Earnings Call Transcript - ATEN Q2 2021

Operator, Operator

Good day and welcome to the A10 Networks’ Q2, 2021 Earnings Conference Call. I would now like to turn the conference over to Rob Fink of FNK IR. Please go ahead.

Rob Fink, IR Representative

Thank you, operator. And thank you all for joining us today. This call is being recorded and webcasted live and may be accessed for at least 90 days on A10 Networks’ website. 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 second quarter 2021 financial results. Additionally, A10 published a presentation and supplemental trended financial statement. You may access the press release, the presentation, and 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 projections, future operating results, including extra revenue, our continued efforts to improve operational efficiency, focus on driving growth, business optimization, and overall profitability; our belief that we can continue to build upon customer momentum going forward; our expectations regarding future opportunities and our ability to execute on those opportunities; our expectations for future market growth and the general growth of our business including in Japan; the development and performance of our products; and anticipated customer benefits from use of our products, our expectations and priorities with respect to 5G. These statements are based on current expectations and beliefs as of today, July 27, 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 on the 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 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. With all that said, I would now like to turn the call over to Dhrupad Trivedi, President and CEO of A10 Networks. Dhrupad?

Dhrupad Trivedi, President and CEO

Thank you, Rob. And thank you all for joining us today. The second quarter was a strong quarter for A10 validating the changes we have made in our strategy while driving operational improvements. We delivered 12.7% year-over-year growth in the quarter, resulting in 7% growth for the first half of 2021 and reinforcing our confidence for the year. I'm encouraged by all of our trends, including our improving revenue mix, our customer diversification, and market traction for our strategic product initiatives. As previously mentioned, we have made changes last year to improve commercial execution in the Americas, which is an important growth opportunity. Those investments are now delivering results as revenues in the Americas which includes Latin America, increased 20% year-over-year in Q2. The quality of our sales funnel and customer opportunities give us confidence that this is not a short-term fluctuation in buying patterns. We are systematically capturing market share in both of our verticals, driving larger sales with existing customers and building a more diversified customer base. In the service provider market, which includes telcos, MSOs, Cloud, and satellite providers, we continue to expand our customer base and grew our revenue even as our historically largest customer was not the largest contributor for the quarter. Their buying pattern was in line with their spending cycles and our projections. We were able to grow our customer count and expand our revenue per customer to deliver consistent growth in line with past projections. In North America, our average revenue per customer among our top customers has increased more than 30% year-over-year compared to the second quarter last year as our security solutions are helping us expand deals with key customers validating our opportunity to grow share of wallet with compelling solutions. This also contributes to further revenue diversification as we align ourselves better to secular tailwinds. Entering 2021, we stated that our strategic goal was to grow recurring revenue faster than consolidated revenue. Year-to-date, our recurring revenue has outpaced consolidated revenue growth rate, and we see that trend continuing. This is due in large part to the growing security needs of our customers and our offerings in this area that are helping us gain market share. Our solutions are built upon a foundation of high throughput, low latency, and the ability to scale. These have been further enhanced by natively integrating multiple securities like DDoS that offers sophisticated zero-day protection and multi-level remediation methodologies that can be fully automated. These attributes are directly relevant to solving our customers’ business problems and help deliver better returns on CapEx and OpEx for our customers, achieve cybersecurity objectives, and assist them in their own technology transitions while protecting current investments. We continue to invest in our strategic priorities while maintaining discipline in our resource allocation. We have taken steps to mitigate COVID-related challenges within the supply chain with minimal impact to our gross margins, as we focused on ensuring timely delivery to our customers. The net result is that our GAAP net income was $6.6 million in the quarter and we generated $17.2 million in cash flow from operations, enabling us to further strengthen our balance sheet even while repurchasing more than $11 million of stock in the quarter. Today, A10 is very well-positioned in growing markets with secular tailwinds. Striking events such as the colonial pipeline ransomware attacks continue to drive demand for security-led solutions. And we have the best-in-class solution to help address those challenges. The ongoing multi-year 5G rollout and focus on network availability with security is also driving ongoing demand. We remain focused on driving strategic initiatives for sustainable profitable growth, uniquely addressing the opportunity across cybersecurity, 5G, and digital transformation of businesses. With that, I'd like to turn the call over to Brian for a detailed review of the quarter. Brian?

Brian Becker, CFO

Thank you, Dhrupad. As Dhrupad mentioned, revenue in the second quarter was $59.2 million, up 12.7% year-over-year. Product revenue, which is a lead indicator for future recurring revenue growth, was $34.4 million, representing 58.1% of total revenue, up 17.6% compared to $29.2 million in the second quarter last year. Services revenue, which includes maintenance and support revenue, was $24.8 million, or 41.9% of total revenue, up 6.5% compared to $23.3 million in the second quarter last year. Moving to our revenue from a geographic standpoint; revenue from North America, including Latin America, was $28.8 million, up nearly $5 million or 20% year-over-year. Revenue from Japan was $15.6 million, up $2.7 million or 21% year-over-year. Asia-Pacific revenue excluding Japan was $7.7 million compared with $8 million in the second quarter last year. EMEA was $7.1 million compared with $7.7 million in the same quarter last year. As Dhrupad said revenue from the Americas increased due to the stronger commercial execution and improving market conditions. We expect that to continue throughout 2021. In Japan, we had said that Q1 results were impacted by the rescoping of the Olympics and a strong book-to-build gave us confidence in normalization. As expected, revenues in Japan did normalize, growing 20% year-over-year, and we believe Japan will deliver results in line with our expectations for the remainder of the year. As you can see on our balance sheet, our deferred revenue was $116.3 million as of June 30, 2021, up 10.8% compared to $105 million as of June 30, 2020. Recurring revenue defined as support and subscription revenue grew 6% year-over-year to $27.1 million in the second quarter. With the exception of revenue, all the metrics discussed on this call are on a non-GAAP basis unless otherwise stated. A full reconciliation of GAAP to non-GAAP results is provided in our press release and on our website. Gross margin in the second quarter was 77.9% despite industry-wide global supply chain constraints and temporary increases in logistics costs resulting from the global pandemic. Non-GAAP operating expenses in Q2 were $35 million compared to $34.1 million in the prior year. This reflects that increasing investment in our priorities and some resumption in sales and marketing activity. We reported $11.1 million of non-GAAP operating income compared to $7.2 million in the year-ago quarter. We also continued to improve our adjusted EBITDA significantly, delivering $13.2 million for the quarter, a $3.4 million improvement year-over-year. Non-GAAP net income for the quarter was $10.5 million or $0.13 on a per share basis. Diluted shares used in calculating earnings per share were 79.3 million shares. On a GAAP basis, net income for the quarter was $6.6 million or $0.08 per share compared with net income of $3.8 million or $0.05 per share in the second quarter of last year. For the quarter, we generated $17.2 million of cash from operating activities due to financial leverage of our business model. Revenue for the first six months of 2021 was $114 million representing 7% growth compared to the first six months of 2020. We reported $21.9 million of non-GAAP operating income compared with $11.4 million in the first six months of last year. Year-to-date adjusted EBITDA was $26.2 million, a $9.2 million improvement year-over-year. Non-GAAP net income was $20 million, or $0.25 per share. On a GAAP basis, year-to-date net income was $9.3 million, or $0.12 per share compared with net income of $3.5 million or $0.05 per share last year. As of June 30, 2021, we had $166.8 million in total cash and cash equivalents compared with $158.1 million at the end of 2020. We continue to carry no debt. On September 17, 2020, the company announced a share repurchase plan for up to $50 million of our common shares over the next 12 months. During the second quarter, we repurchased 1.2 million shares at an average price of $8.99 per share for a total of $11.1 million. We have approximately $19.6 million remaining in the plan. Based on improved visibility, we now expect quarter revenue for the third quarter of $60.6 million to $63.4 million with the bottom line growing faster than the top line. I'll now turn the call back to Dhrupad for closing comments.

Dhrupad Trivedi, President and CEO

Thank you, Brian. In summary, this was a strong quarter for A10. Systemic improvements we have made in our roadmap, organization, and commercial execution continue to drive and improve our business model. We have diversified our customer base and we are capturing market share. We are more efficient, growing our profitability faster than our revenue, and generating significant free cash flow. We are strategically well-positioned to benefit from significant secular tailwinds and growth catalysts including cybersecurity and the 5G rollout. We are increasingly viewed as a value-added leader in security solutions with best-in-class offerings. Operator, you can now open the call up for questions.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Christian Schwab with Craig-Hallum Capital Group. Please go ahead.

Christian Schwab, Analyst

Thank you for taking my questions. Great quarter and guidance. As we look to the improved visibility. I’m just wondering if you can give us some direction whether it’s kind of some of the bigger secular tailwinds like security in 5G that’s driving that which you highlighted or just a normalization of the Japan market. If you could give us any clarity on kind of the mix of those attributes to the improved visibility.

Dhrupad Trivedi, President and CEO

Sure. Yes. Good question. Thank you. So I think the first element around improved visibility comes from just a more positive outlook that we see in the market with customers and spending patterns and specifically during the business resumption where countries are coming out of lockdowns, there is optimism around the vaccine where people can go in and build out data centers and do testing and validation. So I think that is helping create more certainty around not just the need for our solutions but the timeline to actually implement them. So that’s the first element of it. The second element I think you spoke about security and 5G and I think the cybersecurity market in general is driven by two factors: one is the volume and sophistication of new attacks. But second, also by public announcements or known breaches that raise awareness and budget for protecting our businesses better. So that is certainly causing a reprioritization where that is an important budget category and high priority for customers to carry out and complete quickly. And last as it relates to Japan, in our Q1 conference call, we had spoken about the impending uncertainty around whether the Olympics would be canceled or resized or moved by year, etc., which had caused local service providers to moderate their investments more in line with data growth. So as we had said, we still expect that on a full-year basis they would spend the same amount, just that they did not have to do it in Q1. So as it stands now, obviously, I hope everyone is enjoying the Olympics as they have started already. And as we expected, the spending pattern instead of peaking in Q1 has spread out over the year and so but I would say that's a small part of our confidence and visibility which is driven more by what we see as customer attraction, engagement, and timelines where they need to deploy our solution.

Christian Schwab, Analyst

Great, thank you. And a question on the security business. And in your comments regarding share gains. Can you walk us through who you believe you're winning against most often in the security market right now as far as a competitor?

Dhrupad Trivedi, President and CEO

Yes. Fair question. So obviously the complexity with the security market it's highly fragmented and there are a lot of categories that people need to choose and prioritize around what is most important to their situation. So typically, our solutions which are using technologies like DDoS attack prevention, SSLI and so forth, we will be competing with a wide variety of companies in the space including but not limited to obviously, Juniper, F5, Radware, Citrix and everyone but more importantly, it's not just about replacing competitor one for one it's more about helping the customer solve that security problem and prioritizing our solution as being the most relevant thing for them to do.

Unidentified Analyst, Analyst

On the competitive front, when you win against various vendors, what are the top two pieces of feedback you receive from customers about why you won? Can you provide more insight into that?

Dhrupad Trivedi, President and CEO

Of course, yes. So the number one reason why we win is when customers carry out technical head-to-head testing of multiple solutions, our solutions are able to deliver higher throughput with lower latency and withstand a higher volume and complexity of cyber attacks. So that's probably the number one reason. The number two reason is our cybersecurity solutions because of the legacy of the company and the great technical foundation, the solutions are fully integrated and have not been built upon a series of acquisitions we made over the years. So from a customer perspective, that directly results in lower CapEx and lower OpEx to operate our solutions.

Christian Schwab, Analyst

That's great. All right. Fantastic. No other questions. Congrats on the great results. Thank you.

Dhrupad Trivedi, President and CEO

Thank you.

Operator, Operator

The next question comes from Hamed Khorsand with BWS Financial. Please go ahead.

Unidentified Analyst, Analyst

Hi, this is Zaheer for Hamed. Thank you for taking my question. I have a couple of inquiries for you. First, can you explain the decline in operating margin in Q1 compared to Q2 and what contributed to that difference?

Dhrupad Trivedi, President and CEO

Thank you for taking the question. Just a couple of questions for you. The first one on operating margin. Could you provide some details on why there was a decline in Q1 not so much in Q2 and so what led to that difference?

Brian Becker, CFO

Yes. Thanks for your questions. Thanks for joining. Q1 in the last earnings call we announced that there was lower than expected travel and entertainment expense just related to lockdown. Obviously, we had some challenges with closures at the customer sites and doing proof of concepts and even delivering and installing equipment. But as the pandemic has been easing and seeing, things opening back up, we're beginning to see things resumed to normal. We really saw in Q2, travel and entertainment, as well as event expenses pickup. We also were able to reintroduce more installation services and other travel expenses. So that's largely what you're seeing is because of the pandemic, there was basically a deferral of sales and marketing expenses into the later part of the year.

Unidentified Analyst, Analyst

And do you expect that to continue for the rest of the year?

Brian Becker, CFO

No, I mean, there will be a little bit of carryover in terms of the lockdown. We won't be able to make up everything that we've planned for the year, but for the full year, we continue to expect to see the same level of expenditure in OpEx. As we begin to grow revenues further than expected, we'll see that grow at a slower rate, but we will see a growth.

Unidentified Analyst, Analyst

And then the last question on costs. Are there other areas where you see cost-cutting opportunities?

Brian Becker, CFO

Well, I guess the answer to that is we're not necessarily in cost-cutting mode at this point. We're redeploying resources, investing in growth for our strategic initiatives. So I wouldn't say that we're looking for cost containment as much as ensuring that we're deploying resources the most efficiently for the best return on our investment.

Dhrupad Trivedi, President and CEO

And I think the way to think about it is there's two parts to it. There is structural cost reduction which we carried out beginning in 2020 which is to resize our cost pool for the business and potential and then obviously, on an ongoing basis, as Brian said, we ensure resource allocation to the best growth opportunities, and then continue to drive process improvements, which allow us to grow the top line but also grow the bottom line faster than that.

Unidentified Analyst, Analyst

So that's more of an evolving quarter-to-quarter change where you see opportunities to take advantage of efficiencies. Okay. Perfect. Thank you.

Dhrupad Trivedi, President and CEO

Yes, it's more of a continuous improvement category than massive structural cost reduction. Correct.

Unidentified Analyst, Analyst

Thank you.

Operator, Operator

The next question comes from Anja Soderstrom from Sidoti. Please go ahead.

Anja Soderstrom, Analyst

Hi, and thank you for taking my questions. Congratulations on another great quarter. And also some questions about the expenses on the gross margin for the products. It's been a bit larger this quarter and last quarter stuff due to the supply chain issues or what's driving that. And how do you see that coming quarters?

Dhrupad Trivedi, President and CEO

Yes. Thanks Anja for the question. As you said, you're exactly right, we did experience some pressure and margins related to the logistics and freight, as well as some of the costs on our inventory as a result of the pandemic and global supply chain challenges. I'd say we've done a pretty good job of mitigating the impact of that and neutralized most of it. But you do see a little bit of impact. As far as where we think we will be going with that, I believe we've addressed most of our current risks and expect to continue to improve as we go throughout the year.

Anja Soderstrom, Analyst

Okay, thank you. And then this global distribution center transition expense. Is that related to improving your supply chain organization or what is that in regards to?

Dhrupad Trivedi, President and CEO

Yes. Good question. So our global distribution and delivery center is related partly to that, but is more about the idea of continuing to simplify our footprint and improve efficiency. So it is actually helping us become more efficient in multiple functional areas while at the same time, of course, also helping with the supply chain-related simplification. So it's more around our footprint and being proactive like a year ago to continue to drive and set it up in a way that allows us to continue to drive improvement on an ongoing basis while simplifying our operating structure so we can spend more time on growth and strategy.

Anja Soderstrom, Analyst

Thank you. Regarding your strong revenue performance this quarter and your guidance for a solid third quarter, I am aiming for around 8% annual revenue growth. How should this be considered in light of the recent developments?

Dhrupad Trivedi, President and CEO

Yes, that's a good question, Anja. As we've mentioned in the first and second quarters, there has been a timing shift in some of our regions due to macroeconomic conditions. You're right that our Q3 guidance positions us to potentially achieve the higher end of our range or slightly better. As market conditions improve, we aim to capitalize on that, but our guidance is based on our own initiatives and factors within our control. If the adoption of 5G accelerates, as we've discussed previously, we see that as a positive driver for our business. Brian, do you have anything to add to that?

Brian Becker, CFO

That's exactly right. As things are improving, as we see as the pandemic is lifting and things are opening up which just presents opportunities for us and as well as the market conditions. And we are seeing a lot of activity in the market which is really pushing us along from the tailwind perspectives.

Anja Soderstrom, Analyst

Thank you. Regarding the Olympics in Japan and their operation without an audience and other live streaming, how is that impacting your business?

Dhrupad Trivedi, President and CEO

Yes. Good question Anja. So as we had not known but anticipated in Q1 our customers were faced with a situation of if there were going to be a lot of visitors, and they wanted them to have a good experience on 5G and connectivity and so forth. They were going to invest earlier in the year to be ready for that. As the scope changed in relation to visitors from other countries and so forth, as we had expected, their investments are now more in line with growth in data and video and subscribers in the market. So instead of spending it up front in Q1, and then less in Q3 to Q4, we expected that to be more spread out over the year. And that is consistent with what we see in our funnel and opportunities and kind of customer discussions. The full-year outlook may not be different. It's just not as front-loaded, as they had to spend it all in Q1 to be ready for the Olympics.

Anja Soderstrom, Analyst

Okay, given that then is also then chance that maybe some of that spills over into next year, or?

Dhrupad Trivedi, President and CEO

There is a chance that some of it goes over into next year. Absolutely correct. Yes. Because it will be more driven by growth in data and subscribers versus a specific event. And as Brian said, earlier, in Q2, we did see that rebound where the Q1 investments had been moved forward to Q2 at least. So that's correct. Yes, it's possible that it continues to carry over.

Anja Soderstrom, Analyst

Okay, thank you. And then one last question, if I may. You alluded to our portfolio pruning, and even on this call. How's that progressing? And how is that affecting your near-term revenue opportunities?

Dhrupad Trivedi, President and CEO

Yes. So for us, I think we had spoken in an earlier call more related to the concept of portfolio management. So we are not discontinuing any product lines. We have not stopped any customer project. It was more to do with how do we align our OpEx whether it's in sales and marketing or R&D, with the best growth opportunities and the best customer opportunities and therefore, it's right to make those investments from a portfolio perspective to the best opportunities, some of which may be longer term. So I think it was more in the context of how do we continue to deliver new innovation and products with our current R&D, and sales and marketing OpEx and how do we manage that as a portfolio. So that was more of a concept. So there's no revenue impact. If anything, we are hopeful that doing that is going to help us grow faster.

Anja Soderstrom, Analyst

Okay, thank you. That was all from me.

Dhrupad Trivedi, President and CEO

Great. Thank you Anja.

Operator, Operator

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

Hendi Susanto, Analyst

Good evening Dhrupad and Brian. Hi Dhrupad, can you provide more insight into the business dynamics in enterprise? A few months ago, we discussed the impact on self activities. How do you currently characterize the business dynamics in enterprise?

Dhrupad Trivedi, President and CEO

Sure. Hendi, thank you, good question. So for us, the enterprise market focus heavily is on large enterprises and especially within that on applications that focus on managing a lot of data, worried about security, etc. with critical business and IT applications. So in that market, we are seeing two things happen. One is that is increasing awareness and concern around cybersecurity, which obviously is favorable to us in terms of engaging those customers in that conversation. And second is we certainly see in regions that are seeing high vaccination rates and so forth, there is more optimism and opening around deployments that they can start conducting and testing with our products as well. So I think we see that as something that continues to open up versus where businesses were let's say a year ago that were more concerned about ensuring that people can work from home rather than that IT infrastructure.

Hendi Susanto, Analyst

I see. And then Dhrupad and Brian, the recurring revenue target of 120 million exiting year-end 2021. Can you help us break down between products and services in that 120 million?

Brian Becker, CFO

Sure, yes. Hi, thanks for your question Hendi. Just to level set, so recurring revenue half of our revenue base portion of that is support services and a portion of that is security products exiting we expect to have from growth to 120 million, and I'd say about 10% at least will be attributable to our security products.

Hendi Susanto, Analyst

That's helpful. Brian, if I look at the operating expenses, I remember that the baseline is approximately 142 million, plus or minus 4 million to 5 million of expenses with earnings post-COVID. If I consider that, it suggests higher operating expenses in the second half, is that a correct assumption?

Dhrupad Trivedi, President and CEO

Yes, I think you're exactly right. Based on last year’s 142 million annually in operating expenses, we are anticipating a similar level with a return to normal sales and marketing expenditures, including travel, entertainment, and marketing events in the range of 45 million. That reflects what you are observing, but as we continue to produce and grow the business and increase revenue, we expect some sales and marketing expenses to rise accordingly. However, as we've mentioned, operating expenses will trend at a rate lower than the top line. Therefore, with our overall revenue growth for the year projected at 6% to 8%, we expect operating expenses to grow at a slower pace, leading to quicker improvements in our bottom line results.

Hendi Susanto, Analyst

Okay. And then Dhrupad, it's quite interesting to see sequential increase in R&D spending and then assuming that you will spend more on R&D in the second half, can you give us some insight into where you are spending in R&D?

Dhrupad Trivedi, President and CEO

Sure, yes. Good question. And I think that's a fair assumption is that we will grow our cost structure at a slower rate. But certainly, we want to make sure we are investing in the right priority. So for us from an R&D spending perspective, the most important areas of spending growth will be in security-related products, whether that's DDoS, or SSLI, or features in our platform that make it more secure. So that's the most important thing. The second area where we continue to invest in R&D is on differentiation in our products that is based on creating higher throughput and low latency for all applications. And the third area for us is really where we are able to integrate or add more and more features to our common platform, which makes it easier for a customer to consume and use our products. So those are sort of the semantically the most important areas of investment for us.

Hendi Susanto, Analyst

I see. And then last question for me, if I see the year-over-year decline of 8% in EMEA, besides lockdown and COVID, are there still other reasons?

Dhrupad Trivedi, President and CEO

No, I think that is purely macro driven impact when we look at how our business is evolving in core Europe or emerging parts of Europe. It's all positive developments as it relates to customers and funnels. So that is purely a timing impact about COVID-related shutdowns and slowdowns.

Brian Becker, CFO

And I might point out that if you look to 2019 to 2020 to 2021, there was a pretty large growth year-over-year from 2018 to 2020. And then back to more normal levels in 2021. So I wouldn't see it as much as a decline year-over-year as much as an improvement over the last few years as a whole.

Hendi Susanto, Analyst

Thank you, Brian. Thank you, Dhrupad, and great Q2 executions.

Dhrupad Trivedi, President and CEO

Thank you Hendi. Thank you.

Operator, Operator

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

Dhrupad Trivedi, President and CEO

Thank you. And thank you to all our shareholders for joining us today and for your ongoing support. And thanks to all the great A10 employees that made these results possible. Thank you.

Operator, Operator

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