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A10 Networks (NYSE:ATEN)
Q3 2018 Earnings Conference Call
Oct. 30, 2018 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the A10 Networks third-quarter 2018 conference call. [Operator instructions] Please note, today's conference call is being recorded. And at this time, I'd like to turn the conference call over to Ms. Maria Riley with investor relations.

Ma'am, please go ahead.

Maria Riley -- Investor Relations

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 and 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 third-quarter 2018 financial results.

Additionally, A10 published the presentation, along with the 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 future operating results, our ability to transform our sales team, our expectations regarding future opportunities and our ability to execute on those opportunities, 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 or expectations with respect to the 5G market, 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, October 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 statements posted on the company's website. We will provide our current expectations for the fourth 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 those charges, which are excluded from these non-GAAP measures.

Before I turn the call over to Lee, I'd like to announce that on November 16 at 8:00 a.m. Pacific time, management will host a tech talk and Q&A session for investors and analysts to discuss 5G and the need to auto-scale, auto-protect and automate the network. Now I'd like to turn the call over to Lee Chen, founder and CEO of A10. Lee?

Lee Chen -- Founder and Chief Executive Officer

Thank you, Maria, and thank you, all, for joining us today. The A10 team delivered solid results in the third quarter, building on the highest second quarter in our history. We delivered a revenue of $60.5 million in the third quarter, exceeding the high end of our guidance range. We also delivered a total non-GAAP gross margin of 78.8% and on the bottom line, generated non-GAAP EPS of $0.03.

Our performance in the quarter was led by our security portfolio, strong growth large cloud customer, combined with our sharpened focus on execution. CFW And TPS was strong during the quarter. In the quarter, we continued to execute our initiatives to transform our sales team and improve our execution. Earlier this year, we made a number of important changes to reorganize and energize our global sales team.

While it is still early in our sales transformation, we are pleased with the initial result of our efforts. In EMEA, which is a region where we have historically not have strong performance and recently changed leadership, we were especially pleased to see product revenue more than double sequentially. We are also seeing good progress in APAC, where product revenue grew nearly 50% year over year. We are building a culture to win in our selected markets and have an enhanced focus on new businesses.

Our sales team did a terrific job driving sales into a number of new accounts, and we are building a strong funnel of opportunities for our 5G, security and cloud solutions. In total, we added over 200 new customers in the quarter. We have more work ahead to continue transforming our go to market engines, but believe we are on the right path and remain confident in our strategy to grow our business. 5G, security and cloud opportunities are large and growing for A10.

We are focused on expanding our advanced suite of 5G, security and cloud solutions to address the evolving trends in the market, including the growing cyber threat landscape and cloud-based applications. Our vision is to simplify application security by providing visibility and, ultimately, operations, while reducing cost for our customers. We are building momentum in the market with our highly scalable and intelligent automation-driven security solutions, and we are winning with our customers as we take a holistic approach. We achieved record product revenue for our Thunder CFW solution and sequentially nearly tripled our product revenue for our Thunder TPS solutions.

Security product revenue was over 40% of total product revenue in Q3, and we are seeing the momentum continue as we experience -- experiencing healthy booking growth in CFW and TPS. We are pleased with the strong traction we are building globally with our security solutions, and we are well on the path to meet our goal for security product revenue to exceed 30% of all product revenue mix in 2018. Our security solutions continue to gain industry recognition. Our Thunder TPS was recently awarded the DDoS Defense Effective Certification by NimbusDDoS.

Thunder TPS is the only DDoS solution in the market to receive this award. We believe this award, along with many others we have earned this year, demonstrates the power of our advanced innovations. A10's Harmony controller plays a strategic role in driving our vision in automated operations through prescriptive data analysis and machine learning. We continue to innovate and expand the analytic capabilities of our security offerings across Harmony controller platform.

We recently released an upgrade that expands Harmony controller's connecting intelligence capabilities through a new Harmony controller app that supports A10's enterprise SSL inspection solutions. With this offering, we provide a complete solution with new level of controls and simplified analytics to help business keep up the rapid growth in encrypted traffic and ever evolving cyber threats. The Harmony controller simplified multisite deployment and management, with detailed visibility and insight into application traffic. We believe A10 stands out competitively with these solutions due to the diverse range of security features designed to provide customers with greater performance, scalability and reliability in managing the delivery and security of their applications.

Harmony controller is one of our growing number of products offer -- offerred on a subscription base, and it is helping us to build a strong pipeline of opportunity to drive more software subscription revenue. 5G is an evolving market that I'm mostly -- I'm most excited about. 5G will be large, global and significant. We have been hard at work making advances across our entire product portfolio to win in 5G.

The planned scale of 5G networks around the world represents a new era of high-speed connectivities and a dramatic transformation in mobile services. Beyond faster speeds, 5G will drive new applications in IoT, autonomous vehicles, telemedicine robotics, and smart factories and cities. To enable the true vision of 5G, the industry will require massive scale, realtime data transmission and automation, which means we have to increase the reliabilities, reduce latency in the 5G networks and provide centralized management with machine learning. With existing 4G networks, the Carrier Grade NAT, firewall, ADC, DDoS, deep packet inspection and other elements have been traditionally provided by a variety of vendors.

This heterogeneous approach creates complexity and latency, all the things you do not want in emerging 5G networks. A10's 5G-GiLAN solutions consolidates all these network security application capabilities into one single platform. We deliver low latency, operational efficiency, better security and lower cost -- total cost of ownership. On top of this, our Harmony controller adds deep analyst -- analytics and machine learning, which provides service provider the ability to manage and troubleshoot all these functions from a single pane of glass.

A10's 5G-GiLAN solution is the only converged solution currently on the market that provide Carrier Grade scale and comprehensive application and network visibility through Harmony controller. This synergistic approach drove all major expansion win during the quarter with a Japanese mobile operator, one of the most progressive carriers leading the charge in 5G. Our strong 4G installed base of service providers provides us with an advantage as we bring our 5G-ready products to the market with Harmony controller. While it is still early, we are having very good discussion with carriers in Asia and Europe regarding their 5G plans.

Stay tuned for more to come. Before I pass you to Tom, I would like to highlight a few recent customer engagements that show how A10's solutions are helping secure and improve the performance of network and mission-critical applications. A next-generation managed security service provider based in Europe that ensure high availabilities of its customers' assets by protecting them against high-scaled DDoS and cyber threats, was looking for highly scalable and reliable DDoS defense solution and shows A10's Thunder TPS. A10 provided the best performance with the smallest footprint, which was a key selling point for these customers.

Moreover, A10's OpenAPI allowed these customers to view their own fully customized service dashboard on top of our technology. Following a competitive bake-off, a leading automotive component supplier based in Japan selected A10's Thunder CFW, with SSLi to augment their existing cloud proxy solutions to improve the user experience and secure their Office 365 environments. A10 solution was selected because the customer saw immense value in the ability to manage and troubleshoot these functions from a single pane of glass, and found our Harmony controller platform extremely reliable and easy to use. A finance agency of the U.S.

government shows A10's Thunder CFW with SSLi to provide a security blanket in front of its next-generation application firewall by decrypting, inspecting and reencrypting incoming traffic. Our solution's speed and ability to quickly scale up will help strengthen this customer's security posture against cyber threat hidden in encrypted data and meet their compliance requirements. In summary, we are pleased with our improved execution and the initial results we are seeing from our sales transformation. Our product portfolio is strong, and we have more enhancements coming.

We are excited about the momentum we are building in the market and the many technology advancement that materially matter to our customers. We have a clear strategy and are hyper-focused on maximizing our opportunities in the fast-growing area of security, 5G and cloud. With that, I'd like to turn the call over to Tom to review the details of our third-quarter financial performance and fourth-quarter guidance. Tom?

Tom Constantino -- Chief Financial Officer

Thank you, Lee. Third-quarter revenue was $60.5 million compared with $62 million in the same period last year. We grew deferred revenue 5% year over year to reach $94.9 million. Third-quarter product revenue was $38.3 million, representing 63% of total revenue, and service revenue was $22.2 million or 37% of total revenue.

This compares with product revenue of $40.4 million or 65% of revenue and service revenue of $21.6 million or 35% of total revenue in Q3 of 2017. From a geographic standpoint. Third-quarter revenue from the United States was $27 million compared to $29 million in Q3 of last year. Third-quarter revenue from Japan was $14 million compared with the record $16.6 million in Q3 of last year.

Third-quarter revenue from APAC, excluding Japan, was $9.3 million, up 30% year over year. Third-quarter revenue from EMEA was $8.1 million, representing a 33% year-over-year increase. Revenue from LatAm was $2 million compared with $3.1 million in the same period last year. Enterprise revenue grew 21% year over year to reach $35.8 million or 59% of revenue.

We had one cloud customer that contributed 15% of total third-quarter revenue. Service provider revenue was approximately $24.8 million or 41% of revenue. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis unless stated otherwise. We delivered third-quarter total gross margin of 78.8%, an increase of 20 basis points from last quarter and up 50 basis points from Q3 of last year.

Third-quarter product gross margin was 77.1%, an increase of 20 basis points from last quarter and up 10 basis points from Q3 of 2017. Our improvement in gross margin was driven by geo mix, which always plays a factor, as well as higher mix of software and security revenue. Services gross margin came in at 81.8%, flat compared to last quarter and up 100 basis points compared to Q3 of 2017. We ended the quarter with headcount of 875 compared with 855 at the end of last quarter.

Non-GAAP operating expenses came in at $45.1 million compared with $45.3 million in the prior quarter. Non-GAAP operating income was $2.5 million compared to $2.4 million in the prior quarter. Non-GAAP net income for the quarter was $2.3 million or $0.03 per diluted share compared with $2.6 million or $0.03 on a fully diluted per-share basis in Q3 of last year. Diluted and basic weighted shares for computing non-GAAP EPS for the third quarter were approximately 74.9 million shares.

Moving to the balance sheet. Average days sales outstanding were 78 days, up from 75 in the prior quarter. At September 30, 2018, we had $123.6 million in total cash and marketable securities compared with $127.4 million at the end of June. Moving on to our outlook.

We expect fourth-quarter revenue to be in the range of $58 million to $64 million. We are once again increasing our guidance for gross margin. We expect gross margin to be in the 77% to 79% range and operating expenses to be between $46.5 million and $47 million. We expect our non-GAAP bottom-line results to be between a loss of $0.03 and profit of $0.04 per share.

Please note that if we report positive net income, our share count will be 75.6 million diluted shares versus 74 million basic shares if we report a loss. Operator, you can now open the call up for questions. 

Questions and Answers:

Operator

[Operator instructions] Our first question today comes from Catharine Trebnick from Dougherty. Please go ahead with your question.

Catharine Trebnick -- Dougherty & Company LLC -- Analyst

All right. Thank you. Nice print, gentlemen. Quick question.

On your -- of your 200 new customers, how many of those would you say were -- are 5G-related? And really, you've introduced several products in the last couple of months. We spoke a great deal about 5G traction in the marketplace. I'm trying to really get a sense of where you are in this because a lot of -- there've been a lot of large deals that've been awarded to Ericsson and Cisco across the globe, so I'm just trying to figure out where you are in relationship to some of the awards that have been done. Thanks.

Lee Chen -- Founder and Chief Executive Officer

Catharine, Lee. So I'll answer the 5G questions. The -- our strong 4G installed base of service providers provide us with advantages as we bring our 5G-ready product to market. So we have two 5G customers, both came from our 4G installed base.

So I will have Chris answer the rest of the 200 new customers.

Chris White -- Executive Vice President of Worldwide Sales

Yeah. Hi, Catharine, this is Chris. So to Lee's point, it's -- we just got a couple of customers today that we leveraged from the 4G installed base. But I will say that, holistically, we've got strong interest and strong pipeline around 5G and really leveraging early adopters at this point.

So as they've said in the soft track, we -- it's early in the process of 5G, but we're really pleased with the traction and the opportunity that we have in front of us.

Catharine Trebnick -- Dougherty & Company LLC -- Analyst

All right. And are these opportunities more Japan-related, the two customers, or any U.S.-based?

Lee Chen -- Founder and Chief Executive Officer

The two customers we have, one is in Asia, not Japan, the other one is on [Inaudible] , really the significant mobile carriers in Japan. And then we also have a good engagement with customers, carriers in both Europe and in Asia of our 5G. We're also going to host a Tech Talk and Q&A session with investors to discuss about 5G.

Catharine Trebnick -- Dougherty & Company LLC -- Analyst

All right. Thank you. Other quick question is, security look like that picked up. Looks like you ended up with some solid SSL wins.

Are you using more of the channel to sell in -- to sell your SSL? Or are you using more direct sales?

Chris White -- Executive Vice President of Worldwide Sales

Yes. So it's a great question. So we continue to enhance our partnerships and relationships in the channels. So the majority of our business today is through the channel and that will continue to be that way.

And through our sales transformation, we're looking to gain increased leverage. But we're still early in that process of gaining leverage, but we are seeing increased access and interest from our partner community around SSLi.

Catharine Trebnick -- Dougherty & Company LLC -- Analyst

All right. Thank you.

Operator

[Operator instructions] Our next question comes from Luke from D.A. Davidson. Please go ahead with your question.

Luke Morison -- D.A. Davidson & Co. -- Analyst

Hey, guys. This is Luke on for Mark. I was hoping you guys could provide a little bit of color on how your sales force reorganization since Q1 has progressed. Do you view that as sort of an ongoing process? Or is there still progress to be made there?

Chris White -- Executive Vice President of Worldwide Sales

Yes. Hey, Luke, thanks for joining the call. This is Chris White. Yes, it's definitely an ongoing process.

I mean, we're excited by a lot of the early trends that we're seeing as part of that transformation. We were seeing increased sales productivity from the teams, increased participation rates from the teams, as you saw an increase in our security business and overall increase in our pipeline and early progress on our sales enablement strategy, right? So certification with both our field sales team and our partner community. But it's definitely ongoing, and we're early in the process but pleased with the results so far.

Luke Morison -- D.A. Davidson & Co. -- Analyst

Great. And one other, I was hoping you could provide a little bit of color on the competitive environment. Is there any changes you guys have seen? Are you seeing anyone more or less often?

Chris White -- Executive Vice President of Worldwide Sales

Yes. From my perspective, I think it's relatively the same and obviously varies a little bit by market. But we see the usual suspects, depending on which solution offering we're bringing to market. I don't see any increased engagement from what we've seen in prior quarters, and we still feel like we're well-positioned with our solutions.

One of the things I would say is that we have a lot of opportunity around what I will call the vendor consolidation strategy. So from a competitive landscape, we do bring a broader range of solutions to bear and we're seeing increase traction with that compared to what our competition could bring to the table.

Luke Morison -- D.A. Davidson & Co. -- Analyst

Great. That's helpful. Thanks, guys. Good quarter.

Chris White -- Executive Vice President of Worldwide Sales

Thank you.

Operator

And ladies and gentlemen, at this point, we reached the end of the allotted time for today's question-and-answer session. I'd like to turn the conference call back over to Lee Chen for any closing remarks.

Lee Chen -- Founder and Chief Executive Officer

Thank you and all our shareholders who joined us today and for your support. Thank you and good day.

Operator

[Operator signoff]

Duration: 28 minutes

Call Participants:

Maria Riley -- Investor Relations

Lee Chen -- Founder and Chief Executive Officer

Tom Constantino -- Chief Financial Officer

Catharine Trebnick -- Dougherty & Company LLC -- Analyst

Chris White -- Executive Vice President of Worldwide Sales

Luke Morison -- D.A. Davidson & Co. -- Analyst

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