A10 Networks, Inc. (ATEN) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the A10 Networks' Third 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'd 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’ third 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. Members of A10 management team joining me today are Lee Chen, Founder and CEO; and Tom Constantino, CFO. Before we begin, I would like to remind you that shortly after the market close today, A10 Networks issued a press release announcing its third 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 comments, and trended financial statements on the Investor Relations section of the company’s Web site at www.a10networks.com. During the course of today’s call, management will make forward-looking statements, including statements regarding our projections for our fourth quarter 2017 operating results, our expectations for future revenue growth and market opportunities, the performance of our products, profitability, operating margin and operating expense, our ability to penetrate certain markets, anticipated customer needs, expected product launches and the general growth of our business. These statements are based on current expectations and beliefs as of today, October 26, 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 description 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 may be 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 fourth 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'd like to turn the call over to Lee Chen for opening remarks. Lee?

Thank you, Maria. And thank you all for joining us today. We delivered a strong third quarter. Revenue grew 12% percent year-over-year to $61.4 million, which exceeded our initial and revised guidance, and we achieved non-GAAP EPS of $0.03. Our top line performance was driven by solid demand and the team’s improved execution. Our sales team did a terrific job closing a number of large deals that contributed to our top line results. We also continued to build traction with our security platform, which include strong sales of our Thunder convergent firewall or solutions. We saw strength with our marquee service provider customers, including: a large win with a mobile provider in the U.S., where we continued to expand our footprint and replaced the incumbent ADC vendor with our Thunder ADC and Thunder SSLi solutions. In total, this customer contributed 14% of our Q3 revenue. Our first seven-figure win with a leading mobile provider in Mexico for our CGN and ADC solutions. We are excited to have won this competitive deal, which represents both a new customer logo and an opportunity to expand our relationship over time. And, new project wins with four of the top telecommunication providers in Japan. Overall, in Japan we delivered outstanding performance that was partly driven by traction with our security solutions. On the product front, we achieved strong product bookings for Thunder ADC, and record product bookings for our Thunder SSLi and Thunder CFW solutions. With the enhanced SSL capabilities we introduced earlier this year, our SSL processors now handle advanced ciphers and offload intensive SSL processing with greater performance, scalability and reliability. Our Thunder CFW platform provides a suite of integrated firewall solutions with a diverse range of security features, helping customers protect their security infrastructure and defend against web application attacks at scale. A few of our recent customer wins in security included: an organization of the executive branch of the Japan’s government looking for a highly-scalable and reliable solution to protect their IT infrastructure chose A10's Thunder CFW and SSLi solutions for the high performance of ACOS and for our Open API. A federal enforcement agency in the U.S., chose A10's Thunder SSLi to cope with the growing amount of encrypted traffic on their networks. Our ability to easily integrate our solution into their existing security stack was a key decision factor in this competitive win, and a major retail group in Japan chose A10's Thunder CFW and Thunder SSLi as the Cloud proxy for its new Office 365 deployment. We believe security and cloud are powerful market opportunities for A10. We are focused on leveraging our strength as a trusted performance leader and our global marquee customer base, to capitalize on this opportunity. In the era of connected intelligence, traffic volumes and complexity continue to significantly increase. Customers will need automated capabilities to learn, predict, recommend and dynamically enforce policies. A10’s mission is to provide customers with intelligent automation to comprehensively enforce policies for security and application delivery solutions to strengthen and simplify their security posture. The recent enhancement to our TPS platform demonstrate our continued progress toward this objective. A10’s TPS platform is an industry leading DDoS protection solution with a TPS Detector that automatically orchestrate policies to detect sophisticated DDoS attacks. When an attack is detected, it notifies the TPS management system to automatically perform countermeasures to mitigate DDoS attacks in real-time. We are encouraged by the initial customer response for our expanded TPS capabilities. We are actively working to build our pipeline, which will take time. While it is still early days in establishing A10's brand and reach in the security market, we are pleased with the progress. In summary, we delivered a strong third quarter and are pleased with the team’s improved execution. With our innovations and strong customer support, we believe we are establishing a strong portfolio of solutions that help enterprises, service providers and cloud providers secure and improve the performance of their networks and mission critical applications. We are making solid progress, but still have a lot of work ahead in order to continue to capitalize on the fast-growing areas of our market while delivering more consistent top line results and profitability. I am excited about our future opportunities and look forward to sharing our progress with you. We remain committed to enhance -- to enhancing shareholder value. As we announced in our press release today, the Board of Directors has authorized another $20 million share repurchase program, which reflects our continued confidence in market opportunities and business. With that, I’d like to turn the call over to Tom to review the details of our third quarter financial performance and fourth quarter guidance. Tom?

Thank you, Lee. Third quarter revenue grew 12% year-over-year to $61.4 million. We also grew deferred revenue 9% year-over-year, to reach $91 million. Third quarter product revenue grew 12% year-over-year to $39.4 million, representing 64% of total revenue. Third quarter service revenue was $22 million, or 36% of total revenue. From a geographic standpoint, third quarter revenue from United States was $28.8 million, up 19% on a year-over-year basis. Third quarter revenue from Japan was $16.6 million, up 4% on a year-over-year basis. Third quarter revenue from APAC, excluding Japan, was $6.7 million, compared with $7.4 million in the same period last year. Third quarter revenue from EMEA was $6.1 million, representing a 1% year-over-year increase. Service provider revenue increased 36% year-over-year to reach a record $32.5 million, or 53% of revenue. Enterprise was 47% of revenue, or $28.9 million, compared with $31.2 million in Q3 of last year. 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 of 78.3%, an increase of 120 basis points from last quarter and Q3 of last year. Third quarter product gross margin was 77% percent, an increase of 200 basis points from last quarter and up 180 basis points from Q3 of 2016. Our improvement in gross margin was driven by geographic and product mix. Services gross margin came in at 80.6%, increasing 40 basis points from last quarter and flat compared to Q3 of 2016. We ended the quarter with headcount of 877 compared with 892 at the end of last quarter. Non-GAAP operating expenses came in at $45.4 million, compared with $44.2 million in the prior quarter. Non-GAAP operating income was $2.7 million, compared with $0.3 million in the third quarter of last year. Non-GAAP net income for the quarter was $2.1 million, or $0.03 per diluted share, compared with $0.2 million, or break-even on a fully diluted per share basis in Q3 of last year. Diluted and basic weighted shares used for computing non-GAAP EPS for the third quarter were approximately 73.6 million shares. Moving to the balance sheet, average days sales outstanding were 68 days, down from 87 in the prior quarter. At September 30, 2017 we had $123.9 million in total cash and marketable securities, compared with $132.2 million at the end of June. Under our existing share repurchase authorization, which expires this month, during the quarter we acquired 351,524 shares on the open market, at an average price of $6.42 for a total consideration of approximately $2.3 million. In total, over the past 12 months, we have repurchased approximately 678,000 shares in the open market. As Lee mentioned, the Board of Directors has authorized another share repurchase program of up to $20 million over the next 12 months. Under the authorization, 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 expresses our confidence in our opportunities and long-term financial performance. Overall, we delivered a strong third quarter and we are pleased with the initial progress we are seeing from the actions we took to improve execution. More specifically, we improved our forecasting processes and sales performance analytics which led to improved sales execution. We also improved our focus on accountability and performance management. Similarly, we have taken steps to improve our cross-functional collaboration in support of sales in delivering the quarter. While we have more work to do as mentioned by Lee, we believe we are on the right track and that our efforts helped us deliver a strong finish to the quarter. Moving on to our outlook. We currently expect fourth quarter revenue to be in the range of $64 million to $67 million. 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 between a profit of $0.01 and $0.07 per share using approximately 74 million shares on a diluted basis. Operator, you can now open-up the call for questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes Mark Kelleher with D.A. Davidson. Please go ahead.

Congratulations on a very strong quarter. Service providers coming in very, very strong, but enterprise looks like the third quarter in a row of declines and year-over-year decline. Can you just tell us what the dynamic there is? What's your expectation for the enterprise?

Hey, Mark. This is Tom. How are you?

I am well. Thanks.

Thanks. So enterprise, we are continuing to win logos in enterprise. So we don't believe it is an indication if there is a challenge for us in that regard. Having said that, we have work to do to bolster up our top line there as we go forward. We know there are areas that we can drive and so we are working on that. But we are also seeing a lot of positive feedback and momentum around our security products. And so, we continue to remain optimistic and positive about it.

Does the low-hanging fruit, let's call it around the service provider side take sales force attention away from the enterprise. Is there any of that going on?

I don't think that's the case. I mean, the large deals that we won on the service provider side, and those are deals that have been in the works for a while. They take a lot of -- continued focus by our teams, but that doesn’t distract from others who are concentrating more on the enterprise side. So, I don't think that's the case, Mark.

All right. And just one last question. The security revenue, can you give us an indication of what that was as a percent of revenue?

I think we don’t break down security revenue quarter-by-quarter, but we made a commitment on more than 20% of the product revenue will come from security for the year and we remain committed to that.

Okay.

Also the -- also I think we announced in -- during the Q2 conference call, the first half of the -- the first half of 2017 security revenues 26% of the product revenue. So we are on track to achieve that.

Okay, great. Thanks.

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

Great. Thank you. I actually want to follow-up on the enterprise question. Can you just dive -- delve in a little bit into the color there. You indicated that you’re winning more logos, but is there something in the timing of the ramp and you say you are confident that business will be fine. But is that going to tend to be pretty lumpy similar to service provider? Just [indiscernible] some of the underlying dynamics why even with the new logos it continues to be a bit below or not growing?

Hey, James. This is Lee. As you remember in the past, we talked about we improved some of the core providers such as Microsoft, I would say enterprise customers. So enterprise became …

Okay.

… meeting with their cloud business, so that could be lumpy from quarter-to-quarter. But on the other hand, we are very pleased we saw security wins among enterprise. If you look at the Q3, one of our strongest quarter for security both for the Thunder CFW and Thunder SSLi. The half of the -- our security wins in Q3 are new customer -- enterprise customers. So, in general, we’re very pleased with strong enterprise momentum other than a few lumpy deals that could vary from quarter-to-quarter.

Okay, great. And then, in your guidance, what are your expectations for large deals there? Just wondering how you try to net those out as you’re formatting your guidance and what the opportunity for even more upside might be, if some of the lumpy deals come through, just -- how do you incorporate that into your guidance formulation? Thanks.

Shall I go first?

Sure.

Yes. So, our guidance will be based on historical trends, based on pipeline, based on the backlog and based on the customer engagement we have. So it really it did not particularly come a lot of logical coming in. So if we had several deal I expect to come in that can potentially provide upside, but we are not counting on that.

Okay. That's great. And then last question for me as you look at your large deal opportunity and going into 2018, how is the pipeline developing and what are the key things that you feel like need to be done to make sure you take full advantage of that pipeline?

I think first of all the -- we normally don't comment beyond one quarter. But we look at the product portfolio, our service, the investment we’ve made in security and cloud, we think for 2018 -- with all the program we have going on, we do think [indiscernible] long -- longer term and provide a lot of good market opportunity for A10.

That's great. Thank you very much.

Thank you.

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

Hi, [indiscernible] got on for Catherine. Thanks for taking my question. You seem to have pretty good solid growth in the product segment. I was just wondering if you could drill down a little bit on your long-term strategy to grow your service revenue?

So today if you look at our service revenue, the majority of the service revenues came from the service renewal. But we do have a plan to grow our subscription base revenue. So you're going to see the upcoming product portfolio, new product portfolio coming from A10 will offer subscription base services. So that will be really on top of our today’s -- most of our revenue from appliance. So software, security and subscription will be in the futures.

Okay, great. And just one other thing I saw you announced today, a new VP of Worldwide Marketing. Just wondering how that changes the organizational dynamics there at all and what we will see definitely going forward?

We are always looking for good changes. We believe and say [indiscernible] somebody who know A10 for a while, who has been with A10 for a while, so to us it's really the least disruptive and also most knowledgeable about the industry, the product and above our solution. I think it's a major plus for us.

Great. Thanks.

[Operator Instructions] The next question comes from Tal Liani with Bank of America. Please go ahead.

Hello guys. I have a few questions. I want to state the higher level and understand the difference between your great results and the disappointment from F5 yesterday. Where do you think -- why do you think you can do better than the industry or better than F5 this quarter and kind of over a longer-term? And then one of the issues of F5 was that virtual solutions are cannibalizing the market are basically having deflationary impact on the market. Why does it impact them and doesn't impact you?

Okay. That is -- I will close there, I think it's one of the improved execution. I think we have a strong momentum globally with our service provider customers. And if you look at our heritage, our innovation, we really are -- our products deploy in some of the most challenging network environment. And I believe we're really -- we have a strong foundation to penetrate, the fast-growing segment of the market where visibility, facilities can become performance [indiscernible]. If you look at our product offering today, it's kind of a little bit different from F5. We have a very strong percentage revenue, security offering. We have really good CFW. CFW actually has a record product booking in Q3. We also have momentum in SSLi. So, our Thunder TPS, and other security solution we just have enhanced capability of Thunder TPS and our initial [indiscernible] on customer are great.

You do have also enterprise exposure. How are the trends in the enterprise exposure, in the enterprise segment?

I think overall if you look at quarter-by-quarter, we acquire between 150 to 200 new enterprise customers. And in this quarter we also acquired several new logo. One good thing about -- we observe about our security offering is half of our security customer are new to A10.

So, again, the question here is twofold. Number one is, within the enterprise space cloud, cloud strategy and virtual solutions is a key element, how come they're being impacted and you are not and that's on the ADC side. And on security, I would say the same question, why are you successful and they are not? I am trying to understand your uniqueness -- I understand the basic position of security on the platform and why you are successful, why you are offering it and why you’re successful where you are? I am trying to understand what make you successful why -- while a similar company is not successful trying to do more or less the same thing in the same sector. I'm trying to understand the uniqueness of your angle or your strategy here?

Yes, on the cloud and virtual, I think we offer a suite of the cloud and virtual solution. If you look at A10 strategy, especially with a [indiscernible] controller. So our strategy is really to transition customer for both from the traditional infrastructure to multi-cloud. So how many controller is a micro service [indiscernible] base solutions. I don’t really know if they have similar offering, which I believe they don’t. So that’s one difference. The other thing we offer a really strong -- you look at all virtual, there is the recent announcement at Microsoft [indiscernible], top of all the virtual TPS solution to offer up to 30 gig of performance which is the leading performer, virtual performers in the industry for TP -- for DDoS protection. So on the security front, I think again our offering is quite different. I think F5 in the past as I know has been focused on a while, and also were focused on Gi firewall. We have lot in Gi, but we offer a suite of firewall features. So we are not just offering one thing and there are trends in security offer is realigned [ph] to again go through ACOS platform, which in the past ACOS platform give us several time performance among the Layer 4 and also give us the scalability in terms of number of session [ph], number of flow can be supported by our platform. I think we -- really is the performers scalability and also we get a lot of customers -- having the customers on the existing customers, which means we have a strong traction among all multi service provider customers. Many of [indiscernible] provide customer take not just one product [indiscernible] A10. The take ADC, CGN, SSLi, CLW, and TPS from A10. We have several of these customers serviced by [indiscernible] waiting for all their solution used -- maybe [indiscernible] of ACOS with [indiscernible] solution on their networks.

So sorry, I’m taking too much time, but I have one last question. If I look back a few quarters, there were some disappointment and now you are starting to show solid momentum. What changed -- what drove, is it -- was it really just sales execution or timing of projects. I am trying to understand how much of today's momentum or strength is a reflection of something you fixed in the business, maybe go-to-market or anything and how much of it is products and the offerings and what changed now versus before?

It's really a combination of both. Why is it due to the fact we have a lot of the marquee customer in service provider, that business can be lumpy from quarter-to-quarter. But we look at -- if we look at annually, we still -- I think we are in the good trajectory, but on a quarter-to-quarter basis that’s -- its timing of the project. The second is [indiscernible] as you just pointed out, it's a sales execution. I think we improved our sales execution last quarter. We still have a lot of work to do and we are working diligently to improve our go-to-market sales enablement and also sales execution and also alignment among sales, marketing, and engineering. We are working on all of that. We still have a long way to go.

Right. Thank you.

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.