A10 Networks, Inc. (ATEN) Q2 2022 Earnings Report, Transcript and Summary

Good afternoon, and thank you for attending today's Second Quarter 2022 Earnings Conference Call. My name is Tania, and I will be the moderator for today's call. [Operator Instructions]. It is now my pleasure to pass the conference over to our host, Rob Fink, of FNK IR. Please proceed.

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 via the A10 Networks website at a10networks.com. Hosting the call 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 2022 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. You may access the press release, presentation and the trend 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 its projections for future operating results, potential revenue growth, industry and customer trends, focus on investment in go-to-market strategy and infrastructure, capital allocation strategy, M&A opportunities, supply chain constraints and expectations, it's positioning, it's repurchases and dividend programs and its market share. These statements are based on current expectations and beliefs as of today, August 2nd. 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. Its business and operations that could cause actual results to differ to differ materially and you should not rely on them as predictions of future events. A10 does not intend to update information contained in these forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law. For more detailed description of these risks, and uncertainties, please refer to A10's most recent 10-K. Please also know 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 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 company's press release issued today and trended quarterly financial statements that was posted on the company's website. With all that said, I'd like to turn the call over to Dhrupad. Dhrupad call was yours.

Thank you, Rob. And thank you all for joining us today. The second quarter was another strong quarter for A10. It was our 10th quarter in a row of meeting revenue and EPS expectations. I'm proud of the team we have built at A10 and the significant operational improvements we have driven together, leaning into our proprietary security led solutions, transitioning away from legacy offerings and positioning A10 as a recognized leader in one of the most important market catalysts in technology today, network security. A10 faces the same market conditions, supply chain challenges and economic realities as our peers. But despite COVID recessionary conditions, currency headwinds, and a global supply chain crisis, we have established a clear and durable track record of success. Central to this success has been our focus on the network security needs of our customers and our diversification efforts. We sell to two main customer groups, enterprises and service providers. And within these two groups, our business is aligned with two secular tailwinds infrastructure and cybersecurity. In the first half of 2022, the economy had a disproportionate impact on this mix. Cybersecurity continues to grow and the global geopolitical events have only served as more of a catalyst for this growth. Simultaneously, infrastructure build out requires capital expenditures, which can be impacted by interest rates and inflation unless it is linked to revenue generation. Like our peers, our visibility with small and midsized enterprises, especially related to infrastructure build out is not as clear as it was exiting 2021. However, cybersecurity solutions are being prioritized even amid economic challenges and especially by service providers for whom network security and reliability is a business essential. The net result for A10 is performance in the first half of the year that exceeded published expectations for the strengthening our confidence in our full year outlook and ability to invest for future growth. Driven by continued adoption of our proprietary security led solutions, revenue increased 14.9% year-over-year, our gross margin was better than 80% despite continued supply chain challenges and input cost pressures, driving higher levels of operating income, EBITDA and net income. During the second quarter, we achieved our rule of 40 goal. With revenue growth of 14.9% and adjusted EBITDA margins of 26.4%, representing a combined 41.3%. We ended the quarter with nearly $167 million in cash, or $2.13 per share. Even after returning more than 7 million to shareholders in the form of share repurchases and a cash dividend. We have a fortress balance sheet, positioning us to thrive. If the economy slows, and creating incremental opportunities as relative valuations reset. We also have a proven business model, with our bottom line growing faster than our top line. Building upon a strong legacy, we have built security solutions into every facet of our portfolio. As discussed before, product mix improvement is an important metric for A10. Standalone ADC continued to decline as a percent of overall revenue, even as consolidated top line grew 14.9% demonstrating the progress we have made in transitioning to a security and infrastructure solutions company. Today, A10 focuses on customer centric innovation, and a solution based sales approach, delivering tangible business value and industry leading total cost of ownership for our clients. Regardless of whether the solutions are deployed on prem in private cloud or public cloud. The cybersecurity threats only growing magnitude, frequency and sophistication. The war in Ukraine and the global diplomatic response has created new threats and exacerbated old ones. Our advanced machine learning solutions continue to identify and mitigate new challenges, such as the emerging LDP amplification threats. Our current solutions identify and cover a significantly broader spectrum of threats, including setting the standard for identifying and isolating DDoS attacks. A10s technology strengths, trends and infrastructure allow us to do this efficiently while providing best-in-class cybersecurity, integrated with network traffic flow. CIOs are increasingly focused on security first, and A10 is capturing share because of our differentiated approach to solving our customers problems. Let me highlight some key areas of progress within our business. Our revenue growth continues to be driven by our proprietary security led product revenue, which on a trailing 12-month basis, is now up 26%, backed by secular tailwinds overall product revenue, which is a leading indicator of future recurring service revenue increased 21% versus Q2 of 2021. From a geographic perspective, revenue from the Americas grew 33.7% year-over-year to $38.6 million reflecting our investment in commercial initiatives in the Americas, and strong demand for our solutions. AMEA revenue increased 10.5% year-over-year. Asia, including Japan was essentially flat on a constant currency basis, exceeding our expectations. Inclusive of the significant foreign currency impact APJ revenue decreased 7.1% year over year. Our diversification continues to provide a resilient foundation as different regions navigate macroeconomic and geopolitical headwinds. We continue to focus our investments in growth opportunities, including expanded and new capabilities in cybersecurity. We also continue to partner on hybrid solutions, enabling our customers to navigate their own technology roadmaps amidst the current economic climate. A priority within these investments is improving our ability to cross sell solutions to our customers, while enabling them to reduce overall CapEx and OpEx. Our own OpEx increased 11% year-over-year demonstrating these investments. Over the past year, our product revenue growth rate with existing customers has consistently exceeded our target growth rate, demonstrating our ability to successfully leverage our strong install base and bolsters our confidence in delivering 10% to 12% consolidated growth compared to the prior year. We are committed to maintaining a discipline flexible and opportunistic capital allocation strategy. The recent economic conditions have impacted valuations across the board. And while we will continue to demonstrate rigor in evaluating potential uses of shareholder capital, the current market conditions are only likely to provide increased opportunities. Supply chain issues continue throughout our industry. But to date, A10 and has been able to navigate these conditions, as evidenced by our gross margin improvements and our consistent ability to deliver products to customers. Our year-to-date performance reinforces our expectation that we can achieve our full year targets of revenue growth of 10% to 12% year-over-year, and EBITDA in the range of 26% to 28% of revenue for 2022. We have taken the current external environment into account and have identified levers in our business to achieve our targeted bottom-line performance for the year. With that, I'd like to turn the call over to Brian for a detailed review of the quarter. Brian?

Thank you, Dhrupad. Second quarter revenue was $68 million, up 14.9% year-over-year, the second highest quarter revenue in our history. Product revenue, which is a leading indicator for future revenue was $41.5 million representing 61% of total revenue, up 20.7% year-over-year. Services revenue, which includes maintenance and support revenue was $26.5 million or 39% of total revenue. Moving to our revenue from a geographic standpoint, as Dhrupad mentioned, revenue from the Americas including LATAM was $38.6 million, up 33.7%. Revenue from EMEA was $7.8 million compared to 7.1 million last year, you p 10.5%. Revenue from Asia, including Japan was $21.6 million down 7.1%, compared to $23.3 million in the second quarter last year, which is exclusively due to the depreciating yen to dollar currency exchange rates. As you can see on our balance sheet, our deferred revenue was $127.9 million as of June 30, 2022, up 10% year-over-year. Recurring revenue defined as support and subscription revenue grew 7% year over year to $29.2 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 are provided in our press release and on our website. Gross margin in the second quarter was 80.6%. Also, as Dhrupad mentioned, we continued to successfully mitigate the impact of industry wide global supply chain constraints and input cost increases. Non-GAAP operating expenses in Q2 were $38.7 million compared to $35 million in the second quarter last year, reflecting increasing investment in our growth priorities, including cybersecurity technology and commercial execution. We reported $16.1 million in non-GAAP operating income compared to $11.1 million in the year ago quarter. Adjusted EBITDA was $18 million for the quarter or 26.4% of revenue. Non-GAAP net income for the quarter was $13.4 million or $0.17 on a per share basis. Diluted weighted shares used for computing non GAAP EPS for the second quarter were approximately 78.3 million shares, compared to 79.3 million shares in the year ago quarter. On a GAAP basis, net income for the quarter was 10.4 million or $0.13 per share, compared with net income of $6.6 million or $0.08 per share in the second quarter last year. Turning to the year-to-date results, revenue for the first six months of 2022 was $130.6 million compared to $114 million in the same period last year. Up 14% year-over-year. Product revenue was $78.5 million year-to-date, up 21% from $64.9 million. Services revenue was $52.1 million of 6.1% from $49.1 million. Year-to-date gross margin was 80.4% which was driven by favorable product and geographic mix. Non-GAAP operating income was $27.8 million year-to-date, up 26.7% compared to $21.9 million last year. Adjusted EBITDA year-to-date was $31.5 million or 24.1% of revenue. Non-GAAP net income was $23.4 million or $0.30 on a per share basis. Weighted shares used for computing non-GAAP EPS for the first six month period were approximately 78 million shares. On a GAAP basis year-to-date net income was 16.8 million or $0.21 per share. Turning to the balance sheet, as of June 30, 2022, we had $166.8 million in total cash and cash equivalents, effectively unchanged from the year ago period. Year-to-date, we ever purchased 2.4 million shares, or $31.8 million worth and issued $7.7 million in cash dividends. We continue to carry no debt. In addition, the board has approved a quarterly cash dividend of $0.05 per share to be paid on September 1, 2022 to shareholders of record on August 15, 2022. In total, we returned more than $39 million to shareholders in the first half of 2022 between share repurchases and dividends. As Dhrupad mentioned, we are now well positioned to achieve our full year revenue target of 10% to 12% growth year-over-year and full year adjusted EBITDA margin of 26% to 28% of revenue. I'll now turn the call back over to Dhrupad for closing comments.

Thank you, Brian. I'm proud of A10’s ability to continue to perform better than the overall industry, both in terms of growth and in terms of navigating external challenges. Our proprietary security led solutions are enabling us to capture market share, and expand our customer base. We remain well diversified in terms of product mix, regional mix, and customer make, enabling a more durable model in spite of macro headwinds. Operator, you can now open the call up for questions.

Absolutely. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Hamed Khorsand with BWS Financial.

Could you just talk about the competitive landscape given the stronger dollar and how that could be impacting or benefiting you and some of your international markets?

So if you look at our global mix rights, of course, our strongest growth region was North America. So in terms of currency, that doesn't affect us. When you think of our business in Japan, clearly, as the yen exchange rate has gone from something like 105 to 136, it created a headwind, and we were able to overcome that by performance in North America. In Europe, our business is conducted mostly in USD denominated transactions. So while it creates a little bit of headwind in terms of higher local currency rate, it was not a material impact for us so far.

Okay. And is there any contributing standpoint from OpEx line given the strong dollar?

Not a significant impact from that perspective, because obviously, the local sales and marketing and other offices are offices and local currencies as well, so not a meaningful impact for as positive or negative.

And then the last question was, could you just talk about your sales funnel looking out? How much clarity do you have and do you see any customers pushing out potential orders?

So I think, we, of course, monitor multiple metrics to think of demand and our outlook on it. We see a win phenomenon where, because a lot of the lead times from several of our companies in the space are extended dramatically, but as it relates directly to A10, we are not seeing customers deliberately pushing out, meaningfully. So there is some push and pull, of course, with war in Europe and things like that the sales cycles are a little bit longer, but we don't see deliberate choice, where somebody's saying we will put this off for six months or nine months and I think Hamed, I would relate it back to because our solutions are directly linked to customers revenue generation, or maintaining quality or performance of networks versus just modernization. I think you know, we see those as being different categories, then discretionary IT spending, which may be more likely to be pushed out.

The next question comes from Christian Schwab with Craig-Hallum.

Hey, guys, congratulations on another solid quarter and 10 quarters in a row. And kudos on navigating, continued challenging supply chain environment, but kind of a tremendous shift in currency and kind of unprecedented again. When we look at your exposure there, and you're talking to customers, et cetera, where does the dollar to yen conversion rate should it moderate back from kind of this 12% extreme movement in the quarter to make your products competitive or not maybe possibly delayed if they actually were?

Yeah, good question. So, I think, I would say, even as it relates to Japan, we did not see delays or push outs because of currency concerns, per se. I think it's more, because the local transactions are in yen, so, it's more that we were able to absorb that on a constant currency basis, if you will, within our overall growth of 14.9%. And so from a demand perspective, because the local demand is in yen, and we are fulfilling it in yen, we don't see that as being something where things are different a lot. And in fact, our Japan team, in terms of yen performance is on track to what we expected. As things moderate out, I think, certainly, it eases out that headwind for us. But as I mentioned in the script, obviously, we are always navigating a lot of things. And we would also appreciate when that kind of tapers out, but in the meantime, we look for ways to offset that to still get to where we need to.

Thank you for the clarity in the set of slides on product differentiation, I think an explanation of making it more simpler for some investors to understand, as an analyst who's had to explain it to people. I appreciate that. With that being said, can you just give us an update on the competitive landscape and who, you guys are seeing the most often and who you believe your products stack up best against?

Sure, yeah. So, I think roughly two thirds of our sales are to the service provider segment, which includes cloud, telcos, MSOs, and so forth. And one third is enterprise. On the service provider portion on the security products, we would be competing with someone like Arbor networks, which is part of NetScout. And on the core sort of service provider, traffic and other features, we will be competing with someone like Juniper, and that landscape really has not changed, I would say materially from 90 days ago or even longer. On the enterprise side, which is one third of our business, it is predominantly large enterprises. And that would be financial services and other institutions that handle a lot of data and are handling a lot of users and security. On that segment, our competition would most often be someone like F5 networks. But the way our product is architected is we combined multiple kind of categories of products, which is a little bit unique, which is true for every company. But so it's not a one for one comparison, but those would be the names we would see most often as competitors.

And then my last question, I think, when you guys were talking about your extremely strong balance sheet and successful buyback program, dividends, et cetera. Did you hit your suggestions, you may use that to make acquisitions or to look at M&A with valuation multiples in the marketplace coming down to potentially create more capabilities/scale for your preexisting customer base?

As I said before and it's still true, is our first priority is investing in organic growth. And you can see, obviously, we are increasing OpEx to fuel faster growth, because that's the most efficient and fulfilling way to grow as well. Second is, of course, you know, return for investors, in addition to everyone else. And so in that context, we talk about buybacks and dividends. I would say the last part for us is we have already, the whole time, of course, opportunistically looked at ideas that might help us bolster either a product capability or reach a different vertical or customer base. And we will continue to do that. But do it in a way that's financially rigorous. And then you're correct. I think as things reset, maybe there's more things to evaluate. But our primary focus is really organic growth. And our plan is based on how we can continue to fuel that growth. Having said that, with that balance sheet, we feel good, that we can navigate turbulent times. And if something makes sense and is financially discipline way to do it, we will continue to look at those options as well.

The next question comes from Anja Soderstrom with Sidoti.

I'm just curious on the sales and marketing, it looks like that scaled back a little bit for this quarter and why is that?

I'm not sure, Anja, maybe that's on a GAAP basis. But on in absolute terms, sales and marketing is up 10% year-over-year. And R&D is up about 11% year-over-year. So I think we can tie out later, but we continue to invest more. And sales and marketing is higher, effectively one for the higher sales. So cost of sales for the higher revenue. And second is we continue to invest in more solution selling and security oriented sales. And R&D is up year-over-year as we invest more in as I said, new types of cyber threats and continuing to expand our net det.

Okay, sorry, my mistake. And then are you adding headcount to capture this stronger growth or you're not meaningfully adding any headcount?

It's a mix. So I think, you know, our growth in sales and marketing is a balanced approach. So we focus on better solution selling, expanding more categories with existing customers, selling based on security and ROIC value proposition and expecting obviously, productivity improvements as well, right. So yeah, we add headcount, but our growth is based on all of those things. And increasing headcount is just one factor and as obviously, they ramp up and become more productive, that's positive as well. But it's not limited to growing by adding more sales people, it's doing all those things together.

Okay, thank you. And then if you can just remind us, again, how correlated you are to this service providers CapEx cycles, and where you see the transition to 5G and where we are in that at this point?

Sure, yeah. So I think you know, for us, and yeah, of course, service provider category includes cloud companies as well as telcos and MSOs. And for us, obviously, we are engaged in many 5G design wins around the world. And obviously, that cycle is not as fast as originally a lot of people had expected. But for us, the approach was always a balanced one where we are engaged with those customers to modernize their current systems as well, by doing things like virtualization, offering more security. And as they make the investments to move to 5G, we are well positioned to take advantage of that. As it relates to correlation with their CapEx cycles, there is some correlation, but if you think specifically of 5G, the sequence is, there's a spectrum sale, then there's a radio build out, then there is infrastructure or optical backbone build out, then it's deployment of services. And so we are well positioned for that. But in the meantime, all those service providers also continue to invest their current CapEx and OpEx for either more security than they used to do or because they are adding new services or more subscribers, they need to add more capacity to handle that traffic. So we participate in those cycles, both existing and new. And security spending is not highly related or correlated to that CapEx cycle. It's more secular phenomenon. And infrastructure build out is more related to CapEx cycles. And as we said, obviously, with interest rates and other fears, that is little more depressed, but security is kind of secular from that.

The next question comes from Hendi Susanto with Gabelli Funds.

Hi, Dhrupad. I would like to inquire our secure perspective on the growth between enterprise and service providers. So service providers, they do for growth like above 20% for the first half, while enterprise growth is a select low to mid-single digit. Do you expect that growth profile to remain or should there be any catalyst that may let's say result in like higher growth in enterprise and maybe lower growth in service providers?

So, I think as we mentioned before, we don't try to specifically achieve a certain mix there. But the phenomenon is this, right? In the first half of this year, as I was saying before, service providers continue to have to navigate, adding subscribers, new services and facing new security threats. And so we continue to make progress with those around the world, whether it's MSOs, telcos or cloud companies. As it relates to enterprise side, of course, that is the segment where, our exposure is mostly to large enterprise, but that is the segment where economic conditions have had a stronger impact. And if you look at a lot of the peer groups that compared to, obviously, right, they are signaling very low or negative growth in that segment this year. So we think that that is a macro phenomenon that is impacted by war in Europe, interest rate, inflation, uncertainty, all that kind of issues. So we focus within that on verticals where we are more and more differentiated. And I think as the economic environment improves, that number could go up and service provider could be a little slower. But we look to achieve that, and I'll probably bring it back to my original point, right, that by design, we have built a more durable source of revenue where we are not dependent on one region or one vertical or one product to achieve our goals. So this is helping us also be much more balanced.

And then Brian, I would like to ask questions about gross margin. The first question is like the non-GAAP surface gross margin has been running at 85% to 86% in the first half, significantly above historical level. How sustainable is it at mid-80%. And then the second part is, during Analyst Day, you said the midterm 2020 to 2023, gross margin target is 78% to 80%. First half of 2022, gross margin is 80% at the high end. Is there any scenario that may bring 2022 gross margin closer to the low end of 78%? Or should we think that A10 is well positioned to be in the upper end of that like 78% to 80% mid-term target?

No, you're exactly right. We had guided 78% to 80% for this year on a full year basis for gross margin, we still think that that's the right range. We're obviously tracking towards the higher end of it, so I would say that's probably the right way to look at it. And then like you said, out years, we're targeting 80% to 82%. So we're tracking pretty well managing through what we can give in the environment.

And I think, Hendi, just one thing to add to that, right is, of course, what we don't know as a headwind is cost pressures, whether it's on shipping and logistics or ship supply or whatever. But what we do know is we are also driving a lot of productivity measures that have helped us offset those, right, which is what has helped us keep it at 80%.

There are no further questions in the queue. So I will now pass it back to Dhrupad Trivedi for closing remarks.

Thank you. First of all, I want to thank all the global employees of A10 for a great quarter and continuing to build a strong technical and commercial foundation for the future. And thanks to all of our shareholders for joining us today and for your continued support. Thank you.

This concludes the second quarter 2022 earnings conference call. Thank you for your participation. You may now disconnect your line.