睿科網路 (ATEN) 2016 Q4 法說會逐字稿

Good afternoon, and welcome to the A10 Networks' fourth quarter and year 2016 financial results conference call. All participants will be in listen only mode.

(Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Maria Riley, Investor Relations for A10 Networks. Ms. Riley, you may begin.

Thank you all for joining us today. I'm pleased to welcome you to A10 Networks' fourth quarter and year 2016 financial results conference call. This call is being recorded and webcast live and may be accessed for one year via the A10 Networks website at www.a10networks.com.

Joining me today are A10's Founder and CEO, Lee Chen; A10's CFO, Greg Straughn; and our Executive Vice President of Worldwide 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 fourth quarter and year 2016 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, www.a10networks.com.

During the course of today's call, management will make forward-looking statements, including statements regarding our projections for our first quarter 2017 operating results, our expectations for future revenue growth or security product revenue, profitability and operating margin, expectations of customer buying patterns, expected product launches and the general growth of our business. These statements are based on current expectations and beliefs as of today, February 9, 2017. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control that could cause actual results to differ materially, and you should not rely on them as predictions of future events.

A10 disclaims any obligation to update information contained in these forward-looking statements, whether as a result of new information, future events, or otherwise. For more detailed description of these risks and uncertainties, please refer to our most recent 10-Q filed on November 3.

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. 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 2017 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 present at the Morgan Stanley conference in San Francisco on March 1, and we hope to see many of you there. Now, I would like to turn the call over to Lee for opening remarks. Lee?

Thank you, Maria. And thank you all for joining us today.

The fourth quarter was a very strong close to the year. We are pleased with our results. Improved execution and momentum we continued to build in the market for our security and cloud solutions. Revenue grew 13% year over year to reach a record $64 million. And exceeded the high end of our guidance. Our continued focus on driving leverage through our operating structure led to a significant improvement in our operating results and margin. On the bottom line, we delivered the $0.03 in a non-GAAP EPS, which was within our guidance range.

Let's take a deeper look into our fourth quarter top line performance. Across the board, the A10 Team executed and reached several new records, including record product revenue of $43.5 million, up 23% over Q3 and 10% over last year. Record security revenue. Record revenue in the US which grew 38% over Q3 and 6% year over year to reach $33.5 million. Record bookings. Which led to the highest backlog in our history. And record deferred revenue of $92.9 million, which grew 28% year over year.

Our record performance was driven by continued expansion within cloud provider, service provider and web-scale customers, as well as strong demand for our security solutions. Including our recently launched Thunder 14045 security appliance. Pound for pound, our standard 14045 is the highest-performing DDoS mitigation appliance on the market, providing 300 Gig throughput within an extremely small footprint and modular chassis. Designed especially for high-performance networks, such as those used by service providers, cloud providers, e-commerce, and online gaming companies, our Thunder 14045's CapEx, OpEx, and security performance advantages has resulted in strong traction within these customers. Measured by bookings in the first two quarters since its availabilities, the Thunder 14045 is the most successful product introduced in A10's history and our pipeline continues to grow.

In addition to the early success of Thunder 14045, our record security revenue and bookings in the quarter was driven by strong demand across our lineup of stand-alone solutions, including Thunder TPS, which provides the industry's best DDoS mitigation performance and scalabilities. ACOS Harmony OpenAPI enables TPS to easily integrate with third party management and detection solutions. Thunder Convergent Firewall, which delivers multiple security functions on a scalable ACOS Harmony platform that enables customers to achieve high performance and manageability. And Thunder SSLi which provides visibility into encrypted traffic, helps eliminate blind spots in corporate defenses, and maximize customers' firewall assets. Together, our security solutions are providing more and more customers with a strategic portfolio-based approach to collectively address some of the nastiest threats and risks for their business plans, and their own customers

The increase in security demand was led by our cloud customers, including a leading cloud provider that contributed 13% of total revenue in the fourth quarter. As they modernize their architectures with our latest solution to increase capacity and fortify their defenses. We also saw continued demand for gaming, financial and mobile operator customers.

Let me share with you several recent engagements that show how customers are using A10 solutions to help secure and improve the performance of their networks, and mission-critical applications.

A tier-one service provider in the US selected our Thunder TPS and SSLi solutions to help protect customers on their dedicated internet service from DDoS attacks and gain visibility into encrypted traffic. A leading service provider in the US chose our Thunder ADC with SSL Offload to help improve the performance of a cloud software solution running on their managed service platform.

A leading mobile carrier in South Korea is deploying our Thunder CFW solution with our combined Gi Firewall and CGN functions to replace an incumbent security vendor's product. In the performance tests conducted by this customer, A10 solutions demonstrated six times lower latency and 20% better CPU utilization in half the footprint when compared with our largest competitor.

A large international organization was looking urgently to increase visibility into the growing amount of encrypted outbound traffic on their networks, but without upgrading their firewall capacity. To meet their needs, they deployed our Thunder SSLi alongside their existing firewall installation.

And lastly, a leading mobile provider in Japan selected our TPS solution on a new Thunder 14045 high-capacity appliance to help protect their network from large-scale DDoS attacks. We are proud to say that the top three mobile carriers in Japan are now using our TPS solution.

Since our inception, A10 strength has always shined in high-performance networks. Because of our heritage, we continue to gain attention from cloud provider and web-scale customers. These customers have built their business on cloud infrastructures that require flexible and agile solutions for accelerating and protecting applications, while reducing CapEx, OpEx, and the total cost of ownership.

Based on our ability to meet the needs of this and many other service providers and enterprise customers, we see cloud and security as powerful market opportunities for A10 Networks. We are positioned very well across both traditional data center and cloud-based application environments. We see the opportunity to be the industry leader in secure application services. In other words, providing solutions for controlling and centrally managed secure application services across all customer spectrum of data centers and various cloud types, from private to public to hybrid cloud alike.

While hardware remains our core business on a revenue perspective, we are unlike other competitors in that we can comfortably expand beyond our core business and address customers' needs that require many -- that require any combination of hardware, virtual, bare metal, and cloud-based solutions. We believe A10 has the most complete portfolio available on the market.

As a reminder, during 2016, we acquired Appcito which helped accelerate our vision and further differentiate A10 in the market. Staying focused on execution, we successfully integrated the Appcito team without disrupting our path to profitability. We launched the A10 Lightning, the industry's only advanced cloud native, controller-based ADC as a service offering. And we are on track to deliver additional Lightning cloud offerings this year.

In short, our strategy is working. For the full year, we grew revenue 16% to reach $230 million. We exceeded our goal for security product revenue in this year. And we expect our security product revenue to be over 20% of all total product revenue in 2017.

We achieved this result while driving leverage through our model and significantly improving our bottom line. We reduced our non-GAAP net loss by 88% and met our goal to deliver a profit in the fourth quarter. With the top-line growth and continue the focus on financial discipline, we expect to expand our profitability in 2017. And we remain committed to reach our target operating model by 2019.

In summary, the A10 team's diligent focus and execution met with record fourth quarter and strong close to the year. We are excited about our performance, market opportunities, and momentum we are building. We intend to continue to focus on growing our brand awareness and customer base and leveraging our strength in high-performance environments. We believe the trends we see in the market today are in direct alignment with our product strategy and strength as a Company.

We will continue to leverage our technology platform to bring new innovations to market that are designed to secure and perfect some of the most demanding networking environments, including cloud networks. We believe we are well-positioned to continue our success, all while remaining focused on driving leverage in our model and growing our bottom line.

Before I turn the call over to Greg, I want to personally comment on his resignation as CFO effectively upon the filing of the Company's 10-K. I know I speak for the entire A10 Team when I express my sincere gratitude for everything he has contributed to the Company over the past six years. Greg was instrumental in taking the Company public, has served as a trusted spokesperson to the investment community, and implemented many of the programs needed to foster and support our growth.

Along the way, he also built a great finance team and I'm pleased to announce that Shiva Natarajan, our Vice President and Controller, has been appointed Interim CFO, effective upon the effectiveness of Greg's resignation. Shiva has over 20 years of accounting experience and has played a key role in helping lead our finance department since he joined A10 in 2015 as Vice President and Controller. We are confident Shiva will do a great job leading the organization through this transition and to help facilitate this transition. Greg will remain with the company until April. \

And with that, I would like to turn the call over to Greg to review the details of our fourth quarter financial performance and first-quarter guidance. Greg?

Thank you for those kind words, Lee, and thanks to all of you for joining us today.

Fourth quarter revenue grew 13% year over year to a record $64 million, exceeding our guidance range of $59 million to $63 million. We also delivered deferred revenue growth of 28% year over year.

For the full year, revenue grew 16% to reach $230 million. Fourth-quarter product revenue grew 10% year over year and 23% sequentially to reach $43.5 million representing 68% of total revenue. Product revenue for the full year grew to $153.9 million, up 11% from 2015. Fourth-quarter service revenue grew 20% year over year to reach $20.5 million, or 32% of total revenue. Service revenue for the year grew to $76.1 million, up 25% in 2015.

From a geographic standpoint, fourth-quarter revenue from the United States was $33.5 million, up 6% on a year-over-year basis. For the year, revenue from the United States grew 11% to $118.7 million. Fourth-quarter revenue from Japan was $15.1 million, up 32% on a year-over-year basis. And for the full year, revenue from Japan grew 49% to $53 million. Fourth-quarter revenue from APAC, excluding Japan, was $7.9 million, up 38% on a year-over-year basis. And for the full year, revenue in the region grew 25% to $29.8 million. In EMEA, we continued to see softness in select areas of the region and revenue in the EMEA region for the fourth quarter was $6.1 million, a 10% year-over-year decrease bringing the full year to $23.1 million, reflecting a 15% decrease from 2015.

Enterprise revenue grew to a record $39.5 million, up 45% from Q4 of last year. As Lee mentioned, we had one cloud customer that contributed 13% of total fourth-quarter revenue. Enterprise revenue for the full year grew to $134.9 million, up 22% from $110.2 million in 2015. Service provider revenue came in at $24.5 million, down 16% when compared with $29.3 million in the fourth quarter of 2015. Service provider revenue for the full year grew to $95.2 million, up 7% from $88.7 million in 2015. Our enterprise and service provider revenue split this quarter with 62% and 38% of total revenue, respectively.

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 77.6%, above the high end of our expected range at 75% to 77%. This is an increase of 50 basis points from last quarter and 120 basis points from Q4 of last year. Total gross margin for the full year was 76.6%, an increase of 30 basis points from 2015.

Fourth-quarter product gross margin was 76.2%, an increase of 100 basis points from last quarter and 40 basis points from Q4 of 2015. Fourth-quarter services gross margin came in at 80.6%, increasing 10 basis points from last quarter, and 280 basis points versus Q4 of 2015.

We ended the quarter with staff of 895, compared with 885 at the end of last quarter, and up 8% from the end of 2015.

Fourth-quarter non-GAAP operating expenses were in line with our guidance and came in at $44.9 million, or 70.2% of revenue, compared with $42.2 million or 76.6% of revenue in the prior quarter. Sales and marketing expenses increased by $2.5 million, primarily due to higher commissions related to our record bookings. We achieved fourth-quarter, non-GAAP operating income of $4.7 million, or 7.3% of revenue, above the high end of our guidance and a significant improvement from the operating loss of $3.2 million in the fourth quarter of last year.

We achieved non-GAAP net income of $2.3 million, or $0.03 per diluted share, which was at the high-end of our guided range of breakeven to $0.04 of earnings. In the fourth quarter, we incurred a $2.4 million expense, or $0.03 per share, due to the unexpected post-election movement in the yen to dollar exchange rate. This expense is reflected in the other expense line in our income statement.

Our net income performance this quarter represents a significant improvement from a net loss of $3.7 million in Q4 of last year, bringing our full-year, bottom-line improvement to 88% on a per share basis. Diluted weighted shares used for computing EPS for the fourth quarter were approximately 73.1 million shares while basic shares outstanding for computing the net loss for the 2016 year were 65.7 million shares.

Moving to the balance sheet. At December 31, we had $114.3 million in total cash and marketable securities, compared with $116.8 million at the end of September. Our cash balance reflects the use of approximately $2.4 million to fund operations during the quarter.

Additionally, during the fourth quarter, pursuant to our stock repurchase plan the Board implemented in late October, we repurchased a total of 227,000 shares of our common stock in the open market and average cost of $7.92 per share, for a total of approximately $1.8 million in consideration.

For the full year, we generated $18.8 million in cash from operations and increased our cash and marketable securities balance by $16.2 million. Average day sales outstanding were 84 days, up from 74 in the prior quarter, reflecting our record billings in the quarter.

Moving on to our outlook. As Lee mentioned, we ended the fourth quarter with our highest backlog in history, which totaled $19 million. Balancing this strong start with the normal first-quarter seasonality in parts of our market, we currently expect first-quarter revenue to be in the range of $59 million to $61 million. At the midpoint, this represents a 12% year-over-year revenue growth for the quarter. We expect gross margin to remain in the 75% to 77% range and operating expenses to be between $46 million and $47 million. We expect our non-GAAP, bottom-line results to be a loss -- to be between a loss of $0.01 and a profit of $0.01 per share using approximately 76 million shares on a basic and diluted basis.

And briefly, before we open the call to questions, I'd like to take this opportunity to thank the entire A10 team for their dedication, determination and can-do attitude. You've made A10 into a company that shows you can create an environment that is both team-oriented and results driven.

I'd also like to thank Lee for his technological vision and leadership that has fueled A10's growth. During my years with A10, I've been privileged to tell the A10 story to an outstanding group of investors, analysts, and bankers, each of whom have added to the richness of my experience here. I look forward to our paths crossing again.

As a team, we have accomplished many of our objectives since I joined six years ago. I feel A10 is in very good place and I am confident it will continue the growth and profitability trends we have established.

Operator, you may now open the call to questions.

(Operator Instructions)

Rod Hall, JPMorgan.

Hi guys. Thanks for taking the question.

I guess a couple of questions I just wanted to see, Greg, if you could give us a little bit more color on what's driven you to resign. I assume that it's kind of been in the planning for a while, but I like to get your thoughts or your words on that.

And then secondly, just a little bit more -- you guys continue to do really well in this DDoS area, and we continue to hear that is a critical area of security for a lot of people. I just wonder how big you think that market is? And do you have any feeling for what your share in the market is? So, those are my two starting questions. I might have a follow-up. Thanks.

I will start. Rod, you're right. These decisions don't come quickly or easily.

But A10 is at a point now where we've got a great Team. We've put some great results up for 2016 for Q4. We had a very strong finish to the year. So, I think it creates a great timing opportunity to find that mixed company where I can very where I can contribute in a very meaningful way, whether it's going through an IPO or through a growth phase.

So, it really comes down to having achieved the goals we set out to do here and looking to do that one more time. So I have a high degree of confidence in the Team that remains here, and I will be an A10 shareholder.

Okay. Great.

And then what about the DDoS project and what's your -- do you guys have any feelings of what your market position is there, in terms of share?

Sure. We are in not in a position to give you a market size of the share we have, but I think we are still in the early days. And we see lots of opportunity to grow within security, especially with DDoS. We are very happy with the momentum, especially with the cloud provider, mobile carrier, gaming and banking industry. We set a goal to be over 20% of product revenue for this year.

Okay, and just following up on Greg.

Lee, is it your intention to initiate a search for a replacement, or is the idea for the Interim CFO to potentially work into a full and permanent job?

So, Rod, we initiated a search and we have an ongoing search.

Okay. All right, great. Thank you, guys. Nice job.

Ittai Kidron, Oppenheimer.

Hi, guys. Congrats on good numbers, and Greg, sorry to see you leave.

Maybe you could talk a little bit about the outperformance. How much of it in the quarter was really the deals that got delayed that closed your master capture. What kind of swept through last quarter versus the upside driven by new business transactions. If you can give us some color, that would be great.

Sure. Well, of the deals that we had talked about at the end of Q3, some of those did close in Q4. Some of those are in the pipeline and we would expect to close in Q1.

But I think the key thing to note is that we had massively strong bookings within the quarter. We talked about a $19 million backlog, which is well beyond anything we've seen before. And so the traction within the quarter was where the quarter was made.

So those deals, some of those deals are in revenue, but the real story for our business traction is the record bookings and how that contributed to backlog.

When you look at that backlog, is it -- are there large deals in there that made a jump like this? Or is it pretty widely distributed?

There's a combination. It's not all small deals. There is some good-sized transactions in there. And that backlog will likely come into revenue, not all in Q1. There will be some spread to it.

But we're really very, very pleased with the quantity and the quality of that backlog.

Go ahead.

The backlog's from many customers.

Got it. And Lee, lastly on DDoS, it's good to see you're making good progress. Maybe you can give us some color from your perspective on who ordered the profile of the customers. And what I mean by that is I'm trying to understand how much of the DDoS opportunity is going to be within enterprises versus with providers that will take your solutions and then offer DDoS as a service.

If you could give me a little more color as whether you think it's going to be the more important driver to the business, that would be greatly appreciated.

I think it's really about probably both. If you look at -- we have a lot of success and a lot of momentum in cloud provider, mobile carrier. There's a lot of success in gaming, banking, many of these service providers, they use our solution to offer DDoS as a service. So we see the opportunities are pretty big.

And the top three mobile operating in Japan; they are using our DDoS solutions. And in Japan, a lot of mobile carriers, they are the cloud provider; they are the service provider. So they also offer services to enterprise customers.

Got it. Are you worried with -- Japan clearly had a big rebound year. I think the last time it was this big was when you were just about when you went public, if I remember correctly, and after a little while they had some challenges over there.

Is that a market where the revenue is concentrated with a small number of customers? And if yes, how do you get comfort or visibility into what they might do with you in 2017.

You know, you never get really comfort. You always have like, the market dynamic. But we feel very good about our position with the customer. If you look at compared today versus when we went IPO, our position is much stronger compared to IPO.

In IPO we were primarily an ADC company. Today, we resell our secure application services. So application, delivery and security solutions to many of our existing customers and the new customers. I look at all the security success. Most are driven by the demands by the growing cyber security needs, new requirements and the growth of our customers.

In 2020, Japan's Olympics, so I'm looking forward to that.

Very good. Good luck, guys, and good luck to you also, Greg, in your next step.

Mark Kelleher, D.A. Davidson.

Great. Thanks for taking the question. I was wondering if you might provide some more detail on the 13% revenue customer, the cloud provider. What was the profile of the products you sold in there? And what's the use case that that cloud provider is implementing?

Greg, do you want to answer that question? Or do you want me to?

I'm happy to go ahead and comment on that. So the 13% customer purchased a couple of different products. They didn't purchase one particular product. They did buy some from our security portfolio, as well.

So -- and the use case there was basically building out their cloud infrastructure so that they could protect their cloud infrastructure from various attacks. We usually don't go into too much detail about those types of sales, however.

Okay.

The customer is a customer we have been doing business for several years.

Okay. And how about on the geographic spread? It looks like some very different geographic results from EMEA and from APAC. What's the dynamic going on there? Is that macro over in Europe or is there some execution issues that could be improved there?

Yes, I think speaking specifically about the macro-economic issues. All of the computers are reflecting whatever's happening in their respective areas, obviously. You've seen definitely what other people are seeing in the EMEA theaters, especially over in the UK and Middle East. But there's always opportunities to improve actual execution, as well.

Over in Japan you're seeing a nice surge of our landing expand strategy as we move from the ADC into the security marketplace. But also along with strong execution and building pipeline, we're also diversifying that market portfolio. We're addressing markets a little differently.

In North America, pretty much as we would've expected, we pretty much called that one very, very close to the pin. The catalyst there is security, especially within the service providers and then also on the cloud service provider side.

Okay, great. Thanks.

Alex Kurtz, Pacific Crest Securities.

Thanks, guys. And Greg, sorry to see you go. Nice quarter to exit on though.

I thought so.

Definitely, a little bit easier tonight. So maybe you could talk a little bit about the backlog and the mix between security and traditionally ADC in the backlog that you guys had exiting the quarter?

Yes, I don't have too much on specifics there, but I will say that backlog is, it's diverse and it has -- it's not that different from our overall product revenue. I see it's fairly representative, both in customer type, customer products that are purchased, and it might be a little skewed towards the US. But that's probably the skew that is in there.

Okay. And maybe just a little bit more about the competitive landscape with Arbor Networks. I was wondering if you could go into if there is any competitive bake-offs in the quarter that resulted in some of the backlog generation, or just generally where that stands today?

I'm happy to comment on that. From a competitive perspective, obviously we see Arbor and other competitors in the DDoS space. And we going into bake-offs like you would expect in any part of our business, and the good news is we come out on top in various ways, specifically around performance and mitigation capacity, and our ability to bring together a complete solution. So you know, there's many facets of this industry. We have a nice spot in that opportunity and we continue to gain share.

It's -- the catalyst for us in terms of growth there, you've heard me talk about it, is in the cloud area, the mobile providers, gaming and banking. And, you know, the good news is customers are really happy with our solution and keep buying more.

This industry never really gets smaller, it just keeps getting bigger. The attacks get more diverse, a little bit more challenging to address, and we have a great solution for those customers.

Fair to say, there was some one-on-one bake-offs with Arbor this quarter?

Yes. As you would expect, one on one, one on two. All the various (inaudible - multiple speakers) you could imagine.

All right guys, thanks.

Thanks, Alex.

(Operator Instructions)

James Faucette, Morgan Stanley.

Thanks a lot. I think you indicated that North America was pretty close to what you had expected, maybe a little bit weaker in Europe. Could you talk about what the products and confirm the geographies, where we did a little better than you thought in the quarter?

And then also, can you talk a little bit about linearity during the quarter? Just wondering how customers reacted to the elections and then -- into the end of the year and the beginning of 2017? And then I have a follow-up question.

Okay. I'll start with the linearity question first. You know, James, the, you know -- we go back and we look at performance year over year and what we expect in Q4. Linearity was pretty much right exactly as we'd expected, so there is no real news on linearity. It was just good linearity throughout the entire quarter, and we finished very strong. And the first part of the question --

I'm just wondering like where your sources of outperformance were, both geographically and from a product perspective?

You know, it's -- that's actually a -- there's a lot of different ways we can look at that. From a geographic performance, we saw, obviously very good performance across Asia and Japan. And we are benefiting in multiple ways in terms of why there's a growth catalyst there.

It's very strong attention to pipeline generation. We've got some good leadership plays. We're extending into new markets, et cetera. And we've added a couple of new significant customers in Asia in the service provider domain.

So that was actually really strong execution for us, but in North America the catalyst was security. And we were really pleased with the outcome from what we are able to convert out of the pipeline there.

Yes, I think the media saw our win, Rave, remain high. So the security on cloud really are two driving factors for you. The revenue to be exceeding our guidance.

Got it. And then just last question for me is, when you look at your security strength in the US, is that having any impact on sales of the rest of the product portfolio? Or would you expect there to be impact on sales to the rest of the portfolio? I guess, I'm just wondering if there's an opportunity for pull through for the more traditional mainline part of A10's business? Thanks.

It's a good question. A lot of the sales we're making in the security space tend to be to larger types of customers, like lab providers, mobile service providers, gaming customers, things of that sort. They have a use case that goes beyond the security portfolio that we sell them.

So, on the larger customer side clearly a landing expand strategy is in play here and definitely those customers are buying other products, as well. And we see the reverse occur as well.

Being well-positioned in the ADC market actually gives us access to security opportunities with large customers as well. So, you know, we sell sometimes single solutions to smaller customers, but generally the larger customers buy more than one product from us.

Yes, we have one customer in Korea using our CGS solution due to the fact we have a Gi Firewall and our CFW Convergent Firewall. They combine those functions and purchased our CFW security solution.

That's very helpful. Thanks.

Dariush Ruch-Kamgar, Bank of America, Merrill Lynch.

Hi guys. Thanks for taking my questions, and congrats on the quarter. Greg, also sorry to see you go, but congrats on getting to your long-term goal of positive operating margins.

Thank you.

So looking at gross margins, they've been trending higher for a couple of quarters now, in both the product and services line. Can you provide some color behind what's driving it? And is some of the product margin improvement due to an uptick in your software only bare-metal solutions?

Sure. You know, I'll talk about the product side first. Beyond the product side, there are several factors that are part of the lift there.

One is that as we move, and have a higher proportion of our sales coming from security products, they tend to have a higher gross margin, pretty much across the board.

Additionally, as we've continued to work with our manufacturers on product, we've been able to put enhancements in our design and in the manufacture of our products that, even for a specific product, we're getting better margins through cost efficiencies and design deficiencies in the hardware itself.

As software and virtual products become a larger piece of our business, still small, but as they move in that direction, those are additive to gross margin as well. And then the other pieces that -- as we see regional shifts, as we see Japan and North America become a larger proportion of the sales traction, they tend to be higher gross margin markets. So those are the things that are on the push-up side.

The effect that we see the has potential to go the other way, we've seen it a little better recently, is that currency impacts can have a slight negative effect coming out of Japan primarily. And then as we bring through and cycle some new product in, we occasionally have write-downs of old product. And so most of that's worked its way through the system. And so our expectation is as we move through 2017, that the general trend will be upward, which is not the same as saying that each quarter will be upward. So there will still be some volatility around it, but the general trend on gross margin should be improving on the product side.

On the service side, as we continue to have a larger and larger install base, we begin to see incremental economies of scale come in on the maintenance and support piece of that. As our professional services organization grows, we start to see some economy scales in that piece to market. So in the service society, just, it comes down to efficiency and how our people are mobilized as service customers, both in a support and in a field perspective.

Thanks for the color. That's really helpful. Could you provide any additional color into what security revenues look like as a percent of total revenues this quarter?

We exceed our security revenue for the year. We set a goal for 20% of our total product revenue for 2017. We probably will not break out the percent of security revenue for the year.

Thanks. And if I take out T-Mobile, which is a 20% customer in Q4 last year, and I take out the 13% cloud provider in this quarter, service provider sales declined pretty significantly. But your commentary seems to be pretty bullish on service providers. So, can you provide some additional color into what's driving this?

Yes, I'll take a shot at that, Dariush. Obviously, the one thing you do know about our business is that service provider revenue is lumpy. So we do see some trends moving from one quarter to the next. And they do tend to buy in large quantities, but you know, the good news is we feel very good about our -- we feel very good about our positioning there.

We're going to benefit is workloads move into the cloud and workloads move and are managed in the service provider domain. So that's a long-term, positive growth-driver for us in the service provider business as well.

And you heard the commentary. We had a very strong quarter in Q4 also in service provider. And we articulated a couple of key wins for us that were very significant in both the ADC, but primarily in the security space.

Yes. We put cloud customers in the enterprise. We have many other companies that we put cloud customers and service providers. So if we put a cloud provider into the service provider, also the revenue will be very strong.

Okay. Thanks for the clarity there. I'll hop back in the queue. Thanks, guys.

Thank you.

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

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.