A10 Networks, Inc. (ATEN) Q4 2020 Earnings Report, Transcript and Summary

Good day, and welcome to the A10 Networks Fourth Quarter 2020 Financial Results Conference Call. All participants will be in 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 of FNK IR. Please go ahead.

Thank you, operator, and thank you, everyone for joining us today. This call is being recorded and webcasted live and maybe accessed for at least 90 days on A10’s Investor Relations website at a10networks.com. Hosting the call today are 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 fourth quarter 2020 financial results. Additionally, the Company published a presentation and supplemental trended financial statement. You may access the press release, presentation and trended financial statement on the Investor Relations section of the Company's website. During the course of today's call, management will make forward-looking statement, including statements regarding our positioning, industry trends and opportunities, strategy, including diversification, portfolio management, recurring revenue, deferred revenue, operating margin, growth and portability and volatility. These statements are based on current expectations and beliefs as of today, February 9, 2021. 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 as future events. A10 does not intend to update information contained in these forward-looking statements, whether as a result of new information, future events or otherwise except required by law. For a more detailed description of these risks and uncertainties, please refer to the Company's most recent 10-K. Please note with the exception of revenue, financial measures discussed today on a non-GAAP basis and have been adjusted to exclude certain charges. The non-GAAP financial measures are not intended to be or considered in isolation or as a substitute for any results prepared in accordance with GAAP and 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. 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. The fourth quarter represented a strong end to a solid year for us. We have established the foundation for sustainable growth and profitability. In fact, we reported our fourth consecutive quarter of positive year-over-year organic growth, delivering total growth of 6% for the year. Importantly, we have refined our go-to-market strategy, establishing strategic relationships with partners and resellers, streamlining our sales organization around the globe to focus on the most promising and profitable opportunities and transition from a provider of commoditized solutions to a strategic integrator, providing best-in-class solutions in several growth-oriented technological areas. In particular, we are well-positioned in cybersecurity, the 5G rollout and network availability, including DDoS attack prevention. Each of these areas represents strong multi-year secular opportunities for us. They enjoy broad tailwinds. And our offerings are not only best-in-class, but differentiated by building upon strong historical leadership in these segments that has been built over 10 years. Let me speak to some of our solution-based approaches and how they are resonating with customers. A major service provider in Japan was faced with growth in mobile Internet traffic as well as increased volume of cybersecurity attacks. A10 was able to provide an integrated solution that included multiple functions, was able to operate efficiently at hyperscale and provided the best path for them as they continue to grow their network all while adding more security. Our solution was chosen for technical performance, alignment with customer’s business metrics and reduction in the customer's OpEx with ease of management. In another example, one of our important service provider customers was planning to expand their existing 5G rollout. In spite of COVID-related restrictions, A10 was able to work with the customer to deliver a virtualized solution that helped them to address their growing Internet traffic. This was an important step as it demonstrates that A10 can support customers solutions based on their needs, which can sometimes be a mix of virtualized and physical solutions. Government agencies have been faced with increasing external cyber attacks during 2020. A10 was able to partner with a government agency in Southeast Asia to deploy our DDoS protection solution to protect them and vital services from disruption. Our solution was chosen because it was easy to deploy, integrated well with their infrastructure and most importantly, provided the strongest protection in technical evaluations. Today, A10 has a global presence helping us navigate the COVID challenge demand environment. We have revenue diversity mitigating our reliance on large customers and individual product offerings. Throughout the last year, our primary focus was to deliver growth while maintaining cost discipline and maximizing our efficiency in all functional areas. With that foundation in place, we are turning our focus in 2021 towards portfolio management. This includes broader security-led solutions for our customers, enabling 5G and 5G readiness and increasing our recurring revenue in line with our customer's business goals. This effort will make our business even more sustainable, while increasing our visibility into our quarterly performance. Our goal is to grow our recurring revenue faster than our overall revenue. For perspective, our recurring revenue on December 31, 2019 was $94 million and grew to approximately $105 million by end of last year. During 2021, we anticipate this transition to be neutral to our operating margins as we invest the incremental revenue into backend support to grow this stream. Beginning in 2022, we expect this initiative to be slightly accretive to our operating margin. As part of this initiative, beginning in the first quarter, we plan to call out total recurring revenue and deferred revenue. Deferred revenue represents a leading indicator of future revenue and can provide some insight into total lifetime value of a customer relationship as it represents contracted revenue that has not yet been recognized. This initiative is strategically important. It adds a new pillar of sustainable growth in line with our customer's needs. While we are benefiting from macro tailwinds related to cloud computing, Internet of Things, growth in data and convergence of networks, trends which closely aligned with our value proposition to customers, ultimately our long-term success is based on choosing the right opportunities and on execution. The last year has demonstrated our ability to build upon our technical foundation and improve execution and the impact of that is evident in the sustainable and profitable growth we generated. With that, I'd like to turn the call over to Brian for a detailed review of the fourth quarter and full-year. Brian?

Thank you, Dhrupad. As Dhrupad shared, revenue in the fourth quarter was $62.7 million, up 4% year-over-year. Fourth quarter product revenue was $37.7 million, representing 60% of total revenue. Services revenue was $24.9 million or 40% of total revenue. Security-driven product revenue comprised 53% of total product revenue in Q4. Moving to revenue from a geographic standpoint. Revenue from Japan was $18.5 million, up $2.3 million or 14% year-over-year. Asia Pacific revenue, excluding Japan was $8.2 million compared to $9.3 million in the fourth quarter last year. EMEA was $9.2 million, up 28%. Revenue from the Americas was $26.8 million compared to $27.5 million in the fourth quarter last year. With the exception of revenue, all of the 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 website. Gross margin in the fourth quarter was 79.6%, up 112 basis points year-over-year due to a more favorable product mix. We ended the quarter with headcount of 749 compared with 748 at the end of Q3 and 819 at the end of last year. This reflects the actions taken to focus on the appropriate strategic priorities and to maximize productivity. Non-GAAP operating expenses in Q4 were $36 million, down 9% from $39.7 million year-over-year. Our continued focus on execution to maximize efficiency and profitability in all areas contributed to this year-over-year decline. At the same time, we continued to reallocate resources to the most important long-term growth opportunities and to optimize our global footprint to further improve execution. We reported $13.9 million in non-GAAP operating income, an increase of more than 80% compared to $7.7 million in the year-ago quarter. We also continued to improve our adjusted EBITDA significantly, which came in at $16.1 million for the quarter is $6.1 million improvement year-over-year, which reflects our continued focus on and commitment to improving profitability. Non-GAAP net income for the quarter was $13.9 million or $0.18 on a per share basis. Diluted weighted shares used for computing non-GAAP EPS for the fourth quarter were approximately 78.8 million shares. On a GAAP basis, net income for the quarter was $7.8 million or $0.10 per share compared to $51,000 or $0.00 per share in the fourth quarter last year. Turning to our full-year results. Revenue for 2020 was $225.5 million, up 6% over the prior year. For the full-year 2020, product revenue was $129 million, representing 58% of total revenue. Services revenue was $95.7 million or 42% of total revenue for 2020. Security-driven product revenue comprised 58% of total product revenue for the full-year. By geography, revenue from the Americas was $98.2 million for the full-year 2020 compared to $89.9 million in 2019. In Japan, revenue was $67.1 million, up $7.6 million or 13% year-over-year. Asia Pacific revenue, excluding Japan was $29.8 million, down 17%. EMEA was $30.6 million, up 11%. With the exception of revenue, all of the following financial metrics are on a non-GAAP basis, unless otherwise stated. Full-year 2020 total gross margin was $78.6 million, up 87 basis points compared with 77.8% last year. This is due to a more favorable product mix. Services gross margin for 2020 was 79.8%, which is down compared to 80.6% for all of 2019 due to the impact of COVID shutdowns leading to fewer direct customer engagements. Non-GAAP operating expenses for the full-year 2020 were $142.1 million, down 13% from $162.7 million in 2019. We reported $35.3 million in non-GAAP operating income for the full-year 2020 and adjusted EBITDA of $45.6 million. Adjusted EBITDA improved by $33.9 million over the last year, again, reflecting our continued focus on and commitment to improving profitability while driving growth. Non-GAAP net income for the full-year 2020 was $35.3 million or $0.44 on a per share basis. Diluted weighted shares used for computing non-GAAP EPS for the full-year were approximately 80 million shares. On a GAAP basis, net income for the full-year 2020 was $17.8 million or $0.22 per share compared to a GAAP net loss of $17.8 million or $0.23 per share for 2019. As of December 31, 2020, we had $158.1 million in total cash and cash equivalents compared to $129.9 million at the end of 2019. For the full-year, we generated $55.3 million in cash from operating activities due to the changes in our expense structure and the financial leverage of our business model. We generated $51.7 million in free cash flow for 2020 and $15.8 million in the fourth quarter alone. As a reminder, we defined free cash flow as net cash provided by operations less capital expenditures. Capital expenditures is the purchase of property and equipment. In 2020, the company announced a share repurchase plan for up to $50 million of our common shares over the next 12 months. During the quarter, we repurchased 2.7 million shares at an average price of $7.11 for a total of $19.2 million. I would point out that we ended the year with cash and cash equivalents of $158.1 million, just $1 million lower than cash and cash equivalents as of September 30, this while spending $19.2 million on share repurchases in the quarter. This speaks to our strong positive cash flows, and we were able to fund the entire stock buyback with cash generation for preserving our strong balance sheet. As the global economy has continued to reopen, we remain laser-focused on driving sustainable balance of growth and profitability. On an annual basis, we expect to generate approximately 6% to 8% with higher non-GAAP bottom line growth than our topline. In addition, we expect to maintain GAAP profitability going forward. We also expect some somewhat higher quarter-to-quarter volatility, particularly in Japan, if there are decisions to further delay or cancel the 2020 Olympic Games. Operator, you can now open the call up for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Hamed Khorsand with BWS Financial. Please go ahead.

Hi. So first off, just wanted to ask you on – you're talking about on your slide presentation about some of the global issues going on and lower visibility. Could you expand upon that? What are you seeing that's lower visibility if you're mostly a software-oriented company?

Yes. Hamed, thanks. This is Dhrupad. So I think as we reiterated at the end, right, we still expect to achieve growth of 6% to 8%, right. So that is independent of all those observations. When we talk about the uncertainty on timing, that typically relates to operating in regions, which might be in a physical shutdown for 60 days. And yes, even though it's predominantly software, we are typically dependent on the customer's network group, IT department or security department, being available to turn on the network, test it and complete all of those criteria. So the connection for us is not in terms of demand, it's simply the slight variation that we expect, which I would say is no different than what we saw in 2020 and managed it. And like everyone, we remain very optimistic that with the vaccine that kind of subsides much more so in the second half, right. But nothing different than 2020, simply a reflection of uncertainty when business is not able to operate in that environment.

Okay. And then what have you seen in your business since the SolarWinds hacking incident?

Yes, good question. So I think, cybersecurity as a category, in general, benefits or gets a boost in attention whenever there is a large public incident similar to what we saw with Target a few years ago. So this incident like many others has certainly raised two things; one is awareness on the level of risk and exposure that comes from sort of ubiquitous connectivity everywhere. And I think that second is as people prioritize where to invest and what to do first with the new kind of working environment, it has certainly raised the ranking of cybersecurity as a budget item as they review those priorities. So we certainly see heightened awareness conversation and potential to get budget allocation. At the same time, I would also say that typically cybersecurity is a complex topic. So while we do see all those positive trends, typically customers will do multiple things to become more secure, which could range from training employees not to click on emails that look suspicious to installing DDoS protection and so forth, right. So we absolutely see an increased awareness, increased budget allocation, hopefully. And certainly our value proposition led by cybersecurity resonates even more now with these customers.

And have you gotten word from your number one customer as to what their budget outlook looks like for A10?

Yes. So I think, of course, all our customers are number one, Hamed, right. But I would say when we look at some of the larger customers you think about, they are highly focused including this one on growing their capacity to support and run more data and becoming more secure. So we see trends that are consistent with their plans to continue enhancing and expanding that.

Okay. And would it still be a volatile quarter-to-quarter depending on how they're spending?

It will be, but it was in 2020 as well, right. So I think it's something we try to understand better, manage it and we'll continue to do what we did in 2020, right, and continue to get more insights so we can be more precise.

Okay. Great. Thank you.

Thanks.

Our next question comes from Anja Soderstrom with Sidoti. Please go ahead.

Hi. Thank you for taking my question. So the first one is, you were talking about the mid-enterprise in North America slowdown in the third quarter due to budgetary prioritizing, what have you seen in the end of fourth quarter and going into the first quarter?

Yes. Thanks, Anja. Good question. So yes, we did see that and that was sort of an industry phenomenon. I think what we are seeing now is there is obviously still concern ongoing about COVID environment. But I think people are also turning to look a little bit more forward and expecting more optimistic outlook by second half at latest. But we already see, I would say slightly improving signs of where people are revisiting the priorities where the first instinct was as things change and people work from home, how do you support that and make it safe? And I think now it's evolving back to how do we make the infrastructure better and go back to some of their original priorities around the business. So we do see that as a positive trend. It's not suddenly better, but it is not trending. I think it's trending towards positive.

Okay. Thank you. And also how was the fourth quarter trending and how was it trending going into the first quarter, just in general, the sales momentum?

Yes. Good question. So I would say when we look at our business globally, there is of course differences, but in general, we saw that our value proposition on security-led solutions continues to gain positive momentum. And I think even as we look at by regions in general, as you can see our numbers were affected in Asia Pacific, excluding Japan, of course, a lot by COVID. But beyond that, everywhere we are seeing positive momentum as well.

Okay. Thank you. And then you were mentioning about investing in your own infrastructure to be able to support the growth in 2021. Can you just elaborate a little bit about that?

Sure. Yes. And I think to be clear what I meant is, we continue to drive business efficiency and we will reinvest that to invest in the most important priorities, right, so we are not planning to build major data centers. That is not the plan. Our CapEx profile is not going to be different, right. I think it's more related to saying how do we further accelerate what growth we can achieve with cybersecurity-led solutions, which may require us to add newer capabilities and ways to support our customers, right. So it's more related to reallocation to those priorities versus maybe some of our older product lines.

Okay. Thank you. And does that have to do also with the pruning you did of the portfolio in the fourth quarter?

Yes. So I think that's exactly right. So we continue to look at our portfolio in terms of growth and profitability and make sure that we are putting our current OpEx levels on the most important priorities for our customers as well. So that's exactly consistent with that.

Okay. Thank you. That’s all for me.

Thank you, Anja.

[Operator Instructions] Your next question comes from Hendi Susanto with GAMCO Investors. Please go ahead.

Good afternoon, Dhrupad and Brian.

Hello.

Hi.

Dhrupad, first question, in service providers in 2020 A10 benefited from the needs for more capacity, security and flexibility throughout the year and then somewhat driven by COVID-19 also, and then looking into the first half of 2021, COVID pandemic is still problematic. So what should be our expectation in terms of service providers in terms of capacity, security and flexibility applications in the first half of 2021? Should we expect something like moderation or should we expect the trend to continue?

Yes. Good question, Hendi. So I would say you are correct. In 2020 with the Service Provider segment, what we saw was the phenomenon that where they were originally building capacity and security for a more centralized version of operating. They had to adapt to doing a more distributed version right. Now as we go into the next year, I don't see that moderating or dramatically accelerating. We expect that to be pretty consistent because in general, our business derives from the fact that whether you call it Internet of Things or something else, as more and more things are connected, it generates more data, needs to have more security and ultimately through a network, right. So that need is independent of whether it's a remote work or not. Second is, we heard about recent high profile cyber attacks and the volume and complexity of those continues to grow. So we expect service providers, whether they are cloud or telco or MSO, to continue to enhance their networks to be better protected as well. And the last thing I would say is, we navigated the landscape last year between helping service providers get ready for 5G as well as those who are rolling out 5G. And we expect that trend to be also stable because we are not counting on one extreme or the other, right. We are able to help them in both those environments. And so as that continues, we benefit whether 5G takes off faster, and if it doesn't take off faster, we still benefit because existing customers use us for investment protection and enhancing their networks.

Yes. And then second question, Dhrupad, you talked about portfolio management as a focus in 2021. And then you also talk about the broader security applications, 5G and then increasing recurring revenue. In terms of your product portfolio and then product roadmap, can you give more colors? Like whether or not, let's say we may see like a tremendous like differences in your portfolio upgrades? Or it's more of a continuation of like putting like more features that address like complexity and that you alluded before?

Yes. Another good question. So I think, I would say, for us, really, as we said at the outset, right, we are managing that in the context of saying where we have product lines that are not achieving profitability goals and not accretive to our growth targets. How do we – we are not going to just discontinue them, but how do we refocus our investment on to faster growth, right. So that's the idea of portfolio management. It's not saying we discontinue these four products or something like that because we still need to deliver the net growth. Second thing I would say is the roadmap is really oriented around looking at our customer's evolving needs. And you will see like some product releases and stuff that will support the idea that if you are a service provider customer, what are you worried about today? And how will we keep adding features, consumption models, all those things to our portfolio, so that we improve the ease of use for that customer and align with their business goals, right. So – and that could include not just new hardware or new software, right, it could have to do with how they consume our products, how we partner with them, how we work with channels, all of those things. So really it's around maintaining or improving our business models, but at the same time, finding ways to improve our growth profile by focusing on the right opportunities and aligning with customers.

And Dhrupad, when you mentioned increasing recurring revenue, does that imply, let's say, like new, let's say, like subscription-based services?

Yes. So for us, it's a combination, and we'll – obviously, as I said, starting with quarter one, talk about that more. So in the enterprise market for small and mid-enterprise customers, they have a very, very strong bias to consume things as a service. So the first step we are doing is not building a big data center for them, right. That's not what we are doing. Our service provider customers build and operate their own data centers, but are interested in new consumption models, which align with their use of public cloud or not and so forth. So it will be a combination of software, subscription and services.

Got it. Yes. And then question for Brian. First question. Brian, when you mentioned the goal of maintaining GAAP profitability, may I clarify whether that is on an annual basis or a quarterly basis?

Of course, when I was speaking about 6% to 8% revenue growth and maintaining GAAP profitability, that is on an annual basis, but we intend on managing expectations on a quarterly outlook to deliver the same.

Got it. Yes. Any guideposts on OpEx considering that there is a mix of dynamics between possible return of like sales and marketing, travel and events versus, let's say, like the other fact that we are still dealing with the pandemic in the first half?

Sure. Yes. Non-GAAP OpEx for 2020 was $142 million. We expect that to continue with the return of salespeople and marketing going back to normal. We lost about $4 million to $5 million last year and we expect some of that, if not all of that to return in 2021.

So $140 million as a baseline, plus like $4 million to $5 million of like some, let's say, like the return of travel and expenses?

That sounds about right. I might suggest $142 million.

Oh, okay. Oh, sorry. $142 million, yes.

$142 million base and $4 million to $5 million variable.

Correct.

I see. Got it. Okay. Thank you, Dhrupad. Thank you, Brian.

Thank you.

Thank you. Thanks for your questions.

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. A10 continues to execute amidst a challenging and uncertain environment. And our strong balance sheet, global presence and improved profitability, position us for continued success. I would also like to thank all the employees of A10 who put in tremendous hard work and focus in 2020 to achieve these results. Thank you and have a good day.

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