A10 Networks, Inc.

Good afternoon and welcome to the A10 Network's fourth quarter and year 2018 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Maria Riley with Investor Relations. Please go ahead.

Thank you all for joining us today. This call is being recorded in webcast live and may be accessed for one year via the ATEN Networks website, www.atennetworks.com. Members of ATEN's management team joining me today are Lee Chen, founder and CEO of 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, ATEN Networks issued a press release announcing its fourth quarter in year 2018 financial results. Additionally, ATEN 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 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, 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 our 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 margins. These statements are based on current expectations and beliefs as of today, February 7, 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. A-10 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 10Q and 10K. 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 first quarter of 2019 as well as our long-term model 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 the charges, which are excluded from these non-GAAP measures. Now, I would like to turn the call over to Lee Chen, founder and CEO of ATEN Network.

Lee Chen Thank you, Maria, and thank you all for joining us to discuss our fourth quarter and the year 2018 results. We deliver a solid quarter on our piece with our continued momentum in security, 5G, and multi-cloud. Revenue increased 11% year-over-year to $61.8 million, and we maintain a healthy non-GAAP growth margin of 78.2% and generated non-GAAP EPS of 5 cents. We have been investing in security. and believe we are building momentum in the market with our highly scalable and intelligent automation-driven software-based security solutions. We believe our performance, scalability, and software-based solutions position us to grow in the hyperscale converged security 5G and multi-cloud world. In this quarter, we deliver a strong quarter for our security solutions. which included some nice win for our CFW and SSRI offerings. For the years, our security product revenue grew 36% year over year to reach 38% of product revenue as customer continue to focus on security. Our holistic approach has resonate with our customers and we remain committed to innovate and bring new solutions to the market. In TPS, we recently released a new version of software to include dynamic pattern recognition, enhanced detection analytic engine, inclusion prevention systems, and support a new 220-gig high-end appliance. ATAN continues to deliver on its mission of intelligent automation to reduce cost for our customers and we believe our solutions stand out among the competition. We also enhance our analytics and management software for TPS and CFW and introduce a new multi-cloud secure service mesh solution for applications deployed in the open source Kubernetes container environments. This solution provides teams deploy microservices applications with an easy, automated way to integrate enterprise-grade security and load balancing with comprehensive application visibility and analytics. We believe these new solutions demonstrate our commitment to helping customers navigate the evolving multi-cloud threat landscape efficiently and affordably. 5G is an exciting market opportunity for our security solutions. We believe our stronghold in the service provider segment and the high performance and scalability of our solutions position us extremely well to meet the evolving security and performance needs of our 5G customers. Building upon our technology strength, we have developed a robust suite of solutions to help mobile carriers need a significant capacity, performance, and security demand in the age of 5G. Also under CFW, this integrated carrier firewall, multi-vector DDoS protection, carrier-grade map, application visibilities, and traffic-sphering capabilities is a great example of our product advances in this space. This differentiated high performance solution provide a consolidated and secure 5G solution for a effective defense against attacks. We have been hard at work innovating across our entire product portfolio, and our early bets on 5G has been paying off. We secured three additional 5G security wins, which built on the two we announced in the third quarter. These five appraisers are deploying ATAN's 5G GI LAN solutions in a variety of form factors and plan to launch their first commercial 5G services in the first half of 2019. ATAN has a long and successful relation with these appraisers, and we believe our design wins demonstrate our ability to gain share in these large and growing opportunities. Adoption is still early and related standards continue to evolve. We anticipate operators will experience a new set of challenges. Network architectures will require a full spectrum of physical, virtual, and containerized offerings that can handle multi-terabyte scale with reliability, high agility, and automated security. Big data and cutting-edge predictive analytics through AI and machine learning were emerged as key priorities in order to cope with the exploding scale of new security threats, such as IoT attacks. ATN stands in high performance, rich carrier security offerings, and network visibility position as well for 5G. Our Harmony Controller provides the necessary visibility and keep the operator informed and in control of their networks. As a result, network operator will be able to scale and protect their network in real time and manage it from a single pan of glass. We have partnered with key technology providers to develop a product roadmap that will expand the capability of our 5G solutions to further prepare our points position in these large and growing opportunities. In the fourth quarter, we expanded our partnership with NEC to now include the integration of ATAN's CFW solution into NEC's 5G SDN and FV orchestration infrastructures. NEC was looking for a partner who could seamlessly consolidate security application layer networking into AEC's innovative mobile and fixed network solution offering. This partnership will help provide service providers with continuously protected from security challenges and help them to achieve the scale needed to rapidly commercialize their 5G services. I'm also excited to announce that we have partnered with Microsoft Azure to provide our cloud-native ADC solution, including our Harmony Controller vThunder ADC and Lightning ADC on the Microsoft Azure Marketplace. The flexibility and convenience of multi-cloud comes with its challenges, and our Harmony Controller solution with its prescriptive data analysis and machine learning help alleviate these issues. Harmony Control is one of our growing number of product offer on a subscription basis and is driving more software subscription revenue. We believe this is a unique offering in the market today and is a large part of the discussion with our customers. Harmony Control is also gaming industry recognition. It was recently named the finalist in the 2018 CRM Tech Innovators Awards and took top honor in the business intelligence and analytics category. We are very excited about the market's response to them. Many significant advancements we have made to our solutions. I would now like to spend a moment on our sales transformation, which was a major priority for us in 2018. We made good progress during the quarter. We improved sales productivity by 7% year-over-year and were pleased to see the double-digit product revenue growth in North America, Japan, APEC, and Latin America. We are also encouraged to see our pipeline of security opportunities increase 31% year-over-year. While it is still early in our sales transformation, we are pleased with the early results and believe we are on the right path. As we enter the new years, we have several changes taking effect to help further incentivize the sales team to drive new product sales with both new and existing accounts. We are also expanding our go-to-market technical leadership with our recent appointment of Ravi Raj Bhat, as a Senior Vice President and Global Field Sales CTO. While we joined ATEN from Ericsson where he was, he was the Vice President of Engineering. We believe his extensive service provider expertise will be instrumental in helping ATEN capture share in 5G and expand our global alliances. We just wrapped up our annual sales kickoff and I have to tell you that the energy level was dynamic. Our partner, our product team, our field personnel, and all of us at ATEM are energized. Together, we will build on this momentum. We have a very clear vision, a line of sight to what we will accomplish, and our sales force is eager to monetize the company's growth opportunities. in security, 5G, and multi-cloud. We have subscription-only platforms set to grow. We have innovative products set to arrive. And all this is being led by new sales leaders eager to win. With clarity of visions and focus on execution, we are excited about what we can achieve this year and beyond. We are building a strong funnel of opportunities for our security 5G and multi-cloud solutions. Our win rate remains high, and in total, we added 162 new customers in the quarter. Let me share with you some of the recent customer engagement. A multinational retailer based in the U.S. looking to redesign their perimeter of its network. and replace the incumbent proxy solution high standardized on ATAN's Sounder SSRI solution globally. This ATAN customer deploys Sounder SSRI to decrypt outbound traffic and provide visibility and control over traffic management. This win is an expansion of a new logo that we won earlier in 2018, and we are pleased without continued traction with this customer. A federal executive department replaced an incumbent solution with ATEN's sounder SSRI solution and harmony controller to reduce the load on its existing firewall assets and provide a single decryption architecture. The key to winning this new customer was ATEN's superior SSRI performance, analytics, and engineering support. Alongside our partner, Ericsson, we secure a new service provider customer in Latin America. This customer will deploy our CGM solution in Brazil, Colombia, and Argentina as part of its virtual evolved tactic core. ATEM provides the most affordable and comprehensive set of features, which were key selling points for its customers. Moreover, The customer saw immense value in our partnership and integrated offering with Ericsson. Looking into 2019, our top priority for the year will be to drive growth in security, 5G, and multi-cloud. In security, we expect to build on the momentum we have generated with our Thunder CFW solution and further drive sales for our Thunder TTS and SSRI solutions. Our goal is to grow security product revenue to be 40% to 45% of product revenue for 2019. In 5G, we look to add our strong early wings, further leverage our strong base of existing mobile providers. We have a unique value proposition with Harmony Controller, and is resonating with in the market. The launch of our multi-cloud ACoS 4.1.4 goal release will enable our customers to deploy common controller across their ATAN solutions, providing them the full benefit of dynamic visibility, prescriptive data analysis, and machine learning. Along the way, we will increase our subscription revenue fine-tune our marketing engine, and further improve our productivity. In summary, we are excited about the momentum we are building in the market and the results we are seeing from our sales transformation efforts. We provide our customers and partners a differentiated value that we believe sets us apart. We have a clear strategy and believe we are well-positioned to maximize our opportunity in the fast-growing area of security, 5G, and multi-cloud. With that, I would like to turn the call over to Tom to review the details of our first quarter financial performance and the first quarter guidance. Tom?

Thank you, Lee. Fourth quarter revenue increased 11% year-over-year to $61.8 million, compared with $55.5 million in the same period last year. For the year, we generated revenue of $232.2 million compared with $235.4 million in 2017. Fourth quarter product revenue increased 18% year-over-year to $39 million, bringing our total product revenue for the year to $144.7 million, or 62% of total revenue. Security product revenue grew 36% over last year and contributed to 38% of total product revenue in 2018. Service revenue for the year was $87.5 million, or 38% of total revenue. Moving to our revenue from a geographic standpoint, for the fourth quarter, revenue from the U.S. for the United States increased 10% year-over-year to $25.7 million, compared with $23.4 million in the same period last year. In Japan, revenue was $16.2 million, an increase of 21% year over year. Revenue from APAC excluding Japan was $9.5 million, up 25% year over year. In EMEA, revenue was $7.6 million, compared with a record $9.3 million last year. Revenue from LATAM in the quarter increased 57% year over year, to $2.9 million compared with $1.8 million last year. We are changing the way we disclose our revenue by customer vertical in order to provide more transparency into our exposure to WebGiant and cloud customer revenue, which was previously primarily accounted for in enterprise revenue. We will now report three customer verticals, service provider, enterprise, and WebGiant. A service provider revenue in the quarter increased 28% year over year to $28.1 million, or 45% of revenue. For the year, service provider revenue was $99.5 million, or 43% of revenue. Enterprise revenue in the quarter declined 11% year over year to reach $24.1 million, bringing our total enterprise revenue to $91.1 million for the year, or 39% of our revenue. Our web giant revenue grew 46% year-over-year to $9.6 million in the quarter and was $41.6 million for the year, or 18% 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 fourth quarter total gross margin of 78.2%, and our total gross margin for the year was 78.3%. an increase of 40 basis points from last year. Fourth quarter product gross margin was 76.8%, an increase of 140 basis points from Q4 of 2017. Our year-over-year improvement in product gross margin was driven by a higher mix of software and security revenue. Services gross margin in the quarter came in at 80.6%, compared to 84.5% in Q4 of 2017. We ended the quarter with headcount of 860 compared with 875 at the end of last quarter. The decrease in headcount was primarily in international sales as our new sales leaders transform their teams in preparation for 2019. Non-GAAP operating expenses in Q4 came in at $45.1 million, which is well below our guidance and was flat compared to the prior quarter. Non-GAAP operating income was $3.3 million compared with $2.5 million in the prior quarter. Non-GAAP net income for the quarter was $4.1 million or 5 cents per diluted share compared with $4.4 million or 6 cents per diluted share in Q4 of last year. Diluted shares used for computing non-GAAP EPS for the fourth quarter were approximately 75.7 million shares. Moving to the balance sheet, average day sales outstanding were 80 days, up from 78 in the prior quarter. At December 31st, 2018, we had $128.4 million in total cash and marketable securities, compared with $123.6 million at the end of September. Before moving to our outlook for the first quarter, I would like to make a couple comments regarding our long-term model and path to achieve it. We will continue to focus on the growth areas of our market, security, 5G, and multi-cloud, further improvements in our go-to-market transformation, and continue disciplined focus on expense control. With these efforts, we expect to be able to deliver incremental operating margin each year and to progress to our target operating margin of 20% or greater within three to five years. Moving on to our outlook for the first quarter. We expect first quarter revenue to be in the range of $49 million to $53 million. We expect gross margin to be in the 77% to 79% range and operating expenses to be between $44 million and $45 million. We expect our non-GAAP bottom line results to be between a loss of $0.10 and a loss of $0.03 per share using a share count of approximately 74.5 million basic shares. Operator, you can now open the call up for questions.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. The first question will come from Mark Keller of DA Davidson. Please go ahead.

Great. Thanks for taking the questions. Could you just talk a little bit about that revenue guidance for Q1 that's calling for a pretty significant sequential drop down? How much of that is just typical seasonality? Are there any other factors that cause you to be a little conservative on that quarter?

Yeah. Hey, Mark. It's Tom. Thanks for the question. We typically see a seasonal decline from Q4 to Q1, and this is certainly within that range of what we would expect in normal seasonality. We'll call that a modest increase from Q1 of last year. But, yeah, it's in the range of what we'd expect in seasonality. Right.

So at the midpoint of that, revenue guidance should be up about 4% year over year, something like that. Yes. Go ahead. Thanks for the visibility on the breakout of revenue in the verticals. Just looking at that, it looks like the web giant contribution tends to be all over the place. Can you tell us what type of visibility you have there, what products you're selling in there, just some more around the web giants?

Sure. And that certainly is a reflection of the lumpiness of that portion of our customer base. As you, you know, I'm sure would expect, Mark, that has our largest customer in that category, which can be lumpy, but it just is lumpy by nature of that category. And then, you know, we do typically have decent visibility quarter to quarter in it. It's a little hard to get out beyond one quarter with some of that, but we're always working on improving that.

All right. And on the balance sheet, inventory popped up a little bit sequentially. Is there anything going on there?

Yeah, just a little bit of buildup. It's tied to the timing of some of the commitments we have to make on our supply chain. You know, that should naturally come down a little bit. It's just a little bit unusually high right now. But that's not an indication of a continued trend that I would expect.

Okay. And the five security wins that you have, for 5G installations. What does the ramp look like behind that?

So their current plan is to launch their service in the first half of 2019. So all the 5G design we did ship some equipment, including both the hardware and software solutions to these providers, and they are in the lab environment today. So they plan to launch by first half of 2019.

So a bigger ramp on that product in the back half of the year?

We believe the opportunities are large and growing. It will also be multi-years between now and 2025. Based on the IHS and our internal study, the market we can address is going to grow 50% over the next several years.

Mark, this is Chris. Just to add a comment to that. In Q4, one of those design wins was out of EMEA. So we expanded from just kind of the Asia-Pac and Japan market into EMEA as well, and we're starting to see opportunities in the pipeline in North America as well. But as Leah stated, while we're going to see growth this year in that market, we're going to see accelerated growth as we get into 2020 and through 2025.

And also we are engaging with many service providers around the globe. So we expect to have more design wins this year.

And Mark, just to clarify, when we have a design win, those are productive within themselves in terms of having a live order and revenue, meaningful revenue, and each one of those lays the foundation for add-on business that will grow. So this is the first step in actually an expansion that we would expect to play out over the horizon that Lee mentioned. Okay, great. That's all I've got.

Thanks. And again, if you wish to ask a question, you can press star, then 1. The next question will come from Zach Turcotte of Doherty. Please go ahead.

Hey, guys. Thanks. Zach Turcotte for . First is one on OPEX. Do you expect any sort of near-term ramp in OPEX maybe related to the build-out for 5G or, you know, I saw your long-term operating margin guide, 20% in three to five years is pretty aggressive. I would expect some more OPEX near-term or just, you know, continually be more efficient.

Yeah, hey, Zach. Yes, we are actually focused on reducing OpEx this year. So we will not see a ramp up. Now, you might see quarter to quarter some fluctuations in how that plays out. But for the year, we do expect OpEx to come down as we're getting more productive in sales. And the sales productivity metrics that were called out by Lee on the call are a representation of that, that we're on a trajectory there that we think is going to help us reduce our OpEx in 19. And if you look out into Q1, you know, we expect we'll see just, you know, a little bit better efficiency, and then we think that'll play out and continue throughout the year for us.

Okay. So we have invested more in our strategic area, such as 5G security and multi-cloud. But overall, you look at the OpEx, we do not expect overall increase due to the investment in security cloud and 5G.

Okay. I have one or two on 5G as well. First, who are your primary competitors you're seeing for the 5G design win? What are your win rates like for that?

Yeah, in the 5G design win, we had, as you typically suspect, some of the security company for the net, Juniper and in one case F5 and typically you will go through a POC. I would say in the first five cases I think we won fairly easily due to our scale performance and ability in our AI analytics.

Yeah, and Zach, this is Chris. Just to add to that, to your win rate question. As we've shared in the past, we've got very strong win rates holistically, but I would say they're even accelerated and higher in the 5G space because we believe we're ahead of the curve on that and improve that out through the POCs that Lee mentioned.

Right. So it definitely seems to us you were ahead of the curve in developing a scalable 5G solution with integrated analytics and everything. So do you feel that in the next 12, 24, 36 months competition will kind of ramp up as your competitors continue to build out their solutions in future steps?

You know, in technology world, you always have to continue to innovate yourself. But we are comfortable with the position we are in due to the investment is not just from yesterday. We have been investing in analytics for the past five years. And we are very strong without the carrier firewall, carrier security. We will continue to invest in the areas. We also have a close to 250... Service providers globally deploy our hyperscale carrier-grade NAT solutions. So we feel pretty good about it. Also, our solution really is differential in many ways. If you look at the 5G solution, one of the things the carrier and us expect, anticipate, there will be a surge in the DDoS attack due to IoT. And we are one of the few vendors that has really strong offering in DDoS protection. So our solution is really differentiated. And I feel good about our position. Of course, we need to continue to innovate.

All right. Great. Thanks.

And this concludes today's question and answer session. I would now like to turn the conference back over to Lee Chen for any closing remarks.

Thank you and all of our 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 your lines. Have a great day.