Wednesday, October 17, 2012

Infoblox: A Few Warnings

I stumbled onto Infoblox through's top CEO sells feature. Infoblox stood out from last week's list because not only did the CEO sell 195,000 shares, a few other insiders sold the stock in big chunks as well. Below is the full list:
InsiderPositionDateBuy/SellSharesShares Owned Following ThisTrade Price ($)Cost ($1000)Price Change
Since Trade (%)
Andrews Christopher J.EVP, Worldwide Field Ops2012-10-11Sell50,00024,583$201000-5.2Link
Banahan ThomasDirector2012-10-11Sell1,342,2731,834,501$2026845.5-5.2Link
(Click for the stocks that their CFOs have bought)
Nye Wendell StephenExec VP, Product Strategy2012-10-11Sell50,0000$201000-5.2Link
Parekh Sohail M.Exec VP, Engineering2012-10-11Sell60,0000$201200-5.2Link
(Click for the stocks that their CEOs have bought)

Even though someone may argue it's common for company insiders to pocket some profits after IPO, I think it's worthwhile noting that 2 Executive VPs liquidated their shares completely. And one of the director cut his holdings by approximately 40%. Intrigued, I pulled the company's first ever 10-K report. 

Infoblox Inc, in the company's own words, "is a leader in automated network control and provides an appliance-based solution that enables dynamic networks and next-generation data centers. Our solution combines real-time IP address management with the automation of key network control and network change and configuration management processes in purpose-built physical and virtual appliances."  

I'm not an expert on dynamic networks companies but from reading the business description, I obtained a general idea on what the business does. It's not hard to tell that this company is operating in a highly competitive and constantly-changing environment. 

The company's disclosure of risk factors is really interesting, here are a few ones that can immediately raise concerns: 
1. An investment in our common stock involves a high degree of risk, you might lose all or part of you investment.  
2. The company has a history of losses, and my not become profitable or maintain profitability. In fact, since the company's inception in 1999, the company has only made money in 1 year -2010. 
3. Operating results may be affected as a result of the guidance under GAAP. 
4. The company expects to incur significant additional expenses in expanding its sales and development personnel and its international operations in order to achieve revenue growth. 
5. The company often makes acquisitions without being certain that they will result in products or enhancements that the market will accept or that they will expand its shares of its market. 
6. The company relies on a Sole Source Third-Party Manufacturer for substantially ALL of its products and depend on it for the supply and quality of its products. 
7. The company is an "emerging growth company" and not required to comply with Sarbanes-Oxley Act if it can maintain the "emerging growth company" status. 
8. The company's stock could decline as a result of the large number of outstanding shares of its common stock eligible for future sale. 37.1 million shares are restricted until mid-October 2012. (Guess where we are right now-mid October!)

The company performs a GAAP-Non GAAP reconciliation for Net Income and EPS. Under this reconciliation, losses were magically converted into gains. Now, there are two reconciling items-stock based compensation and intangible asset amortization expenses. Stock based compensation expense is $10 million for 2012 and $5 million for 2011 and GAAP net losses were $8 million and $5 million respectively. By not considering SBC as part of regular business, the company actually thinks it makes money. However, the company claims that "stock-based-compensation has been, and will continue for the foreseeable future, a significant RECURRING expense in our business and is an important part of our employee's compensation that affects their performances." How is excluding a significant  "RECURRING" expense a better measure for a company's financial results? 

Another red flag I noticed lies in the company's Statement of Cash Flows. For a company that loses money continually, its cash flow from operations is actually not bad at all. In fact, the company's CFO was $21 million in both 2011 and 2012 compared to losses of  $5 million and $8 million respectively. 

What's driving this CFO-Net Income divergence. A deeper look at the SCF reveals that the positive CFO is driven primarily by adding back stock-based-compensation expense (sounds familiar) and significant increase in deferred revenue, which is a liability account and a "cookie jar" reserve account. Deferred Revenue increased $19 million in 2011 and $14.7 million in 2012.  Is it a mere coincidence that a common accounting gimmickry when sales fall short of expectation is to release deferred revenue account?

Let's not forget what Ben Graham has told us long ago: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative." It seems like Infoblox does not meet the requirement of an investment operation. 

If you own shares of Infoblox, I encourage to carefully reevaluate your decision. 

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