A10 Networks, Inc. (ATEN) Q1 2020 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the A10 Networks First Quarter 2020 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Rob Fink, FNK IR. Please go ahead.

Thank you, operator, and thank you all for joining us today. As the operator just mentioned this call is being recorded and webcasted live and may be accessed for one-year via the A10 networks website at 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 closed today, A10 Networks issued a press release announcing its first quarter 2020 financial results. Additionally, A10 published a presentation and supplemental trended financial information. 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, management will make forward-looking statements, including statements regarding their projections for future operating results, including its continued reductions in operating expenses; its continued efforts to improve operational efficiency; its focus on driving growth, business optimization and overall profitability; its their belief that they can contribute to build upon customer momentum going forward; their expectations regarding future opportunities and ability to execute on those opportunities; expectations for future market growth and the general growth for its business; the development and performance of its products; and anticipated customer benefits from use of its products, expectations and priorities with respect to 5G. These statements are based on current expectations and beliefs as of today, May 7, 2020. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond the Company's control, such as the potential impact of COVID-19 on its business and operations that could cause actual results to differ materially, and you should not rely on them as predictions of future results. A10 does not intend to update the 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 the Company's most recent 10-Q and 10-K. Please note 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 intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP, and they may be different from non-GAAP financial measures presented by other companies. A reconciliation between GAAP and non-GAAP measures can be found in the press release issued today and on the trended quarterly financial statements posted on the Company's website. Company will provide current expectations for operating expenses and gross margin for the second quarter of 2020 and operating expense trends for the full year on a non-GAAP basis. However, the Company is unable to make available a reconciliation of non-GAAP guidance measures to corresponding GAAP measures on a forward-looking basis due to the high variability and low visibility with respect to the charges, which are excluded from non-GAAP measures. With all that said, I'd now like to turn the call over to Dhrupad. Dhrupad, the call is yours.

Thank you, Rob, and thank you all for joining us today. To begin, I'd like to thank all of our employees, partners and customers for their hard work, support and dedication during these volatile and uncertain times. As an organization, protecting the health and safety of our employees and our global community has been our top priority. Over the past several weeks and months, we have taken action to protect our staff, our business, and do our part to help slow down the spread of COVID-19. Thankfully, to date, we have not experienced any meaningful negative impact to our business or our supply chain. In fact, amidst quarantines and shelter-in-place orders, networks across the globe are being stressed, with unprecedented usage and increasing demand for bandwidth, underscoring the need for the critical communications infrastructure solutions we provide and bolstering the long-term tailwinds that drive our business. With $143 million in cash and no debt, we are well positioned to operate from a position of strength to navigate this environment. On today's call, I hope to provide a transparent view into our business. What we are seeing in each of our operating segments and geographies as well as the proactive steps we are taking to mitigate risks as we remain laser-focused on improving our execution, our efficiency and long-term objectives with a clear goal to maximize profitability and build sustainable shareholder value. I'm pleased to report that we delivered strong operating results in the first quarter. Total revenue of $53.8 million in Q1 increased 7% year-over-year and exceeded the high end of our guidance range. Our focus on efficient execution to drive profitability continued. We delivered $7.2 million in adjusted EBITDA in the first quarter, which resulted in $0.05 in non-GAAP EPS, both of which exceeded the high end of our guidance range and represented significant improvements over the prior year quarter. Our gross margins in the first quarter were at the high end of guidance, and our operating expenses were right in the middle of the provided guidance range, speaking to our rigor in managing our operations. We remain laser-focused on improving our execution and our efficiency. Our stated goal is to reduce operating expenses by $10 million on an annualized basis, and I remain confident that this is an achievable goal. Tom will give further detail on our financial performance during his remarks. We added a total of 128 new customers in Q1. And believe that we can continue to build upon that momentum going forward with strong focus on improving execution in all areas. To that end, I'm proud to be able to highlight some signature recent wins. A large telecom operator in Europe selected A10 in a competitive bid for a multi-year project to help improve its total cost of ownership in addressing critical capacity and security needs in preparation for 5G. We won this competitive project due to our demonstrated performance and long-standing track record of success within this account. A large multinational conglomerate in Asia selected A10 to help improve its network performance and simplify its operations when accessing cloud applications. Network conditions had become unstable from the frequent use of web conferences, which had rapidly increased during the coronavirus. A10 won this deal due to its demonstrated performance in such environments and simplification of operations utilizing the A10 management platform. Let me spend a moment and speak to how the quarter progressed, as it was certainly a rapidly changing and volatile period for us all. I'll start with our situation as we entered the new year, peak to the changes we saw as the pandemic progressed, first in Asia, then in Europe and ultimately here in the Americas. And then I'll provide a little color on what we are seeing as we move into the second quarter. We entered the first quarter with strong momentum, benefiting from a large and growing pipeline of business and continued demand for our solutions as our customers look to improve their network infrastructure. As the quarter progressed, our customers in Japan and Asia experienced COVID-related disruptions. The most immediate impact of this disruption was in Asia Pacific, excluding Japan, where revenues declined approximately $4 million on a year-over-year basis. The impact in Japan was not initially as pronounced, but the postponement of the Tokyo Olympics will certainly impact revenue from the geography in the weeks and months ahead, as service providers adjust their spending plans to align with the new time lines. The challenges in Asia Pacific were offset by solid results from the Americas with revenues up 20% year-over-year. Our strong results in the Americas were driven by strong demand from a large web giant accounting for greater than 10% of Q1 revenue and included in the service provider category for existing design wins. It's important to note that while we continue to have a strong market position, with this large web giant, we are also dependent on their investment cycles, which can last multiple years and result in variable demand levels on a quarterly basis. Subsequent to the end of the quarter, we started to see encouraging signs in Asia Pacific. We remain cautiously optimistic about our near-term prospects in this region as 5G-driven demand continues to be an opportunity as service providers expand their networks. At the same time, the impact of COVID-19 has shifted to Europe and the Americas, as you would expect. As this occurred, our near-term visibility became limited. While our pipeline remains solid and demand remains strong, our ability to accurately forecast the timing of regional and customer order patterns within a 90-day window has become challenging. As a result, we have made the decision to temporarily stop our practice of providing quarterly guidance regarding revenue and earnings. Tom will provide an outlook on our current visibility, but we expect to maintain profitability in the second quarter as we continue to make progress on our long-term operating model. As the situation abates and our visibility improves, we hope to return to providing estimates about our expected results. We have a strong balance sheet and a base of recurring revenue to help us navigate these uncharted waters. With that, I'd like to turn the call over to Tom to review the quarterly operating results in more detail. Tom?

Thank you, Dhrupad. As Dhrupad shared, revenue in the first quarter was $53.8 million, up 7% year-over-year and above the high end of our guidance range. First quarter product revenue was $30.7 million, representing 57% of total revenue. Service revenue was $23 million or 43% of total revenue. Security-driven product revenue comprised 66% of total product revenue in Q1. As a reminder, beginning in the fourth quarter of 2019, we revised our reporting to include our largest web giant customer within the service provider vertical. Moving to our revenue from a geographic standpoint, revenue from the Americas increased 20% from the year ago period to $25.4 million compared with $21.1 million in the first quarter last year. In Japan, revenue was $17.6 million, up $4.5 million from the year ago period based on a strong start to the year as service providers continued ramping spending to prepare for the Tokyo Olympics. As Dhrupad shared, with summer Olympics being postponed to 2021, we would expect to see some delays from our customers as service providers align their investment plans with the rescheduled start date. Asia Pacific revenues, excluding Japan, declined $4 million from $8.8 million in the first quarter of 2019 to $4.9 million in the first quarter this year. And finally, in EMEA, revenue was $5.8 million, a decline of 20% when compared with $7.2 million in the first quarter last year. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis, unless stated otherwise. A full reconciliation of GAAP to non-GAAP results are provided in our press release, and in our trended quarterly financial statements posted on our website. Our first quarter total gross margin was 78.3% and at the high end of our guidance range. First quarter product gross margin was 77.7%, 416 basis points better than the year ago period. Services gross margin in the quarter came in at 79.3% compared to 79.9% in Q1 of 2019. We ended the quarter with headcount of 785 compared with 819 at the end of Q4, reflecting the actions taken to reduce total headcount in the first quarter as we advanced efforts to rationalize our expense structure to better maximize productivity. As a reminder, the annualized savings from this rationalization and other cost savings measures will enable a reduction in OpEx in 2020 compared with 2019 of approximately $10 million. Non-GAAP operating expenses in Q1 were $38 million, down slightly sequentially from the fourth quarter, but 14.2% lower than $44.3 million in the prior year first quarter. Our continued focus on execution to maximize efficiency and profitability in all areas contributed to this year-over-year decline. We reported $4.1 million in non-GAAP operating income. We also continue to improve our adjusted EBITDA significantly, which came in at $7.2 million for the quarter, a more than $10 million swing from the year-ago period, beating the high-end of our guidance range. As Dhrupad mentioned earlier, this reflects our intense focus on improving profitability. Our non-GAAP net income for the quarter was $4 million or $0.05 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 first quarter were approximately 79.7 million shares. Moving to the balance sheet. Average days sales outstanding were 73 days, compared with 82 days in the prior quarter. At March 31, 2020, we had $142.9 million in total cash and marketable securities compared with $129.9 million at the end of December. During the quarter, we generated $12.2 million in cash from operations and $11.3 million in free cash flow, largely due to the strong collections of shipments from prior quarters. As Dhrupad shared earlier, given the uncertainty in the environment and the inability to predict the course of the current pandemic, we have decided to temporarily suspend our practice of providing full quarterly guidance, and we will resume when we have increased visibility. We remain committed to advancing our goals for profitable growth and our efforts to advance initiatives to improve operational efficiency will continue. We have put in place processes to reduce discretionary spending, and we expect second quarter operating expenses to decline sequentially from the first quarter. In addition, we expect to maintain profitability in the second quarter as we continue to make progress on our long-term operating model and track to our goal of reducing OpEx by $10 million on an annualized basis. In addition, we expect gross margin to be consistent with our historical range of 76% to 78%. Operator, you can now open the call up for questions.

We will begin the question-and-answer session. [Operator Instructions] The first question comes from a Hamed Khorsand of BWS Financial. Please go ahead.

Hi. Just a couple of questions here. One is what kind of order trends are you seeing outside of Asia Pacific, especially in the U.S. and Europe, and with 5G deployments? Is it making it hard given that COVID-19 travel is restricted?

Hi, Hamed. Thanks for the call. I appreciate it. Do you want to cover that, Dhrupad? The question about the – what we're seeing in the...

Yes. No, thank you. So yes, I think so. I think, first of all, I would say, Hamed, that the fact that people cannot travel so much is not really an impairment to the business for us as such. The order trends outside of Asia Pacific are generally in line with the macro trends where service providers and cloud providers have to deal with actually increased volume, adding capacity and worrying more about security, whereas on the negative side, customers who are not operating because of lockdown or shelter in place restrictions are constrained from deploying things rapidly in an enterprise environment, for example. So net-net, I think, outside of Asia Pacific, we see, because of our exposure to service provider and enterprise segment, some positives and some negatives.

Are you able to capture new customers in this environment? Or are you relying on all your previous existing customers?

So I think it's both. So we are, of course, always looking to support our existing customers more. But what has also changed is we have adjusted our own tactics, right, to be more digitally oriented, have our marketing activities become much more digital quickly, and we are seeing good traction from the customer base and getting our own sales teams to become more effective that way. So we don't know yet what the Q2 net numbers will be, but we certainly have adapted to that environment as well.

And lastly, talking about operating expenses being down sequentially, is that the essence of your sales department not being able to do the normal travel and marketing expenses? Or that's immaterial quarter-over-quarter?

Good...

I think so – good question, and it's both right. So yes, we have taken structural cost actions, which will result in us stating earlier annual cost reduction goal. You are correct in that in current period and current environment. There will be sort of a temporary decrease in those expenses as well. But I think our goal is to achieve the structural objectives. And in the meantime in Q2, we might see a benefit also from a temporary pausing of those activities.

Yes.

The next question comes from Hendi Susanto of Gabelli Fund. Please go ahead.

Good evening, Dhrupad and Tom.

Hi.

Hi, Hendi. Thanks for the call.

Yes. So Dhrupad, you talk about cloud and service providers adding capacity. How should we relate A10 networks to the current global COVID-19 lockdown when it comes to work from home and distance learning, like A10 has presence among OTT, video gaming and media in general. But I would like to get more insight into how much presence you have and whether you see benefit from work from home and distance learning in those three areas like OTT, video gaming and media?

Yes. Good question. So I think maybe I'll split into the individual portions of that. So first part of it is with the work from home and shelter-in-place restrictions, obviously, more and more people are doing remote access and remote access is certainly putting some pressure on network capacity as well as security versus how those were originally planned. So in that context, we see some of the service providers, certainly looking to add enhanced capacity. They're not going to do a big new build-out. And the cloud provider, certainly, who support the remote connectivity as well as gaming as well as hosting, right, and OTT kind of things are also in the mode of adding more capacity to handle more traffic than they had planned. We are positioned with service providers as we had been supporting new 5G build-out as well as upgrading existing 4G build-outs. So we expect those customers to make and continue to make incremental CapEx investments in their networks to the degree that some of our security products were also being used in gaming and other applications. We certainly expect an uptick from there as well, right? So I think our exposure comes from where we are providing the ability for a service or cloud provider to increase capacity in the most efficient way with security, right? So that's where we would see the benefit and the connection.

And Dhrupad, any stories or insight into video game – how video game consumption with – this increasing benefit? You mentioned that – you mentioned about cloud providers, but I'm wondering whether specifically to game providers like Xbox and Sony whether you have some insight into that area?

Yes. No. I think it's a good question. And I think certainly, as you can appreciate, because we provide cybersecurity, we cannot talk specific customers. But you are correct in that most of them are seeing quite a bit of increase in volume and traffic. And as they look to handle that, in parallel, they have to deal with the idea that increasing volume and traffic also attracts more cybersecurity attacks into them. So there is a higher need from a security perspective in those applications in addition to just capacity.

Okay. And then Dhrupad, do you have exposure to new OTT players, names like HBO Max, NBC Peacock, Disney+, CBS All Access, when it comes to like users viewing the OTT streaming on their, let's say, like mobile device, do you have exposure to that space?

Yes. So today, I think the exposure to that space for us would be indirect because all those services, whether it's consumed on a mobile device or tablet or your home-connected television. All those services ultimately put that data and the volume on the backbone of the service providers. And that's where we intersect more is as that volume of data and video consumption increases with OTT, that needs then a bigger pipe, if you will, and a cleaner pipe, if you will, to carry that increased traffic, right? And that's where we would intersect with it.

Okay. And then Dhrupad, one last question for me. So in the month of April and early May, how do you describe business activities in Asia? I'd say like one, I think some parts of Asia have started to reopen their economy, but I'm wondering what kind of pace when it comes to like restoring business activities in A10 Networks area.

Yes. No, it's a good question. And of course, as a company, we have historically had very good strength in Asia across many countries. And I would say it's a little bit varied by country, if you will. So in some countries, in Southeast Asia, where they are under complete lockdown, of course, a lot of the projects are delayed, right? And one of the challenges is we don't know if they are delayed by 30 days, 60 days or 90 days. And – but we know that the plans are still in place. It's not canceled, we have not lost it. But it's postponed because you simply cannot conduct business when they are in locked down. So we have that issue in some of the Southeast Asian countries. A little bit resumption, I think, as we said before, not all the way, but a little bit resumption in China and Korea, for example, and in Japan, which is a very important region for us. The normal activity is there, but what we initially called out is – difficult to predict is the spending plans and capacity expansion related to the Olympics certainly will be pushed out a little bit, right? So we have to make that up in other regions.

And then as a follow-up, Dhrupad, may I know how – you have great presence in Japan. May I know how much presence do you have in China and Korea with service providers?

Yes, we don't break that...

So I think we don't break it out. Yes. We don't break it out that way, but I think what we have said in the past is we have highlighted joint announcement and press releases with some of the top service providers in Korea, right? So that's an indication of people we work with.

Thank you so much, Dhrupad. Thank you so much, Tom.

Thank you, Hendi.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Dr. Dhrupad Trivedi for closing remarks.

Thank you. And thank you to all of our shareholders for joining us today and for your continued support. This was certainly a challenging quarter but I'm encouraged with the way our team responded. And I believe that the results we reported amidst this period of uncertainty are encouraging. Thank you, and have a good day.

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