A10 Networks, Inc. (ATEN) Q3 2015 Earnings Report, Transcript and Summary

Good day, everyone. And welcome to today's A10 Networks' Third Quarter Financial Results Conference Call. At this time all participants are in a listen-only-mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note this call maybe recorded. I will be standing by if you should need assistance. It is now pleasure to turn the conference over to Ms. Maria Riley. Your may begin.

Thank you all for joining us today. I am pleased to welcome you to A10 Networks’ third 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 third 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 our fourth 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, October 29, 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 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 most recent 10-Q filed on August 6. 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 fourth 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 Cowen Networking and Cyber Security Summit in New York in December and we hope to see many of you there. Now I would like to turn the call over to Lee for opening remarks. Lee?

Thank you, Maria. I would like to thank you all for joining our third quarter 2015 financial results conference call. I am pleased to report another strong quarter that included achieving record revenue for the second consecutive quarter. As we continue to execute on our growth strategy and deliver results. We also continue to drive leverage through our operating structures and improve our bottom line by 50% year-over-year. Additionally, we generated $4.2 million in cash from operations. Looking at our top line performance in more detail, total revenue grew 17% year-over-year and 7% sequentially to reach a record of $50.8 million. Total revenue grew 11% over last year and 5% over Q2 to reach $35 million and we achieved record enterprise revenue of $30.4 million, up 15% from last year. Our growth this quarter was driven by sales of all high end security focused Thunder product, including our ADC with advanced security features, such as SSL insight and our Thunder TPS DDoS mitigation solution in which part of our revenue grew 17% sequentially. The innovation we had made in security are opening new doors for A10, those within new and existing customers and partners. I will like to highlight a few recent wins where our products are being deployed in security environments. A mobile cloud operation provider in the US shows our Thunder TPS platform as a backbone for their DDoS as a service offering. A large US service provider customer selected our Thunder TPS platform to ward off volumetric DDoS attacks on their public cloud. While these carriers already an A10 customer, this was our first win into their cloud infrastructures. To improve overall security a Fortune 500 technology company selected our Thunder ADC with SSL to encrypt and decrypt data between their data centers, and as a branch of the US government looking to improve performance and overall security for their web and email environments, turning to A10 [ph] Thunder ADC with SSL Insight. Our device technology platform is based on all highly flexible and scalable ACOS software at the core of our ability to add new customers, expand within existing customer and quickly bring new product to the market. We have worked to expand all addressable market and diversify our customer base by introducing new security products and features. Based on the market trends we see today, we believe the security features will continue to converge on to an ADC base platform. With our highly scalable, flexible and cloud ready ACOS software platform, we see significant market expansion opportunities as the industry continues to converge. We plan to announce a new standalone security solution on November 10. We look forward to sharing the details of our new product with new demand. In summary, we are pleased with our third quarter performance. We believe we are making substantial progress in executing our strategy to build a strong foundation for long-term growth, while at the same time, improving our bottom line and driving closer towards profitability. So with that, I would like to turn the call over to Greg to review the details of our third quarter financial performance and fourth quarter guidance. Greg?

Thank you, Lee and thanks all of you for joining us today. Third quarter revenue grew to $50.8 million, up 17% compared with $43.4 million in the prior year. Deferred revenue grew 30% year-over-year to reach a record high of $66.3 million. Third quarter product revenue grew 11% to $35 million, representing 69% of total revenue, compared with $31.6 million or 73% of total revenue in the prior year third quarter. Service revenue grew 33% to $15.8 million, or 31% of total revenue, compared with $11.8 million or 27% in the third quarter of 2014. From a geographic standpoint, third quarter revenue from the United States grew 23% year-over-year to reach $25.1 million or 49% of total revenue. Third quarter from Japan was $8.8 million or 17% of total revenue, compared with $9.9 million or 23% of total revenue in the third quarter of 2014. On a constant currency basis Japan revenue would have been was flat year-over-year. Revenue from APAC excluding Japan grew 27% year-over-year and 44% sequentially to reach $8 million or 16% of total revenue. And in EMEA we generated record revenue of $7.3 million or 14% of total revenue, which represents a 48% year-over-year increase. Our enterprise and service provider revenue split this quarter was 60% and 40% of total revenue, respectively. We achieved record enterprise revenue of $30.4 million, representing a 10% increase from the prior quarter and up 15% from Q3 of last year. Service provider revenue came in at $20.4 million, compared with $20 million in the prior quarter and $17.1 million in the third quarter of 2014. From a customer perspective, our revenue was well diversified with no 10% or greater customers in the quarter, revenue outside of our top 10 customers grew 24% over Q3 of last year and 24% sequentially, representing 69% of our total revenue. Moving beyond revenue, all further metrics disused on this call are on a non-GAAP basis unless expressly stated otherwise. We delivered third quarter total gross margin of 75.8% within our expected range of 75% to 77%. Product gross margin was 75.8% in Q3 of '15 compared with 76.4% in the prior quarter and 72.2% in the third quarter of 2014. Product gross for the quarter was negatively impacted by 100 basis points due to additional investments we made related to two new OEM opportunities. Our services gross margin came in at 75.9%, a decrease of 27 basis points versus Q2 of '15 and 142 basis points from Q3 of '14. We ended the quarter with a staff of 816, up from 800 at the end of Q2, with the majority of headcount additions seen in R&D and sales and marketing. Our Q3 sales and marketing expense was $23.7 million, compared with $23.1 million in the prior quarter. On a percentage basis, sales and marketing expense decreased to 46.6% of revenue, compared with 48.6% in the prior quarter. In Q3, R&D expense totaled $12.1 million or 23.8% of revenue, compared with $12.4 million or 26.1% of revenue in the prior quarter. Third quarter combined G&A and litigation expense was approximately $6.8 million or 13.3% of revenue, compared with $5.5 million or 11.6% of revenue in Q2, which included some favorable one time items. In total, third quarter non-GAAP operating expenses were $42.5 million, compared with $41 million in the prior quarter. Third quarter non-GAAP operating loss was $4 million, compared with a loss of $4.7 in the second quarter. Our non-GAAP net loss in the third quarter was $4.4 million or $0.07 per share, ahead of our guided range of $0.08 to $0.12 per share. Q3’s net loss represents an 18% sequential improvement, compared with a net loss of $5.3 million or $0.09 per share in Q2, and a 50% improvement when compared to loss of $8.8 million or $0.15 per share in the third quarter of 2014. Basic and diluted weighted outstanding shares for the third quarter were approximately 62.8 million shares. Moving to the balance sheet, at September 30, 2015 we had $100.5 million in total cash and equivalents, up from $96.2 million at the end of June. During the quarter, cash generated from operations was $4.2 million, reflecting strong billings and collections activities and expense management. This is second our sequential quarter of generating cash flow from operations and we are pleased with the improvements in our working capital management. However, we would like to remind you that we expect to use up to $2 million in cash per quarter to fund operations until we reach operating profitability on a non-GAAP basis. We ended Q3 with $41.5 million of net accounts receivable, compared with the Q2 '15 balance of $46.2 million. Average day sales outstanding declined to 80 days compared with 95 days in the prior quarter. Moving on to our outlook. We are entering Q4 with a solid backlog and are pleased with our strong start to quarter. We currently expect fourth quarter to be in the range of $53 million to $56 million. We expect gross margin to remain in the 75% to 77% range and operating expenses to be between $45 million and $47 million. We expect to report a non-GAAP net loss of between $0.06 and $0.09 per share using approximately 63.7 million shares on a basic and diluted basis. In setting this, we are assuming the yen exchange rate remains in the range of 119 to 121. With that, I would like to open the call up for your questions. Operator?

Thank you. [Operator Instructions] We'll take our first question from Tal Liani with Bank of America. Your line is now open.

Hi, guys. Congrats on a great quarter. I have a question on the composition of revenue. Your North American revenues were down 8% sequentially, and the rest of the world everything else created all the strength. Can you describe or can you elaborate on what's happening in North America, why is down sequentially and what's temporary and what's more long-term pressure et cetera? Thanks.

Let me start from just a financial perspective and then return to Ray for some color on the dynamics in North America. And the first thing I would remind is that, last quarter for North America was a record quarter for us. And so, when you look at the year-over-year we're 23% growth in North America and so when we look at the – the growth in that market we're very please with where we've gone. And also if you remember, had a very large service provider deal and a 10% customer within North America – within the quarter. So that would have been a very hard quarter to real offer [ph] sequentially. Let me have Ray to add a little bit of color to the dynamics in that market.

Yes. I think Greg pretty much covered it, just reminding you that we had a pretty substantial customer win in Q2. But we're seeing very good movement in North America, especially in the security arena with our security products. And you probably have noticed that we continue our expansion in the enterprise domain as well. We had a record revenue in that area as well, we were up 15% year-over-year in enterprise revenue. So overall the real color here is that was a good quarter for us in North America and we feel good about the momentum in North America going forward.

Got it. And let me cut the numbers while showing a different way, your non-top 10 customers grew very sharply, grew 24% sequentially, it goes up I think 24% year-over-year. I am just looking at the numbers from a – on a different cut, your top 10% customers declined sequentially and also on a year-over-year basis. So can you also describe in your answer the dynamics between top 10% and then the other customers and what drives the decline with the top 10% customers, is there a concentration there that is coming down? I am sure that we have the 10 what's driving the growth in the non-top 10? Thanks.

Yes, within the top 10 customers that group has historically had a very high representation of service providers. And for the last several quarters we've talked about, just the buying patterns of service providers with smaller deals and more spread out. And so within that group we're seeing a lot of things, customer’s representative, but their buying patterns are just - are smaller. And so what we've been pleased with is that in the face of that, that the things that we've been doing to develop our security products, to develop our channel and to expand revenue diversity and given as a stronger base underlying those top 10 customers and when service providers begin their spending again, typically what we've seen from that 18 months ago, so we're well positioned to see strong growth both in the top 10 and outside of the top 10.

Got it. Quick one, just one follow, what about Web 2.0, how is it vertical would be helping this quarter?

Could you repeat that Tal, we cut that?

I said what about Web 2.0 customers, can you discuss the trends and the vertical of the big cloud company?

Yes, I am going to take that one, its Ray Smets. The Web 2.0 customers continue to be source of strength for us and this is a trend for us in the global markets. We announced a few activities in that area. We announced in the past some significant wins with customers like Microsoft Azure and we announce an additional win with the security solutions with a public cloud company just this quarter. So the Web 2.0 is absolutely a strength for us. We known to be leaders in that area and while we let the service providers kind of go through their situation over the recent couple of quarters the Web 2.0 would definitely flow to us.

Perfect. Thank you.

Thank you, Tal.

Our next question comes from Mark Sue with RBC Capital Markets. Your line is open.

Thank you, gentlemen. Can you hear me?

Yes. Mark, are you there?

All right. Can you hear me now?

Yes.

Yes.

Not now…

Mark…

Hey, Mark?

Operator, why don’t we go to the next question and Mark…

All right. Sorry about that. Can you hear me now?

Yes. We can hear you.

Thank you. Maybe just on how you see the longer term trend as it relates to virtualization and how customers are buying hardware and also the software element. And also there are some – as we think about AWS and their plans to kind of move further into this market, how you might those dynamics impact A10 that will be helpful? Thank you.

Maybe I'll try to your first comment, Ray you can help me on the AWS.

Yes.

So we see the virtual and software as a nice growth record to all hard and virtual product and we participate in the market in a couple of ways. Customer can buy a license virtual software only product or they can buy our solution as a service. If you look at in the quarter we actually secured more multiple large wins with the cloud service provider. So in addition, we continue to see strength of presence with the cloud provider market. As you know the – I think Ray mentioned about Microsoft Azure is a big customer for A10 and also we sold GPS into another public cloud provider. Furthermore our TPS solution is a backbone of the DDoS as a service offering and they are selling to their customer as a cloud service. So our high performance, scalable, flexible platform has – is very well suited to how to move to a cloud and we feel good about it. Maybe Ray can talk about it.

Yes, Mark what was your question on AWS specifically?

The growing pattern?

So from an AWS perspective, the way that we see it in the marketplace, is that we have a very good position selling into cloud service providers currently. So as we mentioned, I mentioned earlier we have a very nice position there. We do tend to sell a higher performance solutions. So customers that to come to A10 come to us because of our reputation in terms of scale and performance and we believe that the customers are going more towards the AWS routers, are going to more of a lower performance solution. So we don’t really see AWS as a competitive solution. However we also participate in the AWS marketplace as an option for some our customers who choose to business there too. So we - generally speaking we see AWS is a market expansion area opportunity for us…

Thank you, gentlemen. Good luck.

Also we are seeing very strong growth, year-over-year growth in our software and virtual revenue.

Our next question comes from Ittai Kidron with Oppenheimer. Your line is now open.

Thanks. Good quarter, guys. I wanted to get your perspective on some of your peers in the market. I mean, clearly F5 did not have good number, [indiscernible] do not have good numbers, both have pointed to US, as a region that’s been a little bit more challenging for them, it seem gross for service providers. You are correct that you have very strong growth into US, but on a sequential basis it’s clearly wasn’t great and your service provider business has been stuck there at that $18 million to $20 million for a good three, four quarters now. So is there anything that you are seeing out there with respect to those two areas that you think is challenging?

Yes. I'll go ahead – I'll jump on that and see if Greg maybe back in on that. But, specifically the service provider domain, we are not different, we've definitely seen what others have remarked about in terms of the slower spending in the service provider domain. But for us over the last couple of quarters, we really happen to see a change in that behavior. The deals are still in the pipeline and so we're seeing the deal volume. We still have the relationship in place with service providers that we have close relationships with. We're not seeing any churn to a competitor in that domain, but we are observing that the deals continue to be a little bit smaller and we reported that in prior quarters and that’s affected our top 10 customers. But we're very happy with the Q3 revenue in the service provider space, you probably had noticed like higher it is than it was in Q2 despite the reported top 10 customers were in Q2. So overall we feel pretty good about that. We are going to experience some fluctuation there because these are deals are lumpy, they tend to be our largest deal sizes and – but we maintain a great relationship in that domain and we're going to continue to benefit for them certainly as the market recovers there. And I like to talk about North America, we've been really happy with North America. The other things I'll add there is from a federal perspective we actually had a good quarter. We pretty much delivered what we anticipated. In fact, in the domain you saw that probably in other areas as well. And we continue to benefit from the deployment of our affinity channel partner program where we continue to see deals coming from the partner that generates more demand. So we saw sequential decline in North America, probably just related to the top 10 customer that we reported in Q2, overall North America did what we needed it do…

Okay. Very good. And Greg, you delivered to the high end of your range which is – could be a good thing. But I can help but feel that you're kind of hoping to do above that. So - can you walk through details, whether it be a region or product specific and kind of tell us what did better relative to your plan and what did not do as good relative to your plan. And my second question is regards to TPS, I mean, clearly you are seeing very good strong traction there, but is there way to – if you separate TPS from your product revenue is your ADC business growing or not how do you think about that?

That’s – lots of unpack in that one. From a growth perspective when we look across our geographies, we saw pretty much what we were expecting across such geographies. We've invested and hope for growth in our European environment. We saw them do strong quarter-to-quarter and year-to-year. North America, coming off of the quarter where they had grown 20% quarter-to-quarter from Q1 to Q2, we didn’t need to see them to grow sequentially beyond that, we knew we had other parts of our business that we're going to back build [ph] as we've talked about it on the last call, that was one how do back build behind a customer who was, I think it 15%. And I think we saw that across geographies. And so I actually wouldn’t stand here and say that we were disappointed with the deliveries in any region, there is always ups and downs in deals if you think you're going to come it, that don’t and others did, you don’t expect to do, and we always have that service provider volatility and sometimes its up we just saw. We had sizeable service provider deals in the quarter we just closed as well. So I think that when we look across the whole of our business, there is always going to be minor ups and downs, but there is market we look at and say, that one, way over performed or way underperformed our expectations.

And with regards to the splits ADC and DDoS?

Yes. Let me just comment on Q3, we actually are happy with the growth we had in Q3, if you exclude in Japan, in Q3 we grew 25% year-over-year and without the 10% customer and we continue to grow nicely due to diversification and the great performance we saw in security product. So [indiscernible] I think if you look – we don’t break up the products revenue, but if you look at TPS and other products, there it grew both TPS and other products. We achieved 17% revenue growth year-over-year, 7% sequential dealing to that. Product revenue grew nicely in the quarter. So we definitely are very happy, yes, we see Q3 performance in terms of the product strengths across all three center owned product line and security definitely is a big driving factor for the ADC growth.

Very good. Good luck, guys.

Thank you.

Our next question comes from Rod Hall with JP Morgan. Your line is now open.

Yes, Hi, guys. Thanks for the question. I guess I'll dive into the services revenue little bit. The year-over-year growth there is 33.5% and starting to lap some slower growth in the product revenue from a while back. So I am just wondering, I mean, that’s up the 45% of product revenue now, do you think, or when you are at stability point there where we lapped all of the higher product growth from the past or do you expect that to continue growing in – can you talk just little bit about what else might be driving that growth? Thanks.

Sure. This is Greg. We had seen flat product growth over the last up until the prior last two quarters, so Q2 and Q3 we had to see reinvigorate product growth and so during the 12, three or four quarters preceding that we were seeing service growth more rapidly. Now that product is kind of reignited, we've seen a two consecutive quarter’s growth in products. The two that we'll start to become more in sync with one another. And so on the services side we're seeing growth from both the maintenance renewals, which our maintenance cycle is greater than 95% of the customers renew. So that keeps adding install base. We'll also – we begin to build our professional services organization. So while its not contributed gross margin yet, we talked about that, it is beginning to add to the service line in terms of absolute dollars. So over time the Q growth rates will begin to move back into – to be somewhat more synchronized, that right now the services piece will outstrip product for the next few quarters I suspect.

Okay. Thanks, Greg. And then I also wanted to follow up and ask you, Microsoft [ph] said they are going to increase investment again in Azure. I just wondered could you guys comment on – is there any reason you wouldn’t participate in that increased investment. I know some of that maybe overseas and so on. So could you just kind of comment on how you – what you're reaction to that increase investment is and where you think the impact on the business might be?

Rod, this is Ray. Obviously we're very happy about that. Microsoft continues to be a very important customer for us and we supply them in multiple areas, not just in Azure but in other areas in Microsoft including Xbox and we sell multiple products in each of those areas. So we actually see their investment as a positive for us and we continue to bring in some very nice deals on it even on a quarterly basis for Microsoft. So overall that’s a positive sign for us and we will be – looking for ways to participate in that and we expect we will.

Okay. Great. Thank you, guys.

[Operator Instructions] We'll take our next question from Mark Kelleher with D.A. Davidson. Your line is now open.

Great. Thanks for taking the question. I want to look at gross margin a bit, you said that you were investing the quarter to support some possible OEM relationships, can you size how much that affected how many basis points, that might have affected and whether that investment has continue for the next quarter and when we might see those OEM to kick in perhaps?

So I think Mark, we can address that. So first of all the impact was 100 basis points on product gross margin and about 70 basis points on total gross margin. We do not expect that that is something that will continue. But these investments were made, because these are signed and completed OEM agreements that we have in place and this was getting the initial product ceded into the organizations for them to begin to adopt their programs against. So we don’t expect the cost to continue, revenue for us the expectations will be modest amount, small, small amount in Q4 but most would be as we grow into 2016 as they roll their program that more aggressively. So these – they are strategic, they are important but I think experience says that OEM agreement often takes longer than one originally anticipates and its not entirely in our control over how they get rolled out, but we think these will be very interesting.

All right. And then just clarification, you said you're going to announce something on November 19, I didn’t quite pick that up. Could you just help me on that?

We will have a new standalone security product to be announced on November 10, it’s a new standalone security product.

Okay. Great. Thanks.

And our final question comes from James Fawcett with Morgan Stanley. Your line is now open.

Hi, this is Yuuji Anderson on for James. Just a little bit more on service provider, what is the latest you're seeing in Japan?

So, this is Ray. I'll just talk a little bit about Japan. So you noticed we are flat year-over-year on constant currency which we feel pretty good about. And we actually feel pretty solid in terms of our position in Japan where we think we stabilized that marketplace in terms of our business in that marketplace. So we pretend to say very strongly in the service provider domain with a relationship with every service provider. We know what the major projects are. We participate hitting for those major projects and expanding our position there. What we've done in Japan while the service providers in that kind of headwind situation as we worked very hard to diversify in a couple of different ways, we diversified more aggressively in the enterprise over the last year and we're very pleased to progress there. But we've also been back at the table with our service provider customers and our enterprise customers with our TPS solution, our SSO [ph] solution and basically selling the street which is in our ADC. So all of that really has kind of added to the stabilization of our Japanese business and so despite the economic slowdown that we see there and the currency issues that we see there in Japan which are pretty severe, we've actually been able to maintain our own position there.

Okay. Great. That’s really helpful. And just a little bit on the sales force, and how you're feeling about efficiency and sort of your hiring cadence at this point?

We've had very good luck in terms of the global sales force, we added some significant new leadership over the last year. We've had really strong retention and we've had really good success adding some significant sales and enter this region as Greg mentioned what total headcount is. So we're pretty good about that. In terms of total productivity, we definitely see increase in productivity on a bookings basis across the sales organization, just exactly what we would expect to see. So we are getting greater leverage there. And we're achieving that greater leverage on a number of different fronts through additional enablement and things of that sort. But just go to market strategy and rolling out our affinity channel programs to really catalyze some additional activity in the marketplace. Just as an – in Q3 we did efficiently rollout the affinity channel program across EMEA that was a big deal for us and about two weeks over in Bali, Indonesia we'll be growing out the Asia Pac version and of affinity as well. So all this really catalyzes the deal volume and we're happy from this.

Okay. Thanks so much.

And I'll now turn the program back over to Lee Chen, for any closing remarks.

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

This does conclude today’s teleconference. You may disconnect. Thank you and have a good evening.