for more than 10% of net revenues in the first nine months of fiscal 2001 and fiscal 2000, respectively.
This is bad. It's been known for at least a year that VA is a one-client company - effectively, if anything happens to Akamai, or if they find another vendor, VA is in serious trouble. Not so long ago, VA were telling us that they had plans to land more big accounts to diversify revenue streams a bit more ....
No other customer accounted for more than 10% of net revenues during any of the periods presented. We have limited visibility of future revenue but currently expect revenues to be sequentially flat or vary by plus or minus 15% as a result of the slowdown in the economy and our focus on enterprise customers which have a longer sales cycle.
"Limited visibility" means what it says; this is a crap shoot. VA's clients equal Akamai, plus a load of tiny dot coms, which are going down like jelly shots on the Fourth of July. Remember the bit abut "focus on enterprise customers", it comes up again later.
COST OF REVENUES
Cost of revenues decreased to $25.1 million for the three months ended April 28, 2001, as compared to $28.4 million during the same period ended April 28, 2000. Cost of revenues for the first nine months of fiscal 2001 increased to $118.2 million from $58.7 million for the same period in fiscal 2000. The gross margin percentage was (23.6%) and 0.6% for the three and nine months, respectively, ended April 28, 2001, as compared to 17.8% and 15.7% for the three and nine months, respectively, ended April 28, 2000. The decline in margin for the three months ended April 28, 2001 was primarily due to decreased leverage of our manufacturing, customer support, and professional service infrastructure as total revenue decreased and key personnel were retained, and to additional charges of $3.4 million primarily from an inventory write-off caused by the closing of our San Diego operations and severance attributable to 69 people, of which 28 former employees had been terminated as of April 28, 2001. The decline in margin for the nine months ended April 28, 2001 was primarily due to an additional inventory provision of $17.4 million to establish a reserve for excess material that resulted from a high level of inventory compared to the Company's current reduced expectations for systems and services revenue, restructuring charges of $3.4 million, and from lower selling prices. Pricing pressures due to the competitive market, the liquidation of excess inventory, potentially below our costs, changes in sales volume, and changes in customer demand may adversely impact our gross margins.
In other words, VA's costs are at rock bottom. Fair enough, they've been hit by one-off restructuring charges, but the fact remains that there is no fat left to trim - they're even having to pay up to "retain key people". Unless revenues start to arrive, they're going to have to start making cuts which will strike at the heart of the business.
SALES AND MARKETING EXPENSES
In absolute dollars, sales and marketing expenses increased to $9.7 million and $32.7 million for the three and nine months, respectively, ended April 28, 2001 from $7.6 million and $19.8 million for the three and nine months, respectively, ended April 28, 2000. For the three and nine months of fiscal 2001 ended April 28, 2001, the increase primarily reflects expenses associated with increased branding activities for our new products, costs related to new locations and costs related to the OSDN. Sales and marketing expenses were 47.7% of net revenues for the third quarter of fiscal 2001 and 27.5% of net revenues for the first nine months of fiscal 2001, an increase of 25.8 percentage points when compared to the third quarter of fiscal 2000 and a decrease of 0.9 percentage points when compared to the first nine months of fiscal 2000. The increase as a percentage of net revenues for the third quarter of fiscal 2001 was primarily due to revenues significantly decreasing while spending for branding activities increased. The decrease as a percentage of net revenues for the first nine months of fiscal 2001 was primarily due to leveraging our investment in marketing expenses as revenues significantly increased. We expect that sales and marketing expenses will remain relatively constant or slightly decrease in absolute dollars.
Great self-delusions of our time: the check's in the post, I won't come in your mouth and "marketing expenses will remain constant". The branding expenditure is not a one-off; if it had been, they wouldn't still be spending on brand-building for OSDN when it was first launched over a year ago.
However, due to the limited visibility of future revenue, sales and marketing expenses may increase as a percentage of net revenues.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist of payroll and related expenses for software and hardware engineers and cost of materials for prototyping and testing units. We expense all of our research and development costs as they are incurred. Research and development, as a percentage of net revenues, was 23.7% and 12.1%, respectively for the three and nine months ended April 28, 2001 and 8.6% and 11.8%, respectively for the three and nine months ended April 28, 2000. In absolute dollars, research and development expenses increased to $4.8 million for the three months ended April 28, 2001 and $14.4 million for the first nine months of fiscal 2001 from $3.0 million and $8.2 million for the three and nine months ended April 28, 2000. The increase in absolute dollars was due to an increase in engineering personnel and spending for prototyping material for new product development. The increase as a percentage of net revenues was due to revenues significantly decreasing while spending increased. We expect to continue to invest in system design, Open Source software and other research and development initiatives. Additionally, we expect research and development expenses to be relatively constant or to slightly decrease in absolute dollars. However, due to the limited visibility of future revenue, research and development expenses may increase as a percentage of net revenues.
Interesting to see that VA is still increasing spending on R&D - this is usually the first thing to be cut, and the fact that it hasn't been is the first spot of good news so far. The story this paragraph is telling us is that they've been spending on developing new products. How do they plan to launch these while keeping "sales and marketing expenses relatively constant"?
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses consist of salaries and related expenses for finance and administrative personnel, professional fees and costs associated with implementing and expanding our information systems. General and administrative expenses, as a percentage of net revenues, were 23.5% and 15.3%, respectively, for the three and nine months ended April 28, 2001 and were 6.0% and 7.5%, respectively, for the three and nine months ended April 28, 2000. In absolute dollars, general and administrative expenses increased to $4.8 million and $18.3 million, respectively, for the three and nine months ended April 28, 2001 from $2.1 million and $5.2 million, respectively, for the three and nine months ended April 28, 2000. The increase in absolute dollars for the third quarter of fiscal 2001 was primarily due to an increase in administrative personnel and the associated costs of new business activities. The increase in absolute dollars for the first nine months of fiscal 2001 was primarily due to an additional provision for bad debts of $2.5 million, an increase in administrative personnel and the associated costs to support our increased operations. The additional bad debt provision of $2.5 million was a result of a deterioration of the Company's ability to obtain payment from certain "dot-com" customers.
We do not intend to increase our current level of spending to support our infrastructure, and, as a result we expect general and administrative expenses to be relatively constant or to slightly decrease in absolute dollars in the future. However, due to the limited visibility of future revenue, general and administrative expenses may increase as a percentage of net revenues.
This is where the squeeze will first be seen. You can always squeeze the G&A budget by 5 to 10 per cent; perhaps more in the context of a company that's been run with a plentiful supply of IPO cash in the recent past. A 10% reduction in overhead would only be worth $2-2.5mn, however. That might prop up the R&D budget if revenues remained constant; if sales took another drop, it's meaningless.
RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES
[snip - synopsis is that they're treating this in a quite prudent fashion, writing off assets that might still be worth something] -- SL
AMORTIZATION OF DEFERRED STOCK COMPENSATION EXPENSE
In connection with the grant of stock options to employees during fiscal 1999 and prior to our initial public offering in fiscal 2000, we expensed deferred stock compensation of $2.7 million and $8.1 million, respectively, for the three and nine months ended April 28, 2001. We expensed $4.6 million and $11.7 million, respectively, of deferred stock compensation for the three and nine months ended April 28, 2000.
In connection with our acquisitions, we amortized $17.2 million and $53.0 million, respectively, of compensation expense for the three and nine months ended April 28, 2001.
Stock options - what happened to these? the insider trades screen on Yahoo will tell you. I see that Larry Augustin still doesn't think the stock is cheap enough for him to buy.
AMORTIZATION OF GOODWILL AND INTANGIBLES
WRITE-OFF OF IN-PROCESS RESEARCH AND DEVELOPMENT
[both snipped] -- SL
INTEREST AND OTHER INCOME, NET
Interest and other income, net includes income from our cash investments, net of other expenses. Net interest and other income of $1.7 million and $5.4 million, respectively, for the three and nine months ended April 28, 2001 decreased from $2.0 million and increased from $3.2 million when compared to the same periods, respectively, in the prior year. The decrease for the three months ended April 28, 2001, was primarily due to a lower cash balance, while the increase for the first nine months was primarily due to a higher average cash balance for the period. We expect interest and other income, net to decline as our cash balance decreases to support our operations.
The "burn rate". This line tells us that the accounting picture is not misleading - VA is running down cash. VA says it has about $100mn left, which makes it interesting that they've generated $1.7mn of "interest and other income". If this was all interest on the cash balance, it would imply an annual yield of 6.9% -- well above current CD rates. The highest current CD rate available on www.bankrate.com is 4.5%. To generate $1.7mn of income at this rate would imply that the average balance over the period had been $153mn. Either there's a lot of "other income" in here, or that's a pretty high quarterly "burn rate".
As of April 28, 2001, we had federal and state net operating loss carry-forwards for tax reporting purposes available to offset future taxable income. The federal net operating loss carry-forwards expire at various dates through 2021 to the extent that they are not utilized. We have not recognized any benefit from these net operating loss carry-forwards because of uncertainty surrounding their realization. The amount of net operating losses that we can utilize is limited under tax regulations because we have experienced a cumulative stock ownership change of more than 50% over the last three years.
LIQUIDITY AND CAPITAL RESOURCES
At April 28, 2001, cash and cash equivalents and short-term investments totaled $99.1 million, down from $176.3 million at July 28, 2000. This decrease was due to cash used in operating activities and cash used to acquire property and equipment.
Heh, my average balance figure wasn't too far off!
For the nine months ended April 28, 2001, we used $62.1 million in cash for operating activities, compared to $12.1 million for the nine months ended April 28, 2000. This represents an increase of 413% and is primarily due to an increase in our net loss of $235.2 million for the nine months ended April 28, 2001, compared to our net loss of $42.2 million for the nine months ended April 28, 2000. The increase in our net loss is primarily due to the amortization of goodwill of approximately $71.4 million, the amortization [my bolds - SL] of compensation expense of approximately $53.0 million, both in connection with our acquisitions, restructuring costs and other special charges of $43.4 million, and to an increase in our operating expenses for sales and marketing, research and development, and general and administrative purposes.
If the person who wrote this can tell me how "amortization" (the quintessential non-cash item) reduced cash balances by $73mn, let them post it here. The fall in cash was driven, purely and simply, by an excess of costs over revenues.
For the nine months ended April 28, 2001, $2.7 million was provided by investing activities and for the nine months ended April 28, 2000, we used $25.1 million in cash for investing activities. In the nine months ended April 28, 2001, cash provided by investing activities was from the sale of short-term marketable securities. We used cash for the purchase of computer and facilities-related assets, and for acquisition-related activities. In the nine months ended April 28, 2000, we used the cash for investing activities for acquisition-related activities and for the purchase of property and equipment.
For the nine months ended April 28, 2001, and April 28, 2000, we generated $2.5 million and $143.9 million in cash from financing activities, respectively. In the nine months ended April 28, 2001, cash provided by financing activities was due to proceeds from the issuance of common stock, partially offset by payments on notes payable. In the nine months ended April 28, 2000, cash provided by financing activities was due primarily to the proceeds from our initial public offering.
Worrying. It's all stock issue and "short term marketable securities". What you'd like to see here would be the support of a big bank, with the balance sheet to lend and bring VA through a short-term financing crunch to see it through to profitability.
[snipped, irrelevant] -- SL
RECENT ACCOUNTING PRONOUNCEMENTS
[most of these appear to be industry boilerplate, and have been snipped. All except the first ] -- SL
RISKS RELATED TO COMPETITION WITHIN OUR INDUSTRY
IF WE FAIL TO ATTRACT AND RETAIN LARGER CORPORATE AND ENTERPRISE-LEVEL
CUSTOMERS, OUR REVENUES COULD DECLINE SUBSTANTIALLY. We face competition from different sources, and we must compete effectively against other current and future competitors to retain and expand our customer base. To date, our revenues have been principally derived from smaller companies in the Internet marketplace. We have begun to focus our sales and marketing efforts upon larger corporate and enterprise-level customers. This strategy to broaden our customer base by, among other things, pursuing business opportunities from larger corporate and enterprise accounts may fail to generate sufficient revenue to offset the substantial demands that this strategy will place on our business, in particular the longer sales cycles, higher levels of service and support and volume
pricing and terms that larger corporate and enterprise accounts often demand. A failure to successfully obtain more of our revenues from larger customers could materially adversely affect our operations.
Again, VA seems to believe it can do this without increasing its marketing spend. Using, perhaps, the same sales and marketing strategy that has, so far, failed to land them any big clients other than Akamai? There is some cognitive dissonance going on here.
These guys need to understand, and quickly, that profit is the difference between revenue and expense. Expenses appear to be cut to the bone. So they need to grow revenues. Either the Internet booms back up, or they get some more enterprise clients - competing against the sales forces of IBM and the like (in fairness, this is disclosed as a material risk). I suppose if you want to run a company without "marketroids", you need an environment in which the fish will snap at an unbaited hook. Unless the clue train arrives soon, there are problems.
If VA cut capital expenditure to the bone (so that the only remaining drain was its operating loss), made no more provisions (which it could afford to do; it has been very conservative up to now), kept its revenues constant (quite optimistic given that marketing expenditure is not going to change), and squeezed the G&A budget by 10%, we could make the following assumptions:
This gives a burn rate of $31.1mn per quarter. Which gives VA three quarters to reach profitability, or it will have to cut core functions. Larry Augustin thinks they can make it by October 2002. That's five quarters, by my countin'. Something's gotta give.