A10 Networks, Inc. (ATEN) Q3 2016 Earnings Report, Transcript and Summary

Good day, everyone and welcome to the A10 Networks Q3 2016 Financial Results Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note that today’s event is being recorded. At this time, I would like to turn the conference call over to Ms. Maria Riley with Investor Relations. Ma’am, please go ahead.

Thank you all for joining us today. I am pleased to welcome you to A10 Networks third quarter 2016 financial results conference call. This call is being recorded and webcast and maybe accessed for one year 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 Worldwide 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 2016 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, expectations for future revenue growth, profitability and operating margin, expectations of customer buying patterns, anticipated benefits from our acquisition of Appcito, expected product launched, and the general growth of our business. These statements are based on current expectations and beliefs as of today, October 27, 2016. 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. And you should not rely on them as predictions of future events. A10 disclaims any obligation to update information contained in these forward-looking statements whether as a result of new information, 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 5th. 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 2016 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 these non-GAAP measures. 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 2016 financial results conference call. We reported revenue of $55.1 million, up 8% year-over-year and below our guidance of $58 million to $60 million. Our continued focus on driving leverage through our operating structure led to a significant improvement in EPS. For the quarter, we reached non-GAAP breakeven, which was at the high end of our guidance. Although we achieved break-even, which we believe is an important milestone for the Company, we are disappointed in our topline performance. While total bookings grew 24% year-over-year and were ahead of our forecast, our revenue results reflect lower than expected product bookings in North America where we received a couple orders too late in the quarter to ship and some deals slipped into future quarters. These deals were in both our enterprise and service provider customer verticals and remain in our pipeline. We are closely engaged with these customers and we expect these transactions to be closed in either Q4 or Q1. We are also continuing to focus on refining our go-to-market strategy and execution to drive growth, and at the same time, find efficiencies in our investments to improve our bottom-line. In the last quarter, we added R&D and sales and marketing resources to support growth, as well as significantly increased our outbound marketing campaigns to drive greater brand awareness and customer acquisition. We believe we have the right strategy in place to drive long-term growth. Let me share with you some of our accomplishments in the third quarter that we believe demonstrates the momentum we are building with customers. We delivered very strong 83% year-over-year revenue growth in Japan driven by expanding our footprint with both service provider and enterprise customers. This included a large mobile carrier selecting our Thunder TPS solution to help protect their network from large-scale DDoS attacks. Two out of the top three mobile carriers in Japan are now using our TPS solution. Additionally, this customer is deploying our Thunder SSLi solution for their managed services to uncover malware hidden in encrypted traffic. We believe our ability to expand to new areas of the network within our marquee customers demonstrates the compelling value of A10’s ACOS Harmony Architecture. The A10 value proposition is also bringing new customers to A10 as they look for flexible and agile solutions to improve their application performance and security, while at the same time reducing CapEx and the total cost of ownership. Compared to this time last year, we have grown the total number of A10 customers by 17%. In the third quarter, this included adding a new U.S. Tier 1 mobile operator to the A10 family with our Thunder ADC. This customer plans to use software features in our Thunder ADC to help them monitor the health of the network and improve efficiencies. A key differentiator in winning this business was our industry-leading Open API built into ACOS. We now serve the top four Tier-1 mobile operators in the U.S. We also secured a significant win with an executive branch of the U.S government that chose our Thunder ADC, Thunder SSLi and Thunder Baremetal solutions. The ability to manage all A10 products with a single management system, aGalaxy, at less than half the TCO of the competition were key differentiators for this new A10 customer. And lastly, with our ability to deliver ADC and Carrier-Grade NAT on a single appliance, we helped a communications provider in the U.S. cope with running out of IPv4 addresses and replace their aging ADCs. We continue to innovate and drive the application networking market forward with product enhancements that are all built on our ACOS Harmony Architecture. We recently introduced a new high-end Thunder 300 gig throughput modular chassis that is well-suited for high-performance networks such as service providers, cloud providers, e-commerce and online gaming. We have already sold this new appliance with TPS to a leading public cloud provider in the U.S., and with CGN to a large mobile operator in Southeast Asia. The 300 gig Thunder TPS solution offers industry-leading performance at a time when DDoS attacks are dramatically spiking in both magnitude and sophistication. As we announced last quarter, we acquired Appicto at the end of June and the integration is going well. We are on schedule to launch our new native public cloud offering this quarter with additional offerings to follow early next year. While we expect to see only modest amount of revenue from this product in 2017, we are excited about the opportunities Appcito is already bringing to A10 including driving new conversations with customers around the globe. We believe our technology vision and holistic approach to solving the application networking and security challenges of today and tomorrow positions us well within the evolving trend we see in the market. As we look ahead, we are excited to extend the A10 Harmony value proposition to native cloud applications. We are committed to executing on our strategy and continuing to grow our business. And lastly, as we announced in our press release today, the Board of Directors has authorized a $20 million share repurchase program, which reflects our confidence in our market opportunities and business, as well as our commitment to enhance shareholder value. With that, I’d 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 to all of you for joining us today. Third quarter revenue grew 8% year-over-year to $55.1 million, but fell below our guidance range of $58 million to $60 million. As Lee mentioned, the revenue shortfall was primarily in North America where product bookings came in lower than we had expected. Total bookings did come in above our forecast and grew 24%, driven by strong demand in Japan for both products and services. The third quarter was our strongest renewals booking quarter to date and this is reflected in a 25% year-over-year and 10% sequential increase in deferred revenue bringing the total to $83.2 million. Turning back to revenue. Third quarter product revenue grew 1% year-over-year to reach $35.3 million, representing 64% of total revenue. This compares with $35 million or 69% of total revenue in the prior year third quarter. Service revenue grew 25% year-over-year to reach $19.8 million or 36% of total revenue compared with $15.8 million or 31% of total revenue in the third quarter of 2015. From a geographic standpoint, third quarter revenue from the United States was $24.3 million compared with $25.1 million in the third quarter of last year, representing 44% total revenue. Third quarter revenue from Japan, grew 83% year-over-year to reach $16 million and represented 29% total revenue. Revenue from APAC excluding Japan was $7.4 million or 13% of total revenue. While we did see some sequential improvement in the EMEA region, the overall environment remained soft especially in the Middle East. Revenue from EMEA was $6 million in the third quarter compared with $7.3 million in the same quarter last year and $5.9 million last quarter. Enterprise revenue grew to $31.2 million, up 2% from Q3 of last year. Service provider revenue came in at $23.9 million, up 17% when compared with $20.4 million in the third quarter of 2015. Our enterprise and service provider revenue split this quarter was 57% and 43% of total revenue, respectively. In this quarter, we had no customers accounting for more than 10% of our total revenue. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis, unless stated otherwise. We delivered third quarter total gross margin at 77.1%, slightly above the high-end of our expected range of 75% to 77%. This is an increase of 160 basis points from last quarter and 130 basis points increase from Q3 of last year. Product gross margin was 75.2% in Q3 of 2016, increasing 40 basis points from last quarter and decreasing 60 basis points from Q3 of 2015. Our services gross margin came in at 80.5%, increasing 340 basis points from last quarter and 466 basis points from Q3 of 2015. We ended the quarter with staff of 885, up 19 when compared with 866 at the end of last quarter. Third quarter non-GAAP operating expenses were $42.2 million or 76.6% of revenue, compared with $45 million or 78.8% of revenue in the prior quarter, as we drove additional leverage through our model and closely managed our expenses in support of our stated plan to achieve non-GAAP profitability by the end of 2016. Additionally, our sales and marketing expense was lower than planned due to lower commission expense related to shifts in the regional mix of sales. In R&D, please remember our third quarter operating expenses include the addition of a full quarter of 31 new employees joining us via the Appcito acquisition. We achieved third quarter non-GAAP operating income of $0.3 million, a significant improvement from a loss of $1.9 million in the second quarter of 2016. Our non-GAAP net income in the third quarter was $0.2 million, or break-even on a fully diluted per share basis, landing at the top of our guided range of breakeven to a loss of $0.02 per share. Our net income performance this quarter represents a significant improvement from a net loss of $4.4 million in Q3 of last year. For the nine-month period, our bottom line, on a per share basis, improved 73%. Basic and diluted weighted shares outstanding used for computing EPS for the third quarter were approximately 72.8 million shares. Moving to the balance sheet. At September 30, 2016, we had $116.8 million in total cash and marketable securities, a $3.1 million increase from the end of June, and up $16.2 million compared with September 30, 2015. Our cash balance reflects $2.5 million in cash generated from operations during the quarter. This brings our year-to-date cash generated from operations total to $21.8 million. Back to the balance sheet, average days sales outstanding were 74 days, up from 65 in the prior quarter, reflecting late billings in the third quarter. As Lee mentioned, the Board has authorized a share repurchase program of up to $20 million over the next 12 months. Under the repurchase plan, shares may be repurchased on a discretionary basis through a variety of means including the open market. This repurchase authorization reflects our commitment to enhance shareholder value as well as expressing our confidence in our opportunities and long-term financial performance. Moving on to our outlook, we currently expect fourth quarter revenue to be in the range of $59 million to $63 million. At the midpoint, this represents 8% year-over-year revenue growth for the quarter and 16% growth for the full year. We expect gross margin to remain in the 75% to 77% range, and operating expenses to be between $44.5 million and $45.5 million. We expect our non-GAAP bottom line results to be between breakeven and earnings of $0.04 per share using approximately 75.1 million shares on a basic and diluted basis. With that, I’d like to open up the call for your questions. Operator?

Ladies and gentlemen, we’ll now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Dariush Ruch-Kamgar from Bank of America. Please go ahead with your question.

Questions on the deals push outs, wondering are these customers that typically purchase every quarter or two, so does this -- and what I’m trying to ask is does this represent slower total growth for next couple of quarters? And are there any similarities between the customers that you’re seeing or why they pushed out orders?

So, first of all, all of the deals that we saw that moved out of the quarter were with existing customers. And so, they are customers where we have ongoing relationships. And I won’t go so far to say they buy every quarter but they are usual suspects for us. And so, we know pretty well what deals are going to close but it’s the time that becomes the issue and that’s what we saw this quarter. So, I don’t think this points to any kind of larger trend for us. It was an isolated group of customers, and I don’t think there’d be any common thread we can point to as to either why they pushed out or what they were buying or what they were I guess the process they were going through.

Okay. So, it’s safe to say this wasn’t something was competitive?

No, in each of this cases, these were down to -- they were either in purchasing, going through testing, it was a logistics topic. We were not in active competition on these particular accounts.

I wanted to switch to DDoS; there is -- obviously, it’s been making the headlines recently with the attacks into the DNS servers. This has been a good growth driver for you guys in the past. Wondering if you’ve seen -- obviously, can you talk about the DDoS market and what you’re seeing in that market in terms of demand from customers as well? Obviously, other networks, I think that’s got to double-digits growth by other networks this past quarter. So, qualitatively anything you provide about the market will be helpful.

Yes. We definitely are seeing a great opportunity in the pipeline. As a matter of fact, we just announced a higher end 300 gig throughput GPS product, which in a very, very short time, we landed as very large public cloud provider in the U.S. We continue to see opportunity. We feel good about our position, especially with our cloud offering. We are the leading vendor in terms of the mitigation ability; the reason [indiscernible] look at the spike in the magnitude. We feel we are very well positioned.

And then just last question from me, were there any 10% customers in the quarter?

There were not.

And our next question comes from Catharine Trebnick from Dougherty. Please go ahead with your question.

Thanks for taking my question. Kind of one of the things I had, I missed one housekeeping item because I got on late on call. What the America’s growth question, America’s growth, contribution.

The America’s the quarter-over quarter growth?

Yes. If you just give me the percent of the total that would be fine. I missed that in Asia Pac.

Okay, I can give you both of those numbers there. So for APAC was 13% -- I am sorry, APAC excluding Japan was 13%; Japan was 29%; North America was 44%.

Okay, thanks. Could you update us a little bit on the [indiscernible] partnership that you announced late last summer and where that is and what the opportunities for that are? Thanks.

I think the partnership is going well. We still are working on the integration. We have not announced a product based on their technology yet.

Okay. So, are there opportunities for this partnership that possibly drove it then, Lee?

Yes. Again, the product is still in development. So, we definitely are looking for really a next year’s event, if any opportunity will be next year. But we do have a lot of customers with very interest in the combined solutions.

And our next question comes from Alex Kurtz from Pacific Crest Securities. Please go ahead with your question.

A couple of questions for me guys. Can you just give us an update on the percentage of revenue coming from security versus the traditional ADC business?

Yes, it’s fairly consistent with what we talked about over the last couple of quarter; we are in the mid-teens range on that. And again, that’s combined security at this point.

Okay, and that didn’t change sequentially it sounds like. Just back to these two transactions in the U.S., I just want to clarify both of them were in the service provider or one was in service provider, one was in enterprise?

You say the two transactions, are you talking about the once that we said were -- that did not ship?

Yes.

Yes. So, those were -- those are both in -- actually there is one of each in that environment. And so just to clarify, these were deals that came in and what we saw was that in the quarter just ended, we saw a backlog that was larger than we had anticipate in the quarter and larger than what we had seen coming out of Q3 last year. And interestingly with the backlog, the addition to backlog, if it is shipped and shippable as we would have expected, that would have put us into the lower end of our range for the quarter.

So, are these two transactions still at the approval process and just waiting for POs to be written or is it a couple of steps away from that?

So, these are -- I should be more -- these are actually orders. So, we have received these orders, we have the POs in house, but they did not leave loading dock by the end of the Q3. So, orders are done; there is no procurement to go on there; that has sustained from when we talked about a few deals that slipped out of the quarter, those are the ones that are in a purchasing process or final phases of testing.

We got appeal, it’s timing of appeal we received too late.

I understood. And did I hear that you grew bookings 24% year-over-year; was that the member I heard at the outset?

Correct.

And what was that number last quarter, just so I get a sequential growth in bookings?

Yes, we wanted to get some color on the bookings though we tend not to put that number out there. And I think the main point that we wanted to reflect there was that we actually did see strong bookings within the quarter, but what we saw was the composition of those bookings were different than we expected. We saw more of those bookings coming from Japan and we saw more that represented by services than we would have expected going into quarter.

Okay, last question from me. Service margin, looked like it picked up above 80% here. Any reason that you can’t hit that utilization rate going forward or you expect to come back down into the high 70s?

There is no reason why we can’t. Although, I will say that here is a piece of our support business that if we open a new office, you may see a discontinuity in the cost structure, because you can’t open an office with just one person. So, you may see little blips. But there is no reason that wouldn’t stay in the high 70s and up to 80s. So, give us a couple of points of variation there.

Our next question comes from Rod Hall from J.P. Morgan. Please go ahead with your question.

Hi, good afternoon. This is RK [ph] on behalf of Rod. Thanks for taking my question. I wanted to go back to the discussion on the competitive dynamics. Could you comment on the win rates you saw in the quarter, if there was any insignificant change? And are you seeing and do you expect to see any impact from F5 product refresh?

The question was about any changes in the competitive dynamic and any response to for seeing anything from F5’s refresh?

Yes, and your win rate.

And the win rates.

Yes. So, this is Ray Smets. I just wanted to comment on that. First of all, we tend to be in a pretty competitive environment, but we maintained, continue to maintain a very high win rate in. So, when we do a head to head competitively and scenarios that I think you’re referring to, we win more often than we lose. So the competitive win rate is 78% or more. So, we are actually maintaining that. So, we have I would say from a competitive perspective in the marketplace, we continue to hold our own very, very effectively. We have a very good competitive campaign offer in the marketplace in our channel currently. And we are executing very, very well getting traction in new accounts. I would say overall our competitive position is quite strong. So, the activities in Q3 really are not associated with some sort of competitive activity.

Yes, this is Lee. Basically, we feel confident about our product offering and our relationship with our customers. We offer the highest performance on market today.

Okay. And as a follow-up, could you comment on the trends you’re seeing with the public cloud customers? Because we heard the hard disk drives are putting very good trends, but then we’ve had the optical component guys are putting better trends and I’m just curious as to hear what kind of trends you’re seeing?

This is Lee, again. I continue to feel the public cloud is a tailwind first. We, as you know, as we are talking more of quarter, we have a lot of marquee customer, they are cloud providers. And our solution including a module form based on the ACOS, ACOS Harmony is a software defined platform for application and security services. If you look at our ADC, CGN and TPS and all products that can be deployed as a universal machine, can be deployed as baremetal. AWS Azure [ph] incidence rate, [ph] we’re also building containers in the future. So, I feel we’re industry leading API management solution positioning A10 very well with a cloud provider.

[Operator Instructions] Our next question comes from Ryan Flanagan from Buckingham Research Group. Please go ahead with your question.

Hi, thanks guys. It’s Ryan on for Ro. I’d a question on the guidance. It looks like the little bit of wider range than normal. Does that imply sort of variability on pipeline visibility or some uncertainty around closing these deals, any color on the rationale behind that?

I think certainly coming off of a quarter in Q3 where we had some deals within the quarter that didn’t cross the line as we expected, leads you to think about how you do Q4 as well. And so, I think we just want to give ourselves a little bit flexibility in dealing with that variability. Q4 has traditionally been a big quarter for us. And so, we want to give ourselves room to exceed but also have to be realistic on what we saw in Q3 and factor that in.

And then just a couple of quick follow-ups, I know you mentioned security momentum, sounds like it’s pretty good, that based on Lee’s comments you mentioned that it’s in mid-teens. Can you give some directionality on sequential year-over-year?

Not at this point, we’ll probably talk a little more about that when we have full year results and get ourselves through Q4.

And then the last one I had was just want to talk about FX, I know you had a little bit of a benefit last quarter, from yen conversion, was there any notable currency impact this year around?

There was very little currency impact on the income statement itself as in the currency conversion of the other income. But revenue -- if you look at revenue year-over-year, because of the yen change, there was a couple of million dollars of differential in Japan for Q3 last year to Q3 this year.

Our next question is a follow-up from Catharine Trebnick from Dougherty. Please go ahead with your follow-up.

Can we talk a little bit about how you’re doing with some of your partnerships, FireEye, perhaps Cisco, and are you getting to other than Cisco security areas or not and kind of flush that out for us, so that we’ve a better feeling on opportunities ahead and catalysts that we can look forward to?

Ray, do you want to take that?

Sure. Catharine, this is Ray. We don’t talk too much about the OEM relationship that you just talked about -- or actually questioned about, but let me comment little bit about Cisco. We have that relationship in place now for second quarter and it continues to build momentum, the pipeline continues to develop. It’s specifically focused around our SSL -- offering an SSLi which we think is quite competitive. We know this is a good catalyst for us. You know that the encryption levels continue to grow. And I think we’ve crafted a great relationship with Cisco that should deliver some significant opportunities for us over time. It’s really still early days. You know how this works for the big partner like Cisco, but we’re very satisfied with the OEM relationships we’ve in place, we’re satisfied with the relationship we have in place with Cisco and it’s really all about execution right now.

And then are there other partners you’re looking at, I mean competitively are running into F5 and their newer SSLi product that you’re running into Blue Coat with their product, Netronome et cetera, I mean how does that look? Because this SSLi opportunity when we do our field work, continues to be a star for you guys. I’m just wondering competitively how is that working out.

So, I can comment on that a little bit Catharine. So, first of all, the SSL market is growing very-very nicely. So, we see this is an opportunity. We’ve a strong position, as you mentioned in the marketplace; we feel very good about the product. It’s pretty clear I think in the marketplace that the way we’ve developed SSL decryption into our ADC solution and also delivering it a standalone solution gives us a lot of technical differentiation, both in terms of performance and maturity level. We’ve been in the market with this product for quite some time. So, customers are definitely turning to A10 Networks to find ways to decrypt with this with they can’t see in their blind spot currently. So, we’re going to drive the Cisco relationship; we’re going to continue to drive activity within our channel partnerships, which I know that you check from time to time. We are very optimistic about the SSL growth factor for A10.

Also we feel good about our SSLi, the solutions integrate into our product across ADC, CGN and CFW. Also we have a standalone SSI solution. We feel we are very strong positioned into SSI solution. We were first to the market, and also -- the product has been doing good number of years. As you can see, we said during the call, we had several wins in the quarter of our SSLi.

And our last question for today comes from Rod Hall from JP Morgan. Please go ahead with your question.

Hey guys, this is RK again. I just wanted to check with you, could you give us any color on the magnitude of the two push-outs you saw this quarter and also to what extent is that they are reflected in your guidance for Q4?

So, the magnitude of the push outs and to the extent they’re projected into guidance. So, on the magnitude, kind of in two different reactions. One is that from a deal size, they tended to be $0.5 million to $1.5 million deals. So, not small deals but not bigger deals that we sometimes run across. And there a handful of them. So, there were a very clearly identifiable group of accounts that were we focused on. When we look at guidance for Q4, alternatively we go through the same process that we go through every quarter. I’ve talked few times about the layer cake that we build up starting with the services that we know are coming in, looking at our backlog, looking at deals that work, and then going to our evaluation process. So, these deals go through that same analysis. I mean they likely have a higher probability because we are closer on them than some of the others. But they kind of go into that same analysis that we look at. They don’t get special treatment necessarily. So, we would expect to think as we said some of them -- most close in Q4, may be one or two goes to Q1 but they’re factored we think appropriately to Q4.

And ladies and gentlemen, at this time I’m showing no additional questions. I’d like to conclude today’s question-and-answer session and turn the conference call back over to Lee Chen, CEO, for any closing remarks.

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

Ladies and gentlemen, that does conclude today’s conference call. Would do thank you for joining. You may now disconnect your lines.