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A10 Networks (NYSE:ATEN)
Q2 2019 Earnings Call
Jul 30, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good afternoon, and welcome to the A10 Networks Second Quarter 2019 Financial Results Conference Call. [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.

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; 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 the 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 and security solutions, expected product launches and adoption of recent new products 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 margins. These statements are based on current expectations and beliefs as of today, July 30, 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?

Lee Chen -- Founder and Chief Executive Officer

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'm very excited about A10's future, the innovations we have brought to the 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 secure 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 strategic committee, which consists of Eric and existing director, Peter Chung, and Tor Braham. The strategic 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 a revenue of $49.2 million, non-GAAP gross margin of 78% 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 less spending and deployment on 5G infrastructure is ahead in certain international markets as compared to the U.S. market. 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've 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 attack and applies 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 defense that can accomplish the task automatically. A significant portion of the R&D investment we have made over the past couple of years have been focused on solving this critical problem of 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, lightweight 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 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 the 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 this new partnership 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.

Chris White -- Executive Vice President of Worldwide Sales

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. We'd like to emphasize that our win rate remains 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 to both new and existing accounts as well as launch two important go-to-market changes in North America. This included a partnership with Arrow Electronics and the move to a two-tier channel structure. We also are 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 transform its previous global ADC vendor.

This agreement enables Dell EMC to resell a 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 Network 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 and orchestration dashboard provide Oracle Cloud customers with actionable intelligence through a single pane of glass for operational efficiency. While both these partnerships will take time to ramp, we've 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 large 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 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 a 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 and 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're making progress on our broader go-to-market initiatives and forging new 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?

Tom Constantino -- Chief Financial Officer

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 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 year 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 head count 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 of 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 for questions.

Questions & Answers:


Operator

Thank you. [Operator instructions] Our first question comes from Greg Bogdanski with Dougherty & Company. Please go ahead.

Greg Bogdanski -- Dougherty and Company -- Analyst

Hi. Thank you. Thank you for your time. So how's the new distribution model working out? Last quarter, you announced Arrow added nine new partners.

This quarter, how many were added? And what time do you expect these new partnerships will incrementally add to top line revenue?

Chris White -- Executive Vice President of Worldwide Sales

Yeah, thank you for the question. This is Chris responding. So the overall partnership with Arrow is turning well but slowly. There's a traditional ramp that's required as we transition to distribution, 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.

Greg Bogdanski -- Dougherty and Company -- Analyst

Great. Thank you. 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, government, specific verticals or regions?

Chris White -- Executive Vice President of Worldwide Sales

Yeah, thank you for the question. So it's part of the overall Dell technology, Dell EMC tech, 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 and engineering effort from an OEM perspective as well.

Lee Chen -- Founder and Chief Executive Officer

So I want to add one thing. This is Lee. So it's A10's virtual solution running on Dell's appliance, hardware appliance.

Chris White -- Executive Vice President of Worldwide Sales

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

Greg Bogdanski -- Dougherty and Company -- Analyst

OK, thank you. 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?

Chris White -- Executive Vice President of Worldwide Sales

Yeah. So the overall pipeline, we're seeing an improvement in Q3 and especially strength in Q4. You will get it from a global perspective. You see that as well not just from a North America perspective.

And then we're seeing a special -- especially seeing strength in our 5G platform, especially internationally. I think the U.S. carriers, while they are leading from maybe a marketing perspective, from a deployment standpoint, we're seeing greater deployment and use cases being constructed in Asia and Europe and the Middle East. And we continue to see strength there as well as we've got a very strong security pipeline in the second half.

Greg Bogdanski -- Dougherty and Company -- Analyst

Great. Thank you. Thank you for your time. That's all the questions I have.

Chris White -- Executive Vice President of Worldwide Sales

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Lee Chen for any closing remarks.

Lee Chen -- Founder and Chief Executive Officer

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

Operator

[Operator signoff]

Duration: 27 minutes

Call participants:

Maria Riley -- Investor Relations

Lee Chen -- Founder and Chief Executive Officer

Chris White -- Executive Vice President of Worldwide Sales

Tom Constantino -- Chief Financial Officer

Greg Bogdanski -- Dougherty and Company -- Analyst

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