A10 Networks, Inc. (ATEN) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon. Welcome to the A10 Networks' Third 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. Please note that this event is being recorded. I would now like to turn the conference over to Rob Fink. Please go ahead.

Thank you, Operator, and thank you all for joining us today. Today's call is being hosted by A10's management team through Dhrupad Trivedi, A10's President and CEO; and Brian Becker, Interim 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 third quarter 2020 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 Web site. During the course of today's call, management will make forward-looking statements, including statements regarded to projections for future operating results, continued reductions in operating expenses, continued efforts to improve operational efficiency, focus on driving growth, business optimization, and overall profitability, our belief is that we can continue to build upon customer momentum going forward, expectations regarding future opportunities and the ability to execute on those opportunities, the expectations for future market growth and the general growth of the business; the development and performance of its products and anticipated customer benefits from use of the products, and expectations and priorities with respect to 5G. These statements are based on current expectations and beliefs as of today, October 27, 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 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 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 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 Web site. With all that said, I'd like to turn the call over to Dhrupad Trivedi, President and CEO of A10 Networks. Dhrupad, the call is yours.

Thank you, Rob, and thank you all for joining us today. This quarter was, I think, the culmination of our business transformation to date. It has been approximately one year since I joined A10 as the CEO. In the first quarter, after my appointment in Q2, 2019, A10 reported negative organic growth and roughly breakeven operating income, with operating expenses of $46.8 million on a GAAP basis, inclusive of $2.5 million of restructuring expense. As a company, we have significantly revamped the growth potential and earning power by reducing annual operating expenses by $23.3 million, and reallocating resources to the best market opportunities. This, combined with improved commercial execution and focus on business outcomes for our customers, positions us for sustained performance into the future. An evolving number of new routes to market, with focus on solution selling will allow us to reach broader set of customers efficiently and in line with market tailwinds. This quarter, we reported our third consecutive quarter of greater than 6% organic growth in spite of COVID-19 headwinds. We accomplished this while simultaneously cutting costs. In fact, our operating expense baseline is between $34 million and $35 million on a non-GAAP basis, reflecting an approximate 25% reduction in our steady-state cost structure over the past two years, enabling improved and record profitability. I think it's important to take a step back and look at the progress we have made to establish an efficient, profitable organization. Today, A10 is on a much more solid footing. We generated $10 million in operating income in the third quarter, $12.5 million in adjusted EBITDA, and $10 in net income. We have a strong balance sheet, with $159.1 million in cash, and consistent growing profitability. Effectively, we have removed significant risks from our model, and positioned A10 for long-term sustainable growth building upon our long history, and with our strong consistent free cash flow we are positioned to implement an aggressive share repurchase plan. Networks across the globe are being stressed with unprecedented usage and increasing demand for bandwidth capacity, underscoring the need for critical communications infrastructure, combined with the ability to navigate ever increasing volume and sophistication of cyber attacks. The macro tailwinds of cloud computing, Internet of things, growth in data, and convergence of networks directly aligned with our value proposition to customers and enables them to achieve better ROI, security and flexibility, thereby positioning them to deliver better service levels to their customers. Many of our customers are looking for solutions that help them manage their existing infrastructure, while they continue to migrate parts of their infrastructure to the cloud. Our solutions are now tailored to support them to achieve their business goals in an on-prem cloud or hybrid environment. This provides investment protection as well as a much more flexible approach to navigating uncertain times. Increasingly, we are winning business with a differentiated solutions-based approach. A10 is an enabler of technology and solutions that facilitate secured network expansion and added capacity. We offer multiple product capabilities unified by a common management and analytics platform, which ultimately helps customers with best-in-class features, combined with reduced operating complexity. This is especially valuable while they are also dealing with rapidly-changing budget priorities, and addressing skill gaps in areas like cyber security. Another risk mitigating for our business transformation is diversification. We have always had significant geographic diversity, a competitive advantage and strategic differentiator with roughly half of our business in regions outside of United States. We have diversity in our end market verticals with exposures to cloud providers, service providers, large enterprise, and mid enterprise customers. During Q3, demand in Japan improved as expected after a strong COVID-19 impact in Q2. Like most companies, we saw headwinds in the Americas related to delays and push-outs resulting from the pandemic. Once again, this mix demonstrated the importance of geographic diversity. As a result, our operating results in Q3 were generally in line with expectations with solid growth and improving profitability as we continue to navigate a rapidly-changing economic environment. The environment remains highly fluid with sales cycle elongated by the COVID-19 pandemic, and the timing of projects waiting due to process delays at customers and business lockdown while A10 continues to execute. Overall, Q3 revenue was $56.6 million, up 7.1% year-over-year. This growth combined with continued focus on productivity yielded record GAAP net income of $6.5 million and record adjusted EBITDA of $12.5 million. With that, I'd like to welcome and turn the call over to Brian Becker. Brian has served as our Vice President of Finance and Corporate Controller for two years, and he was appointed interim CFO in September. Brian?

Thank you, Dhrupad, excited to be here today. As Dhrupad shared revenue in the third quarter was $56.6 million, up 7.1% year-over-year. Third quarter product revenue was $32.2 million, representing 56.9% of total revenue. Service revenue was $24.4 million, or 43.1% of total revenue. Security driven product revenue comprised 58.9% of total product revenue in Q3. As a reminder, beginning in fourth quarter of 2019, we revised our reporting to include our largest web giant customers within the service provider vertical. Moving to our revenue from a geographic standpoint, revenue from the Americas was $22 million compared with $22.8 million in the third quarter last year. In Japan, revenue was $18 million, up $2.9 million, or 18.9% year-over-year. Asia-Pacific revenue excluding Japan was $8.7 million, up 3.8% and EMEA was $7.9 million, up 20.8%. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis unless otherwise stated. A full reconciliation of GAAP to non-GAAP results are provided in our press release and on our Web site. Our third quarter total gross margin was 77.6%, down 50 basis points year-over-year due to less favorable product mix. Services gross margin in the quarter came in at 79.2%, compared to 80.2% in Q3 of 2019, due to lower volume. We ended the quarter with a headcount of 744, compared with 753 at the end of Q2, reflecting the actions taken to focus on the appropriate strategic priorities and maximizing productivity. Non-GAAP operating expenses in Q3 were $33.9 million, down 14% from $39.4 million year-over-year. Our continued focus on execution to maximize efficiency and profitability in all areas contributed to the year-over-year decline. We reported $10.3 million in non-GAAP operating income. We also continued to improve our adjusted EBITDA significantly, which came in at $12.5 million for the quarter, an $8.5 million swing year-over-year. As Dhrupad mentioned earlier, this reflects our focus on and commitment to improving profitability. Non-GAAP net income for the quarter was approximately $10.3 million or $0.13 on a per share basis. Diluted weighted share as used for computing non-GAAP EPS for the third quarter was approximately 80.4 million shares. On a GAAP basis, net income for the quarter was $6.5 million or $0.08 per share, compared to GAAP net loss of $174,000 or $0.00 per share in the third quarter last year. Moving to the balance sheet, average day sales outstanding were 69 days, compared with 80 days in the prior quarter. This trend reflects typical seasonal timing of our revenue and collections. At September 30, 2020, we had $159.1 million in total cash and cash equivalents, compared with $129.9 million at the end of December. During the quarter, we generated $15.9 million in cash from operating activities due to the changes in our expense structure and financial leverage of our business model. We generated $14.9 million in free cash flow during the quarter. On September 17, the company announced the share repurchase plan for up to $50 million of common shares over the next 12 months. Due to the uncertainty in the environment and the inability to predict the course of the current pandemic, we are suspending our practice of providing full quarterly guidance. We remain committed to advancing our goals for profitable growth and our efforts to advance initiatives to improve operational efficiency. As the global economies continue to reopen, we anticipate higher marketing and sales expenses when compared to the third quarter of 2020. However, structural changes we have made in our business already position us for significant decreases in total operating expenses on a year-over-year basis. On an annual basis, we expect to generate organic growth of approximately 6% to 8%, with higher bottom line growth than our top line. We expect to maintain profitability in the fourth quarter as we continue to make progress on our long-term operating model, and we expect fourth quarter gross margins to be consistent with our historical range of 76% to 78%. Operator, you can now open up our call for questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Hamed Khorsand from BWS Financial. Go ahead.

Hi. Thanks for taking the questions. So first off, I just want to understand, as far as Japan coming back, was that purely related to delays that you saw? Were these sales booked in the past, or were these brand new and you were able to close them?

Yes, so, Hamed, this is Dhrupad. So good question, so I think it was a mix of two things. So the two things happening in Japan were there was activity in Q2 which had gotten delayed, so some of those deals did get closed in Q3, but we also saw some movement as customers are reassigns their longer-term plans because while the Olympics is not yet cancelled it has been [re-scoped] [ph], and there is an impact on planning. So we saw some of those orders being broken up into potentially smaller deals, et cetera. So a lot of these were deals that were obviously active because the sales cycle is typically six to nine months, but at the same time we saw some resumption of things coming into funnel as well, right, which is positive, although nuanced by the fact that the Olympics is rescaled a little bit. So, we expect that to still be a good thing, but not maybe as much as before.

And then are you seeing any benefit from these extensions of work-from-home, learn-from-home movements, and as far as the companies and how they're prioritizing their spending?

So we see that at an indirect level, right. So where we see that is as that extension occurs there is a more distributed nature of traffic, and data, and video volume, and ultimately that creates the backpressure for service providers and cloud providers to invest in more capacity or more flexibility or more security. So our intersection point is right at that level, in the core of the network is where we see that connection.

And the last question is, are you seeing any traction on the 5G front?

Yes, we are, and I think 5G obviously continues to be a mix thing, which is there's Greenfield 5G and then there's a lot of 5G which is not native or pure 5G. So we participate in both. So as it relates to brand new Greenfield 5G deployments, those are typically delayed a little bit due to COVID-19. However, where the 5G is underway already or they are planning to enhance their current networks, we continue to see positive momentum there, right. So our value proposition there is really around Greenfield 5G, but also 5G readiness and that has given us a more balance exposure.

Okay, thank you.

Our next question is from Anja Soderstrom from Sidoti. Go ahead.

Hi, and thank you for taking my question, and congratulations on a good quarter again. So, my first question is, you mentioned that North America was slowing down a little bit in the three quarter. How did that play out during the quarter, and what do you see going into the fourth quarter?

Yes. Good question, Anja, and thank you. The North America, I would say the phenomenon I would differentiate is between small and mid enterprise, large enterprise, and service provider. So where we see a slowdown was obviously more on the mid enterprise side, which many other companies have talked about as well, right, which relates to companies assessing the budget priorities and timing of their IT spend, versus having to compete with other priorities like remote work and security. So as we saw it through the quarter, what we -- the way we saw it was projected plans to deploy either equipment or software, even though they were planned and scheduled, eventually got delayed or pushed out because customers were dealing with either a lockdown or restrictions on what you could do. So we did see, especially on enterprise side, orders that we were sure would be happening in Q3 getting delayed. I would say that part is probably the hardest to predict on how much of that comes back around in Q4, because it's really more macro phenomenon, right, and not specific about our products or competitors or landscape, and on the service provider side, I think we continue to see, as the CapEx variation occurs, that that moves, right, but overall I would say that trend is positive as they continue to add capacity. So it's more to do with the enterprise market and where people are reassessing plans and budgets and priorities, right, where we see those delays or deferments.

Thank you, and are you seeing any sort of other difficulties among your customers or is it more rather of budget reshuffling and maybe pushing the projects out?

I think that's the single biggest one. I don't think we have seen cancellations, or things like that. I think we haven't seen like skill difficulty in getting the right people to do things, but it has been definitely related to budget priority reshuffling, just based on uncertainty, right, that they're also dealing with.

Okay, thank you, and then in terms of the marketing and sales expenses, you say you expect that to come back as we're able to start maybe traveling again and things opening and up, but to what extent you expect that to come back, and do you see any further cost savings there that you're getting used to doing business more efficiently maybe remotely or via the computers on virtually?

Yes. No, no, good question, Anja, and I think I would separate the two things I saw, of course, we continue to look at structural cost reduction, which is separate. The temporary benefit, I think is two-fold, right. One is there is already by the way, travel that has opened up within parts of Europe, within Asia, and so, we see that already coming in a little bit, right. So, it's not all of it, but at least some of that activity, and within U.S., right, but not international as much. On the marketing side, certainly as you noted, we have continued to substitute online or virtual events, and even our user group will be virtual as a way to replicate the notion of doing lot of local events and gatherings and so forth. So, I think in that case, certainly, we're becoming more efficient, and that will continue to be a hybrid model in the future, where not everything will go back to all in person, right. So, certainly, that's an area we expect. So, I think some of it will pick up because we already see travel opening up and we continue to invest in virtual events as well, but it may not be all the way, that is correct, yes.

Okay, thank you. That was all for me. Thank you so much.

Thank you.

Thank you.

Our next question is from Hendi Susanto from Gabelli Funds. Go ahead.

Good evening, Dhrupad and Brian, great Q3 results.

Thank you.

My first question, I would like to ask about the 7% year-over-year growth in enterprise sales, following multiple quarters of negative growth. How do you characterize the enterprise performance? I think it's very positive when I look from that perspective. I would like to take insights in terms of whether A10 can maintain positive sales growth in enterprise, especially in light of the device and push out the basis to COVID-19 that you mentioned?

Yes, good question, and I would say, the opportunities for us there have had to do two things, right. So, one is, as many of you remember, we focused a lot on commercial execution, working with the channels better, and so forth, and so, we expect certainly that improving commercial execution to help us with growth in the enterprise side, and that's true globally for us. The second part of it is, I would say, we still have goals to continue to focus on improving that in the future by better working with partners that we have talked about, but also focusing on products being easier to use, whether it's on-prem or in the cloud or multicloud, which resonates with what our customers are facing as a reality, right, while that they're not looking at option of ripping out everything, while they're dealing with all the other uncertainties. So, our approach is really to align our solution selling to problems they're trying to solve now, independent of deciding what [form] [ph] factor, and whether it's cloud or not, and as we have made progress in creating that, I think we have seen some positive momentum to grow in those areas.

Got it, and then Dhrupad, would you be able to share insight into your product roadmap and strategy for 5G infrastructure footprint? Would you rely on the current existing product portfolio, or are there like new products that A10 is developing now?

Sure. Yes, so I think for us, as we look at the opportunity with service providers, there're two dimensions of it. So, one is, we have existing products that actually create more value for customers when they're used with other products, because we have a common way to manage, and have a common interface to them, right. So, one area of growth for us is to enable our product portfolio across multiple things to create unique 5G solutions, whether it's security or firewalls, or whatever, and so, that's one really important part of our innovation and roadmap is alignment with our customer metrics and customer outcome. The second is certainly from a technology perspective. We continue to monitor developments there, and as you know, we obviously have plans to continue to release new products but aligned with sort of the customer use cases more so than any specific product technology.

Got it, and then last question for me, so A10 doesn't give Q4 guidance that is understandable, are there some insight or data points that we should have in mind when it comes to Q4 in terms of seasonality, despite of the COVID-19 impact?

Okay. No, that's a good question, Hendi, and I think, in Brian's section, he talked about two or three things, which I think are relevant, right. So, we expect of course gross margins to be consistent with our historic range. Certainly, we expect to maintain profitability, and I think the uncertainty for us is most on top line with -- you know, we have uncertainty coming on with election, with COVID shutdowns, and openings around the world. So, that's the area we're navigating, right, in terms of where we go now. Now, seasonally, Q4 would be stronger than Q3, but what I don't know is you know, a lockdown in two countries could have a bigger impact than seasonality, right, so that's the concern.

Thank you, Brian. Thank you, Dhrupad.

Thank you, Hendi.

Thank you.

This concludes our question-and-answer session. I would now like to turn the conference back over to Dhrupad Trivedi. Go ahead.

Thank you, and thank you to all of our shareholders for joining us today and for your continued support. A10 continues to execute well amidst a challenging and uncertain environment, and our strong balance sheet, global presence, and improved profitability position us for continued success. Thank you, and have a good day.

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