A10 Networks, Inc. (ATEN) Q2 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the A10 Networks' Second 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 of Investor Relations. Please go ahead.

Thank you all for joining us today. I am pleased to welcome you to A10 Networks’ second 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’ website, www.a10networks.com. Members of A10 management team joining me today are Lee Chen, Founder and CEO; Tom Constantino, CFO and Ray Smets, Executive Vice President of Worldwide Sales. Before we begin, I would like to remind you that shortly after the market close today, A10 Networks issued a press release announcing its second quarter 2017 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 remarks, and trended financial statements on the Investor Relations section of the company’s website, www.a10networks.com. During the course of today’s call, management will make forward-looking statements, including statements regarding our projections for our third quarter 2017 operating results, our expectations for future revenue growth and market opportunities, the performance of our products, profitability, operating margin and operating expenses, our ability to penetrate certain markets, expected product launches and the general growth of our business. These statements are based on current expectations and beliefs as of today, July 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-Q and 10-K. 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 measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP and maybe different from non-GAAP financial measures presented by other companies. 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 third quarter of 2017 on a non-GAAP basis. However, we are unable to 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. And thank you all for joining us today. Before we review A10’s second quarter results, I would like to welcome our new CFO, Tom Constantino. In our process to identify a new CFO, we were looking for a leader with strict expertise, in strategic financial planning and operations to partner with the leadership teem as we strive to capitalize our new market opportunities and drive product revenue growth, while, balancing and prioritizing our strategic investments. While it has only been a few weeks, since Tom has joined our team, he has already demonstrated that he is a strong addition to our leadership, and we are excited to have him on board. Moving to our second quarter review. We are disappointed with our results and execution in the quarter. We reported revenue of $53.7 million, which was below our initial guidance range and a 6% decline from Q2 of last year, of a number of opportunities in all pipelines did not close in the quarter. These deals were primarily in the U.S. and for a lesser degree in Japan. Key deals remain in our pipelines. We had commenced a thorough review and analysis of our performance this quarter, and we are taking action to improve our execution and support growth for our expanding product portfolio. As Tom will discuss further in a few minutes, some of the initial changes we are making, include improving the effectiveness of our go-to-market activities. And implementing cross-functional measures to drive accountability. In looking at the dynamics within our customer base, it is taking longer to get large deals closed. Within service provider customers, where we believe we have a strong hold, deals can be large, but timing of when the order is received can be unpredictable and fluctuate from quarter-to-quarter. We believe we are continuing to make progress in expanding within these accounts and adding new logos. This quarter, we saw particular strengths in India, where we expanded our business with one of the largest mobile carriers in the country with our CGN solution. Building upon our customer win last quarter, with the fastest-growing mobile providers in India, our CGN solution is now deployed in two of the top four mobile providers in India. In Japan, the second quarter is seasonally soft for our service provider customers because it is beginning of their fiscal year. This quarter, a couple of our mobile customers in Japan delayed spending decision as they completed their budgets and planned their 5G investment for the year. We believe our pipeline for Japan is very strong and we currently expect revenue in this region to improve sequentially. Over the past few years, we have worked to offset some of the lumpiness with our service provider customers but by driving sales, our entry-level appliances. As we mentioned in the last quarter, a chipset delayed by our vendor impacted the release schedule of our new entry-level appliances. In August, A10 will refresh two new entry-level Thunder ADCs, the Thunder 940 and the Thunder 1040. We will also introduce for the financial sector our new Thunder 3745, that addresses the highest frequency trading with our industry-leading Low-Latency ADC solutions. We believe security and cloud are powerful market opportunities for A10. Leveraging our strengths as a trusted performance leader and our global marquee customer base, to capitalize on this opportunity is an important part of our future. We have invested a significant portion of our R&D dollars to expand our security and cloud capabilities and deliver the compelling performance customers expect from A10. Today, our security portfolio, including Thunder TPS for DDoS mitigation, Thunder SSLi for high-performance SSL decryption and comprehensive policy management, and the Thunder CFW Firewall to help defend against cyber and web application attacks at scale. Our security portfolio helps protect some of the most demanding and forward-thinking network environments. We believe we have a strong and expanding position with our security customers. As an example, in the second quarter a branch of the U.S. government expanded its deployment on our Thunder SSLi solution to cope with the growing amount of encrypted traffic running through their networks. Additionally, we added a U.S. carrier network to our customer base with our Thunder TPS solutions, which is helping protect its 15 rural telecommunications members from DDoS attacks. Security has grown to become a larger percentage of our product revenue, and we are pleased with the progress we have made in the market thus far. Our security solutions were 26% of our product revenue for the first half of 2017. However, it is still early days in establishing A10's brand and reach in the security market. We have been and need to continue enhancing our security solutions in order to address more of the market and broaden our customer base. Ensuring that our products are easy to use, manage and integrate with other security partners, is critical to our ability to drive deeper into the market. We believe the DDOS market overall a compelling near-term growth opportunity for A10. Based on industry reports, we estimate the size of the DDOS market is approximately $800 and growing between 15% and 20%. Since the launch of our Thunder TPS solution for DDOS mitigation, we have built momentum in the market among cloud providers, service providers, gaming and enterprise customers. Today, I'm thrilled to announce that we have expanded our TPS portfolio to include a stand-alone detection module. The new release includes a flow-based detector for standard flow protocols such as S flow, net flow and IPv6. The new detector has an industry-leading high performance collector to compliment our industry-leading mitigation. Our detector is tightly integrated with our TPS management and mitigation solutions. With this new release, we also enhanced our management solutions with comprehensive reporting capabilities, and intuitive dashboards and ease of use configuration wizard. We also received Common Criteria EAL 2+ Certification for our TPS solution. We believe that combining detection and mitigation solution with comprehensive reporting will help open up new market opportunities for A10. SSLi is another area of security market, where we believe we have been investing. In July, we introduced enhanced SSL capabilities. A10's new SSLi processors handle advanced encryption and offload intensive SSL processing and support modern ciphers and technologies with greater performance and reliabilities. We showcased our new SSL capability at the Interop Tokyo, which is one of the premier industry events of the year and very important to our global – to our customers globally. Our new SSL processes won Interop Tokyo Best of Show Grand Prize for performance optimization with our SSL processing performance. The judges highlighted that our solution performed 1.5x faster than competitors’ products in the same price range. As we are looking into longer term horizon, we view cloud as another opportunity for growth, which is why we are making the investments today to engineer new solutions that help enable enterprises, service providers and cloud providers to adopt streamlined, agile, scalable and modern architectures. Our new A10 Harmony Controller, which we announced last quarter, is based on modern container-based, microservices architectures that incorporates sophisticated per-app analytics across all cloud types and traditional data centers. The Harmony Controller integration with ADC, CGN, SSLi and CFW be available throughout the remainder of the year. Customers will have the option to deploy A10's Harmony Controller as a Software-as-a-Service offering managed by A10 or as a customer-managed, scalable on-prem solution within a customer's data center environment. In closing, while it is still early days for A10 in the faster growing security market, we believe we are making solid initial progress, and we are working to selectively expand our capability and reach. Without deep heritage in ultra-high-performance networks, and our continued innovation, we believe we are establishing a strong foundation based on our trusted ACOS platform to penetrate the faster-growing segments of the market where visibility, functionality, manageability, agility, scalabilty and performance matter. We are implementing a number of measures to improve our execution, as well as help drive growth and profitability. With that, I’d like to turn the call over to Tom to review the details of our second quarter financial performance and third quarter guidance. Tom?

Thank you Lee. I am very excited to have joined the leadership team at A10 and to be with you here today. I was drawn to the opportunity at A10 because I recognized a culture of innovation in an environment where I can leverage both my finance and operations experience. Although this quarter did not meet expectations, I’m excited about the opportunities ahead of us and look forward to sharing our progress with the investment community. Second quarter revenue was $53.7 million, compared with $57.1 million in the same period of 2016. Second quarter product revenue was $32.1 million, or 60% of total revenue. Looking at product revenue for the first half of the year, our security solutions contributed 26% of our product revenue, whereas ADC revenue has declined. Second quarter service revenue was $21.6 million, or 40% of total revenue. Our revenue on a geographic basis was $28.6 million in the United States, $8.4 million in Japan, and $6.8 million in EMEA. APAC, excluding Japan, was a bright spot for A10, driven by sales with both enterprise and service provider customers. Second quarter revenue from APAC excluding Japan was $8.7 million up 12% over last year and representing 16% of total revenue. Enterprise was 56% of revenue or $30.3 million, compared with $32.0 million in Q2 of last year. Service provider was 44% of revenue or $23.4 million, compared with $25.2 million in the second 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 second quarter total gross margin of 77.1%, essentially inline with last quarter and an increase of 160 basis points from Q2 of last year. Second quarter product gross margin was 75%, a decrease of 40 basis points from last quarter and an increase of 20 basis points from Q2 of 2016. Services gross margin came in at 80.2%, increasing 10 basis points from last quarter and increasing 310 basis points versus Q2 of 2016. We ended the quarter with staff of 892 compared with 885 at the end of last quarter. Second quarter non-GAAP operating expenses came in at $44.2 million, compared with $46.2 million in the prior quarter. Second quarter non-GAAP operating loss was $2.8 million, compared with operating loss of $1.9 million in the second quarter of last year. Non-GAAP net loss for the quarter was $3.1 million or $0.04 per basic share, compared with a net loss of $1.1 million or $0.02 per basic share in Q2 of last year. Diluted and basic weighted shares used for computing EPS for the second quarter were approximately 69.8 million shares. Moving to the balance sheet, at June 30, 2017 we had $132.2 million in total cash and marketable securities, compared with $116.2 million at the end of March. Our cash balance reflects approximately $13.2 million of cash generated from operations during the quarter. Under our share repurchase authorization, during the quarter we acquired approximately 100 thousand shares on the open market at an average price of $8.18 for a total consideration of approximately $0.8 million. We have approximately $17.4 million remaining on a $20 million share-repurchase authorization. Average days sales outstanding were 87 days, down from 96 in the prior quarter, reflecting a strong collections quarter. Before we move to our outlook for the third quarter, I would like to discuss some of the initial actions we are taking to improve our execution and support growth for our expanding product line. We are increasing our focus to improve our go-to-market efficiency and effectiveness, which includes evaluating our sales enablement engine to ensure we have dedicated the focus and resources necessary to penetrate deeper into our markets, including security. We are also implementing a number of cross-functional actions to increase accountability and improve our performance analytics. In addition to helping improve our execution, we believe these actions will also help drive greater visibility. These are just a few of the initial actions we are taking to improve our execution. Over the next few months we will continue to identify areas where we need to improve and evaluate the effectiveness of our programs. We look forward to sharing our progress with you. Moving on to our outlook. We currently expect third quarter revenue to be in the range of $53 million to $57 million. We expect gross margin to remain in the 75% to 77% range, and operating expenses to be between $45 million and $46 million. We expect our non-GAAP bottom line results to be between a loss of $0.02 and $0.09 per share using approximately 71 million shares on a basic and diluted basis. Operator you can now open the call for questions.

Thank you. We will now begin question-and-answer session [Operator Instructions] And our first question will come from Rod Hall of JPMorgan.

Yes hi. Thanks for taking my question. This is Ashwin on behalf of Rod. Lee I wanted to ask you about competitive dynamics a little bit, could you comment on how often are you seeing a FIR [ph] in the field and on your win rates against them? And then I have a follow-up.

I think there’s really no change when we said. Most of the time when we compete in the ADC market, we compete with FI; the win rate really remain the same. We have very high win rate in the north of 70%.

And then following-up on that. If your win rates remain strong, I'm just trying to understand what drove the weakness. You mentioned that some of the deals did not close and you're commencing a total review. I just wanted to make sure I get some clarity on that. Can you give more – can you be more specific there on what exactly are you reviewing. Did you find some problems with your sales engineering team or you don't have enough right resources or the right processes to respond there, can you give us more specifics around that, please?

Yes, I think we have a visibility to approximately a dozen sizable deals. We felt they were close in the quarter and they did not, right. We also realized we need to improve our execution and taking action to do that, when we get in. So they are dealing in each of our key regions but mostly in the U.S. and Japan, they are including both service provider and enterprise customers, and across our product line. I think Ray you can add more color.

Yes happy too Ashwin. So just referring back to the deals, there are a handful of deals that we are tracking in the quarter that we didn't close, although we expected them to close. And all of the deals had their own particular characteristics. So there was not anyone reason why we saw these deals move from Q2 into Q3. The good news is, we have closed them in the current quarter and most of those remain in the pipeline, also actively and diligently working to be closed in the current quarter as well. But many of our large deals are highly complex. And obviously are quite technical in nature that have to go through POX in order to close. This is very, very typical in the kind of market that we're dealing with. And as we are tracking these deals, we try to estimate is as they may come in. And once again they all have their own characteristics. Some of the characteristics are issues that run into or out our control some, of them are in our control. And the areas where we can do better is exactly where we are focused on.

Okay, thank you.

The next question will come from James Fawcett of Morgan Stanley.

Hi it's Eugene on for James. Thanks for taking my questions. On the entry-level appliances, is there a specific vertical end market that these are kind of geared towards, just trying to get a better understanding of what kind of the incremental market opportunity might be with us.

The entry-level appliance is really for both the enterprise and service provider customers. A lot of the deals actually came from channels, right. Since the entry-level opine the price range, price point particularly are not the deal we like to get the sales heavily involved, particularly the channel-driven deals. And they are meaningful revenue for A10.

Got it. And then a question on the standalone module that you just announced. Is this, do you see this as kind of an up sell opportunity for existing install base, or is this something that's going to – that you think will get you into conversations and entirely new opportunities?

Yes, it will expand our reach; give us a much bigger market opportunity. If you look at the TPS DDoS protection market, it has three components. Litigation, which I believe A10, has the best litigation solution today. Then it's about detections. With this new stand-alone detection module, we offer the highest performing detection module. We feel like we evolved [ph] management integration, which we also have and we also enhanced our management solution significantly. So here we’ve enhanced our offering allow us to compete in some of the deals we used not be able to compete. So definitely expanding our reach in the DDoS protection market.

Got it. Okay, thank you so much.

Our next question comes from Mark Kelleher of D.A. Davidson.

Great, thanks for taking the questions. Just first a clarification, the entry-level appliance, there was no revenue from that built into your guidance right? And that ship didn't become available until quite recently?

Yes, that chip only available recently. As you know, you get a new chip it takes time putting new product and quantify it. So we [indiscernible] sometime in August, so we were getting some revenue, definitely we’ll get some revenue in the quarter. Probably will ramp up in Q4 and next year.

Okay. And you talked about a number of deals, a handful of deals that flipped out. Are you seeing that hesitancy continuing into Q3? Are there deals that you factored into your guidance that you think have flipped from Q3 to Q4?

Yes, we absolutely are factoring into the longer sales cycle, we definitely expect into our guidance. But, Ray you probably can provide more.

Yes so just coming on those deals that slipped, we've actually initiated a pretty thorough review analysis, to try to really get under this. If the deals that we are closing there are fairly complex in nature. And like I mentioned earlier, their complex for a number of different reasons. Somethings we can control and somethings we can't. So we've identified some initial actions that we want to take some action around to improve execution. One area is around making sure that our sales organizations, is more trained to sell in this particularly increasingly complex environment. And we're also looking at ways to improve cross functional measures to improve the products and create a more simplified product so that we can settle. But one of the benefits we have as a small company is we are very nimble. And we can implement these actions very, very quickly and maybe even faster than some large companies. And we are pretty optimistic that the deals that sit in the pipeline are convertible in this quarter and beyond.

Yes, I think, the good thing is most remain in the pipeline. And we already closed out the deals.

So it’s an increased sales cycle, that's kind of the issue that's taking longer to close these complicated deals? And you're factoring that again, the next quarter guidance. Is that correct?

Yes.

I would say – this is Tom. The timing of when those deals may close is definitely not determined and so we may not see those in the quarter. But as we said guidance we looked across all other deals, we try to take a very measured approach to what we could expect in terms of conversion rate of our pipeline and we added an extra level of caution when we prepared our guidance taking that into consideration.

Okay, great. Thanks.

[Operator Instructions] And our next question will come from Catharine Trebnick of Dougherty & Company.

Hi, thanks for taking my question. This is [indiscernible] on behalf of Catherine. You seem to own the higher performance niche, what are you doing to kind of expand your total addressable market?

We always, the higher market we need to comprise not just the high-end appliance also about the richness, the functionality, the manageability, agility, the, of your solution. That's why we compute invest heavily in R&D to make sure we have solutions for both the traditional data center and the cloud. Make sure we also completely security solution, as I believe we offer a great opportunity for A10 to grow.

Okay. And also you have a high concentration of web scale care and your customers. What activities or things are you going to put into play to expand beyond that customer base?

If you look at the most of top 50 customers, they deploy more than one solution for A10, but some deploy three solutions, four solutions. As we continue to expand our security offering and call offering, we expect they will be the early adopter of our earning solution. Longer term, we definitely feel confidence. We saw a new Harmony Controller expansion in security in TPS we definitely offer a greater opportunity for us to expand our footprint within this marquee customers.

Okay, thank you.

Thanks.

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

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