A10 Networks, Inc. (ATEN) Q3 2021 Earnings Report, Transcript and Summary

Good day and welcome to the A10 Networks Q3 2021 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Jeff Stanlis with A10 Investor Relations. Please go ahead.

Thank you all for joining us today. This call is being recorded and webcasted live and may be accessed for at least 90 days via the A10 Networks website at a10networks.com. Members of A10 management team joining me today are Dhrupad Trivedi, President and CEO, and CFO, Brian Becker. 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 2021 financial results. Additionally, A10 published a presentation and supplemental trended financial statement. You may access the press release, the 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 our projections for our anticipate financial results, quarterly dividend payments and our expectations that we expect to utilize our entire net operating loss carryforwards in future periods, future growth and continued improvements to our business model, our visibility of future operations and confidence in our ability to accelerate growth beyond previous targets, and our ability to continue to return capital to shareholders. These statements are based on current expectations and beliefs as of today, October 28, 2021. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, such as the potential impact of COVID-19 pandemic on our 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 our company's most recent 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 not intended to be considered in isolation or as a substitute for 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. I would now like to turn the call over to Dhrupad Trivedi, President and CEO of A10 Networks.

Thank you, Jeff. And thank you all for joining us today. This was another strong quarter for A10, with revenue growth above our expected range and profitability growth that was double our revenue growth rate, again demonstrating the earnings power of our business model. This quarter validates the strategic changes we have made to focus on high value opportunities and regions, streamlining and adjusting our sales and marketing organization to better address these high value opportunities, and focusing on differentiated security-led offerings that drive recurring revenue. Today, we are a faster growing company, outpacing the overall industry and we are much more profitable, with a strong balance sheet and robust cash flow. We delivered 15% year-over-year in the quarter, resulting in 10% growth for the first nine months of 2021. As a reminder, our growth target was 6% to 8% at the beginning of the year. We are ahead of that for the year based on better-than-expected traction from our strategic initiatives, portfolio transformation, and improving execution, overcoming the impact of the pandemic and supply chain constraints. All of the underlying metrics including sales mix and revenue geography are in line with our expectations and highly encouraging. Let me highlight some key areas of progress. Security-led solutions increased 18% year-over-year in the quarter, with North America being the leading driver of this growth. Increasingly, A10 is differentiating itself as a leader in security led solutions, including the Zero Trust architecture. In addition, the ability of our solutions built upon a common platform to deliver superior throughput, security and availability directly drive lower CapEx and OpEx for our customers. As a result, we are taking market share. For example, in the quarter, a US-based tier 1 service provider wanted to deploy DNS over HTTPS or DOH to increase user privacy and security, while also maintaining more control over network traffic. A10 delivered the best price to performance ratio and reliability of any of the solutions the service provider considered, while also providing excellent support during the customer evaluation and solution deployment. The customer plans to rely on A10 for future DOH deployments when they are ready to expand. DOH is a critical part of Zero Trust security strategy. As you may have read in the news, an increasing target for cyberattacks is municipal utility companies. When a large Japanese utility provider sought an SSL visibility solution to address this challenge, A10 was able to answer the call and keep the lights on. The utility company chose A10's leading security solution in order to decrypt traffic across all ports and multiple protocols, eliminating the encryption blind spot and enabling the security infrastructure to inspect previously invisible traffic, detect hidden threats and defend against them. In a final example from Q3, a leading telecom provider in Northern Europe has seen a significant increase of DDoS attacks on both their own and their customers' network traffic. These attacks were increasing in both size and frequency. While they had a strong DDoS detection system in place, they could not mitigate and scrub the affected traffic at speeds that did not negatively impact the experience of their customers and internal users. They chose A10 to provide a clean traffic solution because of the effectiveness mitigation modes we can provide and the ability to manage multi-attack vectors at speed. Another key area of progress is improving commercial execution in North America. Revenues in the Americas, which includes Latin America, increased 47% year-over-year in Q3 and is up 22% year-to-date. The sales funnel and our bookings, as well as improving market conditions, give us confidence that we are well aligned with secular tailwinds, including cybersecurity, 5G and cloud. Led by our security solutions, we are capturing market share, driving larger sales and a more diversified customer base. We continue to see strong growth in our long-term deferred revenue, which grew 16% year-over-year in Q3. We believe A10 is well positioned with a compelling portfolio that is increasingly serving faster growing markets, resulting in consistent financial performance. Cybersecurity is the prime catalyst for our growth. And we are a proven partner to address ransomware attack, hacks and DDoS attacks. With that, I'd like to turn the call over to Brian for a detailed review of the quarter. Brian?

Thank you, Dhrupad. As Dhrupad mentioned, revenue in the third quarter was $65.4 million, up 15.5% year-over-year. Product revenue, which is a lead indicator for future revenue, was $39.8 million, representing 60.9% total revenue, up 23.7% compared to $32.2 million in the third quarter last year. Services revenue, which includes maintenance and support revenue, was $25.5 million or 39.1% of total revenue, up 4.6% compared to $24.4 million in the third quarter last year. Moving to our revenue from a geographic standpoint. Revenue from the Americas, including Latin America, was $32.3 million, up more than $10 million or 46.9%. Revenue from EMEA was $11 million compared to $7.9 million last year. Revenue from Asia including Japan was $22.1 million, down 17.2% or $4.6 million, compared to $26.7 million in the third quarter last year. As Dhrupad said, revenue from the Americas increased due to stronger commercial execution and improving market conditions for cybersecurity solutions, which we expect to continue. As you can see on our balance sheet, our deferred revenue was $117.1 million as of September 30, 2021, up 14.8% compared to $102 million at September 30, 2020. Recurring revenues, defined as support and subscription revenue, grew 3% year-over-year. With the exception of revenue, all 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 third quarter was 80.4%. We successfully mitigated the impact of industrywide global supply chain constraints and price increases. Non-GAAP operating expenses in Q3 were $38.1 million compared to $33.9 million in the third quarter last year, reflecting increasing investment in our strategic priorities including cybersecurity and commercial execution. We reported $14.5 million in non-GAAP operating income compared with $10 million in the year-ago quarter. We also continued to improve our adjusted EBITDA significantly, delivering a record $16.8 million for the quarter, a $4.3 million improvement year-over-year. This represents a 25.7% adjusted EBITDA margin for the quarter. Non-GAAP income for the quarter it was $13.7 million, representing 20.9% of revenue or $0.17 on a per share basis. Diluted weighted shares used for computing non-GAAP EPS for the third quarter were approximately $79.9 million shares. On a GAAP basis, net income for the quarter was $74.9 million or $0.94 per share compared with net income of $6.5 million or $0.08 per share in the third quarter last year. Approximately $65.4 million of our net income or $0.82 per share was related to a non-recurring tax benefit as a consequence of our sustained profitability over the last four quarters. For the quarter, we generated $21.8 million of cash from operating activities, resulting from organic growth and the financial leverage of our business model. We generated $20.8 million in free cash flow for Q3. As a reminder, we define free cash flow as net cash provided by operations, less capital expenditures. Capital expenditures is the purchase of property and equipment. Turning to the year-to-date results. Revenue for the first nine months of 2021 was $179.4 million compared to $162.9 million for the first nine months of 2020. We reported $36.4 million in non-GAAP operating income, compared with $21.4 million in the first nine months of last year. Year-to-date adjusted EBITDA was $43 million, a $13.6 million or 46% improvement year-over-year. Non-GAAP net income was $33.6 million or $0.42 on a per share basis. On a GAAP basis, inclusive of a non-recurring tax benefit, year-to-date net income was $84.2 million or $1.05 per share compared with net income of $10 million or $0.12 per share last year. As of September 30, 2021, we had $187.5 million in total cash and cash equivalents compared with $158.1 million at the end of 2020. We continue to carry no debt. In September of last year, the company approved the share repurchase plan for up to $50 million of our common shares over the next 12 months. Following the third quarter, there was no share repurchase activity under the plan. With that plan having expired, the board of directors has now approved a new $100 million stock repurchase plan. In addition, the board has approved a quarterly cash dividend of $0.05 per share to be paid, subject to any prior revocation by the board on December 15 to shareholders of record on November 12. Based on the year-to-date results, our growing deferred revenue and improved visibility, we are increasingly confident in our ability to deliver consistent financial results. For the fourth quarter of 2021, we expect to generate revenue growth of approximately 10% and we anticipate this growth rate to continue into 2022. This expectation is based on the quality and quantity of our sales funnel, market momentum and improving execution. We expect to grow our bottom line faster than our top line. We anticipate security solutions will continue to become a larger portion of our revenue mix and we anticipate conducting an Analyst Day in early 2022. At the end of the event, we expect to provide additional information about our business and future opportunities. I'll now turn the call back over to Dhrupad for closing comments.

Thank you, Brian. In summary, this was another strong quarter for A10, one of the strongest in our company history, building upon a great foundation. And our year-to-date results are ahead of plan. The systematic improvements we have made in our organization and our business model are driving sustained organic growth and improving customer acceptance of our solutions. This is driving meaningful financial benefits, including improving operating and EBITDA margins, enabling us to fund a significant stock repurchase plan and begin paying a quarterly cash dividend, all while continuing to generate free cash flow to continue growing the business. We are well diversified in terms of product mix, regional sales mix and customer mix, helping to insulate us to some degree from volatility within the dynamic industries we serve. More importantly, we are capturing our market share with proprietary and differentiated security-led solutions, enabling us to outpace the market. We are strategically well positioned to benefit from significant and growing catalysts, including cybersecurity and the 5G rollout. Operator, you can now open the call up for questions.

[Operator Instructions]. Our first question comes from Amit Goswami [ph] with EWS Financial [ph].

First, a couple of housekeeping questions. Was there a 10% customer in the quarter?

Yes.

What's the split between software and hardware?

I think we've discussed in the past, we sell a unified solution, hardware, software integrated into a platform. On a standalone basis, our software sales are approximately 10%.

The question I would ask you is, do you think any of the gains that you had in sales or in revenue beyond your original guidance, was that related to your competitors having issues, the supply chain or was this purely wins based on quality and price?

Good question. I think, typically, as you know, two thirds of our customer base is service provider, one-third is enterprise. And even within that one-third, it's mostly large enterprise. So this is not the profile of customers that is typically qualifying and running two or three different solutions at the same time and allocating share every quarter, right? So, in general, we would work with a customer six to nine months cycle to get designed in and integrated into their operating systems and business processes. So for us, it would be more an impact of was there revenue we were unable to realize because of supply chain constraints, more so than did we pick up orders because the competitor couldn't, right, because it's a long cycle. So, on the tail end of enterprise, that is possible. But most of our growth comes from the high performance valuing customers. And in those cases, it was because of them growing their infrastructure. Second, being more concerned about cybersecurity, and especially in light of government guidelines and things like that. And third, obviously, our ability to then fulfill that and translate to revenue.

The guidance suggests that this was more than just a one-off pent up demand from COVID reopenings. Is it all because security is becoming more and more important? Is it 5G related as far as 5G deployments are concerned?

I think as we noted on the call, on a year-to-date basis, our growth was about 10%. And, I would say, the bigger driver for improving market for us is really related to cybersecurity, and the fact that we are able to provide more integrated, more differentiated solutions. We do see signs on 5G side for new build outs, but as we have noted in previous calls, while 5G remains a tailwind for us, we certainly also continued to do a lot of business, supporting existing deployments with service providers around security and traffic management.

[Operator Instructions]. Our next question comes from Christian Schwab with Craig-Hallum.

This is Tyler on behalf of Christian. Congrats on the strong results and guidance here. I guess, first question, a little bit of clarification. You obviously outperformed your 6% to 8% growth this year. And you said you expect that 10% growth to continue to the future. Is that a comment for the full year 2022?

No. I think, Tyler, good question. I think it's not and I think that's why we pointed out that we plan to hold an Analyst Day in Q1 to talk more specifically about drivers and things about our business. I think it's more reflective that we do not see this as a temporary trend and it continues going forward for now, right, but we are not suggesting or providing that as full-year guidance, which we will do in much more detail at the Analyst Day.

A question on supply chain. I think it's top of mine of a lot of people. And it's great to hear you guys are mitigating those impacts to yourself. I was just wondering if there's potentially any indirect impact you guys might be seeing or benefit? I understand your lead times aren't extended, but maybe customers lead times are, customers planning schedules are maybe extended. Is there potentially any benefit or anything there? Any color there you can maybe provide?

I would say, the nature of that impact for us really is that customers have a need right now. And to the degree that we are able to fulfill that and deploy things on their timeline certainly is advantageous to us. Typically, they are also prioritizing multiple types of projects. And to the degree that we are able to meet that timeline is also beneficial to us, right? There may be, as I said before, instances in small to mid-enterprise where there are multiple vendors and we are the ones who could supply in time. But in general, for us, it's more that we are able to align with and fulfill that customer timeline, which obviously related to things like security can be quite important to them.

Final question, a little bit on the model maybe for Brian. Your OpEx is a little bit elevated in the back half of the year here, understanding revenue is up and you guys are making these investments for growth that you're clearly capturing. So I'm just wondering how we should maybe think about OpEx. Is a $40 million quarterly run rate in the next year a good way to think about that? And I guess do you expect next year to grow revenue faster than OpEx?

We are experiencing a pickup in operating expenses, mostly related to driving growth and revenue. So, be it commissions or travel on events and/or investment in strategic initiatives, be it product or other elements. On a go forward basis, it's running a little higher than I would expect for the full year next year on a quarterly basis. But it's a good indicator of where we're at, adjusted for market growth, given the 15%.

I think, Tyler, just a comment to add to your specific question, you should expect OpEx to grow at a slower paced than revenue as it has for the last eight quarters. And the proof of that is in the EBITDA as a percent of revenue increases every quarter. Right? So which was the case this quarter. We are close to 25%.

Our next question comes from Anja Soderstrom with Sidoti.

And congratulations on a strong quarter. I have a follow-up on the supply chain question. So, you make comments that you had some headwinds this quarter. But despite that, you had a strong margin performance. So, should we assume then that the margins are going to be better this quarter or do you expect further headwinds in the supply chain?

I would say we've navigated the supply chain crisis fairly well. Our sales cycle is six to nine months. So some of this you're seeing as a lag of prior period management and execution. But as it's been trending, we're always guiding between 78% and 80% margins, which I think is about the right range looking forward.

And, Anja, that's affected by product mix and regional mix as well, right. So we continue to navigate it, but that's the range.

Is most of the growth coming from existing customers or do you add new logos as well?

I think it's both. So, consistent with what we said in the past, about 80% of our business growth comes from existing customers, about 20% from new, and I think that trend is still true as we continue to add new logos as well. Right? And so, I think it's same profile as what we have seen before.

In terms of new contract wins, could you sort of speak to the sort of duration and magnitude of those compared to past wins?

Currently, obviously, we had a benefit in our tax expense as it relates to valuation allowance. I think we talked about that previously. Our expectation is that we continue our profitability on a go forward basis, which requires us to analyze our deferred tax assets and our expectation to consume them. So we expect effective tax rate will continue to be stable. I don't expect that we'll see it trending up or down significantly in the next 12 or 14 months.

Actually, that was not really my question. But I had my next question to ask about taxes. But, no, I was asking about the contract wins and the magnitude and duration of those compared to past ones?

I think it's pretty consistent, Anja. And some of the new customer wins, we certainly see the term is a little bit longer. But I think if you look at our historic average, it's not a huge difference for us. The data point you can look at, obviously, is our deferred revenue, and within that particularly long term deferred revenue, which obviously increased 15% plus year-over-year in the quarter. And so, that's obviously where you would see the financial impact of contracts that are longer and therefore appear in the long term deferred revenue line. So, you can see that that is growing pretty steadily for us, which is good and in line with our goals. And that's the connection point to see how much faster that is growing.

Our next question comes from Hendi Susanto with Gabelli Fund.

Dhrupad, you mentioned about Zero Trust network. Many companies mentioned that. Zero Trust network is a wide area. Can you remind us, like, what is unique in terms of A10 offering and whether there's any new use cases associated with Zero Trust network that A10 can capitalize?

I think the concept behind that architecture is, historically, cybersecurity was viewed as everything within a certain perimeter was considered safe. Like, if you're inside the castle, then you're fine. But what happens with things like colocation and sharing and cloud and everything else, that you could be under attack from somebody who is in the same castle as you, not necessarily someone from outside. So the concept of Zero Trust is you don't trust any device or any application until you can, right? And so, in that context, our products – so it is not a single product. But that approach requires multiple things. So we highlighted, for example, our SSL insight solution, which allows customers to manage encrypted traffic in a much stronger way, which is important part of Zero Trust. We talked about our ability to withstand and mitigate complex DDoS attacks at different levels of remediation automatically. That is an important part of Zero Trust. And then, the way our platform is built further adds to the concept of where we can provide more end to end security in many cases for those applications. And the last element, of course, on Zero Trust is training and awareness of users and customers on what are the types of attacks and how do they protect themselves, starting from something as simple as not clicking on emails that look suspicious, right? So, in that context, obviously, we provide that and we have threat intelligence services we provide to customers as well. So, those are all different elements that go into it. And it's not specifically a product, right? It's more of a cybersecurity philosophy and an approach. And so, we are working with our customers, typically on multiple elements of doing that.

Dhrupad, I think my interpretation is that Zero Trust network will strengthen like a dense offering and differentiation. I'm wondering whether in terms of dollar of contents, let's say, whether or not it multiplies dollar contents within the same scope of a project.

I think it's difficult to say that yet, Hendi. And the reason for that is, typically, when we work with CISOs and CIOs, they are looking at six, seven, eight categories of things they could do to become more secure. And so, in some ways, right, they're also prioritizing what to do first, what to do second. And in some ways, Zero Trust expands that opportunity, but also some elements it overlaps with, right? So, on a net basis, certainly we think that more customers adopting Zero Trust architecture is favorable to us. But it's too early probably for us to quantify what that means.

Dhrupad, would you remind us, in terms of products mix, which products have higher gross margins?

Because our products are all built on the same hardware platforms and foundation, there is not a significant difference on gross margin at that level across the products. So, for us, really, we really leverage very common platforms where the same box can be configured as one of five products we sell based on software, persona and identity and load we can put on it. So, for us, that's why we are able to maintain margins in a pretty stable way, even though we are selling much more of the security products.

Last question for me. So, the new share repurchase authorization is large. And then, there's a new dividend initiation. For the new dividend initiation, does it imply that there is no potential sizable M&A in the short run?

No, I think you have to at it maybe, Hendi, in a balanced way, right? So, we are generating, if you look at last quarter, between $15 million and $20 million cash flow from operations every quarter. We think, obviously, the buyback is reflective of our confidence in the business and where we think it's going to grow in the future. That dividend for us is just a balanced way of providing returns to shareholders, while we are still able to keep enough dry powder to fund growth or any other initiatives that we would consider. So, think of it as sort of a balanced way to achieve our goals.

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 ongoing support. We look forward to talking to you again. Thank you.

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