A10 Networks, Inc. (ATEN) Q2 2018 Earnings Report, Transcript and Summary

Good day and welcome to the A10 Networks' Second Quarter and First Half 2018 Conference Call. 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 note, this event is being recorded. I would now like to turn the conference over to Maria Riley with Investor Relations for A10 Networks. Please go ahead.

Thank you all for joining us today. 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's management team joining me today are, Lee Chen, Founder & CEO; Tom Constantino, CFO; and Chris White, EVP of worldwide sales. Before we begin, I would like to remind you that shortly after the market closed today, A10 Networks issued a press release announcing its preliminary second quarter and first half 2018 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 www.a10networks.com. During the course of today’s call, management will make forward-looking statements, including statements regarding our projections for our future operating results, our expectations for future revenue growth and market opportunities, the performance of our products, our future strategies, our ability to penetrate certain markets, anticipated customer benefits from use of our products, expected product launches and the general growth of our business. These statements are based on current expectations and beliefs as of today, August 30, 2018. 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 results posted on the company’s website. We will provide our current expectations for the third quarter of 2018 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. Before I turn the call over to Lee, I’d like to announce that next week management will present at the Dougherty Institutional Investor Conference in Minneapolis and we look forward to seeing many of you there. Now I would like to turn the call over to Lee Chen, Founder and CEO of A10 Networks.

Thank you, Maria and thank you all for joining us. We are pleased to be here with you today and on behalf of the entire A10 team, I would like to thank you for your support and patience as we worked through our internal investigation and restatement. We are glad to have that behind us and with this call we are looking forward to beginning the process of reengaging with the investment community. We have a lot to discuss today. There are a number of trends in the market that we believe play to A10's strengths and we are leveraging our proven platform to enable intelligent automation with deep machine learning to ensure business critical applications are protected, reliable and always available. I will discuss our differentiated position in the cloud, security and 5G markets in more detail but first, I would like to spend a few minutes on the transformation of our sales organization to help improve our execution and drive growth. In early January, we appointed Chris White to lead our global sales team as EVP of worldwide sales. Chris joined A10 from Proofpoint and his extensive background in cyber security sales and channel leadership is helping support the company in our mission to expand our footprint in the security market. Under his sales leadership, we have implemented several measures to energize the sales team and have started to see solid momentum. We made several of these changes in Q1 including appointing a new sales leader in North America and reorganizing the sales team, which negatively impacted our Q1 results. We have since started to see improved results and delivered the strongest Q2 in our history. In late June, we brought on an experienced sales leader, Tony Webb to spearhead growth and expansion in EMEA, which is a region where historically we have not had strong performance. Now let me take you through some of the exciting opportunities we see in Cloud, Security and 5G. We believe the Cloud and Security opportunities are large and growing. Cyber threats have become one of the top ten global risks today and the threat landscape continues to intensify in frequency, scope and sophistication. At the same time, organizations are rapidly adopting new cloud-based applications and moving some of their applications and workloads to private, public and hybrid cloud environments. This increases risks, and reduces visibility and control. With such dynamics at play, our vision is to simplify application security by providing automated operations and maintaining a lower total cost of ownership. A10’s container-based Harmony Controller plays a strategic role in driving our vision in automated operations through data analysis and machine learning. Harmony Controller is a cloud native centralized management and traffic data analytics platform to manage A10’s product line through OpenAPI. It brings total visibility to multi-cloud and on-premises by providing network and application intelligence with a single pane of glass. Operations can troubleshoot faster, manage capacity planning, detect performance issues, enforce security policies and discover security anomalies in an automated manner. Over the past several months we have significantly enhanced Harmony Controller. In August, we added a key feature to Harmony Controller. It is now highly extensible by introducing a framework to run modular Apps. Using the framework, we introduced three new Apps: SSLi, GiFW and CGNAT. With the extensible framework in place, we plan to enable additional Apps for some of the popular third-party software as a service deployments. These modular Apps will provide cloud visibility and enable enterprises to monitor their SaaS deployments. In the second quarter of 2018, we received several industry recognitions for DDoS protection and Firewall solutions. Cyber Defense Magazine awarded our Thunder TPS solution as the Most Innovative DDoS Protection Solution and our Thunder SSLi solution as Best Product for SSL Visibility. Our Thunder CFW 5G-GiLAN solution was awarded the Best-of-Show at Tokyo Interop in June. We continue to make strides in improving our industry leading Thunder CFW and Thunder TPS solutions. In April, we released a version of software for Thunder CFW with new and better security features such as Application Firewall, Cylance HTTP integration, enhanced secure web gateway and high performance converged 5G-GiLAN solution. Our 5G-GiLAN solution consolidates GiFirewall, Carrier Grade NAT and DPI on a single device for lower latency, operational efficiency, better security and lower total cost of ownership. We also announced Non-stop DNS and One-DDoS Protection for our Thunder TPS DDoS solution. Non-stop DNS solution is designed to prevent Domain Name Service meltdowns due to unanticipated DDoS attacks. A global tier-1 Cloud Service Provider has deployed our solution for its mission critical application services. Thunder TPS One-DDoS Protection transforms traditional DDoS detection to be faster, better and stronger by integrating with existing ADC and CGNAT solutions. One-DDoS protection will be available later this quarter. For mobile carriers, 5G creates new business opportunities with unprecedented speed, machine to machine traffic growth, new mobile applications and proliferation of IoT. Given A10's stronghold in protecting and securing hundreds of mobile carriers around the world, we believe we are well positioned to benefit from the global transition to 5G networks between now and 2025 by expanding our footprint within those accounts, as well as growing our market reach into new accounts. We just launched Thunder CFW 5G-GiLAN solution in April and have already secured two large wins from major carriers to accelerate their initial 5G deployments. Since 2017, we have been offering subscription-based services on select solutions, such as real-time threat intelligence. We also made Harmony Controller available through a subscription this year. While subscription revenue is still a small portion of our sales, it grew 187 percent in the first half of 2018 compared with the same period in 2017. We expect subscription revenue to continue to grow rapidly over the next couple of years. Going forward, while we continue to expect some variability in our total revenue quarter to quarter given large deals with our marquee customers, we see significant opportunities for growth when looking at the longer-term trend. We currently expect to grow in the second half of 2018 compared with the first half. We added approximately 340 new customers in the first half of this year and we now have approximately 6,500 customers. Let me share with you some of the recent customer engagements. A Tier-1 mobile carrier in Asia selected our Thunder CFW 5G-GiLAN solution for its next generation 5G network rollout in a highly competitive bake-off. A10’s proven capabilities to consolidate GiFWand CGNAT, simultaneously with IPv6 migration technologies on the same device results in lower TCO, sustained scalability and exceptional performance. A major Japanese mobile carrier selected our Thunder CFW 5G-GiLAN solution for the carrier’s 5G network rollout. A10’s 5G-GiLAN solution provides the mobile carrier with a highly scalable, consolidated and secured solution for a comprehensive network defense, with automation for improved business agility, faster network rollout and overall reduction of TCO. We expanded our footprint within one of our large marquee enterprise customers, with a significant ADC win within their fast-growing cloud division. The largest dental insurance company in America standardized on A10's Thunder ADC with the Harmony Controller. This company was looking to refresh their ADC infrastructure, requiring advanced SSL ciphers, and selected A10 because they found our platform extremely reliable, easy-to-use and they wanted to manage their ADC assets from a single pane of glass. After experiencing increasing levels of frustration and disappointment with a traditional DDoS vendor’s product, a large gaming company chose A10’s Thunder TPS DDoS mitigation solution to cope with the growing volume of DDoS attacks that were impacting the experience of their users. And lastly, a multinational consumer electronics retailer chose to deploy our Thunder SSLiafter a competitor’s solution failed to deliver the performance and reliability needed to cope with their high network traffic demands. In summary, although Q1 was impacted by our sales transformation, we are now making progress on our key initiatives to improve our sales execution. We are excited about many significant advancements to our solutions, and believe we are now well positioned to benefit from the industry trends. We still have more work ahead but believe we are on the right path. We have strengthened our teams, increased our pace of innovations, and targeted our R&D investments in cloud, security and 5G. We have a very focused and aligned management team and we are excited about the opportunities in front of us. I will now turn the call over to Tom to walk you through our financials. Tom?

Thank you, Lee. I would like to echo Lee's comments that we are pleased to have the internal investigation behind us and we look forward to rebuilding an active cadence of communication with our investors going forward. I would also like to note that on August 29, 2018 we filed our 2017 10-K, including adjustments to our financial statements for prior periods. These adjustments are principally related to the timing of revenue recognition of certain transactions as we announced on July 2, 2018. The amended filings did not have an impact on the aggregate amount of revenue recognized by the company but the timing of recognition of revenue among certain quarterly periods did shift. Additional details regarding these restatements are contained in our Form 10-K filed with the SEC. Additionally, we currently plan to file our quarterly reports for Q1 and Q2 of 2018 in September. Lastly, I’d like to note that our 2018 results and guidance discussed on this call are on the new standard ASC 606 that went into effect in January of this year, whereas the 2017 periods are on ASC 605 standard. The effect of the new standard was minimal to our first half results and we expect it to be minimal for the year. Moving to our results, we reported $109.9 million in revenue for the first half of 2018, compared with $117.9 million last year. As Lee mentioned, we had a challenging start to the year as we restructured our North America and global sales teams and ramped our new sales leadership. This impacted our Q1 revenue results, but we are pleased with the steady progress we are making on our initiatives and improved momentum we saw in the second quarter. Second quarter revenue grew to $60.7 million, which represented the strongest Q2 in our history. Improved execution and a significant new expansion win within a fast-growing division of our largest customer contributed to our strong Q2 revenue results. In total, sales to this customer accounted for 19.6% of our total revenue in Q2. I'm pleased to report that in Q2 we achieved year-over-year product revenue growth. Product revenue grew 19% percent year-over-year to $39.2 million in Q2, bringing our total product revenue in the first half of the year to $67.4 million, or 61% of total revenue. Our first half service revenue was $42.5 million, or 39% of total revenue. Before moving on to our revenue mix by geography, I would like to note that for fiscal 2017 revenue from security was 26% of total product revenue and we expect that to be north of 30% of our revenue mix in 2018. Moving to our revenue from a geographic standpoint for the first half, revenue from the United States was $51 million or 47% percent of total revenue, compared with $63 million, or 54% in the same period last year. First half revenue from Japan was $25 million, representing an increase of 17% year-over-year. First half revenue from APAC, excluding Japan, was $18 million, compared with $18 million in the same period last year. In EMEA, our first half revenue totaled approximately $12 million. In other regions over the same period revenue increased to $4 million. Enterprise revenue in Q2 increased 23% year-over-year to $38 million, bringing our total enterprise revenue in the first half of the year to $66 million. Service provider revenue in the first half of the year came in at $44 million, compared with $51 million in the prior year period. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis, unless stated otherwise. We have continued to maintain our strong gross margin profile, which reflects the immense amount of software in our solutions. Second quarter total gross margin was 78.6%, which represents an increase of 100 basis points from Q1 and 160 basis points from Q2 of last year. Total gross margin for the first half of the year was 78.2%, an increase of 100 basis points from the comparable period last year. Second quarter product gross margin was 76.9%, an increase of 170 basis points from last quarter and up 200 basis points compared to Q2 of 2017. Second quarter services gross margin came in at 81.8%, increasing 90 basis points from last quarter and 160 basis points versus Q2 of 2017. We ended Q2 with staff of 855 compared with 866 at the end of last quarter, and down 6% from Q2 of 2017. Second quarter operating expenses came in at $45.3 million, or 74.6% of revenue, compared with $45.6 million, or 92.6% of revenue, in Q1. I would like to note that in the first half of the year, we incurred approximately $7.3 million in costs related to the internal investigation, which have been excluded from our non-GAAP results. We achieved second quarter operating income of $2.4 million, or 4% of revenue, and a significant improvement from the $7.4 million operating loss in the first quarter. In the second quarter, we achieved net income of $1.6 million, or $0.02 per diluted share. Our net income performance this quarter represents a significant improvement from a net loss of $7 million in Q1. Diluted weighted shares used for computing EPS for the second quarter were approximately 74.6 million shares, while basic shares outstanding for computing the net loss in Q1 were 72.2 million shares. Moving to the balance sheet. At June 30, 2018 we had $127.4 million in total cash and marketable securities, compared with $130.7 million at the end of March. Our cash balance reflects the use of approximately $3.2 million in cash to fund operations during the quarter. Average days sales outstanding were 75 days, down from 87 in the prior quarter. DSO improved quarter over quarter due to increased sales in Q2 and an improvement in collections. Moving on to our outlook. We currently expect third quarter revenue to be in the range of $55 million to $60 million. We expect gross margin to remain in the 76% to 78% range which is an increase from our prior range of 75% to 77% and operating expenses to be between $45.5 million and $46 million. We expect our non-GAAP bottom line results to be between a loss of $0.06 and income of $0.01 per share using a share count of approximately 72.7 million basic and 75 million diluted shares. In closing, I'd like to take this opportunity to thank the entire A10 team for their dedication, determination and can do attitude. While we are making progress, we know we still have areas where we need to improve. We are very aligned in focus as a management team and remain confident in our market opportunities, strategy and ability to execute. Operator, you can now open the call up for questions.

Thank you. [Operator Instructions] Our first question comes from Mark Kelleher with DA Davidson. Please go ahead.

Great, thanks for taking the questions. Can you just go into a little more detail on the revenue dynamics between Q1 and Q2 was there push-outs, were there delays, you know what happened with the sales organization that kind of floated particular product revenue and then sort of resurged it in June?

Chris, you want to take the question?

Sure. Hey Mark, Chris White here. Great to speak with you for the first time. So I joined the company January 2nd as Lee talked about and I think some of the things that I identified early when I came in was we were probably overly emphasized on our renewals business versus focusing on new business holistically, so one of the things that we did as part of our overall sales transformation was to shift that focus. So we've made some changes in our overall com structure with the leadership team and it really reemphasized the focus on driving net new bookings. Well renewals are still critically important to us and we have you know maintained and will maintain the excellent renewal rates that we have. The day-to-day execution in the field needs to be focused on new business and we brought that transformation to bear in Q1 and started to see the results of that in Q2.

Tom, do you have anything to add?

Yes, I would just add that, Mark, we obviously are going through a transformation and with the transitions that we had throughout the sales organization it definitely caused us to have some performance matters that’s from a revenue result you see in the numbers. We think we've worked through that and what we've frankly said while we have more work to do on that, that definitely did impact our first quarter results. I will say that, that was mostly expected as we went into the quarter. We knew that it wasn’t going to be a real strong quarter for us, so it wasn't a total surprise that we knew that we had some changes to make in getting that traction in Q2 would benefit us.

Well, yes and this is Chris again. Just to add to Tom's comments Mark is, we referenced that we made some changes and we made significant changes in Q1. So in February of Q1 we appointed a new North American VP of Sales and we also in mid Q1 started to deploy our revised go-to-market strategy around sales segmentation and driving increased focus and accountability in our large accounts as well as in our traditional enterprise space and the goal there again is to focus on net new account acquisition, pipeline development and growth, and with those changes we began to see both increase as we entered Q2 and we started to see increased execution as we delivered revenue in Q2 as well.

And as you've gone through the sort of this re-jiggling your sales force how has your competitive position materialized, are you stronger, what’s the competitive environment like these days?

Yes, I think it's actually helped us to be more effective in the competitive landscape because historically we would have teams that were on a Monday competing in an enterprise an accountant on a Tuesday competing in a large global strategic account and through the segmentation strategy we've got dedicated teams, both technical and sales resources that are focused on not only penetrating those accounts, but as importantly working with our installed base to sell horizontally. As you guys know we have a very broad solution set, so this allows us to go deeper and wider new accounts and improve our competitive positioning and differentiation and it's also the other thing that we've seen in a very short period of time is our level of relationship within the account in a lot of these accounts has expanded due to this focus around segmentation.

Hey Mark, Lee. We remained high and if you look at our gross margin in Q2 it is our highest gross margin I believe in the company’s history. So we definitely have a very differentiated position especially in Harmony Controller.

Okay, one last question for Tom on the numbers question, the litigation expenses are those all behind you now?

Yes, those are litigation expenses Mark, those are what we referenced was investigation related expenses and investigation as we disclosed in early July is complete and so those costs are behind us.

Okay, great thanks.

[Operator Instructions] Our next question comes from Catharine Trebnick with Dougherty. Please go ahead.

Thanks for taking my question. I had a couple of them. One has to do on Mark kind of discussed, what you're doing on the sales side of things but on your go-to-market where are you on your products? I mean, how many new products have you introduced since January? I just want to make sure that you're still firing on the innovation engine and then the other followup to that is, of the new service providers and the dental company, how many of those deals were closed in Q2 versus Q1? Thanks.

So I will answer the product question, I will let Chris answer the sales question. So as you know we continue to make strides in our innovations. Harmony Controller has played a strategic role in driving our differentiation and our vision. So over the last several months we made significant enhancement to Harmony Controller. We made a release in April, we may now release in August. In August the key feature are very significant. It will allow us to have modular pluggable app to be dropped into the Harmony Controller. So, three new apps were released in August. SSLi, CGNAT and Gi Firewall and you should expect additional apps will be released in the coming quarter, coming years.

So your target market for those are going to be carriers migrating to 5G or large data center play just to have a idea about your market?

Actually it will target both the enterprise and also the service provider. 5G definitely is a focus area, but on the other hand if you look at security there's applying to secure your play because you can, for the security Harmony Controller enable operators to troubleshoot faster, enforce security policy, discover security anomalies in an automated manner, so it's also enterprise play.

So for type of metrics keeping is there a - how many of let's say you guys have one 12 deal last quarter, in addition how many of those included the Harmony Controller and how healthy is your pipeline with the Harmony Controller?

Yes, as you know the subscription is a fast growing business as well as Harmony is the main reason why the subscription in 2018, first half of 2018 grew 187% over the same period of 2017. Harmony is a key contributor to the growth.

Okay, thanks Lee.

Yes, and Catharine this is Chris. Just to add a couple of things on that. I mean holistically if you look at our pipeline growth, I mean just in the last twelve months specific to security it has more than doubled in the last twelve months. And even one of the first moves that I made in joining the company in January was we did do a complete sales force dotcom scrub right, so we refreshed aged out deals that maybe had been in there too long. So if you can look at from Q1 and to today August 30 it's more than doubled in that period of time with the scrubbing that we did. So I'm really pleased with the progress there and Harmony is a big component of that as well as CFW. And then to answer your earlier question around new accounts from Q1 to Q2 it's pretty balanced from call it number of units in those larger strategic accounts. The new electronics retailer if you will that Lee mentioned in his example and the dental organization those were both Q2 wins. If you look at some of the large gaming that we had that was a Q1 win. And you talked about our large key account that we have that we referenced is 19.6% of the revenue in Q2, a couple of comments on that. Number one, it was multiple aspects of that account, multiple divisions that we gained revenue from, so it wasn't just a single transaction, it was a combination of transactions with different aspects of that corporation globally. And we also got a much smaller percentage, but some additional business from them in Q1 as well. So yes that one larger transaction was in Q2, but we had a nice blend between Q1 and Q2 and overall large deals.

Yes, I imagine that one would carry on for another quarter or two too.

Yes, I mean as we've talked about there is some dynamics on a quarter-to-quarter basis with that business. Based on our past success I would expect that we'll continue to be successful with that account and continue to expand our footprint with that account?

Alright, thank you very much.

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