A10 Networks, Inc.

Good day and welcome to the A10 Network's first quarter 2019 financial results conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star, then two. Please note this event is being recorded. I would like to now turn the conference over to Maria Riley with Investor Relations. Please go ahead.

Thank you, Alyssa, and thank you all for joining us today. This call is being recorded and 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, Chris White, EVP of Worldwide Sales, and Tom Constantino, CFO. Before we begin, I would like to remind you that shortly after the market closed today, ATEN Networks issued a press release announcing its first quarter 2019 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 and prepared comments and trended financial statements on the investor relations section of the company's website, www.atennetworks.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, 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 partnership 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 market 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, and general growth of our business and our ability to incrementally grow, operating margin annually, and timeline to achieve our target operating margin. These statements are based on current expectations and beliefs as of today, April 25th, 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 we should not rely on them as predictions of future events. ATIN 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. 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 Results posted on the company's website. We will provide our current expectations for the second 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 the charges which are excluded from these non-GAAP measures. I would like to turn the call over to Lee Chen, founder and CEO of ATAN Networks. Lee?

Lee Chen Thank you, Maria, and thank you all for joining us today. We have decided to change the format of our call to include Chris White, our EVP of worldwide sales. I will provide a few comments on the quarters, our progress on the major initiatives, and product innovations. Chris will then discuss our market, customer wins, and go-to-market transformation. And Tom will provide details of our financial performance and outlook for Q2. We hope you find our new approach informative. Moving to our results. In the first quarter, we continued to make progress on our initiative in security 5G and multi-cloud. We delivered revenue of $50.3 million, non-GAAP gross margin of 76.3%, and delivered a non-GAAP loss per share of $0.09. Q1 is traditionally a seasonal quarter for us. And while our year-over-year revenue growth was modest, there are several points I would like to highlight that we believe demonstrate our growing momentum in security 5G and multicloud. First, we continue to see trends in security with both new and existing customers. Security product revenue grew 22% year-over-year to 34% of product revenue led by our Thunder CFW solution that integrates carrier firewall, data center firewall, secure web gateway, IPsec site-to-site VPN, integrated DDoS protection, SSL visibility, application visibility, and traffic steering capabilities. We have been investing in security and believe we are building momentum and recognition in the market with our highly scalable and intelligent automated software-based security solutions. In Q1, this included winning two Cyber Defense Magazine InfoSec Awards for all 5G security and DDoS protection solutions. Additionally, ATAN was top ranked in terms of market share for SSL visibility in Japan by ITR Corporation, which is the largest Japanese-based IT research and advisory firm. Second is 5G, which we believe is an exciting market opportunity for all security solutions. Our stronghold in the service provider segment and the high performance and scalability of our solution position us extremely well to meet the evolving security and performance needs of our 5G customers. One of our goals for 2019 is to grow our 5G design wings with leading mobile carrier globally. In Q1, we secured a new 5G design wing with another top mobile provider in Korea. which builds on ATAN's five-design wing from 2018. This customer selected our flagship Thunder CFW 5G appliance with Harmony controller. Of the three vendors invited to participate in the proof of concept, ATAN's solution was the only one that passes completely and successfully with zero packet loss. Korea is a pioneer in 5G commercial deployments. and new use cases. And I'm thrilled that ATEN has secured a design win with the three largest providers in the country. In fact, earlier this month, we helped the largest provider in Korea launch the first 5G commercial wireless network. We believe our win with these industry leaders will bode well for ATEN in the future as other providers around the world look to ready and secure their networks for 5G. The energy level at the Mobile World Congress was undeniable this year. A number of operators announced their 5G launch plans for 2019. The pioneers unveiled new use cases and several manufacturers announced 5G handsets. Another noteworthy development this year at MWC was security emerging as top of mind in operators keynote, and presentations. As a short, we have productive discussion with many service providers and partners about their security challenge of 5G. With our portfolio of high-performance and automation-driven 5G GISGI firewall, GTP firewall, DMS firewall, and integrated DDoS protection at a hyperscale, ATEM plans to be with NAND to help customers strengthen their 5G security posture. Third, in Monte Carlo, we made good progress with new wins with service provider, government, and financial service customers during the quarter. Tommy Controller is one of our growing number of products offered on a subscription basis, and it's driving our software's subscription revenue. While our subscription revenue remains small, It is growing rapidly, and we were pleased to see the number of Harmony Controller wins increase, which includes some of the marquee wins this quarter. On the product front, we continue to innovate and pioneer new solutions, and we have a robust Thunder TPS roadmap this year. Over the past quarter, we released a number of enhancements to our product portfolio. In March, we announced a new capacity enhancement to our Thunder GPS that now provides the highest performing DDoS defense appliance on the market. The added capacity will enable service provider, cloud, and online gaming providers to build profitable DDoS mitigation services and expand their service offerings while defending their networks and subscribers. With the proliferation of connected devices, expanding bandwidth, and new application services driven by 5G networks, the size and intensity of DDoS attacks will increase exponentially. We believe the performance and the automation available with our Thunder TPS delivers effective protection against this new and evolving attack landscape. In the quarter, We also forge ahead in our effort to drive further product innovation that supports the commercial rollout of 5G network and begin shipping our industry-leading virtual Thunder CFW 100 gigabit per second solution with the fastest throughput available in the market. This solution has already been adopted by a major telco provider in the Middle East for its 5G environment. We believe this new ATAN solution will be critical to helping customers transition to an agile, scalable, and software-defined network function virtualization infrastructure required for the commercial rollout of 5G networks. Overall, we continue to make progress on our top priorities for 2019, which include driving growth and innovation 5G, and multi-cloud. We remain on track to grow our security product revenue to be 40% to 45% of total 2019 product revenue and deliver total revenue growth in the back half of the year. With that, I will turn the call over to Chris.

Thank you, Lee. In looking at the dynamics within the quarter, the demand environment remained consistent. However, it was more backend-oriented than expected. Our win rate remained high, and we have had ongoing strength within service provider and enterprise customers. Our continued success with these customers is based on growing demand for our security, 5G, and multi-cloud solutions. Business with our web giant customers tend to be large and can fluctuate from quarter to quarter. We saw that downside of that dynamic play out in Q1 and expect to continue to be a headwind in Q2, given the tough year-over-year compare where we had a cloud customer contribute 20% of revenue in Q2 of 2018. From a geographic standpoint, we are pleased with our performance in our Asia Pacific theater that excludes Japan, where we delivered double-digit year-over-year growth for the fourth consecutive quarter, and Latin America, where we delivered triple-digit growth. Korea was also strong during the quarter. As we mentioned, 5G is quickly gaining momentum in Korea. We believe we have an early foothold on this market with design wins with three of the largest providers in the country. Approximately 85,000 5G base stations have been deployed in South Korea alone, and the region is fast becoming the pioneer of 5G use cases and commercial deployments. We believe our stronghold in the service provider segment and the high performance and scalability of our solutions positions us extremely well to meet the evolving security and performance needs of our 5G customers. Moving to our go-to-market. In the quarter, we continue to execute on our transformation plan and make progress. As we discussed previously at the start of the year, we implemented several changes designed to incentivize the sales team, drive new product sales with both new and existing accounts. We expect these changes to positively impact the second half of 2019. We also launched two new important go-to-market changes in North America. In January, we announced a partnership with Arrow Electronics and moved to a two-tier channel structure. Arrow enables a community of more than 3,000 channel partners, and through this new partnership, we will focus on recruiting security-centric bars and working together on sales and technical enablement, joint business planning and marketing to find new opportunities. In Q1, we were focused on ramping activities with Arrow, and while it's still early, we are encouraged by our initial progress, which included adding nine new security-focused bars in the quarter. We also formed a new engagement with Televerde to help us expand our lead generation efforts in North America. This program also went into effect in Q1, and we expect to see the impact of both these new relationships as we progress throughout the year. We've already completed a lot of the heavy lifting in our sales transformation. We believe we are halfway through a two-year journey, and our new sales leaders and their teams continue to ramp, build new customer relationships, drive pipeline, and revenue conversion. Approximately 29% of our global sales team has been on board less than three full quarters. The Latin America region is the furthest along in their transformation, and as you can see by the progress in their revenue, growth, and sales productivity metrics. Whereas North America and Europe are still in the early innings with close to 40% of the combined sales team on board less than three full quarters. As we continue to progress through this evolution, the key metrics we are using to measure our success are new customers, which grew to 177 in Q1. In addition to the number of new logos, we were also pleased with the quality and future expansion opportunities represented within these new customers. Two, pipeline of security opportunities, which grew over 20% year over year. And we're also closely monitoring our sales productivity, which decreased slightly in Q1. In aggregate, this metric can fluctuate from quarter to quarter, depending on seasonality, concentration of large deals, and the percentage of new sales hires in the quarter. But overall, we expect it to trend upward as we progress through the year. We're building a strong funnel of opportunities for our security 5G and multi-cloud solutions, and our technology vision and differentiated platform is resonating with customers. In addition to the 5G win lead shared, I'd like to highlight a few recent engagements. We secured a large win with a mobile provider in the US, where we refreshed a portion of their Thunder ADC install base and expanded our footprint by replacing an incumbent vendor with our Thunder SSLI solution. We also gained a foothold with a large mobile carrier in India with our Thunder CGN solution, a key differentiator cementing this new customer with a tight integration with our partner Ericsson. Ericsson put forth a complete packet core solution with ATEM providing carrier-grade NAT component. We believe there's opportunity to expand our sales to this customer over time, especially as they consider their options for 5G. We also secured a customer in Canada that provides IT services to government agencies. This customer selected ATEN's SSLI solutions for large-scale decryption to help harden their security perimeter. This win involved a lengthy RFP process where we were up against a number of competitors. I'd like to thank our partner and our team for their collaboration and hard work to bring phase one of this deal to close. And lastly, with a leading provider in Japan, we secured a large Thunder TPS win. as we grow our footprint with this important customer and continue to replace incumbent DDoS vendor with our high-performance solution. Overall, we're seeing results from our go-to-market transformation, including a growing pipeline of large deals. But we also recognize we have work ahead to ramp and enable our teams and new partners in order to capitalize on 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, line of sight to what we can accomplish this year, 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 first quarter financial performance and second quarter guidance. Tom?

Thank you, Chris. First quarter revenue increased 2% year-over-year to $50.3 million, compared with $49.2 million in the same period last year. Deferred revenue was up 1% year over year to reach $98.6 million. First quarter product revenue was $28.2 million, representing 56% of total revenue. Service revenue was $22.1 million, or 44% of total revenue. Security product revenue grew 22% over last year to reach 34% of total product revenue in Q1. Moving to our revenue from a geographic standpoint, for the first quarter, revenue from the United States decreased 12% year-over-year to $18.1 million, compared with $20.7 million in the same period last year. In Japan, revenue was $13.2 million, up modestly at 1% year-over-year. Revenue from APAC, excluding Japan, was $8.8 million, up 18% year-over-year. In EMEA, revenue was $7.2 million, an increase of 11% when compared with $6.5 million last year. Revenue from LATAM in the quarter more than doubled year-over-year to $3 million compared with $1.5 million last year. As a reminder, last quarter we changed 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. Service provider revenue in the quarter increased 13% year over year to $23.8 million. Enterprise revenue in the quarter increased 7% year over year to reach $22.9 million. Our web giant revenue decreased 47% year over year to $3.7 million in the quarter. 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 76.3%, a decrease of 190 basis points from last quarter, and 140 basis points from Q1 of last year. First quarter product gross margin was 73.5% compared with 76.8% last quarter. and 75.2% in Q1 of 2018. Our year-over-year decrease in product gross margin was primarily driven by a few select strategic opportunities and inventory write-downs. Services gross margin in the quarter came in at 79.9% compared to 80.9% in Q1 of 2018. We ended the quarter with headcount of 834 compared with 860 at the end of last quarter. Non-GAAP operating expenses in Q1 came in at $44.1 million compared with $45.1 million in the prior quarter. Non-GAAP operating loss was $5.7 million compared with operating income, $3.3 million in the prior quarter. Non-GAAP net loss for the quarter was $7 million or 9 cents per diluted share compared with a loss of $7 million or a loss of 10 cents per basic share in Q1 of last year. Diluted and basic weighted shares used for computing non-GAAP EPS for the quarter were approximately 75.2 million shares. Moving to the balance sheet, average day sales outstanding were 80 days, consistent with the prior quarter. At March 31st, 2019, we had $122.8 million in total cash in marketable securities, compared with $128.4 million at the end of December. Moving on to our outlook for the second quarter. We currently expect second quarter revenue to be in the range of $51 million to $56 million. We expect gross margin to be in the range of 76% to 78% range and operating expenses to be between $43 million and $44 million. We expect our non-GAAP bottom line results to be between a loss of $0.08 and break even on a per share basis using a share count of approximately 76 million shares. Operator, you can now open the call for questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed or you would like to withdraw your question, please press star, then 2. Our first question today comes from Mark Kelleher of DA Davidson. Please go ahead.

Great. Thanks for taking the questions. Just wanted to start with the cloud web giants, the cloud and the web giants. You indicated that you're seeing some weakness there. It's lumpy. What drives the demand from the web giants, and how much visibility do you have there?

Chris, do you want to address this? Sure. Hey, Mark. This is Chris. Yeah, I mean, from a predictability standpoint, we do work very closely with our install base of WebGiant accounts, but a lot of it is based on their utilization rates, which aren't always predictable or readily available. And as you look at it, we certainly did have some weaknesses of members, as we called out, on WebGiants in Q1, but as you look at them on an annual basis, we believe that we're well-positioned for 2019 with the WebGiants.

Okay. And on the 5G ramp, you've got some great wins there. When does that begin to be a meaningful part of revenue? Is that really just start to roll out the back half of this year and then bigger next year? What should we expect there from 5G?

Our expectation is in the second half of 2020.

That it will be?

A meaningful revenue.

A meaningful revenue? Okay. How much is the VAR ramp going to help you? Can you talk a little bit more about the VAR ramp and how that should impact revenue and margins?

Yeah, absolutely. So as I called out in the script that we obviously in North America brought on Arrow in the first quarter, and it was certainly a ramp quarter, right, an enablement quarter for them. So we have dedicated resources through Arrow and expect through the recruitment strategy and through the additional resources we have focused on it, we would expect to see some level of increase in the second half of the year, right? And I would really look to 2020 to see that scale, but we should see some impact within 2019 in the second half. And then the other area that it will help us with is around our security growth, right, because we're really focused with them on bringing on new security partners, which you saw we had a handful of those in the Q1 of 2019.

Okay. And last question for me, just the competitive environment. One of your competitors made an acquisition recently, open source NGINX. Has that changed the competitive dynamic? What do you think of that?

Yeah, Mark, this is Chris again. I mean, from my perspective, I think that that acquisition is interesting from a story perspective. And I would say that from an A10 perspective, it doesn't really change the competitive landscape because we're already, you know, having a number of conversations with customers around open source. And with the tools that we bring to the table in that area, we think we can continue to differentiate ourselves there. And, you know, Generically speaking, not specific to that competitor, but generically speaking, as you look at acquisitions, my experience is those take many quarters to come together. So if it's going to have an impact, I think it's longer term than short term.

Okay, great. I'll see the floor.

Thanks. Again, if you have a question, please press star, then one. Our next question comes from Catherine Trednick of Doherty. Please go ahead. Hello.

Yeah, thank you very much for taking my question. So could you pretty much peel from the three segments what your growth looks like without your largest customer during the quarter?

Sure. Hi, Catherine.

Hi, Tom. How are you?

Good. How are you? Thanks for the question. If you take out our top account, it's about 6% growth year over year. Okay.

And then also back to the web giants. It seems to me, as I recall covering you guys since almost public, is that they tend to have a large order and then they buy off that order for a couple of quarters and then you don't see another order. I mean, is that still the case? And then how many large web giants do you count as customers?

Yeah. Hey Catherine, this is Chris. So, um, yeah, we do, we do tend to see a cyclical buying pattern from them. Um, and with your, your history, your, you know, your accurate and kind of the ebb and flow of that. Um, with that said, we are working more closely with them as part of our sales transformation and as a follow on to Mark's question to get tighter with them to add predictability to that. Um, but we're still, you know, working through that with that particular web giant. And we will, you know, we do expect to see, as I said, some uptick in the, you know, Q2 and beyond, I would say, in the remainder of the year with the WebGiants. And then, you know, we are, as you look at our overall pipeline, we have a number of new opportunities in play for 2019 that would enhance, I'll call it our portfolio of WebGiants as well.

And then, I'm sorry, I got a lot of questions. The other follow-on question is really around 5G, Chris. So now you have a total of seven 5G WINS?

Yes, six are Tier 1 mobile operators. Yeah. Okay.

Six Tier 1 sounds like a couple in Japan, several in Korea, and maybe one in Europe or Middle East?

Yes.

Okay. So is that Europe or Middle East, Lee?

Yes, it's two in Japan, three in Korea, one in Middle East. They all are tier one mobile operators.

Okay. And then the other question is, you know, Verizon and AT&T seem to be talking quite a bit lately about 5G and we're rolling this out to different cities. Can you just briefly explain why, you know, have they really supplanted, you know, from what I think about 5G is you have to do the infrastructure and then you, you know, then you offer the service. I mean, can you explain to me what part of 5G are they rolling out? And then are you working with, through Ericsson, to be a part of Verizon or 18 Tier 1s in North America?

Okay. The first to address the If you look at 5G rollout today globally, you see early phase rollout of the 5G spectrum, basically different 5G bands on the 4G infrastructure. So 4G infrastructure, that's where we play well in today's market. It can consolidate multiple 4G infrastructure into a solution. Later on, it can be upgraded to 5G. through the software upgrade. Got it. So that's on the current deployment and also the evolving 5G roadmap. Today, it's really something they call the NSA. It's not a standalone, pure 5G deployment. 5G spectrum on a 4G infrastructure, that's what today. It will be for the next several years. Okay, thank you. AT&T and the Ericsson, I can't give you specific comment on, but we are working very closely with Ericsson and some other partners. And today we have a, in addition to a seven wing we have, we are engaging 12 POC and trials globally, including some of the really big ones.

Okay. So would you say then the Ericsson, I think you at RSA, you know, it sounds like you have Nokia also as a partnership, and then you announced you had NEC as a partnership. So would you say that the Ericsson partnership has helped drive some of these new wins, and that's a very important partnership for going forward?

I think all partnerships are important, especially Ericsson. It allows us to access some of the key mobile operators, which we did not access before. We have strong hold with the mobile operator across the board already.

All right, excellent. Thank you. Appreciate the caller.

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

Thank you and all 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.