A10 Networks, Inc. (ATEN) Q4 2019 Earnings Report, Transcript and Summary

Good afternoon and welcome to the A10 Networks’ Fourth Quarter and Year 2019 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Chris Mammone, Investor Relations for A10 Networks. Please go ahead.

Thanks, Chad and thank you all for joining us today. This call is being recorded and webcast live and maybe accessed for 1 year via the A10 Networks website, a10networks.com. Members of A10’s management team joining me today are Dhrupad Trivedi, President and CEO and Tom Constantino, CFO. Before we begin, I would like to remind you that shortly after the market close today, A10 Networks issued a press release announcing its fourth quarter 2019 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. You may access the press release, presentation and trended financial statements on the Investor Relations section of the company’s website. During the course of today’s call, the management will make forward-looking statements, including statements regarding our projections for our future operating results, our focus on driving organic growth, business optimization and overall profitability, the strength and capabilities of our talent base, our unique position to help our customers, our belief that we can continue to build upon customer momentum going forward; our expectations regarding future opportunities and our ability to execute on those opportunities; our commitment to innovation and bringing new solutions to market; our expectations for future market growth and the general growth of our business; the development and performance of our products; our current and future strategies; our beliefs relating to our competitive advantages; anticipating customer benefits from use of our products; our expectations and priorities with respect to 5G and our investment in product roadmap and channel partnerships in our enterprise vertical. These statements are based on current expectations and beliefs as of today, February 11, 2020. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control that could cause actual results to differ materially and you should not rely on them as predictions of future events. A10 disclaims any obligation to update information contained in these forward-looking statements whether as a result of new information, future events or otherwise. For a more detailed description of these risks and uncertainties, please refer to our most recent 10-Q and 10-K. Please note that with the exception of revenue, financial measures discussed today are on a non-GAAP basis and have been adjusted to exclude certain charges. The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP and maybe different from non-GAAP financial measures presented by other companies. A reconciliation between GAAP and non-GAAP measures can be found in the press release issued today and on the trended quarterly financial statements posted on the company’s website. We will provide our current expectations for the first quarter of 2020 on a non-GAAP basis. However, we are unable to make available a reconciliation of non-GAAP guidance measures of two corresponding GAAP measures on a forward-looking basis due to high variability and low visibility with respect to the charges which are excluded from these non-GAAP measures. Now, I would like to turn the call over to Dhrupad Trivedi, President and CEO of A10 Networks.

Thank you, Chris and thank you all for joining today. I am thrilled to join A10 Networks at an exciting time for the business. A10 occupies an attractive area within networking and security as companies increasingly focus on delivering business outcomes while managing the operational complexities from proliferation of IoT, shift to hybrid cloud environments and ever increasing complexity of the cybersecurity landscape. Service providers around the world also faced the same challenges while getting ready for 5G technology to support many of these consumption trends. Based on our legacy, A10 is well positioned to help our customers address these emerging teams. We deeply understand their applications and have a strong talent base to support them through these difficult transformations. A10 services loyal and enviable customer base who are industry leaders and we are committed to enabling the success of our customers. We are pleased to report fourth quarter revenue of $60.3 million, which represents 14% sequential growth. For the full year, A10 reported $212.6 million in total revenue. Recurring revenue increased from $91 million in 2018 to $95 million in 2019. In Q4, the revenue strength was driven by solid quarter-over-quarter growth in all of our main geographic regions. We saw the most strength from our service provider clients in Japan, South Korea and the Middle East, who are the furthest along in supporting 5G rollouts. In addition to driving organic growth, the management team is focused on operational excellence to drive profitability as we grow the business. We finished the fourth quarter with our highest ever adjusted EBITDA of $10 million meeting our guidance range and representing an improvement of 105% over the prior year quarter. This resulted in non-GAAP earnings of $0.10 per share during the fourth quarter also above the high end of our guidance range. Tom will give further detail on our financial performance during his remarks. Q4 marked continued momentum in the market surrounding 5G related opportunities. We announced our Orion 5G security suite, which brings our customers an integrated version of the highest performance network security, scalability, agility and analytics. This solution is directly helping our customers deploy 5G or get ready for it with their existing 4G networks efficiently. The A10 solution virtual or physical results in lower latency, larger scale, higher reliability and lower total cost of ownership. We are pleased with the level of customer interest in this offering building up on our leadership in deploying high-performing secure 5G networks for our service provider clients in South Korea, Japan and Middle East. We begin 2020 with more than 10 active 5G deployments around the world. While we are encouraged by this level of activity, it is important to remember what a massive undertaking it is for service providers to execute their 5G rollouts and supporting those deployments takes considerable time, CapEx budgets and technical effort to fully materialize. In Q4, we benefited from a sizable order from our largest web giant customer in North America. While we continue to have a strong market position with all of our existing web giant customers, we are also dependent on their investment cycles which can last multiple years and result in variable demand levels. Our enterprise vertical continues to improve with focus on enhancing commercial execution. Our install base is strong. We enter 2020 supporting over 50,000 installations, with over 500,000 apps running on A10 technology. We are a top 3 ADC supplier and see meaningful growth opportunities as our install base moves to multi-cloud infrastructures. We also continue to invest in the product roadmap and channel partnerships that will further enhance execution in this space. We added a total of 840 new customers in 2019 and believe that we can continue to build up on that momentum going forward with strong focus on improving execution in all areas. To that end, I am proud to be able to highlight some signature recent wins. First, a large mobile network operator and repeat A10 customer in South Korea selected A10 for its Gi LAN solution supporting secure 5G services and network address translation in its core network operation center and mobile edge cloud covering approximately 7 million subscribers by the end of 2020. Second, a major airline in Latin America selected A10’s virtual ADC software technology and management platform to support its migration of workloads to the Oracle cloud infrastructure and to help manage a multi-cloud network environment for air towards communications. A10 was selected because of its certification as an Oracle cloud infrastructure partner and its ability to achieve the rigorous performance requirements. As we begin 2020, we have a strong product roadmap and focus on commercial execution to build upon our install base as well as add new customers. Service providers and enterprise customers are addressing different business goals and we will continue to adapt our solutions and expertise to help them with. Tom, over to you?

Thank you, Dhrupad. Fourth quarter revenue was $60.3 million, 14% sequentially from $52.8 million reported in Q3 above the high-end of our guidance range and down 2% year-over-year. Fourth quarter product revenue was $36.9 million, representing 61% of total revenue. Service revenue was $23.5 million or 39% of total revenue. Security driven product revenue comprised 56% of total product revenue in Q4. For the full year 2019, recurring revenue was approximately $95 million. Moving to our revenue from a geographic standpoint, for the seasonally strong fourth quarter, revenue from the Americas increased 21% sequentially to $27.5 million compared with $22.8 million in the third quarter and was down 4% year-over-year. In Japan, revenue was $16.3 million, up 7% sequentially and flat year-over-year. We achieved a double-digit growth in revenue from APAC, excluding Japan, which was $9.3 million, up 11% compared with $8.4 million in Q3 and EMEA where revenue was $7.2 million, an increase of 10% when compared with $6.5 million in the third quarter. Both of these regions were down modestly on year-over-year basis. Service provider revenue in the quarter was 64% of total revenue and enterprise revenue was 36%. We have revised our reporting to reflect the typical purchasing patterns of our largest web giant customers which are similar to other service provider customers. In the fourth quarter, our largest web giant customer now included within service provider contributed $9.1 million in revenue. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis unless stated otherwise. Our fourth quarter total gross margin was the highest of the year at 78.5%, 40 basis points better than Q3 and above the high end of our guidance range. Fourth quarter product gross margin was 77.6%, 100 basis points better than last quarter and also up from 76.8% in Q4 2018. Service gross margin in the quarter came in at 79.9% compared to 80.2% last quarter and 80.6% in Q4 of 2018. Full year gross margins for A10, was 77.8% and this is a level that we expect to maintain or improve upon going forward. We ended the quarter with headcount of 819 compared to 870 at the end of Q3 reflecting the actions taken to reduce total headcount in the fourth quarter as we communicated on last quarter’s call. We believe the annualized savings from this rationalization and other cost savings measures will enable a reduction of OpEx in 2020 compared to 2019 of approximately $10 million. Non-GAAP operating expenses in Q4 were $39.7 million, excluding $2.5 million of restructuring costs. OpEx was roughly in line with last quarter on an absolute dollar basis, a 12% lower than $45.1 million in the prior year fourth quarter. Further reductions in variable compensation, rationalized headcount and disciplined G&A spending all contributed to this year-over-year decline. We reported $7.7 million in non-GAAP operating income. We also continued to improve our adjusted EBITDA significantly, which came in at $10 million for the fourth quarter more than doubling the adjusted EBITDA both for Q3 and the year ago period beating the high end of our guidance range and represents our highest ever quarterly adjusted EBITDA results. As Dhrupad mentioned earlier, this reflects our intense focus on improving profitability. Non-GAAP net income for the quarter was approximately $7.8 million or $0.10 on a per share basis and above the high end of our guidance range. Diluted weighted shares used for computing non-GAAP EPS for the quarter were approximately 79.2 million shares. Moving to the balance sheet, average days sales outstanding were 82 days compared with 79 days in the prior quarter. At December 31, 2019, we had $129.9 million in total cash and marketable securities compared with $122.6 million at the end of September. Before I provide guidance for the coming quarter, I would like to echo Dhrupad’s excitement about the next chapter for A10. Moving into 2020, we will continue to focus on profitable growth by way of driving operational excellence. We plan to build upon our early success in helping our customers prepare for 5G. Moving on to our outlook for the first quarter of 2020, we currently expect revenue to be in the range of $51 million to $53 million, representing year-over-year revenue growth of 5% at the high end of that range. We expect first quarter gross margin to be in the 76% to 78% range and operating expenses to be between $37.5 million and $38.5 million. We expect our first quarter non-GAAP net income to be between $0.01 and $0.03 on a per share basis using a share count of approximately 81 million diluted shares. Finally, we expect our first quarter adjusted EBITDA to be between $3.7 million and $5 million. Operator, you can now open the call up for questions.

Thank you. [Operator Instructions] The first question will come from Hamed Khorsand with BWS Financial. Please go ahead.

Hi, thanks for taking the questions. Excuse me if there is noise in the background. First off, could you talk about the product mix having the impact on gross margins and given the web giant order, how much can you see going forward with the volatility and the product mix on the gross margin line?

Well, gross margin is typically a result of the geographic mix in where the revenue comes from. The – seasonally, we do see typically in Q1 that comes down a little bit typically with normal seasonality, but it’s normally just a factor of where revenue is coming from. Some regions are obviously more profitable than others for us in that regard. Large web giant that we have – we do expect to have some demand in 2020 from that web giants as well and that’s factored into our guidance for Q1.

Okay. And then what kind of pipeline are you seeing as far as 5G is concerned and where you stand with some of the customers that are still early in the 5G deployment?

Yes, 5G is still very early stages for 5G generally and a lot of service providers are still figuring out what they need in terms of their architecture and the install base that we have, it’s very early stages for them. We have had some really strong early success in South Korea who is furthest ahead from what we see in the world. So they are well established in that, but there will be continued business from those accounts. Japan obviously as well is ahead of things in terms of preparing for the Olympics, but this is going to be long race, so we will see a long tail of this process.

Yes. Maybe Tom I can add to that a couple of more comments that might be helpful. So I think the way we approach 5G today is that globally service providers are either going to start building out 5G or they are going to get ready for 5G with their 4G LTE and other solutions, right. So our success today is not just Greenfield 5G build-outs, but also service providers that we are enabling to do a migration without having to replace everything. So that’s one element of it. As it comes to the design wins, I think the sequence of 5G is usually it starts with selling and purchase of a spectrum, then radio infrastructure, then small cell build-out and then services and software in certain countries like the ones we mentioned that has been a specific boost by government spending and other priorities, including that service providers to build out new 5G structure and they are early adopters. In the rest of the regions, I think our focus is today on design wins whether it’s for 5G or 4G upgrades towards the goal that when they do start deploying and building out, we are already selected as the choice, right. So I think you could say that for some years to come, you will see those design wins translate into revenue, but that will be dependent on for example the carriers’ ability to invest in CapEx at that time, etcetera. But our focus is if we have the right technology and we are selected for 5G or 4G upgrades, we are positioned very well for years to come.

Are you seeing any kind of competition that you feed up for your own security front when it comes to 5G? Are you seeing competitive pressures?

Yes. So, we are not seeing competitive pressure in terms of exactly what we do right. So I think we tend to not be competitive head to head with people who do pure-play security or pure-play radios and things like that. For us, our solution is uniquely integrated in the service provider and allows them to do things in a more scalable, more secure way. So of course the competition is going to be what are their alternatives to doing that even if it’s not a one-for-one replacement, right, so that’s more of what it is. And to the degree that we can demonstrate lower total cost of ownership, it’s actually as much a competitive advantage as anything to do with technology.

Okay. And then your guidance implies that you are pretty much immediately seeing that annualized savings in Q1 on the OpEx line, is there more cost savings you could implement or is this pretty much it for 2020?

Well, the full effect of what we announced last quarter will be seen until we get into Q2. So we got a little bit more to go in Q2. And then as you can imagine, we are at a constant mode of looking for how to become more efficient. S, we’ll just be in that mindset all year, but in terms of the specifics to the actions we took, the full impact of that will be seen in Q2.

Okay. And my last question was that there was a 8-K when Lee Chen resigning and is he – what was the reasons behind that and is he going to sell all his stock immediately or anything like that?

Yes. This is Dhrupad. So I would say as per our filing, Lee notified the Board of Directors on February 3 prior to the quarterly board meeting that he would resign from the Board of Directors effective immediately, right. And this was the personal choice made by him. And I would say since I joined the company he has been tremendously supportive in terms of transition, helping with customer insights, helping with team insights and all of that. So I think in some ways he has done even more to help make sure that the company is up to speed and running. Beyond that, I think obviously there are – I am sure there are more legal complications and other discussions on the remaining questions. So, I cannot speculate on them right now, but I think I would say certainly, no, we certainly see Lee as somebody who wants the company that he founded and built to be very successful going forward right and I don’t see anything other than that today.

Okay, thank you for your time.

Thanks Hamed.

And the next question will come from Nehal Chokshi with Maxim Group. Please go ahead.

Yes, congrats on the strong results for all sorts of guidance. This has been happening over all through out calendar ‘19 but long-term deferred revenue has been up year-over-year, while short-term has not been, can you explain that dynamic?

The deferred revenue trends, they do reflect a trailing effect of a decline in products revenue unfortunately. So if you look at products revenue in 2019, it was down – it was down double-digit, right. And so – the deferred revenue is mainly a build up of support contracts that are deferred revenue in nature. So as – and it gets sold as an attach to a product revenue, right, product sales. So that’s really what you are seeing there it’s not that if you look at our service revenue line that is up, so it’s still trending in the right direction in terms of the revenue, but the deferred revenue does get impacted by as a tail to the decline in the products revenue.

And I think maybe down the other data point that’s relevant is we have not seen our attach rate drop, but because of decline in product revenue, the associated attach revenue that would come with support subscription maintenance all that has declined and the only other component of that is professional services which is not bound either.

Right.

But it’s just the attachment rate to the product revenue which is down showing up in that deferred revenue.

Okay, I mean it’s not just to play that product revenue is down year-over-year, that’s driving an install base decline, because whatever might be coming off with renewal 3, 4, 5 years ago that amount is not being – is not as much as what you sold until this current December quarter throughout December ‘19 correct?

Yes, that’s correct. I mean you have to think of it like a waterfall exactly like you are describing so yes.

Okay, alright. But then the long-term deferred revenue is going out and so what’s the driver of that mechanic?

That’s going to be more a factor of the couple of things. One is going to be the nature of the contracts that are purchased, so they can be – they are typically 1 for your 5 year, right. So if we are selling a kind of longer term contract, then you are going to see more of it sitting in long-term and that’s the majority of it. It also does move depending upon rev/rec carve-out impacts, but it’s for the most part is tied directly to the duration of those contracts, the more long-term in nature they are.

Increase in duration of support contracts, so that has something to do with the subscription ramp that you guys have been talking about right?

Subscription is also in there. So I think as the industry move towards wanting to consume products as a subscription rather than a CapEx purchase upfront, we certainly are in line with supporting our customers and while it’s not a meaningful driver of that today that is where we would like that subscription-based recurring revenue to keep coming.

Okay. And can you share any specific metrics on the subscription ramp?

We don’t break it out separately today.

Okay, alright. And then Trivedi, you mentioned that you have a strong product roadmap for 2020 and I think you related that specifically to an improving enterprise performance as you expected, a) can you verify that and then b) if that is indeed the case can you give a little bit more details on what this product roadmap consist of and why it would improve your enterprise performance?

Yes, sure. And I would probably start by saying the product roadmap focus and improvement, are both service provider and enterprise. I think on the service provider side obviously based on the design wins and the customer traction, we feel we are on track right and we need to do more, which we will. I think on the enterprise side, the two things that are very relevant, lot of our legacy install base is historically been on-prem oriented customers and our roadmap will more actively address customers to operate and like an example, we stored in multiple environments which could include on-prem public cloud, private cloud, hybrid. And to enable that obviously, we need to make it easier for our customers and our channel partners to consume those products right. So I think the biggest thing you will see from a roadmap prospective is focus on looking at the customer application and customer buying pattern and aligning to that. And the second is obviously as you know we already have sort of leading performance and things like scalability and agility and so forth which we will continue to invest into maintain that, but the real thing that is a little different would be further adapting that to be consumed by enterprise customers and within alongside our channel partners as well.

Thank you.

You bet.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Dhrupad Trivedi for any closing remarks.

Thank you and thank you to all of our shareholders for joining us today and for your support. We believe that our focus and commitment to profitable growth and improving the operating leverage of our business model will reward our shareholders. I look forward to meeting and spending more time with you as we move forward together. Thank you and have a good day.

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