A10 Networks, Inc.

Good day, and welcome to the A10 Network's second quarter 2020 financial results conference call. All participants will be in a listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note that this event is being recorded. I would now like to turn the conference over to Rob Fink, of FNKIR. Please go ahead, sir.

Thank you, Operator, and thank you all for joining us today. This call is being recorded and webcasted live and will be accessible for at least 90 days via ATEN Network's website at atennetworks.com. Hosting the call today are Drew Patruvetti, ATEN's President and CEO, and Tom Constantino, 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 second quarter 2020 financial results. Additionally, the company published a presentation and supplemental trended financial statements to its website. You can ask for a press release, presentation, and trended financial statements on the investor relations section of the site. During the course of today's call, managers will make forward-looking statements, including statements regarding their projections for future operating results, continued reductions in operating expenses, continued efforts to improve operational efficiency, their focus on driving growth, business optimization, and overall profitability. Their belief is that we can continue to build upon customer momentum going forward and their expectations regarding future opportunities and their ability to execute on those opportunities. their expectations for future market growth and the general growth of its business, the development and performance of their products, and anticipated customer benefits from use of their products, their expectations and priorities with respect to 5G. These statements are based on current expectations and beliefs as of today, July 28, 2020. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond the company's control, such as the potential impact of COVID-19 pandemic on the business and operations that could cause actual results to differ materially, and you should not rely on them as predictions for future events. ATEN 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 the risks and uncertainties, please refer to the company's most recent 10Q report, Please note that with the exception of revenue, financial measures discussed today are on a non-GAAP basis and have been adjusted to exclude certain charges. The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP and 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 company's press release issued earlier today and on the trended quarterly financial statement posted on the company's website. With all that said, I'd like to turn the call over to Dhruv Head. Dhruv Head, the call is yours.

Thank you, Rob, and thank you all for joining us today. During the second quarter, we continued to make progress on our business transformations. While the environment remains highly fluid, with sales cycles elongated by the COVID pandemic and business restrictions in different markets, A10 continued to focus on execution and fundamental progress. I want to thank our entire team of employees and partners for their professionalism and flexibility during this unprecedented environment. To date, we have experienced a modest and manageable COVID-related impact on our business with only a slight impact on our supply chain. Customers are taking longer to make decisions and some larger deployments have been delayed as our customers deal with business restrictions and challenges related to the pandemic. We do not believe we have lost any business and we continue to enjoy strong and steady demand for our solutions. In fact, we delivered increases in both product and service revenue compared to last year, despite these COVID related slowdowns and delays. Overall, our revenue in the second quarter was $52.5 million up 6.7% year over year. From a regional standpoint, Our revenue in Japan and Asia has been more impacted than other areas. And we were able to offset these challenges with strong revenue in other geographies. Increasingly, our geographic diversification with a global footprint provides resiliency and flexibility for the business. Additionally, our strong balance sheet with $143.4 million in cash and marketable securities and no debt positions us well to weather these storms while investing in innovation for our customers. We continue to take structural actions to streamline our business model, which will continue to bolster this advantage further. We remain laser focused on improving our execution to maximize growth and profitability. As part of this, we continue to evaluate our investment decisions with the goal of actively aligning resources to the best opportunities and driving efficiencies in all functions. Our results in the second quarter demonstrate progress against these objectives. During the quarter, compared to the same period last year, and on a non-GAAP basis, we achieved an $8.2 million improvement in operating income, a $7.4 million improvement in non-GAAP net income, all on a $3.3 million improvement in revenue. We continue to believe we can reduce our total annualized operating expenses in line with our strategic initiatives and deliver sustained profitability. We previously stated we would reduce operating expenses for the full year by $10 million compared to 2019. We are raising that goal to at least $14 million for the full year, even as we expect sales and marketing expenses to go up based on economies around the world beginning to open up in second half of the year. Our gross margins in the second quarter were in line with our expectations. We added a total of 95 new customers in Q2 and believe that we can continue to build upon that momentum going forward with strong focus on improving execution in all areas. To that end, I'm proud to highlight some signature wins from the quarter. First, we closed a deal with a new service provider account in Eastern Europe requiring network address translation technology to support their network traffic growth. ATAN solution was selected due to superior product performance. Second, a large investment bank requiring an upgraded secure application delivery solution selected ATAN after a competitive proof-of-concept analysis performed by the customer. We were awarded this business due to our demonstrated low latency, technical feature set, rich analytic capabilities, and reputation for providing strong customer support. Finally, a government agency in Latin America, requiring a solution to enhance its visibility and inspection across its network traffic, selected ATEN to replace the incumbent vendor. ATEN was selected based on its past ADC performance, demonstrated security enhancements, and a unified management platform with ATEN Harmony solution. During Q2, the COVID-related disruption had most impact on Japan and Asia. In Japan, the postponement of the Tokyo Olympic Games shifted projects towards end of the year or in some cases, next year. Many other Asian economies were locked down due to COVID-19 concerns. In the second quarter, revenues in Japan and Asia Pacific decreased by $3.2 million compared to the same quarter last year. This was offset by a $5.5 million improvement in North American revenues and a $1.1 million improvement in revenue from Europe and Middle East. Our improving results in America were driven by expected strong demand from a large web giant accounting for greater than 10% of Q2 revenue and included in the service provider category. It is important to note that while we continue to have a strong market position with service providers, We are also dependent on their investment cycles, which can last multiple years and result in variable demand levels. We continue to drive demand from a diverse global customer base, and that gives us the best opportunity to deliver solid, consolidated results, even as short-term demand patterns fluctuate. In the meantime, we continue to take structural actions to improve our business models. I'm truly excited about the progress we have made on rapidly adjusting our product roadmap and portfolio to better align with market and customer trends and deliver the most meaningful business outcomes for them. These ongoing actions create a strong foundation for sustainable growth in the future in conjunction with our adjustments in the go-to-market strategy. The recently announced partnership with Dell is an example of where we can create value while partnering with a strong player in the market. With that, I'd now like to turn the call over to Tom to review the quarterly operating results in more detail. Tom?

Thank you, Drupad. As Drupad shared, revenue in the second quarter was $52.5 million, up 6.7% year over year. Second quarter product revenue was $29.2 million, representing 55.6% of total revenue. Service revenue was $23.3 million, or 44.4% of total revenue. Security driven product revenue comprised 56% of total product revenue in Q2. As a reminder, beginning in the fourth quarter of 2019, we revised our reporting to include our largest web giant customers within the service provider vertical. Moving to our revenue from a geographic standpoint, revenue from the Americas increased 29% from the year-ago period to $24 million, compared with $18.5 million in the second quarter last year. In Japan, revenue was Revenue was $12.9 million, down $2 million from the year-ago period, due partially to the impact of the delay of the Tokyo Olympics. Age-specific revenues, excluding Japan, declined $1.2 million from $9.2 million in the second quarter of 2019 to $8 million in the second quarter of this year. And finally, in EMEA, revenue was $7.7 million, an increase of 17% when compared with $6.6 million in the second quarter last year. As we move beyond revenue, all further metrics discussed on this call are on a non-GAAP basis unless stated otherwise. A full reconciliation of GAAP to non-GAAP results are provided in our press release and in our trended quarterly financial statements posted on our website. Our second quarter total gross margin was 78.8%. Second quarter product gross margin was 77.7%, 328 basis points better than the year-ago period due to favorable product mix from increased software revenue. Services gross margin in the quarter came in at 80.2% compared to 82.4% in Q2 of 2019 due to higher compensation-related expenses for services personnel. We ended the quarter with headcount of 758, compared with 785 at the end of Q1, reflecting the actions taken to focus on the appropriate strategic priorities and maximize productivity. As Drupad indicated earlier, we entered 2020 with the stated goal to reduce operating expenses for the year by $10 million. Based on our progress to rationalize expenses during the first half of the year, We are revising that to a reduction of at least $14 million, even with an expected increase in sales and marketing expenses in the second half of the year as economies start opening up. We also continue to evaluate optimization of product-related investments aligned with our strategic objectives to drive growth and profitability. Non-GAAP operating expenses in Q2 were $34.1 million, down 10.2% sequentially from $38 million, in the first quarter of this year and down 13.2% compared with $39.3 million in the prior year second quarter. Our continued focus on execution to maximize efficiency and profitability in all areas contributed to this year-over-year decline. We reported $7.2 million in non-GAAP operating income. We also continued to improve our adjusted EBITDA significantly, which came in at $9.8 million for the quarter. an $8.4 million swing from the year-ago period. As Drupad mentioned earlier, this reflects our focus on and commitment to improving profitability. Non-GAAP net income for the quarter was approximately $7.1 million, or 9 cents on a per share basis. Diluted weighted shares used for computing non-GAAP EPS for the second quarter were approximately 80 million shares. On a GAAP basis, net income for the quarter is $3.8 million or 5 cents per share compared to a GAAP net loss of 5.8 million or minus 8 cents per share in the second quarter last year. Moving to the balance sheet, average day sales outstanding were 80 days compared to 73 days in the prior quarter. This trend reflects typical seasonal timing of our revenue and collections. At June 30, 2020, we had $143.4 million in total cash and marketable securities compared with $129.9 million at the end of December. During the quarter, we generated $10.5 million in cash from operating activities due to the structural changes in our expense profile and the financial leverage of our business model. Due to the uncertainty in the environment and the inability to predict the course of the current pandemic, we've decided to continue to suspend our practice of providing full quarterly guidance. We remain committed to advancing our goals for profitable growth and our efforts to advance initiatives to improve operational efficiency. As the global economies continue to reopen, we anticipate higher marketing and sales expenses when compared to the second quarter of 2020. However, the structural changes we have made in our business already position us for significant decreases in total operating expenses on a year-over-year basis. In addition, we expect to maintain profitability in the third quarter as we continue to make progress on our long-term operating model. We expect gross margin to be consistent with our historical range of 76% to 78%. Operator, you can now open the call up for questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we'll pause momentarily to assemble our roster. And our first question will come from Anya Soderstrom with Sidoti. Please go ahead.

Thank you for taking my question, and congratulations on a good quarter. So, if you can just, can you hear me?

Yes.

Okay, okay. Hi. Just want to make sure. So, if you can just maybe elaborate a little bit on the expense reduction. It seems like you did a good job there, and it's more to take out than you had anticipated. Can you just elaborate on sort of what expenses that is, and are there any COVID-related expenses you've taken up now. You were alluding to the traveling and marketing. Are there anything else to think about there in terms of expenses?

Yeah, sure. So I think there's two categories, right, Tanya? And I would say from a COVID-19 perspective, you are correct. The main impact would be related to the idea that during the second quarter particularly, there was almost a complete freeze on travel, right, with sales and marketing activities and so forth. Also, marketing events that were typically part of that spending pattern, we had to readapt that, if you will, to more digital presence, et cetera. So that, I think, is a COVID-related impact that would obviously start to come back, and we would look for it to come back to support organic growth So that's the only one in that type of category. The structural cost changes that we are driving have to do with, if you look at the different categories on sales and marketing side and engineering side, they have more to do with, one, making changes in the organization and leadership, et cetera, to drive a higher performance level and higher expectation and productivity level. Second is creating a tighter focus on what are the biggest customer problems we are solving and how do we take it to market in the most effective way, right? So in that process, we continue to look for ways to leverage channel partners, which is direct sales, how do you best leverage the territory structure, et cetera. And then on the DNA side, I think our thinking is related to A, driving productivity and efficiency, and second is really being more aggressive on functions that are not customer impacting, service or support impacting, so that we are best positioned to continue to fund innovation, right, that our customers see value in, which is good for employees, customers, investors, everybody long term.

Thank you. That was good color. And then you mentioned partnerships. So you made some good progress on that over the past year. What can we expect? How important is that and what can we expect going forward? Like how much are you pushing that?

Yeah, and a good question. And I would say, you know, first of all, I'm very excited because that's a way for us to get to effective market coverage, better reach, and more cost effectively as well. And that is probably one area where, you know, we saw a slight impact from COVID in the sense all sales cycles are elongated. So typically our sales cycle may be six months. And with the new partners, right, we are seeing the same impact as anyone else in any other business. but we do see that as an important part as we build up the pipeline and start seeing those materialize most likely next year and, you know, hopefully somewhat showing up in the fourth quarter as well. But typical sales cycle takes six months and, you know, we are engaged with partners on actual opportunities, but they need to mature and then we'll have a steady pipeline. So it will be a really important part of our go-to-market strategy in terms of reach, as well as efficiency of reaching those customers, right? And we talked a little bit as well about on the enterprise side, particularly we think that leveraging partners and channels is certainly an area of opportunity for us in addition to driving productivity.

Okay, thank you. And then last one, The weakening U.S. dollar, you have a lot of international exposure. How are you seeing that thing? Are you hedging anything, or is that something that we should be concerned about?

Yeah, no, it's not a concern, and I'll let Tom add to it, right, but our transactions are U.S. dollar denominated except for Japan, I think, and that's why we manage that risk.

Sorry, go ahead, Tom. Yeah, and we do deploy... you know, hedging strategies to the extent that we have, you know, risk because of the yen to US dollar ratio.

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

Thank you. Thank you.

Our next question will come from Hindi Susanto with Gabella Funds. Please go ahead.

Good evening, Drupad and Tom, and then congrats on positive Q2 results.

Thank you, Hindi.

Drupad, could you talk more about the enterprise and business environment? And I assume that visibility is low. At the same time, many companies talk about digital transformation taking place in enterprises. So what is your view on enterprise segment?

Yeah, so certainly, and I think the way I would probably split that is you, as you mentioned correctly, you will hear several enterprise companies comment on enterprise market being really good or really bad. And I think the way I segment it further is a lot of the enterprise IT projects were originally scheduled and planned and budgeted based on the pre-COVID idea of everything becomes digital, you sell more services, microservices, etc., Those are the plans where we are seeing possibly a slowdown or push out because customers are dealing with more urgent topics. In the enterprise part, there is a second portion of it, which is with more remote work and more need to move faster to cloud, etc., companies are investing more in things that add capacity, flexibility, more security with people being remote, et cetera. And that's where the enterprise exposure is positive, right? And you'll see companies as they report on both sides of that range. So for us, really, the way we focus on that market is, especially with large enterprise, where there is a premium on performance, low latency, high security, and ease of use, therefore better OPEX for the customer, we certainly see that as a positive trend and expect that to be the case, right? And if you see one of the cases I highlighted was a large financial firm who was faced with adding capacity, adding more security, but really worried about latency. So in cases where there is a premium for that And there is a path for us. We see certainly positive trends in the enterprise. We see slowdown where the enterprise traditional budget was based on pre-COVID kind of planning horizon, right? And that is typically pushed out by a couple of quarters right now because the IT groups are dealing with more urgent topics. I don't know if that answers your question.

Yeah, that's very helpful. And then, Drupad, as the economy reopens, do you prioritize certain markets among different geographies?

Sure. So I think, as you know, of course, we have a strong presence in Japan, and they are going through a difficult period as well, and we hope that comes around and we are positioned very well with our products and customers. Second is, for us, we also... have made some progress last quarter with expanding our footprint and design scope in Europe market as well, which is good progress for us as a company. So as the economy opens up a little bit in Europe, even though today it's restricted to within Europe kind of deals and travel, we expect that to be an area for us with especially focus on products critical applications with high priority, right? And in the North America side, on the service provider part of the business, we saw some business up and down in the sense of companies that were shut down for so many weeks and therefore unable to do anything. But we also saw a lot of telcos, MSOs, cloud companies actively looking to add capacity and security features, right? What we see there, again, is a focus for us, which is, yes, we can help them with all the 5G-related things, but in the meantime, we have good engagements working with them on their existing infrastructure and enhancing that and getting more and more ready for 5G. And lastly, on enterprise, as I said, you know, it will not happen overnight. But I feel really good about things we put in place with partners and channels and so forth that will create a good foundation for us to, again, focus on high-value applications where we bring the most value for customers.

And then, Dupat, with regard to partnership with Dell, how should we think about the targets or your focus? Will it be enterprise, service provider, or both?

So I think it can be both, really, right? But enterprise, of course, they have a great footprint and exposure. So, you know, we will collaborate with them, of course, on either. And the way to think about it is a typical service provider sale is high touch, high technology, because that's, you know, the nature of what they do. And on the enterprise side, we expect to get more customers out of just the reach and access and integration with other solutions, right? So we see, you know, positive in those ways. And as I said, you know, a typical sales cycle is like six months, and I wish it was much faster, but we are very actively engaged with finding opportunities and building pipeline where, you know, it's advantageous and attractive to both of us, right? So I can't give you a number yet, but I'm certainly happy to update as we move forward into next quarter and beyond, where the pipeline stands and what progress we are making.

Drupad, may I know how do you plan to position 810 networks for OTT applications?

So I think when you think about that industry, the place where we intersect with over-the-top applications really is As those providers are creating data centers and huge amounts of content that they have to process and then put ad insertion and package it in different formats and all of that, the back end of that requires building large amounts of data centers, data farms, servers, et cetera. And as you can imagine, of course, there is a premium to maintaining high quality of service independent of how that content is repackaged and distributed. So in those scenarios, our goal is really to work with the OTT provider and in their backend where they are trying to handle a lot of data in a secure way. And that's really our intersection point, like it is for gaming companies, for example. So that's our intersection point. It's not at the device level, but it's at the core level.

Got it. And then one last question I will ask Tom. So Tom, A10 increase its annual cost reduction to like 14 million. If I look at last year operating expense, it was at like 163. So it will run, let's say, about like 148. And then if I look at the first half and then do some calculation, it would imply that second half operating expense will be 76 million. So does that mean that all the cost action plans have been completed?

No, we're constantly looking at how do we optimize, right? And so we're always looking to get as lean as we think we can be and as efficient as we can be. So we're going to continue to monitor that, that we felt comfortable enough with where we're at now to raise that bar for the full year. The numbers you said are – yeah, that's right on what we expect to be.

Got it.

Okay. And I would say the plans are not completed because the original plan for the $10 million were based on a full-year impact, so they were not completed in Q1, for example. But I would say the two elements are there is a structural element, and then there was a time-based element where we got, you know, temporary – on sales and marketing and travel and so forth, right? So I would say the fundamental structural stuff is still ongoing as it was for the full year and Q2, obviously, we saw slight benefit from the reduced travel. Got it.

Thank you, Rupa. Thank you, Tom. And all the best for the remainder of 2020. Thank you.

Thank you, Eddie. Got it.

Our next question will come from Hamid Khorsan with BWS Financial. Please go ahead. Hi.

So I want to start off. Is there a specific area where you're seeing the most amount of new customer additions this past quarter?

So I think so, Hamid. I think for us it was pretty broad-based. So when you look at our addition of 94 customers or so that we announced, I would say, or 95, it was some in Japan, Asia Pacific, EMEA, as well as America, right? And I would say nothing different than usual in that sense.

Okay. And then what are you seeing with customers causing you guys to have a lack of revenue outlook? And is it purely the elongated process or is it budgets being cut?

Yeah, good question. So, I think from that perspective, I would say it's more the latter. And it's two things though, Hamid. I think one is there are places today, right, where we sell that are in a lockdown where it is impossible for them to actually even go and pick up goods, right? So, in those cases, the uncertainty is coming from trying to predict in country X when they might be able to do that. And those can be material dollars. So that's more a question of business disruption rather than anything else. The budget part, we have not seen as a major issue so far. And part of it probably has to do with the fact that the sweet spot for us really is where Service providers are trying to deal with more subscribers, more capacity, more data on their networks. And on the enterprise, on large enterprise, they are dealing with people going remote and trying to support a more distributed environment. So we have not seen it in the sense of budgets being canceled to do something else. But of course, there is a slowdown of where if a certain MSO is closed for two months in Q2, we don't see any progression in our sales cycle, right? So it's sales cycle and business lockdowns around the world.

Okay. And then what is it your sales team could not achieve during the lockdown that requires a higher marketing expense?

So I think a couple of things. So one is obviously, you know, if you think about how our sales team approaches it, right, with our existing customers, they have been pretty effective at calling on them and continuing to sell more products or same products. The hardest things to do in that environment is adding new customers that are significant because those engagements typically need on-site demos, et cetera, et cetera, right? So I think The area where it would impact us really is in generation of opportunities for future. And, you know, while we are fine near term and demand is good, you know, I, of course, always want to be paranoid about am I bringing in enough new opportunities, new customers, new streams to continue growing, right? So I think that getting to kind of where we need to get to in the near term is not the crux of it. It's really much more to do with how do we then continue to enhance and build upon that for outer cores.

Okay, great. Thank you. Yeah, no, thank you.

This concludes our question and answer session. I would like to turn the conference over to Drew Pat Trivedi for any closing remarks. Please go ahead, sir.

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

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