A10 Networks' (ATEN) CEO Lee Chen on Q1 2016 Results - Earnings Call Transcript

| About: A10 Networks, (ATEN)

A10 Networks, Inc. (NYSE:ATEN)

Q1 2016 Earnings Conference Call

April 28, 2016 16:30 ET

Executives

Maria Riley - Investor Relations

Lee Chen - Founder and Chief Executive Officer

Greg Straughn - Chief Financial Officer

Ray Smets - Vice President, Worldwide Sales

Analysts

Ashwin Kesireddy - JPMorgan

Catharine Trebnick - Dougherty

Ittai Kidron - Oppenheimer

Mary Marshall - Morgan Stanley

Ryan Flanagan - Buckingham Research

Operator

Good day, everyone and welcome to the A10 Networks’ Q1 2016 Financial Results Conference Call and Webcast. [Operator Instructions] Please also note today’s event is being recorded. I would now like to turn the conference call over to Ms. Maria Riley, Investor Relations for A10 Networks. Ma’am, please go ahead.

Maria Riley

Thank you all for joining us today. I am pleased to welcome you to A10 Networks’ first quarter 2016 financial results conference call. This call is being recorded and webcast live and maybe accessed for one year via the A10 Networks website, www.a10networks.com.

Joining me today are A10’s Founder and CEO, Lee Chen; A10’s CFO, Greg Straughn; and our VP of Worldwide Sales, Ray Smets.

Before we begin, I would like to remind you that shortly after the market closed today, A10 issued a press release announcing its first quarter 2016 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 second quarter operating results, our expectations for future revenue growth, profitability and operating margin, expectations of customer buying patterns and the general growth of our business. These statements are based on current expectations and beliefs as of today, April 28, 2016. A10 disclaims any obligation to update information contained in these forward-looking statements whether as a result of new information, future events, or otherwise. 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. We disclaim any obligation to update these forward-looking statements as a result of future events or otherwise. For a more detailed description of these risks and uncertainties, please refer to our most recent 10-K filed on March 1.

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. 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 second quarter of 2016 on a non-GAAP basis. However, we will not 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 would like to announce that management will present at the JPMorgan Technology, Media, and Telecom Conference in Boston on May 24 and D.A. Davidson Annual Technology Forum in New York on June 1 and the Bank of America Merrill Lynch Conference in San Francisco also in June. We hope to see many of you there.

Now, I would like to turn the call over to Lee for his opening remarks. Lee?

Lee Chen

Thank you, Maria. I would like to thank you all for joining our first quarter 2016 financial results conference call. The first quarter was a strong start to the year as we continued to build on our solid momentum. Total revenue in the quarter grew 22% year-over-year to $53.8 million. Our growth was driven primarily by the continued adoption of our platform in public and private cloud deployments and high-end security-focused Thunder products. This includes continued strong growth of our Thunder TPS DDoS protection solution and 29% year-over-year enterprise growth. With our continued top line growth and disciplined approach to managing costs, we improved our bottom line by 55% year-over-year and generated strong cash flow from operations.

Looking at our top line in more detail, product revenue grew 19% over last year to $36.4 million, which is our second highest level coming off our record performance last quarter. From a geographic standpoint, we achieved 29% year-over-year revenue growth in the U.S. and 23% growth in Japan. We are particularly pleased with our performance in Japan, as we closed a new TPS deal with one of our marquee service provider customers, as well as achieved 31% enterprise bookings growth in this region. Overall, we delivered a strong quarter, added more than 150 new customers and continued to grow our footprint within our existing customer base.

To expand on this, I would like to share with you a few recent customer wins that demonstrate the power of ACOS platform in building application networking solutions, software-as-a-service and public and private cloud infrastructures. A U.S. based online digital content provider deployed A10’s Thunder ADC with SSL offload, to replace an incumbent solution and efficiently scale their network to manage a large increase in SSL traffic. They were particularly impressed with our auto-generating open API capabilities and command line interface. They also had confidence that our ACOS platform has the flexibility to meet current and future requirements as their business continues to grow.

We continued to expand our footprint within one of our security-as-a-service customers. This customer was looking for a new IPsec solution, because the incumbent vendor was losing packets between global datacenters. In this win, we displaced a competitor with our Thunder solution to help improve the security performance, while meeting their high traffic demands. An online gaming company selected our Thunder ADC with SSL offload to process the high volume SSL traffic that is generated in their worldwide datacenters.

I would like to point out that we first won this customer’s business in 2015 with our Thunder TPS solution. Their adoption of our ADC demonstrates our ability to grow within our customers as they recognize and appreciate the scalability, flexibility and efficiency inherent in the A10 platform. A large global video-sharing website selected our Thunder TPS DDoS protection solution to protect against a growing quantity of attacks. A10 was selected given our ability to scale against growing DDoS attacks, integrate with their existing tools using our open API and improve overall network visibility. And lastly, a cloud infrastructure service provider is rolling out our Thunder CGN solution globally to all new datacenters as part of their critical infrastructure. This rollout continues to demonstrate A10’s value in building out top public cloud infrastructure.

We ended the quarter with a strong backlog and our opportunity pipeline has continued to grow. Contributing to our success is our ability to partner with our customers to drive innovation that addresses their evolving needs and influences the direction of the industry. We continue to execute on our technology vision and leverage our ACOS Harmony platform to expand our high performance security and software solutions.

During the quarter, we brought several new products to the market. We launched our Thunder Convergent Firewall, an inclusive standalone high-performance security product built on A10’s ACOS Harmony platform. Thunder CFW is a software-based converged security solution for service providers, cloud providers and large enterprises, that helps stop cyberattacks and web application attacks at scale. CFW became available for purchase in April and we are encouraged by the early interest from our large installed base.

We also recently launched Thunder SSL Insight, a new standalone security product. This new appliance is built on our advanced SSL inspection technology and ACOS Harmony platform. A10’s SSL Insight solution offers high-performance SSL decryption and comprehensive policy management. Encrypted Internet traffic has grown significantly in recent years due to security and privacy concerns. Our standalone Thunder SSL Insight solution is designed for customers looking for a high-volume dedicated SSL solution to eliminate blind spots in corporate defenses.

We also kicked off the first phase of our fourth generation hardware refresh with the launch of new Thunder Series appliances, including the industry’s fastest single rack unit ADC. These fourth generation appliances offer more options for entry level, upper mid-range and high-end appliances and greater price performance and scalability. And lastly, we recently launched Thunder ADC for Bare Metal. Our newest ADC software offering can be deployed on commodity off-the-shelf servers without using a hypervisor, enabling on-demand deployment. This provides large enterprises and cloud service providers the ability to streamline their datacenter operations by choosing their own bare metal hardware and still gain the flexibility and scalability of A10’s ACOS Harmony platform.

In summary, we believe our product vision, built on our ACOS Harmony platform, is in direct alignment with the trends we see in the market today. We are encouraged by our continued progress in the market and pleased with our execution and the first quarter results. We continued to make solid strides in executing our growth strategy to build a strong foundation for long-term growth, while at the same time improving our bottom line.

With that, I would like to turn the call over to Greg to review the details of our first quarter financial performance and the second quarter guidance. Greg?

Greg Straughn

Thank you, Lee and thank you all for joining us today. First quarter revenue grew to $53.8 million, up 22% compared with $44 million in the prior year. Deferred revenue grew 25% year-over-year and 3% sequentially to reach a record $74.8 million.

First quarter product revenue grew 19% year-over-year to reach $36.4 million, representing 68% of total revenue. This compares with $30.5 million, or 69% of total revenue in the prior year first quarter. Service revenue grew 29% year-over-year to reach $17.4 million, or 32% of total revenue compared with $13.5 million, or 31% of total revenue in the first quarter of 2015.

From a geographic standpoint, first quarter revenue from the United States grew 29% year-over-year to reach $29.6 million, representing 55% of total revenue. First quarter revenue from Japan was $10.9 million, or 20% of revenue and increased 23% year-over-year. Revenue from APAC, excluding Japan, was up 47% year-over-year to reach $6.7 million, or 13% of total revenue. And revenue from EMEA was $5.1 million, or 9% of total revenue compared with $6.2 million, or 14% of total revenue in the first quarter of 2015.

Our enterprise and service provider revenue split this quarter was 60% and 40% of total revenue respectively. We achieved record enterprise revenue of $32.2 million, representing a 29% increase from Q1 of last year. Service provider revenue came in at $21.6 million, up 14% when compared with $19 million in the first quarter of 2015. 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 76.1%, within our expected range of 75% to 77%. This compares with total gross margin of 76.6% in Q1 of 2015 and 76.4% in Q4 of 2015. Product gross margin was 76.2% in Q1 of 2016, down roughly 80 basis points from Q1 of 2015 and up 40 basis points from the fourth quarter of 2015. Our services gross margin came in at 75.9%, an increase of 40 basis points versus Q1 of 2015 and down 190 basis points versus Q4 of 2015 as we continued to invest in professional services. We ended the quarter with staff of 831, up slightly from 826 at the end of Q4.

First quarter non-GAAP operating expenses were $44.9 million or 83.5% of revenue, compared with $46.4 million or 82% of total revenue in the prior quarter. Operating expenses grew 5% as compared with the first quarter of last year. First quarter non-GAAP operating loss was approximately $4 million compared with a loss of $3.2 million in the fourth quarter of 2015. It is worth noting that our first quarter GAAP operating expenses including legal fees and a settlement payment related to a securities claim that was recently settled.

Our non-GAAP net loss in the first quarter was $4.1 million or $0.06 per share, beating our guided range of $0.07 to $0.09 per share. Q1’s net loss represents a 55% improvement when compared with a loss of $9.1 million or $0.15 per share in the first quarter of 2015. Basic and diluted weighted outstanding shares for the first quarter were approximately 64.3 million shares.

Moving to the balance sheet at March 31, 2016, we had $107.5 million in total cash and marketable securities, a $9.4 million increase from the end of December and up $21.9 million compared with March 31, 2015. During the quarter, cash generated from operations was $10.4 million, reflecting a strong collections quarter. Average days sales outstanding were 85 days, up 4 days from the prior quarter.

Moving on to our outlook. We are entering Q2 with a very strong and diversified backlog and are pleased with our strong start to the quarter. We currently expect second quarter revenue to be in the range of $55 million to $57 million. At the midpoint, this represents 18% year-over-year revenue growth and 20% growth for the 6-month period. We expect gross margin to remain in the 75% to 77% range and operating expenses to be between $45 million and $46.5 million. We expect to report a non-GAAP net loss of between $0.04 and $0.06 per share using approximately 64.9 million shares on a basic and diluted basis. We are maintaining our commitment to become profitable on a non-GAAP operating basis by the end of the calendar year.

With that, I would like to open up the call for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question today comes from Rod Hall from JPMorgan. Please go ahead with your question.

Ashwin Kesireddy

Yes, hi. This is Ashwin on behalf of Rod. Thanks for taking my question. Greg, could you comment on the nature of those investments in professional services you are making? Do you see some revenue opportunities ahead of you? How should we think about those investments and implications? And also, I was wondering if you could comment on your traction with financial customers, are you seeing any share gains there, any kind of trial chart and any color you can give there will be helpful? Thank you.

Greg Straughn

So, hi, Ashwin, this is Greg. I will address the professional services question and then I will pass over to Ray to address the financial services customer traction. So, the professional services investment is basically adding people to the team, some ahead of demand. So, as we geographically put our professional services organization into new markets compete on the street, it takes a while for them to fill up from a demand capacity. So, there is really no hard investment to it. It’s just people. And so we do expect growth in that line item and for the margins to improve over time just as we need to have capacity in the field.

Ashwin Kesireddy

Hey, Greg. Can you clarify something there? During this timeframe, should we be thinking like maybe one or two quarters down the line or maybe potentially 2017 how to think about that?

Greg Straughn

Yes, we don’t be too specific on that, but I think certainly as we finish out this year, we should see that be it at better position than it is today whether it was for Q1 I guess, I would say.

Ashwin Kesireddy

Thank you. Okay, on the financial customers?

Ray Smets

Yes, Ashwin, this is Ray Smets. Just a quick comment on financial customers, yes, we are gaining new financial customers every quarter. We did in Q1 as we have in the past quarters. I am not sure I can really represent that as a share gain, because I don’t know what the actual market share looks like in that particular sector. But I can tell you that we are winning some very attractive opportunities with existing financial customers that we have already announced in the past as well as expanding customers.

Ashwin Kesireddy

Thank you.

Operator

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

Catharine Trebnick

Nice friends and we like the guide. I just have a quick couple of questions. Could you give us a little bit more color on what people are really spending on and what applications they are spending on? I think that would be very helpful. And since the ADC growth is expected to be pretty flat, it seems that you guys seem to be doing well in this area. So, could you maybe give us more application related successes? Thank you.

Ray Smets

So, Catharine, this is Ray. Just I will comment on the kind of the larger more macro sector initially. We are definitely seeing very nice catalyst across the board in terms of approaching the private and the public cloud area. And we are seeing some very attractive opportunities related to our security portfolio and selling into the high end of the marketplace. I would say in general, from a service provider perspective, we are seeing a nice catalyst in that area around increase in bandwidth requirements and obviously from the performance perspective, devices attached to their network. So, that does catalyze our CGN product area as well. But we are also seeing also very nice catalyst in the cloud deployment area, where you see a higher demand for higher performing solutions in the ADC space as well as in the security domain as they begin to pickup a bit more in the market opportunity.

Lee Chen

So and then maybe just add in general, I think we see the growth being both ADC and our security portfolio, but especially in the high-end security products such as TPS and SSL Insight.

Catharine Trebnick

Alright, thank you.

Operator

Our next question comes from Ittai Kidron from Oppenheimer. Please go ahead with your question.

Ittai Kidron

Thanks. Hi, guys. Couple of things. First, can you give us some color on Europe, it seems like the only region that’s been down on a year-over-year basis, what are the challenges you are seeing there?

Ray Smets

Hey, Ittai. Ray Smets here. Yes, I would say we did see some little more than normal weakness in EMEA, but mostly in Middle East. I would say nothing more than we had anticipated though just pretty much what others have been reporting. We try to keep upbeat on what others are talking about in the marketplace and we didn’t see anything dramatically different. Some other areas that we happen to notice as others have reported are areas like LatAm, specifically in Brazil. But I would say that it was within the range of what we expected. So, although it was a little bit weaker in Q1 year-over-year, it was within our expected area.

Ittai Kidron

Okay. And Greg, is there anyway you can give us some color of security percent of revenue and perhaps more specifically, is there any concentration if you are in your, I mean, customer concentration within your security revenue? I think everybody recognizes they are clearly doing a very good job over there. I think some of the concerns would be that it’s driven by one or two very large deals that as always when you ramp on your new products, sometimes those large deals upfront are kind of get a little bit harder to feel at the beginning before you start getting into broad distribution?

Greg Straughn

Yes, I would like to give you some color on that, not some specific numbers, but from a security perspective, I will talk first about TPS and then go broader. At the end of last year, we talked about TPS being 10% of our product revenue or about total revenue and we have seen growth quarter-over-quarter and we continue to see growth in the Q1. So, Q1 was positive growth on the TPS side. In addition to that, we actually had more TPS customers by count this quarter than we have had previously. So, we are not just seeing the dollars increase, but the customer penetration by numbers increase. And then add to that, that we have continued to see movement on our SSLI product. It’s too early for CFW, but when we look at our security portfolio, we are seeing growth in both dollars and in numbers.

Ittai Kidron

Okay. So, that growth that you mentioned that was sequential from the fourth quarter you mean?

Greg Straughn

Yes.

Lee Chen

Yes. Well, TPS did well in Q1. And revenue grew sequentially and also on the year-over-year basis.

Ittai Kidron

Got it. And so, that implies it’s somewhere in the low mid-teens as a percent of revenue, Greg, correct me if I am wrong. I guess when I look at SSL and I look at your converged firewall ramping, is there anything in those products that makes you think that they are not going to ramp like TPS did, meaning are they products that you think naturally started smaller deals, smaller customers or they – from a consumption profile have a similar consumption profile to TPS, meaning you do expect to get some million dollar type of deals. That is the possibility. How should I think about the ramp in those two products?

Lee Chen

I think for the CFW, it’s too early to tell the revenue contribution in 2016. So, we are not putting a timetable on this at this point, but we are really encouraged by the early interest on our installed customer base and same for SSI. We did see nice revenue in Q1, but again, it’s too early to tell.

Ittai Kidron

Why do you think this is not going to be a material contribution? What is it about the product or the market that makes you feel? It doesn’t give you the same confidence level like TPS did that you will get traction right away?

Lee Chen

It’s very too early, Ittai. You look at TPS it took almost 9 months before it start to really contribute significant to our revenue, right. And also in the TPS, we had a marquee customer before the product made the general availabilities. So, that’s a nice start for TPS, but still we see with the early interest right from all customers, but it’s too early to tell really.

Ittai Kidron

Okay, very good. Alright, good luck guys.

Greg Straughn

Thank you, Ittai.

Operator

Our next question comes from James Fawcett from Morgan Stanley. Please go ahead with your question.

Mary Marshall

Hey, this is Mary Marshall for James. Couple of quick questions. On the refresh that you guys mentioned, is there any intention to kind of end of life previous appliances or is there just kind of a natural upgrade and kind of what percentage of your installed base would you expect to upgrade? And then the second was just kind of housekeeping about what was the impact of this strength in yen in the quarter to financials?

Lee Chen

Sure. I will answer the first question. You answer the second about yen, yes. So, the new – how I refresh is really continue to execute on our technology division and leverages your scalability and flexibility of ACOS platform. It’s really no different than in the past when we – with this product and the product market that is long enough and then we will announce end of sale. So, some appliance, but not all the old appliance. So, we will have the old appliance, also the new appliance on the market. So, most of them are entry level, mid-range and the high end.

Greg Straughn

Good. And then on the yen question, this is actually the first quarter where the yen was not measured as a headwind. And so as it’s going through this transition, the effect was fairly negligible in the quarter. It was modestly positive, but came in the $100,000 range additive to revenue versus the $1 million decrements that we received as it went the other direction.

Mary Marshall

Okay. Thanks, guys.

Operator

[Operator Instructions] Our next question comes from Ryan Flanagan from Buckingham Research. Please go ahead with your question.

Ryan Flanagan

Hey, guys. Thanks for taking my question. I just want to ask about customer concentration, I know we had customer last quarter I believe it approached around 20%, were there any outsized customers this quarter or are there any baked into the guidance? And then secondly, I want to ask on DSOs ticked up here and it went on in the triple-digit level we were a few quarters ago, but just curious if you can add some color there given SP is now at 40% versus 52% last quarter? Thanks.

Greg Straughn

So, this is Greg. So, on the concentration, no, we did not have any – we didn’t have any because we are approaching the 10% level in this quarter. And so I think as we have talked about that as we participated in these markets, we will occasionally see large customers. We look at them as ways to create upside unless they are kind of booked by the time we have this call. And so we are tend not to be as reliant on them as we were a year, 18 months ago. And as to guidance, we cannot be quite that specific as to whether we are looking at 10% customers within the quarter, but from a forecasting methodology, the way we have set our guidance for the quarter is very consistent with the way we have been doing it for about the last year and a half. So, we are methodologically the same there.

As far as the DSOs go, from a math perspective when we do in Q1, we came out with a very high receivable number in Q4 because of the maintenance renewals in the bookings there. So, that’s still part of the average and then our revenue has been out seasonally for Q1. So, from a total AR value perspective, we are basically at the same level we are today as we were at the end of Q3. So, what you are seeing at the DSO numbers, really the Q4 impact of high receivables, but when we get to our cash number for the quarter be cash flow positive by $10 million. That’s really the result of great collections of those receivables. So, we look at that number as kind of a blip and not something that wants any kind of concern on our part.

Ryan Flanagan

That’s helpful. Thanks, guys. Good luck.

Operator

Ladies and gentlemen, this concludes today’s question-and-answer session. I would like to turn the conference call back over to Mr. Lee Chen, CEO of A10 for any closing remarks.

Lee Chen

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

Operator

Ladies and gentlemen, the conference has now concluded. We do thank you for attending today’s presentation. You may now disconnect your lines.

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