A10 Networks (ATEN) Q3 2019 Earnings Call Transcript

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A10 Networks (ATEN -0.95%)
Q3 2019 Earnings Call
Oct 29, 2019, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the A10 Networks third-quarter 2019 conference call. [Operator instructions] Please note this event is being recorded. I would now like to turn the conference over to Chris Mammone, investor relations. Please go ahead.

Chris Mammone -- Investor Relations

Thank you for -- 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, 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 third-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 with prepared remarks and trended financial statements on the Investor Relations section of the company's website. Now during the course of today's call, management will make forward-looking statements, including statements regarding our projections for our future operating results, including our belief that we will see a sequential increase in revenue during the fourth quarter, increased recurring revenue for 2020; our focus on business optimization and overall profitability, including through a reduction in force; our pursuit of potential alternatives to create shareholder value; our CEO succession plan; the capabilities of our sales team; the refining of our marketing engine; 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 market growth and general growth of our business; the development and performance of our products; our current and future strategies; our beliefs relating to our competitive advantages; anticipating customer benefits around the use of our products; our expectations and priorities with respect to 5G; responses to new security threats; our partnerships with key technology providers and sales partnerships; and our ability to penetrate certain markets. These statements are based on current expectations and beliefs as of today, October 29, 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-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 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 these non-GAAP measures.

Now I'd like to turn the call over to Lee Chen, founder and CEO of A10 Networks.

Lee Chen -- Founder and Chief Executive Officer

Thank you, Chris, and thank you all for joining us today. We are pleased with the delivered results for third quarter that were in line with revenue expectation for sequential growth and better than the guidance range for gross margin and operating expenses that we communicated during our previous earnings call. We delivered revenue of $52.8 million, non-GAAP gross margin of 78.1%, EBITDA of $4 million and reported $0.02 of non-GAAP earnings per share. We believe we will see a further uptick in revenue during Q4.

We continue to see strong engagement with customers while adopting our secure application services for multi-cloud and 5G environments. During my recent visit to Japan and Middle East, many of our customer convey optimism about the demand for their 5G services and are planning to build out their 5G transfer infrastructures over the next several years. Security remain a top concern for our customers, and our differentiated software-driven security solution continue to gain traction. During Q3, we announced industry-leading innovation with the Cloud Access Proxy, which provides stronger security, better performance and enhanced user experience for Software-as-a-Service, SaaS, applications, such as Microsoft Office 365.

Through our work with Intel, we were recognized with the Winners' Circle Leaders Board Award for 5G security and NFVi innovations. A10's 5G solution continued to drive a number of significant wins during the quarter. Thunder CFW was adopted at SK Telecom for the world's first 5G commercial service and which took sale for hyperscale, virtualized, carrier-grade net services. In the Middle East, we also secured a $1 million-plus 5G design win with mobile operators.

Moving now to strategic topic. On our last earning call, we announced both the formation of a strategy committee of the board of directors, as well as a CEO succession plan. This strategy committee continues to evaluate opportunities to maximize shareholder value. Meanwhile, the search committee continue to evaluate CEO candidates.

I remain fully committed to my role as CEO of A10 Networks and will work closely with the team to help ensure a smooth transition to my successor when that time comes. In summary, I have greater confidence in our ability to navigate effectively through a dynamic business environment closing out this year and heading into 2020. I believe we are in a strong position to continue to drive customer engagements and successes around our core strategic security solutions in 5G and multi-cloud. And there's continuing shift under way with respect to our recurring revenue.

We are targeting $100 million in recurring high-margin maintenance and subscription revenue in 2020. With that, I would 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 $52.8 million, up 7% sequentially from $49.2 million reported in Q2 and above the midpoint of our guidance range. The year-over-year decline in revenue is driven by fluctuating demand from our largest Web giant account in North America. Third-quarter product revenue was $30.1 million, representing 57% of total revenue.

Service revenue was $22.8 million or 43% of total revenue. Security product revenue comprised 44% of total product revenue in Q3. Moving to our revenue from a geographic standpoint. For the third quarter, revenue from North America decreased 27% year over year to $19.6 million, compared with $27 million from the same period last year.

In Japan, revenue was $15.2 million, up 8% year over year. Revenue from APAC excluding Japan was $8.4 million, compared with $9.3 million in Q3 of 2018. In EMEA, revenue was $6.5 million, a decrease of 19% when compared with $8.1 million in the year-ago period. Revenue from Lat Am continued to grow and came in at $3.2 million, up 56%, compared with $2 million last year.

Service provider revenue in the quarter was 50% of total revenue, enterprise revenue was 38%, and Web giant revenue rounded to 12%. 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 78.1%, 10 basis points better than Q2 and also above our guidance range. Q3 marked our highest gross margin performance so far this year.

Third-party gross -- third-party product gross margin was 76.5%, compared with 74.4% last quarter and 77.1% in Q3 of 2018. Our product gross margin was negatively impacted by geographic mix versus the prior-year period. Service gross margin in the quarter came in at 80.2%, compared to 82.4% last quarter and 81.8% in Q3 of 2018. We ended the quarter with head count of 870, compared with 862 at the end of last quarter.

The slight incremental head count reflects our ongoing strategy to expand technical talent in lower-cost locations. Non-GAAP operating expenses came in at $39.4 million, in line with last quarter, and about 13% lower, compared with $45.1 million in the prior year. Further reductions in variable compensation, as well as rationalizations in G&A spending in the midst of the weaker revenue performance contributed to this quarterly decline. We were profitable on a non-GAAP operating income basis this quarter recording $1.8 million and adjusted EBITDA of $4 million.

Non-GAAP net income for the quarter was approximately $1.8 million or $0.02 on a per-share basis, also rebounding from net losses reported over the past two quarters. Basic and diluted weighted shares used for computing non-GAAP EPS for the third quarter were approximately 79.1 million shares. Moving to the balance sheet. Average days sales outstanding were 79 days, compared with 84 days in the prior quarter.

At September 30, 2019, we had $122.6 million in total cash and marketable securities, compared with $119.3 million at the end of June. Moving on to our outlook for the fourth quarter. As previously indicated, we anticipate another sequential increase in total revenue. Currently, we expect fourth-quarter revenue to be in the range of $55 million to $59 million, representing sequential revenue growth of 8% at the midpoint.

We expect fourth-quarter gross margin to be in the 76% to 78% range and operating expenses to be between $39 million and $40 million, excluding one-time charges for severance and restructuring costs. As part of our continuous focus on business optimization and overall profitability, we are planning a global reduction in force of 5%. The full benefit from these reductions should be realized by Q2 of 2020. Related severance and restructuring charges are expected to be approximately $2 million in the fourth quarter.

We expect our fourth-quarter non-GAAP net income to be between $0.04 and $0.08 on a per-share basis using a share count of approximately 80 million diluted shares. Finally, we expect our fourth-quarter adjusted EBITDA to be between $5.4 million and $8.2 million. With that, I will turn the call over to Chris.

Chris White -- Executive Vice President of Worldwide Sales

Thank you, Tom. And looking at the dynamics within the quarter, North America revenue grew 28% versus last year, which far and away was the biggest driver of the company's 7% overall sequential growth. Furthermore, our win rate remains high, and we continue to see the overall quality of the pipeline strengthen. That said, demand from our largest installed base in North America remains challenging.

Although the larger-sized deals, primarily in our enterprise and web giant verticals, continue to be pushed into future quarters, we're starting to see increased traction in smaller-sized deal activity from our strategic accounts in North America. And this at the very least is a positive early indicator. This improved demand enabled us to deliver revenue above the midpoint of our guidance range for Q3. Accordingly, this higher traction activity has extended into the current period, positioning us well for what we believe will be another sequential increase in revenue in Q4, as indicated by our guidance.

In 5G, we are pleased to report that customers who have selected A10 over the past year are beginning to expand their deployments. A10 Networks is focused on 5G security solutions with multiple proven Tier 1 5G deployments that require continued hyperscale, lower latency, agility and advanced security. As an example, we saw a significant continued expansion of our 5G security technology footprint with one of the largest carriers in the Middle East. Intel is the latest industry titan to recognize A10 Networks' 5G security and NFVi innovation as superior in enabling service providers worldwide, recently awarding us with the Winners' Circle Leaders Board Award.

This is the top honor in the Intel Network Builders program, which aims to accelerate network transformation by fostering innovation and solution development. As a member of the Intel Network Builders ecosystem, A10 Networks has contributed to the acceleration of network transformation by working closely with Intel and its ecosystem. Our international product bookings were stable versus the previous quarter and year. On a year-over-year basis, we delivered strong product revenue growth in Japan and Latin America.

During the quarter, we added 185 new customers. Year to date, new customer adds are up 5%. In addition to the number of new logos, we were pleased with the expansions we generated with our existing customers, highlighted by the following recent customer engagements. One of the largest broadband service providers in North America selected our CFW IPsec solution to secure its GRE tunnels for delivering inter-network IP.

The speed and reliability of A10 solutions were significant differentiators in this competitive multimillion-dollar win against lower-priced alternatives. We replaced an incumbent with a mobile provider in EMEA with several of our Thunder solutions. We won this new multimillion-dollar engagement based on our speed, scalability and unique focus on bundling ADC, CGN and CFW features into a solution set capable of supporting this customer's plan for a full 5G rollout by 2021. Expanding with new service providers like this one across the globe, a key initiative for the sales team, we are pleased to see our international progress in Q3.

Additionally, we secured follow-on 5G orders with leading mobile providers in South Korea based in large part on our differentiated features in A10's Harmony Controller versus alternatives in the marketplace. Our product portfolio is strong, our win rate remains high, and we are committed to continuous innovation and refinement to our go-to-market engine. We have a very clear vision, we are eager to capitalize in the fast-growing areas of our market, and our team is energized about the market opportunity for our solutions. Operator, you can now open the call for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] There are no questions at this time. This does conclude our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

Lee Chen -- Founder and Chief Executive Officer

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

Operator

[Operator signoff]

Duration: 19 minutes

Call participants:

Chris Mammone -- Investor Relations

Lee Chen -- Founder and Chief Executive Officer

Tom Constantino -- Chief Financial Officer

Chris White -- Executive Vice President of Worldwide Sales

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