睿科網路 (ATEN) 2015 Q2 法說會逐字稿

Good day, and welcome to A10 Networks second quarter financial results conference call. After the speakers' remarks, there will be a question and answer session. (Operator instructions.) Today's conference is being recorded.

At this time I'd like to turn the call over to Maria Riley, Investor Relations. Please go ahead, ma'am.

Thank you all for joining us today. I am pleased to welcome you to A10 Networks second quarter 2015 financial results conference call. This call is being recorded and webcast live and may be accessed for 90 days via the A10 Networks website at A10networks.com.

Joining me today are A10's Founder & CEO, Lee Chen; A10's CFO, Greg Straughn; and our VP of Global Sales, Ray Smets.

Before we begin, I would like to remind you that shortly after the market closed today, A10 Networks issued a press release announcing its second quarter 2015 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 comments, and trended financial statements on the Investor Relations section of the Company's website at A10networks.com.

During the course of today's call, management will make forward-looking statements, including statements regarding our projections for our third quarter operating results, our expectations for future revenue growth, profitability, and operating margin, expectations of customer buying patterns, and the growth of our business generally. These statements are based on current expectations and beliefs as of today, July 30, 2015.

A10 disclaims any obligation to update information contained in these forward-looking statements whether as a result of new information, future events, or otherwise. 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.

We disclaim any obligation to update these forward-looking statements as a result of future events or otherwise. For a more detailed description of these risks and uncertainties, please refer to our most recent 10-Q filed on May 6th.

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. 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 third quarter of 2015 on a non-GAAP basis. However, we will not 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.

Before I turn the call over to Lee, I'd like to announce that management will attend the Pacific Crest Annual Global Technology Leadership Forum in Vail on August 10th, and the Oppenheimer Annual Technology, Internet, and Communications Conference in Boston on August 12th, and the Jefferies Semiconductor and Hardware and Communications Infrastructure Summit on August 25th in Chicago. We hope to see many of you there.

Now I would like to turn the call over to Lee for his opening remarks. Lee?

Thank you, Maria. I would like to thank you all for joining our second quarter 2015 financial results conference call.

We delivered a strong second quarter with good execution and growing momentum, as the investments we made last year in our channel, field activities, and product development are taking hold.

We achieved the record revenue of $47.5 million, above our guidance of $44 million to $47 million, and up 5% year-over-year and 8% from Q1. We also continued to drive leverage through our operating structure, resulting in a 42% sequential improvement in our bottom line.

From a demand perspective, we added 200 new customers, delivered record enterprise revenue, grew product revenue 9% over Q1, and won a multimillion-dollar order from a current service provider customer in North America as they continue to enhance their CGN infrastructure.

We also saw continued strength for our security focused solutions, including our Thunder TPS DDoS mitigation solution and our ADC with advanced security features. Our pipeline of channel-initiated deals continues to grow, and we are encouraged by the continued progress we see from the channel investment we made last year.

In addition, we have started to roll out our affinity channel program globally, and we believe we are on track to have it launched in our key international markets by year-end. Bookings in the quarter were strong, and we ended the quarter with a backlog of approximately $5 million, which is more than 50% above our 2014 average.

Cybersecurity, network resources, and service management are growing priorities for our customers and for A10. Customers at the high end of the market want products that are rich in features, fast performing, and in small form factors, which are key attributes of our Thunder products that are based on our flexible and scalable ACOS platform.

This is why some of the most demanding enterprise and service provider customers already trust A10 with their networking and security needs. We believe that, with our strong product portfolio and the strategic value we bring with our continued innovations and superior technical support, we are well positioned to grow within the high end of the market, especially as the security threat to business is on the rise.

As we mentioned last quarter, we are seeing growing demand for ADC with advanced security features such as Web application firewall and SSL Insight. Gartner estimates that less than 20% of organizations with a security device are currently inspecting encrypted traffic. This creates a security blind spot where malware and hackers can enter a network through uninspected encrypted traffic.

While firewalls and dedicated security devices provide in-depth inspection and analysis of network traffic, they are not designed to decrypt SSL traffic at high speeds. Our Thunder ADC equipped with SSL security hardware offers a powerful and scalable decryption solution to enable policy enforcement and redundancy as well as load balancing security devices.

The initial launch of our Thunder ADC with SSL Insight solution has been very successful, is attracting attention among both customers and partners, and is helping driving growth in our pipeline. In particular, we are gaining traction within the government, higher education, and financial services verticals with our SSL Insight capabilities.

Additionally, our Thunder TPS DDoS mitigation security solutions continue to build momentum. Our Q2 TPS growth was driven by both new customers and follow-on orders from existing customers as they look to A10 to protect more of their networks from high volume and sophisticated DDoS attacks. For the first six months of 2015, TPS product revenue has contributed approximately 10% of total product revenue.

We continue to strengthen our product portfolio and bring added flexibility and functionality to our customers. In the second quarter, we enhanced our Thunder TPS and ADC platforms with the release of aGalaxy centralized management system that leveraged the fully programmable policy engine in ACOS. Our aGalaxy provides strong configuration management, reporting, and real-time traffic analysis.

We also launched new midrange and high end Thunder ADC models with dedicated hardware for SSL performance and DDoS protection, providing up to two to three times better performance than the prior generation.

We partnered with ThreatStop to create the A10 Threat Intelligence Service. This add-on subscription service is now available on both our Thunder ADC and TPS products.

And we added our virtual ADC to Microsoft Azure marketplace, enabling enterprises to outsource their data center operations with A10 Networks. Additionally, as we announced yesterday, our vThunder ADC was selected by KDDI as the preferred ADC for its corporation cloud infrastructure, KDDI Cloud Platform Service.

Customer driven innovation has been a cornerstone of the A10 vision from our inception, and we intend to continue to invest responsibly to bring new functionality, features, products, and superior technical support to market, including a hardware refresh throughout 2016.

Overall, I'm pleased with our business momentum. We delivered a solid second quarter and are seeing the benefits from the significant investment we made last year in our channel, field activities, and product development, which are all driving our growing pipeline.

With that, I would like to turn the call over to Greg to review the details of our second quarter financial performance and third quarter guidance. Greg?

Thank you, Lee, and thank all of you for joining us today.

Second quarter revenue grew to $47.5 million, up 5% compared with $45.1 million in the prior year. Generally, our deferred revenue primarily consists of customer maintenance and support contracts, but this quarter it included a larger than usual product element and increased 43% year-over-year and 10% sequentially to reach a record $65.8 million.

Second quarter product revenue totaled $33.3 million, representing 70% of total revenue, compared with $34.1 million, or 76% of total revenue, in the prior year second quarter. Service revenue was $14.2 million, accounting for 30% of total revenue, compared with $11 million, or 24%, in the second quarter of 2014.

Second quarter revenue from the United States grew 20% sequentially and 5% year-over-year to reach $27.4 million, representing approximately 58% of total revenue.

Second quarter revenue from Japan was $6.6 million, or 14% of total revenue, compared with $8.5 million, or 19% of total revenue, in the same quarter of the prior year.

EMEA generated record revenue of $6.8 million, a 74% year-over-year increase versus the second quarter of 2014, and representing 14% of total revenue. Revenue from APAC excluding Japan was $5.5 million, up 27% year-over-year when compared with $4.4 million in the same quarter of the prior year.

Our enterprise and service provider revenue split this quarter was 58% and 42% of total revenue respectively. We generated record enterprise revenue of $27.5 million, representing a 10% increase from the prior quarter. Service provider revenue came in at $20 million compared with $19 million in the prior quarter and $17.7 million in the second quarter of 2014.

As Lee mentioned, we secured a large win with an existing service provider customer, helping this customer to become our single greater than 10% customer in the quarter, contributing a total of 14% of Q2 revenue.

As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis, unless expressly stated otherwise.

We delivered a second quarter total gross margin of 76.3%, within our guidance range of 76% to 78%. On a constant currency basis versus Q2 of 2014, gross margin was impacted by a 40 basis point decrease year-over-year due to changes in the yen to dollar conversion rate.

Product gross margin was 76.4% in Q2 of 2015, compared with 77% in the prior quarter and 78.3% in the second quarter of 2014, with the major portion of this decrease related to shifts in our geographic mix.

Our services gross margin came in at 76.1%, up 63 basis points over Q1 2015, and represents a 98 basis point improvement over Q2 of 2014.

We ended the quarter with a staff of 800, up from 761 at the end of Q1, with most of the 39 additions in sales and marketing and R&D.

In Q2, sales and marketing expense was $23.1 million, compared with $22.5 million in Q1 of 2015. On a percentage basis, sales and marketing expense decreased to 48.6% of revenue, compared with 51% in the prior quarter.

In Q2, R&D expense totaled $12.4 million, or 26.1% of revenue, compared with $12.7 million, or 28.9%, of revenue in the prior quarter.

Second quarter combined G&A and litigation expense was approximately $5.5 million, or 11.6% of revenue, compared with $7.5 million, or 17%, of revenue in Q1. The decrease is primarily related to lower bad debt expense, reversal of a reserve for certain sales tax matters, and reduced professional services fees.

In total, second quarter non-GAAP operating expenses were $41 million. Second quarter non-GAAP operating loss was $4.7 million compared with $8.9 million in the first quarter.

Our non-GAAP net loss in the second quarter was $5.3 million or $0.09 cents per share, ahead of our guided range of $0.14 to $0.18 cents per share. Q2's net loss represents a 42% sequential improvement compared with a net loss of $9.1 million, or $0.15 cents per share, in Q1.

Basic and diluted weighted outstanding shares for the quarter were approximately 61.9 million shares.

Moving to the balance sheet, at June 30, 2015 we had $96.2 million in total cash and equivalents. During the quarter, cash generated from operations was $9 million, reflecting strong billings and collections activity and expense management in the quarter.

Although cash flow was strong in Q2, we do not necessarily expect to remain cash flow positive in the near term. Looking into Q3, we expect to use up to $3 million in cash for operations. Additionally, inventory levels were reduced in the second consecutive quarter as we continue to refine our supply chain operations.

We ended Q2 with $46.2 million of net accounts receivable, compared with the Q1 balance of $52.8 million. Average days sales outstanding declined to 95 days compared with 110 days in the prior quarter.

Moving on to our outlook, to establish our Q3 guidance, as we mentioned, we are ending the quarter with a very strong backlog of approximately $5 million, which is above our normal rate. Balancing our strong backlog with appropriate conservatism in the service provider vertical, we expect third quarter revenues to be in the range of $48 million to $52 million.

Further, we expect gross margin to be in the 75% to 77% range, reflecting expected continued currency headwinds and investments in our professional services.

We expect operating expenses in Q3 to be between $43 million and $44 million, and therefore expect to report a non-GAAP net loss of between $0.08 and $0.12 per share using approximately 62.8 million shares on a basic and diluted basis.

In setting this, we are assuming the yen exchange rate remains in the range of $1.22 to $1.24.

With that, I would like to open the call up for your questions. Operator?

Thank you. (Operator instructions.) Itai Kidron, Oppenheimer.

Nice to see business getting back into motion. Greg, if you break down the financial performance here, clearly you did better than targets. But, is there one specific area where you think you really got surprised to the upside? You go through all the details, but it would be great to know where you really did better than what you though you'll do, whether it be a region or a product category.

Well, I think on the revenue side most of the things that we saw were within the range of what we had expected and had set our guidance for. So, that was pretty much as expected.

I think we were -- and we saw strength across the geographies as we expected. So, the drivers of the EPS and the cash piece had to do with management of the expense side of the business and a pretty intense focus on collections activity. And I think that's what helped move the dial on those two metrics.

Got you. And then, regarding the deferred revenue jump, is this related to the one large service provider that you had in the quarter? I'm just trying to understand if, when you look into next quarter, you also assume one large customer. That's kind of one of those things that you kind of tripped on in the past, where you had some big customers that went away. I'm just trying to think about, while it's good to have big customers come along, when you have few of them, how do you maneuver through that smoothly?

So, a couple things. One is that the large customer that Lee had referred to that was the CGN win, that is not -- other than the maintenance and support for that deal, that's not what's impacting deferred revenue. Deferred revenue is a different -- the product piece of that is from a different customer. So, those two items are not directly related.

But, I think on the large customer question, you're right. I mean, that's one of the factors that we're continuing to deal with, and having this customer in the quarter was a very good thing. And with the backlog that we built, we feel it creates a good platform for going forward.

Yes, Itai, I think we feel comfortable with our Q3 guidance. We also are entering Q3 with strong backlog.

Our guidance is really using the same methodology as we used in the past couple quarters. And we really consider all the pipeline, applying appropriate conservatism for large deals.

Right. That large deal, was that -- can you tell me if that was TPS or ADC?

As Lee said in the script, it was a CGN, so ADC related.

CGN, got you. Very good. Good luck, guys.

Thanks, Itai.

Mark Sue, RBC Capital Markets.

Gentlemen, just as a clarification, so the spike in the deferred, the product side, is that one customer or is it more new products related to a broader customer? Just trying to get some clarification there.

It's a small number of customers. It's unusual for us to have product like that in our deferred revenue.

There's usually some piece there, if it's in deferred revenue, that's amortized over time. But, it's not typical for us to have a transaction or a couple transactions that are specific product orders in there that would be recognized as a single unit as opposed to amortized over time. And that's the distinction we were trying to draw calling that out.

I see. That's helpful. So, with that being said and the timing and the lumpiness of that, how should we think about potentially the next several quarters? Because you do have a lot of new products coming out in the pipeline. There is some share gains we're seeing A10 gain on the DDoS side. So, do we spike up and then kind of moderate, or we actually can grow? Just so that we could model the next several quarters, just some qualitative comments would be helpful.

Well, so first off, I think that the specific guide for next quarter is relatively smooth growth off of what we've seen this quarter. And I think we've tried to be relatively explicit that large deals are something that would -- to the extent that they're speculative and lumpy, are something that we're not trying to call when they're going to come in.

And CGN is actually a great example of that, because it is primarily a service proprietor product. That's been the source of a lot of the lumpiness in the past.

So, I think what we're aspiring towards is smooth, progressive revenue growth going forward with the lumpiness being the upside potential so that the spikes are above our guidance, not required to get to a guided number.

Hopefully that's helpful.

Yes, that is helpful. And maybe on Japan, that's a region where you saw a lot of concentration. It has not yet recovered. Are we at the point of turning the corner in Japan anytime soon?

I think we still see the macro pressure in Japan, especially within our service provider customers. And over the past year, we have really worked very hard to build up our business outside Japan to diversify our geographic revenue mix.

Overall revenue trend from Japan has become a low percentage of A10's total business. But, that being said, we continue to have a strong engagement and strong position for our service provider customers. I think perhaps when the service provider buying patterns increase, we will benefit from the service provider buying increase.

Okay, that's helpful. And Greg, it's good to see the decline in DSOs to 95. Can you reduce that by 15 days every quarter?

I don't know if we can do it by 15 days every quarter. But, our expectation is that number will be on a decline over time, yes.

That's great. Thank you, gentlemen, and good luck.

Thanks, Mark.

Rod Hall, JPMorgan.

So, I got a couple. The TPS percentage, you guys called out greater than 10%. From my recollection, you were originally thinking TPS would be 10% by the end of the year. So, is that an acceleration of TPS, in your mind? And if so, what proportion of revenue do you expect it to be by the end of the calendar year here?

And then, I wanted to also ask you about the KDDI vThunder selection, and whether that -- is that just keeping you in the game with KDDI, or does that have incremental revenue impact? And then, I had one more follow up for you, I guess, as well.

Okay. So, first off, on the 10% for TPS, just to clarify, the 10% for the first half is 10% of product revenue. And that we're just describing at the milestone on our way to 10% of revenue. And so, it's not the achievement of a goal, but we think it's a significant milestone, showing progress towards that goal.

But the --.

Okay. And Greg, shouldn't you --?

Let me answer you, Rod. I think we are really pleased with the TPS momentum and growing pipeline. It's definitely our goal to continue to grow the TPS revenue in the upcoming quarters.

But, I mean, just to follow up on that, if you guys are already over 10% of product revenue, I mean, is it -- do you think a services revenue pull-through will be so slow that you'll only end up at 10% of total revenue by the end of the year? It just seems like that's a little bit ahead of schedule to me.

TPS has performed well for us. We are really pleased and share -- that's why we shared that important milestone with all of you.

The service revenue is really a matter of how long you've been in the business. Because it relates to a number of customers, the number of revenue has built over the years. So, we don't expect service revenue will spike quickly in the TPS, but we have a good momentum in TPS. The pipeline remains very strong.

Okay. And then, on KDDI, just what's the incremental impact from that?

Yes, KDDI. We have multiple business with KDDI. In this specific vThunder for KDDI cloud infrastructure, we are replacing a current vendor as a preferred ADC vendor in that KDDI cloud infrastructure.

And how big a proportion of their ADC expenditure is that, Lee? Is it 5% or 10%, or is it a very large proportion of their overall ADC expenditure, that particular part of the infrastructure?

We typically don't break out the -- really the alliances. We don't break out our business with a particular customer, and then we also don't really break out the customer revenue opportunities here.

Okay. And then, I just wanted to clarify one more thing and I'm done. You guys have said before that you took the approach in guidance of leaving out certain -- a lot of the carrier deals that are in your funnel because you've had bad luck with estimating the timing of completion of those deals in the past. Is that still the case? So, when you give guidance, are you leaving out of the guidance potential carrier deals that might develop, or how are you treating the carrier deals in the funnel and the guidance at the moment?

Well, I don't think -- we haven't left them out of the guidance. We've always -- what we've described is using kind of appropriate conservatism and divining at the beginning of the quarter what our line of sight is to closing a particular transaction.

And that's the methodology that we've used for the last couple quarters. It's the methodology we're using for Q3 as well. So, this particular transaction within the current quarter was something that we had clear line of sight on as we entered the quarter, and it played out that well.

But, what we're doing is changing the risk adjustment that we apply to these and provide -- making it a very high hurdle for a large service provider to clear before it has any dollars in the guidance, let alone a large amount in the guidance.

So, we have a higher quality pipeline and forecasting process. This deal has always been part of our forecasting process. So, it's not been left out, but it did provide upside.

Brent Bracelin, Pacific Crest Securities.

A couple questions, if I could here. One, wanted to start with the large CGN deal in the quarter. As you think about kind of that purchase, is this kind of a one-time buy, or do you expect some follow on CGN business outside of the current quarter?

I think the customer has been an A10 customer for quite a while. So, that customer continues to buy almost every quarter. But, in terms of large deals, it's always hard to predict when they're going to buy. But, they have always been a good A10 customer. We see them continuing to purchase from A10.

But, in terms of deal size, that's where we don't have control. That's where we apply our forecasting process and conservatism in anticipating the large deal. A large deal will provide upside to our guidance.

Okay, fair enough. And then, shifting gears to security, obviously TPS, 10% of product revenue. You talked about SSL Insights. I'm wondering if you could just talk to the pipeline. What's the pipeline visibility around security? It seems like you're having a little bit more success here expanding the pipeline beyond ADC and CGN into security. What's the pipeline look like relative to the security business in the second -- as you kind of enter the second half of the year?

I think the pipeline going into Q3 with the advanced security featuring ADC and TPS, both are strong.

Are you seeing any sort of change to the competitive environment? Or as you roll out TPS, have success with TPS, have some success with SSL Insight, who are the competitors you're running into the most there? Who are you winning business the most versus in the past in the core ADC market?

Yes, I think the -- if you look at ADC with advanced security feature, we like our position. We like our technologies. Just to give you an example, SSL Insight, when we compete, we mostly compete with other security vendors.

Then, on the TPS, I think as I mentioned in the call, we released a very important aGalaxy centralized management system for TPS. That's very significant. We have several customers that are engaging with us on the ground with the centralized management system.

So, we like our position, yes. I think just based on the pipeline and growing momentum, we think the products -- and it's very well positioned in the market space.

Fair enough. And then, wanted to also -- my last question here is just a follow up on kind of the product deferred. Just to be clear, that reason that product deferred kind of spiked here, was that tied to kind of orders that you received late in the quarter that you were unable to ship, or was it tied to orders for products where you have some sort of new software capability that you weren't able to recognize yet?

It's more the latter. It's that we're doing some innovative functionality for them that they wanted to have it invoiced and paid ahead of time. So, that's why it's in deferred instead of in backlog.

And that software functionality, do you plan to have the ability to fulfill that in Q3, or is it at some point in the second half of the year?

We really can't go into any of the specifics on that, either as to what it is or the timing at this point.

Okay. Well, I'll ask one other follow up. Is that assumption that you will have additional functionality baked into the Q3 outlook, or is it not factored into the Q3 outlook?

The existence of the functionality is not related to our Q3 outlook at this point in time.

Okay, fair enough. Thank you so much.

Thanks.

James Faucette, Morgan Stanley.

Just a couple of quick questions for me, first a clarification. A little bit surprised to see a sequential decrease in R&D, and just wondering if there was departures there in figuring out hiring, kind of like what drove that. That's just a clarification.

And then, on the enterprise side, it seems like you're clearly finding some success there on that refocus. How much incremental improvement do you think you can make in the enterprise as you continue to rework the sales force? I think you've put a lot effort into that, and just wondering how much you think is sales force versus improved product targeting, etc.

Then finally, the last question from me is just how we should be thinking about security and where ultimately you'd like to target that segment being as a proportion of your total at least product revenue. Thank you very much.

Well, James, I think you hit all three of us. I'll handle the R&D question, toss it over to Ray for the sales force one, and then back to Lee for the security. So, I think you got us all there.

On the R&D side, the sequential down movement there was related to a few items that are just incidental, legal expenses related to immigration, some of those items.

But, also our hiring was a little bit slower in the quarter than we had anticipated, which led to some of that as well. But, as we go forward, we do expect that line item as well as the others to grow into the Q3 number as indicated by our guidance.

And James, this is Ray Smets. I'll take the enterprise question in terms of incremental improvement. I can't give you any specific numbers on this.

But, I will tell you, from a sales execution perspective, in addition to keeping the iron very hot in the service provider fire we're working pretty diligently to keep mining our way into the enterprise domain, which is a big upside for us.

We are seeing quarter-over-quarter improvement in sales productivity as a result of that. This is coming from a number of things, including sales enablement, but also additional investment in our affinity channel program, which is targeted specifically to the ADC and very, very much so targeted into the enterprise, ongoing marketing efforts to make sure that we're getting the demand out in the field and getting the leads that we can turn into qualified leads, and then targeting certain areas in the marketplace where we have exceptionally good and strong traction such as the Web 2.0 domain.

So, we do expect to see enterprise continue to be a strong growth area for us as well. And we're hoping to benefit from the service provider turnaround that we hope to see sometime in the near future as well.

Before we move on to security, I just want to ask quickly where you feel like you're at from a salesperson productivity standpoint on enterprise and carrier right now.

So, I'd love to give you some details on that, but I can't really give you any specifics.

But, I will tell you, James, that we look at this very, very carefully as a growing company making forward investments and growing our geographic mix and our execution in North America. We're forward investing, but the good news is we're beginning to see the return on that investment in terms of expense to bookings ratios and cost to revenue ratios. So, we're moving the needle in the right direction.

And then, I think the next part of your question, James, was about security.

James, customer driven innovation has always been a vision for A10. And we have played at the high end of the market, and many of our customers really are asking us to expand our portfolio into security.

So, we are putting a very significant amount of our R&D into security, but we will not comment on any unannounced products. But, we do expect we'll continue the investment in security.

Next question, please?

Rohit Chopra, Buckingham Research.

I had three questions for you. I wanted to ask about product gross margin. I know you're blaming currency as one of the factors there. But, Japan is down as a percentage of the mix when you look at it over -- year-over-year. And I just wanted to know what else is actually driving the gross margin or product gross margin down. Is it a function of maybe more deals coming through the channel? I know there was some discussion of that in your prepared remarks. So, if you could just explain why we're going from 78.3% last year down to 76.4%, I think that would be helpful.

And a question for Ray. Can you tell us how much is actually coming from the channel? And if that's going to expand, should we expect more pressure on gross margin?

And then, the last question I had, and I know Mark seemed happy about the DSOs coming down, but they are actually still high at 95 days. And if you look at the revenue number for what you did last year and what you're doing now, which is $47.5 million, if we look at what you did last year at $45 million, you look at your service provider mix and enterprise mix, it's almost the same at 60/40. So, I'm just trying to get a sense of why the DSOs are still high when we're roughly at the same revenue levels and we're still roughly at the same service provider/enterprise mix. So, DSO, produce gross margin, and then maybe if you can give us a sense about the channel.

Okay. Let me do the two I can address first, and then Ray can do the channel one.

So, on product gross margin, the yen is certainly an impact on that. And it's -- actually the yen and Japan are an impact in two ways because the compression from -- on the revenue line for Japan last year versus this year is about $700,000. In other words, our revenue would have been $700,000 higher with the business Japan did this year if it had been done at last year's exchange rate, right?

So, there's a compression that occurs there. That's that 40 basis points that was referenced in the call. But additionally, Japan a year ago was a much larger percentage of our business. And it was bringing a high gross margin in.

And so, the mix of business from what had been higher gross margin markets, Japan, the US, to some of the lower gross margin markets has been an impact on the gross margin average itself. So, that's on the product side.

And so, I think that those are the main effects. And then, there are other ancillary things that hit in there, but this is just -- and again, this is just focused on the product side. Service has different dynamics, which has actually gone up in the course of the year as we've seen an increase in the maintenance gross margin.

So, those are the primary effects on the gross margin. And as we adjust the guidance, we're not necessarily saying that we expect it to go down further, but rather we wanted to have the guidance range more accurately reflect, kind of at the midpoint, where we see gross margin coming out versus having it at the boundary.

The DSO, on that metric, yes, 95 is a higher number. It's certainly not what we're shooting for. I will note that the quarter we just finished was our largest invoicing quarter that we've ever seen. And so, beyond what we saw on revenue, we saw a very high invoicing number coming through.

We moved collections aggressively forward. We have more work to do on the collections side. But, again, the geographic mix has some impact on this as well. Whereas the US and Japan tend to be rather fast payers, some of the other markets are not quite as prompt. And so, that is a pull out last year versus this year.

So, I think that the important thing for us is that we're at a point where we're progressing it forward. We're not seeing a lot of issues inside of our receivables other than occasionally people are slower than you would like them to be.

And Rohit, this is Ray Smets. I think your question was around how much of the business is coming from channel and what potential impact that might have on gross margins. Keep in mind, generally speaking, with the exception of a very few select customers who wish to do business direct, we're already a channel-based company.

So, what we're doing with the affinity channel program as we roll it out globally is, in addition to improving the programs, we're actually improving the productivity of the channel. So, we're leveraging the relationships we have in place, but we're also improving the productivity of key channel partners by incenting their behavior.

And the incentive is really not gross margin impacting. It's market expansionary, in fact. We're getting access to deals that we normally would not see.

How much of this will come from channel or the improvement from the affinity channel program, it's pretty obvious to us at this point, as we look at some of the factors that we track very carefully in the regions where we've rolled out affinity, that the deals that we're receiving that are registered by channel partners from channel, whether it's closed or pipeline generated from this activity, is actually going up.

So, the good news is the investment we're making in channel, as Lee has already mentioned, is actually improving overall sales performance. And we expect to leverage that as we get it out globally.

Thanks, Ray. Thanks, Greg. Appreciate it.

Catharine Trebnick, Dougherty.

Hi, nice press. Can we go back to your TPS product? Are you seeing high demand in that from the carrier and/or enterprise or both? And then, who do you see most when you compete against?

It's a mix of enterprise and service provider customers. We saw a good mix also in the new and follow-on orders from the current customers.

Okay. So, just to -- I jumped on the call late. Just so I have this clear, the 10% from that TPS product is for the first half of the year?

Yes. First six months of this year, TPS product revenue is slightly over 10% of total product revenue.

And then, most of the sales include like the ADC exactly, right?

No, TPS is a standalone product.

Standalone, okay.

Yes. So, when we talk about the TPS, we mean the standalone product.

Okay. And then, how are your sales going with the ADC and the security products, like the WAAF?

In general, ADC with advanced security features are gaining momentum. The sales have been -- if you look at our ADC sales year-over-year, it's even better than what we expected.

So, we are very pleased. We will continue to invest aggressively into security features of ADC.

All right. No, that's it. Thank you. Nice job.

Thank you, Catharine.

Thank you.

(Operator instructions.) Mark Kelleher, D.A. Davidson.

Just to make sure I understand, one more time on the deferred revenue because that's kind of going to form the basis of another question I have. That was kind of an unusual situation, kind of a customer asked for it. It's not something you anticipate as an ongoing basis that you would be selling in that manner. Is that correct?

That is absolutely correct.

So, my question is, would you ever consider subscription revenues, some offering like -- I know your competitor F5 offers their Silverline on a subscription basis. Is that anything you would ever contemplate?

If you look at the threat stop, let's say, subscription revenue, so our product is flexible enough, our architecture is so flexible we can offer a subscription. When it meets the market requirement, we will do that.

And we do have subscription pricing out on our virtual products currently. Customer adoption has not been particularly high yet. They're still -- they still economically prefer buying that software upfront. But, we have it in market and available and have the systems to support that.

Okay. And then, just on the competitive side, getting back to the DDoS, I know Cisco is going to be ramping later this year with an OEM partner that's a competitor of yours. How do you view Cisco as coming into the market? Do you think that'll change the competitive environment?

We have not really seen anything change here in terms of the competitiveness. Our TPS momentum has been strong and the pipeline is growing, so we like our position. So, we will let the market play out here.

Okay, great. That's all I have. Thanks.

Thanks, Mark.

It appears there are no further questions at this time. Mr. Chen, I'd like to turn the conference back to you for any additional or closing remarks.

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

This concludes today's conference. Thank you, everyone, for your participation.