Earnings Call Transcript - ATEN Q1 2021

Operator, Operator

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

Rob Fink, Investor Relations

Thank you, operator. And thank you all for joining us today. This call is being recorded, and webcasted live and it may be accessed for at least 90 days on A10 Networks’ Investor Relations website at a10networks.com. Hosting the call today are Dhrupad Trivedi, A10’s President and CEO; CFO, Brian Becker. Before we begin, I would like to remind you that shortly after the market closed A10 issued a press release announcing its first quarter 2021 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. You may access the press release, 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 for future operating results, continued reductions in operating expenses, continued efforts to improve operational efficiency and 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 for our business; the development and performance of our products; anticipated customer benefits from the use of our products, expectations and priorities with respect to 5G. These statements are based on current expectations and beliefs as of today, April 27, 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 the COVID-19 pandemic on the business and its operations that could cause actual results to differ materially, and you should not rely on them as predictions of future results. A10 does not intend to update the information contained in these forward-looking statements, whether as a result of new information, future events or otherwise. For a more detailed description of these risks and uncertainties, please refer to our 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. Dhrupad, the call is yours.

Dhrupad Trivedi, CEO

Thank you, Rob. And thank you all for joining us today. This was another solid quarter for A10, particularly in our strategic initiatives to grow recurring revenue and security solutions. Our deferred revenue, which is a good proxy for recurring revenue, grew by 11.8% year-over-year to $113.2 million. This is contracted revenue, which will be recognized in future periods, creating a solid and growing base for us and giving us greater visibility into our future results. Despite the expected timing impacts in Japan, overall revenues grew 2% year-over-year to $54.8 million in line with expectations. Our full year for Japan remains unchanged and positive. Aligned with our strategic goals, our recurring revenue continues to grow faster than our overall revenue. In fact, it increased 8% year-over-year and recurring revenue is becoming an increasingly large portion of our overall revenue mix supporting our long-term business model. This was our fifth consecutive quarter of organic growth. We have refined our go-to-market strategy, establishing strategic relationships with partners and resellers, and streamlining our sales organization around the globe to focus on the most promising and profitable opportunities. This strategy is enabling us to successfully transition from a provider of commoditized solutions to a strategic integrator providing best-in-class security solutions in several growth-oriented technological areas. The evidence of this is seen in our deferred contract revenue growth and the progress we have made in selling security solutions. Security solutions as a percent of our revenue mix have been steadily increasing. On a trailing 12-month basis, security solutions represented 57% of our revenue compared to about 50% of revenue for the trailing 12-month ending December 31, 2020. In particular, we are well-positioned in cybersecurity, 5G rollout, and network availability, including DDoS prevention. Each of these areas enjoys broad tailwinds and our offerings are best-in-class and differentiated. Additionally, new planned federal infrastructure investments further support these catalysts in the U.S. During the quarter, we had important wins aligned with our strategic goals. A large higher education network in Northern Europe was under heavy cyberattack; A10 was able to help them navigate this challenging time with remote students and also provide a much more comprehensive protection solution that includes multiple elements of protection versus point products from our competitors. Our ability to rapidly deploy a new technical solution and leverage our global support footprint were further enablers. The result is that 600,000 subscribers now have a more secure, robust, and available e-learning platform. Also, an online gaming platform in the Americas saw large growth in their traffic after COVID-related shutdowns. This strained their networks in terms of capacity, as well as increased risk of cyberattack. A10 was able to provide them a better price per subscriber, a smaller footprint, and more security. This competitive win was against a very large global networking giant. A10 won this business because our solutions ultimately provided better performance with lower CapEx and OpEx for the customer. The customer plans to deploy the same solution to other sites in the future. The inherent leverage of our business model is enabling us to grow our profitability faster than we grew our revenue. Due in part to continued disciplined execution, we grew our adjusted EBITDA by 80.9% and our EPS by 135% compared to the first quarter of last year, both ahead of expectations. Our first quarter adjusted EBITDA was $13 million, representing a solid start to the New Year. At the same time, we have increased our investments in areas that support accelerated growth while maintaining our current financial goal. With that, I'd like to turn the call over to Brian for a detailed review of the fourth quarter and full year. Brian?

Brian Becker, CFO

Thanks, Dhrupad. As Dhrupad shared, revenue in the first quarter was $54.8 million, up 2% year-over-year. First quarter product revenue was $30.5 million, representing 55.7% of total revenue. Services revenue was $24.3 million or 44.3% of total revenue. Moving to our revenue from a geographic standpoint, revenue from Japan was $13.6 million, down $4 million or 22.8% year-over-year. Asia-Pacific revenue excluding Japan was $6.3 million compared with $4.9 in the first quarter last year. EMEA was $8.6 million, up 49%, and revenue from the Americas was $26.3 million, compared with $25.4 million in the first quarter of last year. Revenues from the Americas increased 3.3% in the quarter due to stronger commercial execution. And we expect that to continue throughout 2021. EMEA revenue grew 48.5%. APAC excluding Japan grew 29.8%. These regions offset the expected 22.8% decline in revenue from Japan. Book-to-bill in Japan was 1.2 to one in line with full year growth expectations. Recurring revenue defined as support and subscription revenue grew 8% year-over-year to $25.6 million in the first quarter. As a reminder, our recurring revenue for 2019 was $94 million, growing to approximately $105 million last year. During 2021, we anticipate this transition to be neutral to our operating margins. As you can see on our balance sheet, our deferred revenue was $113 million, up 11.9% compared to $101.3 million as of March 31, 2020. With the exception of revenue, all the metrics discussed on this call 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 first quarter was 78.9%, up 53 basis points year-over-year due to a more favorable product mix. Non-GAAP operating expenses in Q1 were $32.5 million, down 14.6% from $38 million year-over-year. Our continued focus on execution to maximize efficiency and profitability in all areas contributed to this overall year-over-year decline. We continue to allocate resources to the most important long-term growth opportunities and optimize our global footprint to further improve execution. In addition, Q1 operating expenses also benefited by approximately $1.9 million year-over-year due to continued COVID-related restrictions, of which approximately $1.2 million from deferred marketing events and approximately $700,000 from reduced travel. We've reported $10.8 million in non-GAAP operating income compared with $4.1 million in the year-ago quarter. We also continue to improve our adjusted EBITDA significantly. This came in at $13 million for the quarter, a $5.8 million improvement over last year. Non-GAAP net income for the quarter was $9.4 million or $0.12 on a per-share basis. Diluted weighted shares used for computing non-GAAP EPS for the first quarter were approximately 79.6 million shares. On a GAAP basis, net income for the quarter was $2.7 million or $0.03 per share compared with a net loss of $297,000 or zero cents per share in the first quarter of last year. As of March 31, 2021, we had $161 million in total cash and cash equivalents compared with $158.1 million at the end of 2020 and $142.9 million as of March 31, 2020. For the quarter, we generated $2.3 million of cash from operating activities due to the changes in our expense structure and the financial leverage of our business model. We generated $1.5 million in free cash flow for Q1. As a reminder, we define free cash flow as net cash provided by operations, less capital expenditures. On September 17, the company announced a share repurchase plan for up to $50 million worth of our common shares over the next 12 months. We repurchased approximately 10,000 shares at an average price of $8.96 for a total of $88,000 during the period. During the quarter, we instituted a 10b5-1 plan to manage our purchases. We intend to review our plan from time to time, subject to compliance with rule 10b5-1. We are reiterating our full year outlook today as provided in the conference call accompanying our fourth quarter and full year results. On an annual basis, we expect to generate organic growth of 6% to 8%. We expect sequential growth in each remaining quarter of 2021. This expectation is based on the quality and quantity of our sales funnel, market momentum, and book-to-bill exceeding one in the first quarter. We expect to grow our bottom line faster than our top line, and we anticipate security solutions will continue to become a larger portion of our revenue mix. We expect this part of our business to grow at approximately 10%. I'll now turn the call back over to Dhrupad for closing comments.

Dhrupad Trivedi, CEO

Thank you, Brian. In summary, I am really excited about our prospects and growth outlook for 2021. We are increasingly viewed as a value-added leader in security solutions with best-in-class offerings and market tailwinds. Our initiatives to grow our recurring revenue are clearly working, and this is helping us increase our profitability. We are well-positioned for a strong 2021. Operator, you can now open the call up for questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question comes from Hamed Khorsand with BWS Financial. Please go ahead.

Hamed Khorsand, Analyst

Hi. So first off, could you just talk about the momentum you're seeing in your business? Is that coming from new customers or existing customers?

Dhrupad Trivedi, CEO

Sure. Yes. So I would say, Hamed, that there are two sides to it, right. So if you recall, about 80% of our business comes from existing customers, 20% from new customers. With existing customers, we definitely see positive momentum as it relates to growing their infrastructure, whether it's for 5G or 5G readiness or enterprise networks. As it relates to new customers, we continue to add new customers continuously as well. And so we are seeing a pretty robust growth from Japan, EMEA, Asia, as well as America, as it relates to adding new customers who will continue to grow and become more relevant, right. So we are seeing both dimensions of it: one is existing infrastructure investment protection or Greenfield investment, and the addition of new customers.

Hamed Khorsand, Analyst

And Dhrupad, as compared to the last call a couple of months ago, what's changed? It sounds like you have better clarity now. What are you seeing from customers that's giving you that clarity where you didn't have it going into Q1?

Dhrupad Trivedi, CEO

Yes. I think there's two sides to that, Hamed. The first is obviously, everybody appreciates there's uncertainties we can't control, whether it's COVID impact in India or elsewhere. But what we are seeing different is either that there are large customers who had paused quite a bit last year but are now growing optimistic with vaccines and things opening up, et cetera, where they are making catch-up investments or beginning to look at newer investments. So moving from purely a reactive mode of, how do we deal with people working from home, to how do we keep up with the infrastructure, right. So that, I would say, is one area where we definitely see improvement. The second place where we see positive momentum is as we have evolved to selling broader security solutions. And what I mean by that is connecting our value proposition to the customers' economic goals rather than simply competing on a commodity product. We continue to see very good traction with customers as it relates to working with us, engaging us more broadly, and buying more categories of products.

Hamed Khorsand, Analyst

Okay. My last question is, was there any 10% customer this quarter?

Brian Becker, CFO

Hamed, this is Brian. No, we don’t have a 10% customer in either revenue or balance sheet items for Q1 2021.

Hamed Khorsand, Analyst

Thank you.

Dhrupad Trivedi, CEO

Thank you.

Operator, Operator

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

Anja Soderstrom, Analyst

Hi. Thank you for taking my question. Can you talk a little about this funnel or what you see in there and are you able to quantify anything about that?

Dhrupad Trivedi, CEO

Yes, Anja, this is Dhrupad. So good question. I think, typically when we look at our outlook for the next quarter and full year, we tend to at least try to look for as many lead indicators as we can. So in that context, when we look at how our funnel is evolving in the different regions and then in the service provider and enterprise market, and when we look at our historical conversion rates on that, we feel very confident to say full year growth up 6% to 8%, right. So it's really connecting multiple lead indicators to our outlook for the year. And you saw the phenomenon with Japan where based on the funnel we had high confidence that on a full year basis, we think there will be positive and in line with what we expect. But based on the funnel, we also understood that there would be some timing impact on that. So it's more about getting better analytics and understanding better lead indicators to project as accurately as we can. Based on those, we feel confident reiterating the full year growth numbers.

Anja Soderstrom, Analyst

Okay. Thank you. You mentioned Japan was very strong for you in the last quarter when America was a little bit slower for you. Now it seems that has shifted. Can you just talk about what's driving that shift and what you're seeing in the different regions?

Dhrupad Trivedi, CEO

Sure. So, I think Japan, the phenomenon we had spoken of was originally, some of our large service provider customers there were planning to make investments in advance of the Olympics, and we prepared with all that capacity and experience in place as the Olympics were downsized and rescheduled. And all the ups and downs that went with it ultimately concluded with the understanding that no one externally is going to be visiting Japan. What we anticipated and observed is that our customers are still planning the same capacity increases driven by network demand, but they don't feel the timing needs to be right upfront, and it's more spread out through the year. So in that case, Japan continues to be one of our most balanced and best-performing regions, and that will not change this year. We just saw a timing impact. When it comes to North America, I would say if you go back to last year and look at Q2, Q3, and Q4, we spoke about addressing the needs to improve commercial execution there, including leadership processes and how we organized territories, et cetera. A lot of the improvement you've seen in Q1 is a reflection of where our commercial execution in America continues to improve relative to what we always used to have from Japan. So we believe that gives us an opportunity and a foundation to build on growth from there. And as you heard earlier, we did this in a very balanced way without a single large customer affecting it. It's a result of improving commercial execution in America.

Anja Soderstrom, Analyst

Okay. Thank you. And can you also talk a little bit about the partnerships with Dell and Ericsson, how those are developing and when we might see positive impacts from them?

Dhrupad Trivedi, CEO

Yes, of course. So I’ll talk about the two separately. So, we announced the partnership with Dell in September, and as we discussed, we continue to work with them jointly to take it to market. This includes joint sales calls, marketing, and all of that. As we expected, the funnel is continuing to grow in line with our expectations. We absolutely are looking at, and have line of sight to multiple deals that will be meaningful for us by the second half. I would say that Dell partnership is progressing along the lines we previously communicated, and we expect it to start impacting our results meaningfully as well. Regarding Ericsson, it's similar. We are working with them on a next-generation software platform and are on track as it relates to customer trials and building that pipeline. As you know, you may have heard from Ericsson's call; 5G was a little bit slowed down with COVID, but they are extremely optimistic about the future and the growth that will come from it. In the meantime, we continue to collaborate with Ericsson as well as other service providers on their existing networks to move them toward 5G readiness. Both of those partnerships are on track as we have previously stated, and we expect them to have a meaningful impact on our results by the second half.

Anja Soderstrom, Analyst

Okay. And can you also just talk a little bit about what you see in the enterprise channel in general?

Dhrupad Trivedi, CEO

Sure. If you look at enterprise in terms of different verticals that make it up, our business is mostly by design targeted at large enterprises, which includes financial and gaming companies and so forth. The reason for that is our value proposition is most differentiated there in terms of throughput, latency, and security. Within the enterprise, the small-to-mid enterprise market, of course, we look forward to addressing it broader with our Dell partnership. In the meantime, our focus is on these large enterprises, and we certainly see continued positive tailwinds as they are increasingly concerned about security following some public breaches that everyone knows about. They continue to see more volume and demand for gaming platforms and related services as well. So, we continue to see that as a pretty stable tailwind for us in the large enterprise market. As for small-to-mid enterprises, we discussed what we are doing, and beyond that, there is general market sentiment of the enterprise outlook improving this year, which we hope will help drive our business, but it's not a major driver for us at this moment.

Anja Soderstrom, Analyst

Thank you. And then in terms of your recurring revenue dynamics, it grew year-over-year, but sort of conferred sequentially. How should we think about it? Is there any seasonality there, or how should we interpret that?

Brian Becker, CFO

Right, I know we've discussed this. It's a small portion of our overall revenue at 10% today, but it's growing faster than our normal run-rate revenues. From an overall recurring revenue perspective, half of it is support and service, and the other half is software and subscription. We are seeing good traction in the marketplace, and we expect to see that begin to benefit us as we continue through 2021 and into the next year. Obviously, with subscription revenues, you can see the impact more prominently at this point on our balance sheet in the deferred revenue, which has been growing significantly year-over-year in the Q1 outlook.

Dhrupad Trivedi, CEO

Yes, that's right, Brian. And just to add to that, Anja, because this is a strategic initiative with a focus to grow faster in the startup or ramp-up phase, yes, you will see some fluctuation. That's why we also tend to look at it as on a trailing 12-month basis to see if it's growing or shrinking. As we progress, you should see that variation reduce more and more so it's not a quarterly phenomenon but a continuous trend. But as we ramp up, there is a little variation. If you look at it trended, you will see that trend clearly.

Anja Soderstrom, Analyst

Okay. Thank you. And lastly, in terms of your balance sheet, you have a pretty strong balance sheet and expect to have strong cash flow generation. What are your capital allocation priorities? And I was a little surprised to see you didn't buy back more shares this quarter. Do you have any comments around that?

Dhrupad Trivedi, CEO

Sure, good question. So, I think our capital allocation priorities are funded by driving organic growth. We continue to look at that as the best way to drive our business model and profitability. Second, of course, is the buyback, and you are correct, Anja. We as Brian mentioned moved to a 10b5-1 plan for our purchases, and we will periodically review that. We do see a significant authorization for buybacks, and we consider it a good use of capital, especially as we continue to believe in the business more and more. So, we'll continue to revisit that. Beyond that, as we have said before, we look at any market opportunities to allow us to accelerate our growth with a small bolt-on product acquisition, but we will evaluate those very carefully because we want to create the foundation first that we can then build upon and accelerate. Our focus will be on whether these actions help us grow faster based on current tailwinds. But yes, we'll continue to revisit those opportunities over time.

Anja Soderstrom, Analyst

Okay, great. Thank you so much. That’s all from me.

Dhrupad Trivedi, CEO

Thank you.

Operator, Operator

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

Hendi Susanto, Analyst

Good evening, Dhrupad and Brian.

Dhrupad Trivedi, CEO

Good evening.

Brian Becker, CFO

Hi, Hendi.

Hendi Susanto, Analyst

First question, may I revisit the prior discussion on enterprise and potential market improvement? Our expectation is that enterprise IT will benefit from the economy reopening, hopefully in the second half of 2021. Would you share more about the outlook for enterprise throughout the remainder of 2021? And whether you have a normal feasibility or less feasibility into that?

Dhrupad Trivedi, CEO

Sure. Yes, good question. We don't publish specific goals for each vertical, but absolutely we expect in the back half of 2021 that we will continue to see improved year-over-year performance in the enterprise segment, especially in North America. We definitely see that phenomenon relating to both improving demand and network and security needs for large enterprises, but also hopefully a broader reopening of investment again in mid and small enterprise. We are definitely optimistic, and when we look at our improvement in growth year-over-year that is one of the key things we are counting on and working towards.

Hendi Susanto, Analyst

Got it. And then the second question, do you have any qualitative insight on further benefits from the Tokyo Olympics? Will it be reasonable to assume sales contribution related to the Tokyo Olympics in Q2 and Q3?

Dhrupad Trivedi, CEO

Yes. I think that's a good question. The way to think about it is that we absolutely will see that, but it will be now more spread out as networks grow in the region, not only tied to the Olympics. There is still growth in subscribers and in security needs, so we will see that. And you are correct, our full year outlook for Japan is still very optimistic and positive based on deals that we expect to happen in Q2, Q3, and Q4.

Hendi Susanto, Analyst

Okay. Even Q4, okay. Got it. That's helpful. And then last question, Dhrupad, can you share what types of subscriptions A10 currently offers, like what types and then the business model?

Dhrupad Trivedi, CEO

Sure. I think it's multiple ideas. I'll go through some specifics. Because the service providers can view products differently than enterprises, for enterprise customers, it could be something that they are paying monthly or yearly; it could be a term subscription, or it should be where they get a monthly security update. It aligns with their consumption model of us providing updates and value add to them throughout that period. The second dimension is where we are working with customers who are also selling subscriptions back-to-back based on our subscription. So, based on the number of users or volume of data, that is a proportional subscription as well. These are just two examples or flavors of it. Because our customer base is still two-thirds service providers, it's a little bit different than a typical company targeting small enterprises.

Hendi Susanto, Analyst

Thank you, Dhrupad. Thank you, Brian.

Brian Becker, CFO

Thank you.

Dhrupad Trivedi, CEO

Thank you, Hendi.

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, CEO

Thank you. Thank you to all of our investors, employees, and customers. As we said in the call, Q1 2021 was a solid start for us to the year, and we really look forward to growth from our strategic initiatives positioning us well for a strong full year. Thank you.

Operator, Operator

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