A10 Networks, Inc. (ATEN) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon and welcome to the A10 Networks Second Quarter 2019 Financial Results 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, Investor Relations for A10 Networks. Please go ahead.

Thank you all for joining us today. This call is being recorded and webcast live and maybe 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 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 second 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. 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 in security solutions, expected product launches and adoption of recent new product or software releases, the general growth of our business, and our ability to incrementally grow operating margin annually and timeline to achieve our target operating margin. These statements are based on current expectations and beliefs as of today, July 30th, 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 and 10-Q. 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 website. We will provide our current expectations for the third 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 these charges, which are excluded from the non-GAAP measures. Now, 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. Before we begin, I would first like to address the news of my planned retirement, which we announced today. I am very excited about A10’s future, the innovations we have brought to market and our position in security, 5G and multi-cloud. Additionally, while our subscription revenue remains small, it is a rapidly growing part of A10’s business. Subscription was 8% of product revenue for Q2, and on a year-over-year basis, it grew over 80%. This brings us to nearly $100 million in annualized run rate of recurring maintenance and subscription revenue. This revenue is high margin, creates customer loyalty and affords improved visibility not present in hardware product sales. We continue to see early success in 5G as we secured follow-on 5G orders during the quarter. Additionally, we are pleased with the level of engagement we see with several service providers across the globe as they prepare and ready their networks for 5G. However, I have decided that now is the appropriate time for me to transition the company to a new leader. I have reached agreement with the Board that I will resign from my role as CEO of A10 once a newly appointed CEO begins. The Board has formed a search committee for my replacement and I will work closely with the team to help ensure a smooth transition. The search has been focused on a strong leader who will bring a different perspective and industry expertise. I would also like to take a moment to welcome Eric Singer of Viex Capital Advisors to A10’s Board of Directors. Eric is one of our largest shareholders and we have had an ongoing constructive dialogue with him for more than a year. He brings deep strategic insight to the Board and we look forward to his continued collaboration. As part of the election of Eric, the company has formed a Strategy Committee, which consists of Eric and existing directors Peter Chung and Tor Braham. The Strategy Committee is tasked and empowered with overseeing and executing specific activities to increasing shareholder value. Please note that we will not make any further comments on this matter. Moving to our Q2 performance. We delivered revenue of $49.2 million, non-GAAP gross margin of 78.0% and reached breakeven on a non-GAAP per share basis. Revenue came in below our guidance as a number of large deals in our pipeline pushed into further -- future quarters or were downsized. These deals were primarily in North America and within the service provider and web giant verticals, and we continue to see this dynamic in Q3. Outside of North America, all of our major geographies met or exceeded expectations for Q2. One of the reasons for this divergence is that spending and deployment on 5G infrastructure is ahead in certain international markets as compared to U.S. markets. Thus, we are seeing earlier and faster uplift in spending in Japan, South Korea and the Middle East in comparison to the U.S. We believe that we are well positioned to participate as U.S. customers move further into the 5G deployment phase. Chris will discuss the market dynamics, customer wins and go-to-market efforts in more detail. We continued to make progress on our major initiatives in security, 5G and multi-cloud. On the solution front, we continue to innovate and execute on our roadmap for the year. In June, we announced the addition of Zero-day Automated Protection, or ZAP capabilities, to our Thunder TPS family of DDoS defense solutions. The ZAP capabilities automatically recognize the characteristics of DDoS attacks and apply mitigation filters without advanced configuration or manual intervention. In today’s climate with the dramatic increase in multi-vector attacks coupled with the chronic shortage of qualified security professionals, organizations need intelligent, automated defenses that can accomplish tasks automatically. A significant portion of the R&D investments we have made over the past couple of years have been focused on solving these critical problems for customers through behavior analysis, machine learning and automation. This new A10 solution is already gaining strong industry recognition, including Best of Show in the security category at Interop Tokyo, which is a premier industry event in Japan. During the quarter, we also announced our cloud-ready, light-weight set of container-based solutions. A10’s Thunder Containers will be available starting this quarter and will offer the industry’s highest performing container solutions with up to 200 gigabit per second of throughput for Thunder ADC, CGN, and CFW solutions. The addition of Thunder Containers extends the company’s multi-cloud portfolio and increases the performance, security and availability of applications, enabling customers to confidently run their critical workloads in multi-cloud environments at hyperscale. This new A10 solution also shined at Interop Tokyo, taking the Grand Prize in the NFV/SDI category. On the partner front, we entered into two new important engagements with industry leaders to help extend our go-to-market leverage. One is a global reseller agreement with Dell EMC and the second partnership is joining the Oracle Cloud Marketplace. Chris will provide the details of these new partnerships in a moment. Overall, while our revenue was below our guidance in Q2, we continue to make progress on our top priorities for 2019, which include driving growth and innovation in security, 5G and multi-cloud. This is an exciting time for A10 and the company is in a strong position to extend its leadership and expand its addressable market to help further position the company for success. With that, I will turn the call over to Chris.

Thank you, Lee. In looking at the dynamics within the quarter, demand from our largest installed base in North America slowed as large deals were pushed into future quarters or downsized, which impacted our Q2 revenue performance. These deals were primarily in our service provider and web giant verticals, where deals can be large and can fluctuate from quarter-to-quarter. I would like to emphasize that our win rate remained high and the majority of these opportunities remain in our pipeline. We are pleased with our international performance this quarter, where we delivered double-digit quarter-over-quarter growth in product bookings. On a year-over-year basis, we delivered strong double-digit product revenue growth in Japan, EMEA and Latin America. We also saw strong triple-digit year-over-year product revenue growth in South Korea driven by our installed base of 5G wins. Moving to our go-to-market. As we discussed 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, as well as launched two important go-to-market changes in North America. This included a new partnership with Arrow Electronics and the move to a two-tier channel structure. We are also working with a third party to help us expand our lead-gen efforts in North America, which went into effect in Q1. While we believe these programs are the right course to help drive sales, they take time to ramp. We continue to expect to see the benefit of these new relationships as we progress throughout the year. Additionally, as Lee mentioned, we expect to extend our leverage with the new go-to-market engagements that we entered into with Dell EMC and Oracle Cloud. Our new partnership with Dell is in the form of a global reseller agreement to become an extended global technology partner. The Dell relationship is a validation of our product architecture, as Dell partners with A10 to transition from its previous global ADC vendor. This agreement enables Dell EMC to resell our full product line of multi-cloud and 5G security solutions, including our vThunder ADC, CGN, CFW, and SSL Insight as well as the A10 Harmony Controller. Dell customers will have the flexibility and choice to run A10 Networks solutions in a private, hybrid, or public cloud with modern analytics and centralized management necessary for these complex environments. It also allows customers to prepare their infrastructures for 5G and multi-cloud demands with security and analytics across multiple points in the network. Second, as we announced in a press release in May, our vThunder ADC and Harmony Controller are now available in the Oracle Cloud Marketplace. A10 solutions running on Oracle Cloud provide Oracle’s customers with agile application delivery controller capabilities focused on secure and efficient application support. Additionally, our leading application traffic analytics, centralized management, orchestration dashboard provide Oracle Cloud customers with actionable intelligence through a single pane of glass for operational efficiency. While both of these new partnerships will take time to ramp, we have already closed our first deals and we are excited by the opportunities they could ultimately bring to A10. During the quarter, we added 215 new customers, which is our highest level in 14 quarters. In addition to the number of new logos, we also are pleased with the expansion generated with our existing customers. I will highlight a few recent customer engagements. One of the largest banks in Latin America selected our CFW-ADC solution. Key features in A10’s Harmony Controller were a significant differentiator and selling point in this competitive win against an incumbent. This was a relationship our sales team worked very hard to cultivate and won with determination and can-do attitude. We replaced an incumbent at a mobile provider in the Asia Pacific with our Thunder CGN Solution. We won this new A10 customer based on our CGN features, ease-of-use and automation through APIs, as well as strong technical engagement through the sales process. Winning new service provider customers across the globe, like this one, is a key initiative for the sales team. We are pleased to see our international progress in Q2. We also secured follow-on CGN business with a leading mobile provider in EMEA. Demonstrating our high-performance prowess, A10 was the only vendor that could meet this customer’s throughput requirements. Additionally, we secured follow-on 5G orders with leading mobile providers in South Korea. While we are making progress on our broader go-to-market initiatives and forging new partnership relationships -- partner relationships, we recognize we have work ahead to ramp and enable our teams and new partners to capitalize on the 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, 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 second quarter financial performance and third quarter guidance. Tom?

Thank you, Chris. Second quarter revenue was $49.2 million, a 19% decrease when compared with $60.7 million in the same period last year, driven by a decline in bookings from our largest web giant account in North America. Second quarter product revenue was $26.8 million representing 54% of total revenue. Service revenue was $22.4 million, or 46% of total revenue. Security product revenue grew 8% over last year to reach 34% of total product revenue in Q2. Moving to our revenue from a geographic standpoint, for the second quarter revenue from North America decreased 50% year-over-year to $15.3 million, compared with $30.4 million in the same period last year. In Japan, revenue was $14.9 million, up 26% year-over-year. Revenue from APAC, excluding Japan, was $9.2 million, compared with a record $10.7 million in Q2 of last year. In EMEA, revenue was $6.6 million, an increase of 21% when compared with $5.4 million last year. Revenue from LATAM continued to grow and came in at $3.2 million, compared with $2.3 million dollars last year. Service provider revenue in the quarter was 39% of total revenue, enterprise revenue was 45% and web giant revenue was 16%. 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 78%, an increase of 175 basis points from last quarter and a decrease of 57 basis points from Q2 of last year. Second quarter product gross margin was 74.4%, compared with 73.5% last quarter and 76.9% in Q2 of 2018. Our product gross margin was negatively impacted by geographic mix in the quarter. Services gross margin in the quarter came in at 82.4%, compared to 79.9% last quarter and 81.8% in Q2 of 2018. We ended the quarter with headcount of 862 compared with 834 at the end of last quarter. The incremental headcount reflects our strategy to expand technical talent in lower cost locations. Non-GAAP operating expenses in Q2 came in at $39.3 million, compared with $44.3 million in the prior quarter. A reduction in variable compensation expenses, due to the weaker revenue performance, was the primary contributor to the quarterly decline. Non-GAAP operating loss was just under $1 million, compared with operating loss of $5.9 million in the prior quarter. Non-GAAP net loss for the quarter was approximately $300,000, or breakeven on a per share basis, compared with an income of $1.6 million, or $0.02 per basic share in Q2 of last year. Diluted and basic weighted shares used for computing non-GAAP EPS for the second quarter were approximately 75.7 million shares. Moving to the balance sheet, average days sales outstanding were 84 days, compared with 80 days in the prior quarter. At June 30, 2019, we had $119.3 million in total cash and marketable securities, compared with $122.8 million at the end of March. Moving on to our outlook for the third quarter. We currently expect third quarter revenue to be in the range of $50 million to $54 million. We also currently expect that we will achieve sequential revenue growth in the fourth quarter 2019 over the level expected in the third quarter. We expect third quarter gross margin to be in the 76% to 78% range and operating expenses to be between $40 million and $41 million. We expect our third quarter non-GAAP bottom-line results to be between a loss of $0.04 and income of $0.03 on a per share basis using a share count of approximately 76.5 million basic and 79.5 million diluted shares. Operator, you can now open the call up for questions.

Our first question comes from Greg Bogdanski with Dougherty & Company. Please go ahead.

So how is the new distribution now working out? Last quarter you announced Arrow added nine new partners. This quarter, how many were added and what time do you expect the new partnerships will incrementally add to top on revenue?

This is Chris responding. So the overall partnership with Arrow is turning well but slowly. There is a traditional ramp that’s required as we transition to the solution and we saw a handful of additional new partners in Q2, and we expect that to trend more positively in the second half of the year.

What is the EMC Dell partnership? Could you kind of talk more about that? And then what products and platform are part of this partnership? And then what markets are being targeted, enterprise or any specific verticals or regions?

So as part of the overall Dell technology -- Dell EMC technology partnership program, and with that our entire portfolio is included in the agreement and the primary focus is going to be on the enterprise market. But you will see some crossover into additional verticals like federal, healthcare, government that you see in the traditional Dell go-to-market selling motion that they have. And again, we did close our first transaction in the quarter but it will also scale over time. Additionally, we are working with them from a -- joining in an engineering effort from an OEM perspective as well.

So I want to add one thing, this is Lee. So it’s A10’s virtual solution running on Dell’s appliances, all appliances.

Yes, the partner from an OEM perspective, and then we have the traditional resale agreement with them as well from kind of traditional transactional model as well.

And then lastly, can you just provide more color about the customer pipeline? What types of opportunities are there, carrier, enterprise, DDoS, SSL or 5G?

Yes, so the overall pipeline, we're seeing an improvement in Q3 and especially strength in Q4. If you look at it from a global perspective, you see that as well, not just from a North America perspective. And then we're seeing a special -- specially seeing strengthen our 5G platform, especially internationally. I think the U.S. carriers, while they are leading from a bigger market perspective, from a deployment standpoint, we're seeing greater deployments and use cases being constructed in Asia, and Europe and the Middle East. And we continue to see strength there, as well we've got a very strong security pipeline in the second half.

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 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.