A10 Networks, Inc. (ATEN) Q1 2019 Earnings Report, Transcript and Summary

Good day and welcome to the A10 Networks First Quarter 2019 Financial Results Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would like to now turn the conference over to Maria Riley with Investor Relations. Please go ahead.

Thank you, Alyssa and thank you all for joining us today. This call is being recorded and webcast live and may be accessed for 1 year via the A10 Networks' website, www.a10networks.com. Members of A10's management team joining me today are Lee Chen, Founder and CEO; Chris White, EVP of Worldwide Sales; 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 first quarter 2019 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, and 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, the capabilities of our sales team, our expectations regarding future opportunities, and our ability to execute on those opportunities, our commitment to innovation and bringing new solutions to market, our expectations for future revenue and market growth, the development and performance of our products, our current and future strategies, our beliefs relating to our competitive advantages, our expectations with respect to the 5G market, responses to new security threats, our partnerships with key technology providers and sales partnerships, our ability to penetrate certain markets, anticipated customer benefits from use of our products, the refining of our marketing engine, improvements in productivity, our priorities relating to 5G growth and our security solutions, expected product launches and adoption of recent new products or software releases, and general growth of our business and our ability to incrementally grow operating margin annually and timeline to achieve our target operating margins. These statements are based on current expectations and beliefs as of today, April 25, 2019. 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-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 second quarter of 2019 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. I would like to turn the call over to Lee Chen, Founder, and CEO of A10 Networks. Lee?

Thank you, Maria and thank you all for joining us today. We have decided to change the format of our call to include Chris White, our EVP of worldwide sales. I will provide a few comments on the quarter, our progress on the major initiatives and product innovations. Chris will then discuss our markets, customer wins, and go-to-market transformation, and Tom will provide the details of our financial performance and outlook for Q2. We hope you find our new approach informative. Moving to our results. In the first quarter, we continued to make progress on our initiatives in security, 5G, and multi-cloud. We delivered revenue of $50.3 million, non-GAAP gross margin of 76.3% and delivered a non-GAAP loss per share of $0.09. Q1 is traditionally a seasonal quarter for us and while our year-over-year revenue growth was modest, there are several points I would like to highlight that we believe demonstrate our growing momentum in security, 5G, and multi-cloud. First, we continue to see strength in security with both new and existing customers. Security product revenue grew 22% year-over-year to 34% of product revenue, led by our Thunder CFW solution that integrates carrier firewall, data center firewall, secure web gateway, IPSec site-to-site VPN, integrated DDoS protection, SSL visibility, application visibility, and traffic steering capabilities. We have been investing in security and believe we are building momentum and recognition in the market with our highly scalable and intelligent automated software-based security solutions. In Q1, this included winning 2 Cyber defense Magazine Infosec awards for our 5G security and DDOS protection solutions. Additionally, A10 was top-ranked in terms of market share for SSL visibility in Japan by ITR Corporation, which is the largest Japanese-based IT research and advisory firm. Second, is 5G, which we believe is an exciting market opportunity for our security solutions. Our stronghold in the service provider segment and the high-performance and scalability of our solutions position us extremely well to meet the evolving security and performance needs of our 5G customers. One of our goals for 2019 is to grow our 5G design wins with leading mobile carriers globally. In Q1, we secured a new 5G design win with another top mobile provider in Korea, which builds on A10's 5 design wins from 2018. This customer selected our flagship Thunder CFW 5G appliance with Harmony Controller. Of the three vendors invited to participate in the proof of concept, A10's solution was the only one that passed completely and successfully with zero packet loss. Korea is a pioneer in 5G commercial deployments and new use cases, and I am thrilled that A10 has secured design wins with the 3 largest providers in the country. In fact, earlier this month, we helped the largest provider in Korea launch the first 5G commercial wireless network. We believe our wins with these industry leaders will bode well for A10 in the future as other providers around the world look to ready and secure their networks for 5G. The energy level at Mobile World Congress was undeniable this year as a number of operators announced their 5G launch plans for 2019, the pioneers unveiled new use cases, and several manufacturers announced 5G handsets. Another noteworthy development this year at MWC, was security emerging as top-of-mind in operators' keynotes and presentations. At the show, we had productive discussions with many service providers and partners about their security challenges of 5G. With our portfolio of high-performance and automation driven 5G Gi/SGi-firewall, GTP firewall, DNS firewall and integrated DDoS protection at hyperscale, A10 plans to be with them to help customers strengthen their 5G security posture. Third, in Multi-Cloud, we made good progress with new wins with service provider, government, and financial services customers during the quarter. Harmony Controller is one of our growing number of products offered on a subscription basis and is driving our software subscription revenue. While our subscription revenue remains small, it is growing rapidly, and we were pleased to see the number of Harmony Controller wins increase, which included some of our marquee wins this quarter. On the product front, we continue to innovate and pioneer new solutions, and we have a robust Thunder TPS roadmap this year. Over the past quarter, we released a number of enhancements to our product portfolio. In March, we announced a new capacity enhancement to our Thunder TPS that now provides the highest performing DDoS defense appliance on the market. The added capacity will enable service providers, cloud and online gaming providers to build profitable DDoS mitigation services and expand their service offerings while defending their networks and subscribers. With the proliferation of connected devices, expanding bandwidth, and new application services driven by 5G networks, the size and intensity of DDoS attacks will increase exponentially. We believe the performance and the automation available with our Thunder TPS delivers effective protection against this new and evolving attack landscape. In the quarter, we also forged ahead in our efforts to drive further product innovation that supports the commercial rollout of 5G networks and began shipping our industry-leading virtual Thunder CFW 100 gigabit per second, a solution with the fastest throughput available in the market. This solution has already been adopted by a major telco provider in the Middle East for its 5G environment. We believe this new A10 solution will be critical to helping customers transition to an agile, scalable, and software-defined network function virtualization infrastructure required for the commercial rollout of 5G networks. Overall, we continue to make progress on our top priorities for 2019, which include driving growth and innovation in security, 5G, and multi-cloud. We remain on track to grow our security product revenue to be 40% to 45% of total 2019 product revenue and deliver total revenue growth in the back half of the year. With that, I will turn the call over to Chris.

Great. Thank you, Lee. In looking at the dynamics within the quarter, the demand environment remained consistent, however it was more back-end oriented than expected. Our win rate remained high and we had ongoing strength within service provider and enterprise customers. Our continued success with these customers is based on growing demand for our security, 5G, and multi-cloud solutions. Business with our Web Giant customers tend to be large and can fluctuate from quarter to quarter. We saw the downside of that dynamic play out in Q1 and expect it to continue to be a headwind in Q2 given the tough year-over-year compare where we had a cloud customer contribute 20% of revenue in Q2 of 2018. From a geographic standpoint, we were pleased with our performance in our Asia Pacific theatre that excludes Japan, where we delivered double-digit year-over-year growth for the fourth consecutive quarter, and Latin America, where we delivered triple-digit growth. Korea was also strong during the quarter. As Lee mentioned, 5G is quickly gaining momentum in Korea and we believe we have an early foothold on this market with design wins with 3 of the largest providers in the country. Approximately 85,000 5G base stations have been deployed in South Korea alone, and the region is fast becoming the pioneer in 5G use cases and commercial deployments. We believe our stronghold in the service provider segment and the high-performance and scalability of our solutions positions us extremely well to meet the evolving security and performance needs of our 5G customers. Moving to our go-to-market. In the quarter, we continued to execute on our transformation plan and make progress. As we discussed previously, at the start of the year, we implemented several changes designed to incentivize the sales team to drive new product sales with both new and existing accounts. We expect these changes to positively impact the second half of 2019. We also launched two important go-to-market changes in North America. In January, we announced a partnership with Arrow Electronics, a move to a 2-tier channel structure. Arrow enables a community of more than 3,000 channel partners and through this new partnership, we will focus on recruiting security centric VARs and working together on sales and technical enablement, joint business planning and marketing to find new opportunities. In Q1, we were focused on ramping activities with Arrow and while it is still early, we are encouraged by our initial progress, which included adding 9 new security focused VARs in the quarter. We also formed a new engagement with Televerde to help us expand our lead-generation efforts in North America. This program also went into effect in Q1 and we expect to see the impact of both of these new relationships as we progress throughout the year. While we have already completed a lot of the heavy lifting in our sales transformation, we believe we are half-way through a two year journey and our new sales leaders and their teams continue to ramp, build new customer relationships, drive pipeline and revenue conversion. Approximately 29% of our global sales team has been on board less than three full quarters. The Latin America region is the furthest along in their transformation and you can see by the progress in their revenue growth and sales productivity metrics. Whereas, North America and Europe are still in the early innings with close to 40% of the combined sales team on board less than 3 full quarters. As we continue to progress through this evolution, the key metrics we are using to measure our success are new customers, which grew to 177 in Q1. In addition to the number of new logos, we were also pleased with the quality and future expansion opportunities represented within these new customers. Two, pipeline of security opportunities, which grew over 20% year-over-year. And we are also closely monitoring our sales productivity, which decreased slightly in Q1. In aggregate, this metric can fluctuate from quarter to quarter depending on seasonality, the concentration of large deals, and the percentage of new sales hires in the quarter, but overall we expect it to trend upward as we progress through the year. We are building a strong funnel of opportunities for our security, 5G, and multi-cloud solutions and our technology vision and differentiated platform is resonating with customers. In addition to the 5G win Lee shared, I'd like to highlight a few recent engagements. We secured a large win with a mobile provider in the U.S., where we refreshed a portion of their ThunderADC install base and expanded our footprint by replacing an incumbent vendor with our ThunderSSLi solution. We also gained a foothold with a large mobile carrier in India with our Thunder CGN solution. A key differentiator cementing this new customer engagement was the tight integration with our partner Ericsson. Ericsson put forth a complete packet core solution with A10 providing the carrier-grade NAT component. We believe there is opportunity to expand our sales to this customer over time, especially as they consider their options for 5G. We also secured a new customer in Canada that provides IT services to government agencies. This customer selected A10's SSLi solution for large-scale decryption to help harden their security perimeter. This win involved a lengthy RFP process where we were up against a number of competitors. I would like to thank our partner and our team for their collaboration and hard work to bring Phase 1 of this deal to close. And lastly, with a leading provider in Japan, we secured a large ThunderTPS win as we grow our footprint with this important customer and continue to replace the incumbent DDoS vendor with our high-performance solution. Overall, we are seeing results from our go-to-market transformation including a growing pipeline of large deals, but we also recognize we have work ahead to ramp and enable our teams and new partners in order to capitalize on fast growing areas of our market. Our product portfolio is strong, our win rate remains high, and we are committed to innovating and refining our go-to-market engine. We have a very clear vision, a line of sight to what we can accomplish this year, and our team is energized about the market opportunity for our solutions. With that, I'd like to turn the call over to Tom to review the details of our first quarter financial performance and second quarter guidance. Tom?

Thank you Chris. First quarter revenue increased 2% year-over-year to $50.3 million, compared with $49.2 million in the same period last year. Deferred revenue was up 1% year-over-year, to reach $98.6 million. First quarter product revenue was $28.2 million representing 56% of total revenue. Service revenue was $22.1 million, or 44% of total revenue. Security product revenue grew 22% over last year to reach 34% of total product revenue in Q1. Moving to our revenue from a geographic standpoint, for the first quarter revenue from United States decreased 12% year-over-year to $18.1 million, compared with $20.7 million in the same period last year. In Japan, revenue was $13.2 million, up modestly at 1% year-over-year. Revenue from APAC, excluding Japan, was $8.8 million, up 18% year-over-year. In EMEA, revenue was $7.2 million, an increase of 11% when compared with $6.5 million last year. Revenue from LATAM in the quarter more than doubled year-over-year to $3 million, compared with $1.5 million last year. As a reminder, last quarter we changed the way we disclose our revenue by customer vertical in order to provide more transparency into our exposure to Web Giant and Cloud customer revenue, which was previously primarily accounted for in Enterprise revenue. Service provider revenue in the quarter increased 13% year-over-year to $23.8 million. Enterprise revenue in the quarter increased 7% year-over-year to reach $22.9 million. Our Web Giant revenue decreased 47% year-over-year to $3.7 million in the quarter. 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 76.3%, a decrease of 190 basis points from last quarter and 140 basis points from Q1 of last year. First quarter product gross margin was 73.5%, compared with 76.8% last quarter and 75.2% in Q1 of 2018. Our year-over-year decrease in product gross margin was primarily driven by a few select strategic opportunities and inventory write-downs. Services gross margin in the quarter came in at 79.9%, compared to 80.9% in Q1 of 2018. We ended the quarter with headcount of 834 compared with 860 at the end of last quarter. Non-GAAP operating expenses in Q1 came in at $44.1 million, compared with $45.1 million in the prior quarter. Non-GAAP operating loss was $5.7 million, compared with operating income $3.3 million in the prior quarter. Non-GAAP net loss for the quarter was $7 million, or $0.09 per diluted share, compared with a loss of $7 million dollars, or a loss of $0.10 per basic share in Q1 of last year. Diluted and basic weighted shares used for computing non-GAAP EPS for the first quarter were approximately 75.2 million shares. Moving to the balance sheet, average days sales outstanding were 80 days, consistent with the prior quarter. At March 31, 2019, we had $122.8 million in total cash and marketable securities, compared with $128.4 million at the end of December. Moving on to our outlook for the second quarter. We currently expect second quarter revenue to be in the range of $51 million to $56 million. We expect gross margin to be in the 76% to 78% range and operating expenses to be between $43 million and $44 million. We expect our non-GAAP bottom line results to be between a loss of $0.08 and breakeven on a per share basis using a share count of approximately 76 million shares. Operator, you can now open the call up for questions.

[Operator Instructions]. Our first question today comes from Mark Kelleher of D.A. Davidson.

Just wanted to start with the cloud Web Giants, the cloud and the Web Giants. You've indicated that you're seeing some weakness there, it's lumpy. What drives the demand from the Web Giants and how much visibility do you have there?

Chris, you want to address this?

Sure. Hi, Mark. This is Chris. Yes, I mean we, from a predictability standpoint, we do work very closely with our install base of Web Giant accounts. But a lot of it is based on their utilization rates, which aren't always predictable or readily available. And as you look at it, we certainly did have some weakness of some members, as we called out, on Web Giants in Q1. But as you look at them on an annual basis, we believe that we're well positioned for 2019 with the Web Giants.

And on the 5G ramp, you've got some great wins there. When does that begin to be a meaningful part of revenue? Does that really just start to roll out the back half of this year and then bigger next year? What should we expect there from 5G?

Our expectation is in the second half of 2020. A meaningful revenue.

A meaningful revenue. Okay. How much is the VAR ramp going to help you? Can you talk a little bit more about the VAR ramp and how that should impact revenue and margins?

Yes, absolutely. So we -- as I called out in the script that we obviously, in North America, brought on Arrow in the first quarter and it was certainly a ramp quarter, right, an enablement quarter for them. So we have dedicated resources through Arrow and expect through the recruitment strategy and through the additional resources we have focused on it, we would expect to see some level of increase in the second half of the year, right. And I would really look to 2020 to see that scale but we should see some impact within 2020 or 2019 in the second half. And then the other area that it will help us with is around our security growth because we're really focused with them on bringing on new security partners, which you saw we had a handful of those in the Q1 of 2019.

Okay. And last question from me. Just the competitive environment. One of your competitors made an acquisition recently, Open Source and Genex [ph]. Has that changed the competitive dynamic? What do you think of that?

Mark, this is Chris again. From my perspective, I think that that acquisition is interesting from a story perspective and I would say that from an A10 perspective, it doesn't really change the competitive landscape because we're already having a number of conversations with customers around Open Source. And with the tools that we bring to the table in that area, we think we can continue to differentiate ourselves there. And generically speaking, not specific to that competitor, but generically speaking, as you look at acquisitions, my experience is those take, you know, many quarters to come together. So if it's going to have an impact, I think it's longer-term than short-term.

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

So could you pretty much peel from the 3 segments what your growth looked like without your largest customer during the quarter?

Sure. Hi, Catharine.

Hi, Tom. How are you?

Good. How are you? Thanks for the question. If you take out our top account, it's about 6% growth year-over-year. Okay. And then also back to the Web Giants. It seems to me, as I recall covering you guys since almost you went public is that they tend to buy -- have a larger order and then they buy off that order for a couple of quarters and then you don't see another order. I mean is that still the case? And then how many large Web Giants do you count as customers?

Catherine, this is Chris. So we do tend to see a cyclical buying pattern from them, and with your history, your accurate in kind of the ebb and flow of that. With that said, we are working more closely with them as part of our sales transformation, and there's a follow-on to Mark's question, to get tighter with them to add predictability to that. But we're still working through that with that particular Web Giant. And we will, you know, we do expect to see, as I said, some uptick in the Q2 and beyond I would say, in the remainder of the year, with the Web Giants. And then we are -- as you look at our overall pipeline, we have a number of new opportunities in play for 2019 that would enhance I'll call it our portfolio of Web Giants as well.

And then -- I'm sorry, I've got a lot of questions. The other follow-on question is really around 5G, Chris. So now, you have a total of 7 5G wins?

Yes, six are Tier 1 mobile operators. One is--

Yes, okay. Six Tier 1. It sounds like a couple in Japan, several in Korea, and maybe one in Europe or Middle East.

Yes.

Okay. So is that Europe or Middle East, Lee?

Yes, it's two in Japan, three in Korea, one in Middle East. They all are Tier 1 mobile operators.

Okay. And then the other question is how -- Verizon and AT&T seem to be talking quite a bit lately about 5G and rolling this out to different cities. Can you guys just briefly explain why -- have they really supplanted -- what I think about 5G is you have to do the infrastructure and then you offer the service. I mean explain to me what part of 5G are they rolling out and then are you working through Ericsson to be a part of Verizon or AT&T, or the Tier 1s in North America?

Okay. So first to address the -- if you look at 5G today globally, it's early phase with roll out of the 5G spectrum. This is different than different 5G band on the 4G infrastructures. So 4G infrastructure, that's where we play well in today's market. You can consolidate more articles 4G infrastructure [indiscernible] solution, later can be upgraded to 5G through the software upgrade.

Got it.

So that's on the current deployment and those are the evolving 5G roadmap today is really something they call the LSA. It's not a standard long purified G deployment. 5G spectrum on a 4G infrastructure. That's what today, it will be for the next several years.

Okay. Thank you.

In terms of AT&T and Ericsson, I can't give you specific comment, but we are working very closely with Ericsson and some other partners. And today, we have - in addition to the seven wins we had, we are engaging 12 POC and trials globally, including some of the really big ones.

Okay. So would you say then the Ericsson ICQ RSA, it sounds like you have Nokia also as a partnership and then you announced you had NEC as a partnership. So would you say that the Ericsson partnership has helped drive some of these new wins and that's a very important partnership for going forward?

I think all partnerships are important, especially Ericsson. It allows us to access some of the key mobile operators, which we did not have access before. In the [indiscernible] we have strong hold with the mobile operator across the world already.

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.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.