A10 Networks, Inc. (ATEN) Q1 2015 Earnings Report, Transcript and Summary

Please standby, we are about to begin. Good day and welcome to this A10 Networks' First Quarter 2015 Financial Results Conference Call. [Operator Instructions] And now I would like to turn the conference over to Ms. Maria Riley. Please go ahead, ma'am.

Thank you, and thank you all for joining us today. I am pleased to welcome you to A10 Networks’ first quarter 2015 financial results conference call. This call is being recorded and webcast live and may be accessed for 90 days via the A10 Networks website, www.a10networks.com. Joining me today are A10’s Founder and CEO, Lee Chen; A10’s CFO, Greg Straughn; and our VP of Global Sales, Ray Smets. Before we begin, I would like to remind you that shortly after the market closed today, A10 Networks issued a press release announcing its first quarter 2015 financial results. Additionally, A10 published a presentation along with its prepared comments for this call and supplemental trended financial statements. You may access the press release, presentation with prepared comments, and trended financial statements on the Investor Relations section of the company’s website. During the course of today’s call, management will make forward-looking statements, including statements regarding our projections for the second quarter operating results, our expectations for future revenue growth, profitability and operating margins, expectations of customer buying patterns and the growth of our business generally. These statements are based on current expectations and beliefs as of today, Mary 4, 2015. A10 disclaims any obligation to update information contained in these forward-looking statements whether as a result of new information, future events, or otherwise. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control that could cause actual results to differ materially. We disclaim any obligation to update these forward-looking statements as a result of future events or otherwise. For a more detailed description of these risks and uncertainties, please refer to our 10-K filed on March 11. Please note that with the exception of revenue, financial measures discussed today are on a non-GAAP basis and have been adjusted to exclude certain charges. A reconciliation between GAAP and non-GAAP measures can be found in the press release issued today and on the trended quarterly financial statements posted on the company’s website. We will provide our current expectations for the second quarter of 2015 on a non-GAAP basis. However, we will not make available a reconciliation of non-GAAP guidance measures to corresponding GAAP measures on a forward-looking basis due to high variability and low visibility with respect to the charges, which are excluded from the non-GAAP measures. Before I turn the call over to Lee, I’d like to announce that management will attend the RBC Mobile and Cloud Networking Investor day in Boston on this Thursday, May 7th and present at the JP Morgan Global Technology, Media, and Telecom Conference on May 19th in Boston and at the Bank of America Merrill Lynch Global Tech conference on June 3rd in San Francisco. We hope to see many of you there. Now I would like to turn the call over to Lee for opening remarks.

Thank you, Maria. I would like to thank you all for joining our first quarter 2015 financial results conference call. Overall, the team executed well during the quarter. We delivered revenue within our guidance and drove leverage through our operating structure, resulting in a 24% sequential improvement in our bottom line. Looking at our results in more detail. Our first quarter 2015 revenue came in at $44 million, reflecting stronger than expected demand in North America, offset by Q1 seasonality and continued weakness in the service provider segment. While we continue to see a cautious service provider spending environment, we gained traction with our security products, and we made good progress toward growing our presence in the enterprise and diversifying our revenue base. Our pipeline remains very strong, our win rate remains consistently high and we are pleased to report that in Q1, we returned to year-over-year product bookings growth. Revenue from the enterprise grew 26% from the prior year and 6% sequentially and accounted for 57% of our total first quarter revenue. In total, we added close to 200 new customers in the quarter and we now serve over 4,000 customers. We saw good demand for our ADC solutions driven by our rich security features including SSL Insight and web application firewall. Industry analysts currently estimate that 20% to 35% of enterprise traffic is encrypted, and they expect this to grow rapidly throughout 2015 and beyond. With the growth in encrypted traffic, we believe we are very well positioned to gain market momentum. Our Thunder ADC solution is the first ADC to offer SSL Insight features and we provide a comprehensive and high performance SSL Insight solution. In the first quarter, we landed a new Fortune 50 customer with our Thunder ADC SSL Insight solution. This customer chose A10 to help protect their network from incoming threats because of our ability to seamlessly scale and inspect SSL traffic as well as load balance between their firewalls. We are very proud of this new win as it was our first sale into this very large enterprise where our largest competitor had a strong hold. We also continue to gain momentum for our Thunder TPS DDoS mitigation security solution and we are receiving positive customer feedback from the recently released fully programmable policy engine. Although TPS revenue remains a small percentage of our total revenue, we are very excited by our momentum among both enterprise and service provider customers. Based on conversations with our customers, we estimate that our TPS opportunity within certain customers could grow to be between three to eight times the initial buy within a two-year period. In Q1, we added a record number of new TPS DDoS mitigation customers, many of which were international. It is important to note that 50% of our TPS customers in Q1 are new to A10, providing us with an opportunity to expand into new areas of their network. Let me share with you a few of our new TPS customer engagements. A North America based broadband provider chose our Thunder TPS solution after repeated outages due to DDoS attacks. In this competitive win, we believe we won because our high-capacity, small form factor product is helping provide both CapEx and OpEx savings to the customers while at the same time increasing the protection of their networks. C4L, a data center colocation provider, chose our Thunder TPS solution because we demonstrated a four-fold increase in the available DDoS mitigation performance on their network versus the competition. And in Japan, both an industry leading enterprise and a marquee service provider customer chose our Thunder TPS solution for an initial deployment. It has been close to one year since we launched our Affinity channel program and we have seen a nice uptick in channel [led] [ph], closed and initiated deals compared with this time last year. Additionally our channel pipeline has grown over 75%. In summary, our high performance Thunder product suite continues to gain momentum in the market driven by our high performance, flexibility and advanced security features as well as our ability to integrate with other leading networking, security and cloud providers. A10 addresses some of today’s most critical application and security challenges. As cyber attacks grow in size and sophistication, the manageability, scalability and flexibility of the network becomes even more important in order to conserve and protect network resources. Our ACOS based Thunder platform enables an open, programmable interface that can easily scale from megabit to terabit of throughput and delivers 2-5 times the performance of our competitors. Our recently introduced proprietary ACOS 4.0, automatically generates Application Programming Interface (API), and provides A10 the agility to deliver new modules, new functions and new features, as well as, rapidly integrate with other solutions. We believe we are well positioned competitively, and we are encouraged by the opportunities we see ahead. Furthermore, we strengthened our executive team with the recent appointment of Sanjay Kapoor as VP of Marketing. Sanjay is well recognized for developing global marketing programs that helped accelerate growth and increase brand awareness at some of the most well known technology companies. With that, I’d like to turn the call over to Greg to review the details of our first quarter financial performance and second quarter guidance.

Thank you, Lee and thank all of you for joining us today. We delivered first quarter revenue of $44 million, compared with $45.7 million in the prior year first quarter. Deferred revenue, consisting almost entirely of customer maintenance and support contracts, was up 36% year-over-year, totaling $59.7 million. First quarter product revenue totaled $30.5 million, representing 69% of total revenue. This compares with $36.4 million or 80% of total revenue in the prior year first quarter. As Lee mentioned, first quarter product bookings grew on a year-over-year basis. Service revenue was $13.5 million, accounting for 31% of total revenue, compared with $9.3 million or 20% in the first quarter of 2014. First quarter revenue from the United States grew 26% year-over-year and 12% sequentially to reach $22.9 million, representing approximately 52% of total revenue. First quarter revenue from Japan was $8.8 million, representing 20% of total revenue, compared with $17.3 million or 38% of total revenue in the same quarter of the prior year, which was unusually high given the backlog from Japan we carried into that quarter. Revenue generated from EMEA was $6.2 million, an increase of 50% over Q1 of the prior year and represented 14% of total revenue. Revenue from APAC, excluding Japan, was $4.6 million, representing 10% of revenue, compared with $4.3 million or 9% in the prior year first quarter. Our enterprise and service provider revenue split this quarter was 57% and 43% of total revenue, respectively. Revenue from enterprise customers totaled $25 million, up 26% from Q1 in the prior year and up 6% sequentially. Service provider revenue was $19 million, compared with $21.7 million in the prior quarter and $25.8 million in the first quarter of 2014. Consistent with the revenue diversification we have seen over recent quarters we did not have any 10% or greater customers in Q1. Moving beyond revenue, all further metrics discussed on this call are on a non-GAAP basis, unless expressly stated otherwise. We delivered a first quarter total gross margin of 76.6%, down 60 basis points when compared with Q4 of 2014. On a constant currency basis versus Q1 of 2014 gross margin was reduced by 50 basis points on a year-over-year basis due to changes in the yen-to-dollar conversion rate. While product gross margin remained relatively in line with the prior quarter and came in at 77.1%, our services gross margin came in at 75.5%, a decline of 167 basis points compared with Q4’14, and an increase of 280 basis points over Q1 of 2014. Services gross margin was impacted by our investment in building out our professional services organization. We ended the quarter with staff of 761, up from 759 at the end of 2014. In Q1 sales and marketing expense was $22.5 million, compared with $24.9 million in Q4 of 2014. On a percentage basis, sales and marketing expense was 51% of revenue, compared with 55% in the prior quarter. In Q1 R&D expense totaled $12.7 million or 28.9% of revenue, compared with $13.1 million and 29% in the preceding quarter. First quarter combined G&A and litigation expense was approximately $7.5 million or 17% of total revenue, compared with $6.8 million or 15% of revenue in Q4. This increase was primarily related to indirect taxes in Q1 and litigation expenses. In total, first quarter non-GAAP operating expenses were $42.6 million. First quarter non-GAAP operating loss was $8.9 million, compared with $9.8 million in the fourth quarter. Our non-GAAP net loss in the first quarter was $9.1 million or $0.15 per share, a 24% improvement when compared with a net loss of $12 million or $0.20 per share in Q4. Basic and diluted weighted outstanding shares for the quarter were approximately 61.5 million shares. Moving to the balance sheet, at March 31, 2015 we had $85.6 million in total cash and equivalents. During the quarter cash used for operations was $5.5 million. We ended Q1 with $52.8 million of net accounts receivable, compared with the Q4’14 balance of $54 million. Average days sales outstanding were 110 days, up from 97 days in the prior quarter. The increase in the Q1 value is primarily related to the above average opening balance at the beginning of Q1 and its impact on calculating the average accounts receivable balance. Moving on to our outlook, to establish our Q2 guidance, we are balancing our Q1 backlog carried into the quarter, bookings to date, growing customer interest in our TPS solution and our growing pipeline with the appropriate conservatism related to the service provider vertical. We expect second quarter revenue to be in the range of $44 million to $47 million. Further, we expect gross margin to remain in the 76% to 78% range. On the income side, we expect operating expenses in Q2 to be between $44 million and $45 million and therefore, expect to report a non-GAAP net loss of between $0.14 and $0.18 per share using approximately 62 million shares on a basic and diluted basis. In studying this, we are assuming a yen exchange rate remains in the range of $1.18 to $1.20. As we progress through 2015, our goal is to continue to drive top line growth while improving our operating margin. And based on our current internal forecast, we expect to reach profitability on a non-GAAP basis during fiscal 2016. With that, I’d like to open up the call for your questions. Operator?

[Operator Instructions] And we will take our first question from Mark Sue with RBC Capital Markets.

I want to pose a question as it relates to the dynamics with the service provider customers. Any thoughts there considering some of your competitors are actually seeing good growth from the service providers. So is it mostly Japan for A10 or is it more broad within the telcos and the cable operators? So perhaps you could give us some qualitative comments with the service providers and how you might be seeing a pipeline shift within that segment?

I will start and Ray can finish. We have a very strong footprint in the service provider sector. We really have not seen any change in these competitive dynamics and service provider is always about timing. Service providers spend on different product at different time. We look our pipeline remains very strong and we have not lost any of the large service provider customers. The service provider win rate, we look at Q1 remained the same as the previous quarter.

And just to pick that up, Lee mentioned the win rate. The win rate remains very strong. That’s actually quite good and when we do a large deal analysis we are seeing about the same number of service provider deals in our large deal analysis, these are deals greater than $1 million in a quarter. But we are seeing in the service provider deals a little bit smaller than what we’ve seen in the past. So we are definitely seeing the service provider headwinds but we are still seeing the volume of deals in the pipeline. So – and that is also the case in Japan as well.

And then on the Fortune 50 competitor - with the ADC SSL win in the Fortune 50, was that a competitive displacement or is that something -- was that an existing A10 customer? I am just trying to see how you were able to get into this account and how you might potentially grow in that account?

That was not an existing A10 customer. Yes, it was a competitive win.

Lastly, Greg, the DSO is above 90 days once again. How should we think about planning for bad debt expense, any thoughts for large or doubtful accounts?

Yes, this is really nothing of note within this quarter. But this was really more of a statistical aberration because we started with such a high balance at the prior quarter. But as far as the quality of receivables there we are not seeing any changes in that grouping.

And the next question comes from Ehud Gelblum with Citi.

A couple of questions. First of all, just to stick on the balance sheet for a moment. The 110 DSOs, Greg, I understand how the math works from the beginning of the quarter but still it’s a very high number. Couple of questions. Was any of that related to the Fortune 50 customer win as in, did you have to give terms that were above and beyond? And I am still a little confused as to why when your competitors have numbers that are literally half of these numbers, how do we end up in the situation in the first place and is it more service provider that is forcing the enterprise and is there a way of kind of just putting stricter terms on some of the deals so that we don’t end up in this situation with the balance sheet but just a little bit tenuous? I had a follow up.

So on the first part of the question, having to do with the large customer we talked about. No, they were not given special terms and the deal closed fairly late in the quarter. So at the end of the quarter, their balance was still well within terms that was in the current period. So that was no impact on the number. In terms of the AR balances themselves, I think that we are in a situation where the mix of business that we have hint to be longer paying customers. I think when we look into markets like Japan where the payment expectations are, like, 45 days plus the first of the month, you get very long standard terms, so that causes the amount that’s in AR in any given time to be large, even though they are in the current bucket. So when we look at the aging of our accounts, we don’t see anything unusual, our current bucket represents the great majority of these and so we don’t see any payment jeopardies, we see these long times of these amounts are outstanding. And so when we look at the payment history, we see fairly consistent payment by these customers. So it’s not something that we worry about, it’s something we are trying to improve because we’d like to see that shorten up. But it’s not an item where we see any particular jeopardies.

Okay, appreciate that. Although I mean is that – I do find it concerning but it’s kind of thing that it does – I think worries a lot of investors. Sticking on the topic of Japan, obviously there has been issues and troubles there, since it peaked a year and a little bit ago. But I thought maybe we kind of were dovetailing out of that at the end of last calendar year. This is their fiscal year in Japan and yet Japan still came down about 20% or so, maybe a little less but still in this quarter. When do we get to the bottom of Japan where it bottoms out, you can start [to see] [ph] seasonality?

I think clearly we do see economic headwinds in Japan. So – but even in that market we are seeing opportunity. If you look at Japan, historically we have a lot of revenue in Japan, came from one large customer. Since we have diversified our revenue base in Japan and also TPS really gained a lot of traction in Japan. So we see Japan as the opportunity but I can never call a bottom until I see a clear rear view mirror.

Was FX, given the weakness in the yen, did that have any impact and not that much on a quarter over quarter basis but still did that have an impact on the Japanese revenue?

Yes, it certainly does. I am glad you asked that because quarter over quarter, Q4 to Q1 there is really not much impact because the yen was flat. But if you look at constant currency and go back to Q1 of ’14, there is about a 12% impact and so on a constant currency basis, our Japan revenue would have been a little bit over $1 million higher that we saw today, and our gross margin would have been about 50 basis points higher as well. So yes, it does have a lingering effect not in the balance – it doesn’t show in income statement, it’s kind of that opportunity cost.

And then if you don’t mind again, Greg, you talked about breakeven in fiscal 2016, was that an EPS or operating margin, and when do you get – when do you expect to get to a cash breakeven?

So that was on operating income basis, we’re talking about that in ’16 and then the cash flow breakeven should be about that same time, perhaps slightly earlier because of the deprecation effect but our cash and book run relatively close to one another, there is not big gaps between the two.

Our next question comes from James Faucette with Morgan Stanley.

Hi, it’s Meta Marshall in for James. A couple of quick questions. The US market seemed to rebound this quarter after kind of weakness in Q3 and Q4. What did you think was kind of most responsible for that? And then if you could just give us – what is the characteristic of kind of the 200 new customers, understanding you have the one Fortune 50 customer but do they tend to be smaller deals, are they large enterprises, just kind of what some characteristic of those 200 customers are would be helpful?

Yes, be happy to talk about that. This is Ray Smets. From a North American perspective, really the underpinning of North America success was really two key factors. The first one was enterprise growth. Without a doubt, obviously it was helped with the significant Fortune 50 win that we had. But also we have been making this investment in building our channel, the Affinity channel program for A10 Networks, and that channel was actually working quite well for us. As Lee mentioned in his prepared remarks, we saw an uptick in channel closed deals as well as channel pipeline development for us in North America. And we saw that as a positive. So despite some of the challenge we saw – the headwinds I would say, we saw in deal size on the service provider side, was enterprise and channel investment that really helped.

Yes and I think just dovetailing after that, is that when you look at across those 200 customers, that’s the same thing that you see as that is penetration within all sides of the enterprise and a large number of these customers trying to come to the channel programs. And so what we are seeing with those customers is kind of the completion strategy we’ve put in place. And it does help the diversity that we have been trying to foster in our revenue stream over the last couple of quarters.

And then one follow up on that, so are the deals that come through the channel, do they tend to be smaller, do they take longer, shorter amount of time to close? I guess is there any distinguishable difference between sales in the channel and kind of sales through your direct sales – traditional sales?

It’s actually – it’s pretty characteristic of what we see normally through our normal and direct touch. So we see deals of various sizes. We like to see the big ones of course but what’s really positive about the investment on channels is that yield volume could go up and the total opportunity value continues to go up. So we think the investment long term will actually pay off.

The new Fortune 50 customer this quarter in Q1 actually was channel initiative.

Next question comes from Catharine Trebnick with Dougherty & Company.

So more back to the enterprise. Are there any markets that you seem to be having more traction into your channel? That’s one. And the other one – has the number of channels that you are now reaching increased?

Catharine, a lot of things hasn’t changed from kind of the channel -- enterprise opportunity. We are seeing them from different categories. The web 2.0, the cloud providers, the gaming providers, and also from the finance sector, so no particular change there but the investment in channel and our visibility into the marketplace gives us more access to these opportunities and from a close rate perspective, our win rate continues to do quite well. We qualify the deals very carefully and then we typically win with the perk [ph]. So from an enterprise perspective, it’s basically steady as it goes, the real challenge here is getting more add-backs.

And then in the service provider, what would you say would be the opportunities you’re getting there? GNET and about any of the new DDoS opportunities, how are you – are you getting enough that bats up the DDoS and are there still opportunities for GNET?

I think in general security area, a lot of service providers talk to us about the ADC really merge with the security is another area, some of these service provider customers are talking to us. Those are the future revenue opportunities within the service provider segment which under the NDA we cannot disclose some of the projects we are working, with some of these service providers. So GNET definitely a wide area.

And just to expand on that a little bit, Catharine. This is Ray again. Our strategy for learn and expand is working really nicely. So we engage the service provider on the ADC front, for example, we take typically get a good add-back for the carrier net. We are certainly leveraging those positions as well to get into the DDoS space as well. So I think it’s really what’s our starting point and where do we expand from but we are really taking all products to all service providers where possible.

And our next question comes from Rohit Chopra with Buckingham.

I just want to get a sense on the competitive environment. I know, Lee, you mentioned win rates are the same but just want to get a sense of what you’re seeing as you move into the security area, if you are bumping into new people there and what that environment is like. And then the second question, Greg, it’s for you. I just want to get a sense of what the minimum level of cash is that you expect at the business because it looks like you continue to burn lot of cash. I just want to get a sense of what your level of comfort is for a minimum, if you don’t mind.

I think we are very excited about our security offering, including TPS and some of the ADC security features such as SSL Insight and the Web Application Firewall. On TPS in Q1, we have the most TPS customer of any quarter in Q1 and 30% of our TPS win – 30% of our TPS customers are new customer to A10. And we are competing with the US back [ph] and we actually like our positioning. And the strategy – our TPS is something really unique in terms of performance, in terms of the policy engine for the API, that can easily integrate with some of the detection solution in the market today. So that puts us in a good position.

Relative to the cash position, I think that this quarter the cash burn rate came down pretty significantly after what we saw last quarter, primarily as the AR balances – last quarter was big use of cash but this quarter we are back down more of that norm, $5.5 million cash used in operations. So when we couple that with our expectation becoming profitable on book and the cash flow basis in 2016, we think of cash levels in the $65 million to $70 million range with the trajectory that we are comfortable that we don’t see any jeopardy coming from the cash side of the business.

[Operator Instructions] And we’ll move to our next question from Rod Hall, JPMorgan.

This is Alex [ph] on behalf of Rod. Thanks for taking my question. Greg, I wanted to understand the OpEx guidance. I thought the initial idea heading into 2015 was to maybe not invest more, a much more in R&D and control [indiscernible] but as a percentage of sales, Q2 OpEx guidance is still running high. Can you probably refresh us on your OpEx thinking for the rest of the year and maybe give a run rate here? And then I have a follow up.

The run rate on OpEx, as we communicated both last quarter and reiterate this quarter is that our expectation is that over the course of the year that the revenue growth rate will exceed the expense growth rate. And there will be some ups and downs as we go through the year and clearly Q1 was a place where we grew much more of the revenue side than on the expense side. Q2 had a little bit of reshuffling of that back to the direction as we picked up some head count for that organization. But over the course of the year it’s very much still our expectation that revenue will outgrow expenses and that’s what sets this up and allows us to focus on and be kind of profitable in 2016. So I wouldn’t extrapolate the expense trend from Q1 to Q2 and make that as extended out for the balance of the year. I think it will moderate via Q2 and out.

Then my follow up is on revenue. If I look at this graphically, it shows top 25 customer repeat purchases, it looks like six of your top 10 customers, 25 customers have not put any every bit orders, given that can you comment on the growth outlook probably for the rest of this year?

So a couple of things to note from that topic because as this will start the Q2, what we mentioned earlier about revenue diversity. And I think that – I noted in the script that this quarter we had no 10% customers and if you remind back 12 months ago, it was roughly the same amount of revenue, little bit less, we had three 10% customers that accounted for 38% of our revenue. Additionally, if we look at our top 10 customers at that point in time, they were 54% of our revenue and now they are 32%. So we’ve seen a very sizable shift and growth in our business in the mid-tier enterprise customers. So that’s been a real growth driver for us. When we look at our top 25 customers, obviously there are service providers in there and they are large enterprise customers and they are very subject to quarter over quarter timing and coming into this quarter, we have seen fairly consistent volume. This just happened to be a quarter where for the timing of projects that fewer bought this quarter and we have seen other quarters where 4 or 5 may have fallen off and not purchased but these are all customers that we continue to be engaged with and they all have projects that are at various stages of our pipeline. So I think the important thing to note is it’s a timing issue, not a competitive loss or competitive dynamic that’s changed. And as we said more than few times, one quarter does not make a trend, the same way we didn’t take 24 – out of that list, 5 bought that they would continue to add every quarter beyond that. So I think it’s just the fiscal thing and the next quarter we’d expect that to go back to something that’s not seven or six out of that list. End of Q&A

And ladies and gentlemen we are out of time for questions. So I would like to turn the conference back over to Mr. Lee Chen for any closing remarks.

Thank you all of our shareholders for joining us today and thank you for your support. Thank you and good day.