A10 Networks, Inc. (ATEN) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the A10 Networks' First Quarter 2017 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Maria Riley with Investor Relations. Please go ahead.

Thank you all for joining us today. I am pleased to welcome you to A10 Networks’ first quarter 2017 financial results conference call. This call is being recorded and webcast live and may be accessed for one year via the A10 Networks Web site, www.a10networks.com. Joining me today are A10’s Founder and CEO, Lee Chen; A10’s Interim CFO, Shiva Natarajan; and our Executive Vice President 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 first quarter 2017 financial results. Additionally, A10 published a presentation along with its prepared remarks 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 Web site, www.a10networks.com. During the course of today’s call, management will make forward-looking statements, including statements regarding our projections for our second quarter 2017 operating results, our expectations for future revenue growth or security product revenue, profitability and operating margin, expectations of customer buying patterns, expected product launches and the general growth of our business. These statements are based on current expectations and beliefs as of today, April 27, 2017. 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 descriptions of these risks and uncertainties, please refer to our most recent 10-K filed on February 24th. 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. The non-GAAP financial results measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. 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 Web site. We will provide our current expectations for the second quarter of 2017 on a non-GAAP basis. However, we are unavailable to make 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. Before I turn the call over to Lee, I would like to announce that in June management will present at the Bank of America Merrill Lynch Conference in San Francisco and we look forward to seeing many of you there. Now, I would like to turn the call over to Lee for opening remarks. Lee?

Thank you, Maria, and thank you all for joining us today. We delivered a solid first quarter as we continued to execute our strategy of capitalizing on security and cloud market opportunities while driving bottom-line improvement. We generated 12% year-over-year revenue growth, bringing revenue to $60.3 million. We also achieved non-GAAP EPS of $0.01, which was at the high end of our guidance range. Our top line performance was driven by ongoing strength and expansion within cloud provider, service provider and web-scale customers. Our continued success with these customers is based on growing demand for our security and cloud solutions in ultra-high performance networks. For example, we continued to expand within marquee customers in Japan with our TPS and CFW security solutions. We also sold more than 200 licenses of our virtual Thunder ADC to a mobile provider for their SDN/NFV infrastructure. Globally, we are excited about the strong traction we are experiencing with our highest-performing Thunder 14045 appliance. As we discussed on our last earnings call, the Thunder 14045 is the most successful product in our company’s history. The product is helping A10 standout competitively due to its high-performance packet processing capabilities in a very small footprint, providing customers with CapEx, OpEx and security advantages, especially for service providers, cloud providers, e-commerce and online gaming customers. At the lower-end of the market, we saw softer sales in North America mostly due to the end-of-sale of our entry-level appliances. In comparison to our first quarter of last year, these entry-level appliances generated approximately $2.5 million less product revenue in North America this quarter. We plan on releasing a new series of entry-level appliances during the third quarter when the newest chipset is available. Our core customers at the high-end of the market increasingly require greater performance, scalability, and reliability in managing the delivery and security of their applications. We believe the strong success of our Thunder 14045 demonstrates that we are well-positioned to meet this growing demand. Let me share several recent engagements that explain how customers are using A10’s solutions to help secure and improve the performance of their networks and mission-critical applications. A major U.S-based cloud provider is upgrading their IPv6 infrastructure globally with our highest-performing Thunder 14045 CGN appliance. In Germany, a telecom and IT services provider looking to improve its security posture against large-scale DDoS attacks, is deploying our Thunder TPS DDoS mitigation solution. A leading financial institution in Europe beginning to refresh incumbent aging ADC infrastructure, selected our Thunder ADC with SSLi because of our performance and ability to help them generate greater return on investment. We are proud that after a competitive bakeoff and performance review, A10 was chosen as this customer’s ADC provider of choice. One of the fastest growing mobile providers in India chose to deploy A10’s Thunder CGN after a competitor’s solution failed to deliver the performance and reliability needed to cope with their network’s skyrocketing demands. In South East Asia, a top financial institution is deploying A10’s Thunder CFW to help improve the performance of their firewall assets. By adopting A10’s Thunder CFW solution, this customer plans to significantly reduce the impact of network outages and deliver a more consistent always-on application experience to their customers. And lastly, we further strengthened our position with one of the top-three providers in Japan. The provider is embracing much of the A10 portfolio to help them driving high performance and security with compelling economics. This quarter, they added CFW to their A10 lineup of solutions and purchased our ADC, CGN, TPS and CFW solutions all within this quarter. We are seeing success globally with our CFW firewall solution. In February, we expanded the capabilities of our Thunder CFW with enhanced Gi/SGi firewall and launched a virtual Thunder CFW for NFV environments. With A10’s scalable CFW solution, customers can achieve exceptionally high connection rates in a compact hardware appliance or a software-based solution that supports up to 256 million concurrent sessions. As mentioned earlier, we believe that cloud and security present great market opportunities for A10 and are areas where we intend to continue to invest. Regardless of where applications are deployed or where users are located, customers want solutions that enable greater operational agility in an environment that is as secure as it is flexible. That is why we continue to innovate and pioneer new solutions that help enable enterprises, service providers and cloud providers to adopt streamlined, agile, flexible, scalable and modern architectures. Earlier this month, we announced a software-based A10 Harmony Controller that centrally orchestrates A10’s secure application services and open-source solutions across various clouds and traditional datacenter environments. Our new A10 Harmony Controller is based on modern container-based, micro-services architectures that incorporates sophisticated per-app analytics across all cloud types and traditional datacenters. The Harmony Controller with ADC integration is scheduled to be available this quarter, and with CGN, SSLi, and CFW to be available later this year. Customers will have the option to deploy A10’s Harmony Controller as a SaaS offering managed by A10 or as a customer-managed, scalable on-premise solution within a customer’s datacenter environment. With our continued innovation and new solutions, combined with our steady progress in expanding within our customer base, we believe we are establishing a strong foundation to penetrate faster-growing segments of the market where agility, scalability and performance matter. In summary, we are pleased with our first quarter results and we are excited about our future opportunities. A10 has a unique opportunity and strong position in the market to help customers accelerate their adoption of cloud architectures while providing the security needed to protect their investments and mitigate business risk. From Thunder 14045 to the A10 Harmony Controller, our leading-edge innovation and the best-in-class customer support are helping us play a leading role in advancing the market. Going forward, we will continue to execute our plan of driving profitability, while continuing our investments in the fast-growing areas of our markets; cloud and security. With that, I’d like to turn the call over to Shiva to review the details of our first quarter financial performance and second quarter guidance. Shiva?

Thank you, Lee, and thank you all for joining us today. First quarter revenue grew 12% year-over-year to $60.3 million, surpassing the midpoint of our guidance range of $59 million to $61 million. We also grew deferred revenue 24% year-over-year to reach $93.1 million. First quarter product revenue grew 9% year-over-year to reach $39.7 million, representing 66% of total revenue. First quarter service revenue grew 18% year-over-year to reach $20.6 million, or 34% of total revenue. From a geographic standpoint, first quarter revenue from the United States was $30.7 million, up 4% on a year-over-year basis. First quarter revenue from Japan was $13.1 million, up 20% on a year-over-year basis. First quarter revenue from APAC excluding Japan was $10.2 million, up 52% on a year-over-year basis. First quarter revenue from EMEA was $5.2 million, a 3% year-over-year increase. Enterprise revenue was 55% of revenue or $33 million, up 2% from Q1 of last year. We had one cloud customer that contributed 12% of total first quarter revenue. Service provider revenue was 45% of revenue or $27.3 million, up 27% when compared with $21.6 million in the first quarter of 2016. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis, unless stated otherwise. We delivered first quarter total gross margin of 77% achieving the high-end of our expected range of 75% to 77%. This is a decrease of 60 basis points from last quarter and an increase of 90 basis points from Q1 of last year. First quarter product gross margin was 75.4%, a decrease of 80 basis points from last quarter and from Q1 of 2016. First quarter services gross margin came in at 80.1%, decreasing 50 basis points from last quarter and increasing 420 basis points versus Q1 of 2016. We ended the quarter with staff of 885 compared with 895 at the end of last quarter. First quarter non-GAAP operating expenses were at the lower-end of our guidance and came in at $46.2 million or 76.6% of revenue compared with $44.9 million or 70.2% of revenue in the prior quarter. Research and development expenses increased sequentially by $1.4 million, as we continue to invest in our cloud and security solutions portfolio. We achieved first quarter non-GAAP operating income of $0.2 million, a significant improvement from the operating loss of $4 million in the first quarter of last year. We achieved non-GAAP net income of $0.7 million or $0.01 per diluted share, which was at the high end of our guided range of a loss of $0.01 to $0.01 of earnings. Our net income performance this quarter represents a significant improvement from a net loss of $4.1 million in Q1 of last year. Diluted weighted shares used for computing EPS for the first quarter were approximately 74.3 million shares. Moving to the balance sheet. At March 31, 2017, we had $116.2 million in total cash and marketable securities compared with $114.3 million at the end of December. Our cash balance reflects approximately $545,000 of cash generated from operations. Average days sales outstanding were 96 days, up from 84 in the prior quarter, reflecting the record billings last quarter and the higher AR balance at the end of this quarter mainly due to timing. Moving on to our outlook. We expect the market trends in the second quarter to be similar to the trends we saw this past quarter with revenue growth driven by demand for our cloud and security-based solutions and expansion within cloud service providers and web-scale customers. We currently expect second quarter revenue to be in the range of $62 million to $64 million. At the midpoint, this represents a 10% year-over-year growth in revenue for the quarter. For modeling purposes, I would like to note that based on the historical order patterns of our large customers, we expect sequential revenue growth in the back half of the year to be more distributed towards the fourth quarter than is currently reflected in consensus estimates. Getting back to our outlook for the second quarter, we expect gross margin to remain in the 75% to 77% range and operating expenses to be between $46 million and $47 million. We expect our non-GAAP bottom-line results to be a profit of $0.01 and $0.03 [ph] per share using approximately 76.6 million shares on a diluted basis. Operator, you can now open the call up for questions.

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Rod Hall with JPMorgan. Please go ahead.

Hi, guys. Thanks for taking the question. A couple things I guess I wanted to focus on. One is we had your competitor report yesterday and they’re talking about some pretty good size wins in tier 1 security systems, firewall like systems and they’re talking about a large increase in data volume from some of these unlimited plans driving some of this? And I wonder are you guys seeing that and how big of an opportunity on security do you think that is? Is the carriers continuing to move toward these unlimited plans and a higher data usage? And I have a follow up to that as well.

Yes, we saw a good traction and wins we saw through the offering in Q1, while Thunder 14045 is really as we mentioned in the last earnings call and also in this earnings call, it’s our fastest growing product in our history. We continue to see success with our Thunder 14045 and we are continuing to see great pipeline we saw through the offering.

Can you say where that – like geographically where that pipeline looks the strongest for you?

Yes, the TPS employees concentrate on North America and Japan but for over the last two quarters we are seeing them expanding globally. CFW we are – Q1 was the first quarter we saw success globally.

Okay, so North America and Japan and CFW also in North America and Japan. Those are your two main --

North America, Japan, APAC and also EMEA.

Okay.

We had success globally on CFW.

And then we noticed – I think we got this right. Your headcount declined a little bit in the quarter. Could you just comment on what drove that? We would have – I think that’s the first time we’d see that happen. So just wondering what’s happen from a headcount point of view?

It’s really about operational efficiency and driving leverage. Actually we increased 1.4 million in R&D. We added more headcount to both cloud and security.

Okay. Do you think your headcount continues to come down or do you think it will just pretty much remain stable looking forward? How should we think about that?

Really if you look at Q1, we tend to have seasonality in the headcount. Every year we plan to continue to invest. As long as we see opportunity, we will invest.

Okay. All right, thanks a lot.

The next question comes from Catharine Trebnick with Dougherty. Please go ahead.

Thank you for taking my question. And Lee, you haven’t talked in the last two or three conference calls. Could you just give us an update on some of your partners? I know a year ago, Cisco was pretty important. You signed Cylance. Recently in the last quarter it was Fidelis. Can you just give us an overall update on that and if you’re seeing some of these partnerships are helping you drive some of these new wins that you’ve been describing today? Thank you.

Yes, I think we have close relationship with Cisco as we go to market together. It’s not an OEM relationship but we are working very close with Cisco globally. And we also continue to invest in our partnership program to drive more partners across the globe. Ray, maybe you want to add something to that.

Yes, I’d add a little bit more, Catharine. From a Cisco perspective, you know they are a technology partner and it’s one of the most strategic partners that we have. In Q1, we definitely expanded our Cisco FirePOWER, SSLi solution opportunity pipeline on a global basis with these guys and we’ve seen an uptick in revenue and conversion rates from the relationship we’ve had with Cisco. So our SSLi products are getting a lot of attention in the Cisco events, like the Cisco Live events and we really like to participate in those. We also announced the Fidelis relationship which is a global SSLi solution partnership and we’re super thrilled to work these guys. It’s really just beginning but we look to build a differentiated next-gen intrusion prevention and advanced threat protection solution with Fidelis that we think is going to be very attractive to customers in North America and EMEA. And with Cylance we continue to build on that relationship as well. We have some upcoming product announcements that we’ll be making on that partnership in the very near future. But we’re looking forward to integrating the AI-based endpoint protection software from Cylance into our security product line. So we’re looking to make some hay with that product as well.

Okay. Thank you. Just for my own clarification, maybe others. Symantec was a pretty good – Blue Coat was a good partner of Cisco as is Fidelis. Are those replacements perhaps because they might view them as more competitive both of those companies?

We’re going to sit alongside these other competitors within Cisco and that’s perfectly acceptable and understandable from us. But I think what will happen over time is Cisco will continue to place the best product forward, and we think we’re in a very good position to compete against the other guys.

All right, thank you. Nice quarter, guys.

Thank you.

Thanks.

The next question comes from James Fawcett with Morgan Stanley. Please go ahead.

Thank you very much. I just wanted to ask a couple of other strategic questions and operational questions. You mentioned that you’re listing the entry-level products until the new chipset comes out. Can you just go into a little bit why discontinue or stop selling it before the new chipset is available instead of just continuing to make it available?

Sure. Really as very large vendors that traditionally never missed the delivery of the chipset. We’ve been working with them for over 10 years. So this is the first time they missed to deliver that line. So they also announced the older chipset end-of-sales. So we followed their pattern. They notified us very late which we already made announcement.

Okay, that makes sense. Okay. And then on ADC, what would be the next highest contributing product this year? Is it CFW or CGN, DDoS? How should we think about the rank order of contribution from the different products?

I think the security and cloud will continue to grow to be a bigger portion of the overall product revenue. As a percentage – ADC is still the biggest but with a decline in terms of percentage. If you look at the product, the TPS has been the market – among the strategic products, TPS has been on the market for the longest. So TPS by definition we’ll expect to be the highest in terms of a revenue contributor.

Got it. And then last question from me is you’ve mentioned security. Once again this quarter it seems like you’re feeling pretty good about that. How are you – like what’s the up-to-date response and the like on security and the ability to sell security independently of the rest of your ADC portfolio, or how much of security sales are really still very much tied to an ADC sale?

If we look at our strategic customers, almost half are sales to our existing customers, half our new customers. So with an existing customer, we continue on LAN [ph] and expense strategy. If you look at one of the marquee customer in Japan, into the first quarter they deploy our CFW – they like to deploy our CFW solutions in addition to the ADC, CGN, CPS. So it’s half and half. They like the fact that we have a centralized management platform managing all these solutions. They also like the fact we use A10 [ph] operating system and it makes it easy for the operator to manage.

Got it. And then did you – can you just in terms of that split of 50-50 that you just mentioned, has that been changing at all or has that been fairly consistent over the last couple of quarters?

Over the last several quarters, it’s very consistent. Half of the customers are new, half customers are the existing customers taking on new solutions.

Okay, great. Thank you so much.

Thanks, Jim.

[Operator Instructions]. The next question comes from Alex Kurtz with Pacific Crest Securities. Please go ahead.

Good afternoon, everyone. Thanks for taking a couple of questions here. Your competitor talked about some weakness out of Europe around Brexit-related issues. And I was just wondering if you could give us an update on what you’re seeing around deal flow out of that region? And then the second question is just sort of your expectations around APJ service provider and requirements from that vertical and that region to drive your Q3 and Q4 internal assumptions?

So maybe I’ll just start it and then Ray will be adding something about EMEA. So we did not experience changes here in the ADC market globally. It’s very stable. It’s a slow single digit growth. The good thing is that our security and cloud portion are growing much faster in ADC. Ray, do you want to comment --

Yes, I’ll just add a little bit on the EMEA front. You may recall we had a bit of a reset of our business in EMEA last year. It affected us all through 2016 and that was contributing – the contributions there were from a number of different factors. But we made some changes and we’re really beginning to see those changes take hold. And actually from a Q1 perspective, we’re pleased with the results. So we’re not immune to some of these macro situations out there but we’re watching them very carefully. But we are listening to our competition and watching what we’re seeing out there to see if there’s any impact for us. From an APJ perspective, you’re right. We had some very good performance in APJ. Part of it was catalyzed by some very strong service provider penetration. These are new service providers and existing service providers expanding into our core product line. We’re using cloud and security as our catalyst in those marketplaces and we’re seeing some very strong competitive wins there. So from an APJ perspective, we do anticipate service provider to be a catalyst for growth in that region.

Okay. Thanks, guys.

This concludes our question-and-answer session. I would like to turn the conference back over to Lee Chen for any closing remarks.

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