A10 Networks, Inc. (ATEN) Q2 2023 Earnings Report, Transcript and Summary

Good afternoon. Thank you for attending today's A10 Networks' Second Quarter 2023 Financial Results. My name is Cole and I'll be the moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. [Operator Instructions] I would now like to pass the conference over to our host, Rob Fink with A10. Please go ahead.

Thank you, Cole. 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 A10 Networks website a10networks.com. Hosting the call today are Dhrupad Trivedi, A10's 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 2023 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. You may access the press release, presentation, and trended financials 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, including potential revenue growth, industry and customer trends, capital allocation strategy, supply chain constraints, and expectations, positioning, or repurchase and dividend programs and market share. These statements are based on current expectations and beliefs as of July 26th, 2023. These forward-looking statements involve a number of risks and uncertainties some of which are beyond the company's control that could cause actual results to differ materially and you should not rely on them as predictions of future events. A10 does not intend to update information in these forward-looking statements whether as a result of new information, future events, or otherwise unless required by law. For a more detailed description of these risks and uncertainties, please refer to the most recent 10-Ks. 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 being considered in isolation or as a substitute for results prepared in accordance with GAAP and may be different from non-GAAP financial measures presented by other companies. A reconciliation between GAAP and non-GAAP measures can be found in the press release issued today on the trended quarterly financial statements posted on the company's website. With all that said, I'd now like to turn the call over to Dhrupad. Dhrupad the call is yours.

Thank you, Rob and thank you all for joining us today. This was an encouraging quarter for A10 with revenues that grew double-digits sequentially and nearly matched a particularly strong year-over-year comp. This performance supports our belief that the first quarter represented the floor borrower results with the expectation of sequential improvement as we move through the balance of 2023. In addition, we generated higher profitability, demonstrating our strong execution and the systemic profitability that is now central A10's business model. Our adjusted EBITDA margin for the first six months of 2023 was a record 26.6%, up 248 basis points compared to the first six months of 2022, demonstrating the earnings power of our business model. This also continues to be in line with our stated goal of 26% to 28% at our Analyst Day in early 2022. The marketplace remains challenging especially in North America and particularly with larger enterprises and Tier 1 service providers. Many of these organizations are taking a cautious and conservative approach to planned spending and the result is the shifting of some projects across periods. In the second quarter our revenue performance in the rest of the world offset this weakness in North America. We do not believe we have lost these opportunities. They have just been delayed. This highlights the importance of diversification in our business both in terms of geography and customer type. Businesses that are heavily reliant on the North American market faced a challenging macro environment right now. Our strong presence in Asia Pacific in particular helped us mitigate the North American headwinds in the second quarter. Additionally while many projects are being delayed, security investments are often the last to be trimmed both on a trailing 12-month basis and year-over-year in the quarter security-led revenue is up 6%. We have received questions about artificial intelligence and the impact of AI on our business. I'd note that we have used machine learning and AI especially in our security-led solutions for some time now. AI helps our DDoS mitigation solutions for example to detect and mitigate threats in real-time. In this respect AI act as a force multiplier, making our technology more effective and more attractive to customers. We will continue to harness the power of AI in this way. We expect the AI infrastructure to require extremely low latency and high throughput, as well as generating more and more network profit. This serves as a catalyst to encourage the construction of new and next generation data centers and the expansion of existing ones. In general, we believe AI serves as a tailwind for our business and aligned with the concept of making AI more cost-effective as that market continues to mature. Our business model enables us to proactively flex operating expenses based on near-term and mid-term demand. I want to note that we were mindful of our long-term goals particularly related to growth as we reviewed our near-term spend. As a result while our revenue is down 5.5% year-to-date, our operating expenses declined more by 6.6% enabling us to expand our profitability even while investing for future growth and navigating macro challenges. In fact our R&D dedicated to security products increased 3% year-over-year and is up nearly 8% from two years ago, demonstrating our commitment to investing in organic growth opportunities. Recently we highlighted how A10 carrier-grade networking and DDoS protection solution helped deliver a secure and consistent subscriber experience for businesses and consumers interest, one of the nation's largest telecom operators with over 50 million subscribers, chose A10 to help facilitate their networks shift to the cloud while protecting their subscribers' critical infrastructure. Our threat protection system provided the backbone to their security operations center, helping to analyze all incoming Internet traffic, detect anomalies and DDoS attacks and block or clear ill estimate traffic. Our new solution, enabling hybrid infrastructure directly helped created customer value in this case. A10’s DDoS mitigation solution has long been deployed by cloud service providers to protect their traffic. Increasingly important is the ability to monetize this mitigation by these cloud providers. In North America, our solution has been utilized by a cloud service provider to provide DDoS scrubbing service and continues to be significantly more effective over alternate approaches for almost five years now. Our consistent profitability fuels our capital allocation strategy. During the quarter, we paid $4.4 million in cash dividends and repurchased $6.2 million worth of our shares, all while growing our cash balance. We continue to focus on our three-pronged strategy for capital allocation. First, investing in our business for future growth. Second, returning capital to shareholders; and third, continuing to explore strategic and accretive acquisitions. With that, I'd like to turn the call over to Brian for a detailed review of the quarter and the first six months of the year. Brian?

Thank you, Dhrupad. Second quarter revenue was $65.8 million, a decrease of 3.2% year-over-year, but in line with expectations. Product revenue for the quarter was $39.1 million, representing 59.4% of total revenue. It's worth noting that sequentially, product revenue increased 25.4% compared to the first quarter of this year, reflecting the improving conditions Dhrupad mentioned. Services revenue, which includes maintenance and support revenue was $26.7 million or 40.6% of total revenue. Moving to our revenue from a geographic standpoint. Revenue from the Americas, including Latin America, was $36.9 million, down 4.2% year-over-year, but up 23.3%, sequentially. The year-over-year decline reflects slowing purchasing from larger customers, primarily service providers due to economic concerns. The decline in North America was partially offset by APJ, which increased 6.6% year-over-year on a constant currency basis. As you can see on our balance sheet, our deferred revenue was $132 million, as of June 30, 2023, up 3% year-over-year. With the exception of revenue, all metrics discussed on this call are on a non-GAAP basis, unless otherwise stated. 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 80.2%, in line with our stated goals. We reported $15.2 million in non-GAAP operating income, down 5.7% compared with $16.1 million in the year ago quarter. Adjusted EBITDA was $17.4 million for the quarter, reflecting 26.4% of revenue. I'd like to note that we were able to achieve our targeted EBITDA margins even as revenue declined by 3%. Non-GAAP net income for the quarter was $14.5 million or $0.19 per share on a diluted basis up from $13.4 million or $0.17 per diluted share in the year ago quarter. Diluted weighted shares used for computing non-GAAP EPS for the second quarter were approximately 75.4 million shares compared to 78.3 million shares in the year ago quarter. On a GAAP basis net income for the quarter was $11.6 million or $0.15 per diluted share compared with net income of $10.4 million or $0.13 per diluted share in the year ago quarter. Maintaining our net income on a lower revenue is a significant accomplishment demonstrating the earnings power we have built into A10. Turning to year-to-date results. Revenue was $123.5 million down 5.5% year-over-year. While product revenue is also down 10.5% representing approximately 50% of total revenue, services revenue was up 2.1% representing about 43% of total revenue. Year-to-date non-GAAP gross margin was 81.6% in line with our target. We reported $28.5 million in non-GAAP operating income up 2.7% compared with $27.8 million in the first six months last year. Adjusted EBITDA was $32.8 million reflecting 26.6% of revenue. Non-GAAP net income for the first six months was $24.5 million or $0.32 per diluted share up from $23.4 million or $0.30 per diluted share in the year ago period. On a GAAP basis net income for the first six months was $15.6 million or $0.21 per diluted share compared with net income of $16.8 million or $0.21 per diluted share. Turning to the balance sheet. As of June 30 2023, we had $153.9 million in total cash, cash equivalents, the marketable securities compared to $150.9 million at the end of 2022. In addition, accounts receivable has increased slightly sequentially and DSOs remained healthy decreasing sequentially. This is a function of delayed customer buying decisions with orders coming in at the end of the quarter. Our receivables remain very small and in line with our historical levels despite. During the quarter we paid $4.4 million in cash dividends and also repurchased approximately 43,7000 shares at an average price of $14.27 totaling $6.2 million in repurchases. We continue to carry no debt. As you have seen we have upgraded our independent audit firm from a regional audit firm to a national audit firm with capabilities to support our growing complexities. As we finished our 2022 fiscal year, we determined it was important to align our independent audit support with our expansion into new geographies and as we grow our business into new areas such as cloud and cybersecurity. We thank Armanino for their many years of support and wish them well. As Dhrupad mentioned, the Board has approved a quarterly cash dividend of $0.06 per share to be paid on September 1, 2023 to shareholders of record on August 15, 2023. I'll now turn the call back over to Dhrupad for closing remarks. <> Thank you, Brian. As expected, our results reflect improving conditions and continued demand for our security-led solutions. We continue to expect sequential improvement in the second half of the year, where solutions are in demand across all customer segments and in each of the target geographies aligned with durable secular catalysts. Operator, you can now open the call up for questions.

Thank you. We will now begin the Q&A session. [Operator Instructions] Our first question is from Gray Powell with BTIG. Your line is now open.

Great. Thank you for taking the question. Just a couple on my side. So it's good to see the decline in product revenue improved in Q2 from Q1. Were there any deals that slipped from Q1 that helped out in Q2? And then just how should we think about the potential for product revenue growth to return back into positive territory over the next six months or 6 months to 12 months? It just sounds like you have better visibility on things there. So would be curious how that should trend.

Yeah, no, good question, Gray, and I'll start and Brian can add to it. So I think in Q1 obviously, we had talked about unusually challenging market environment combined with some internal things we had to put in place. We did not see materially things from Q1 that had moved into Q2 right? I think in Q2 we are seeing improving visibility and potentially improving confidence in North American spending resumption. So I would say, a majority of that is coming from the market side rather than deferrals from Q1 to Q2. And to the second part of your question, as we look forward we continue to expect on the product revenue side improving performance into Q3, Q4 and back half of the year as we see North America markets like the normalizing relative to what we are seeing elsewhere. So we do expect that to not be reflective of things that are just moving across borders, but inherently improving market conditions and commercial programs that we have adjusted and put in place now to kind of resume that.

Understood. Okay. Great. And then I guess my follow-up question would be on the cost side. So, the controls on OpEx year-to-date has been impressive and it seems like visibility on demand is improving. So if that's the case like how should we think about reinvesting in the business particularly on the sales and marketing side? And is that something that would lead a recovery in top line growth, or would be investing on the sales and marketing side lag or recovery in top line growth? Thanks.

Yeah, good question. So I think, the way I would separate two components of that, right? So there's probably a more mechanical component of where sales and marketing spend, which is commissions and rebates and things like that, is, Flex is pretty obviously with revenue levels, right? So that's one component. So as revenues higher, just proportionally commissioned and variable cost of sales will be higher. Our investment beyond that in sales and marketing as it relates to commercial initiatives around marketing themes or events and so forth. Flex generally pretty close to our outlook and funnel. So we generally look at our pipeline, qualified outlook, trends in regions, which are relevant to us or negative to us and reflects our sales and marketing spend outside of commissions to that type. I think you would see not an increase in sales spending followed in six months when they ramp up in revenue I think you would see them occur much closer to each other because when we see opportunities, where we may be limited by adding sales headcount, we generally would add it before we see the rev.

Understood. Okay. That’s very helpful. Thank you very much.

Thank you.

Thank you, Gray. Our next question is from Hamed Khorsand from BWS Financial. Your line is now open.

Hi. I was hoping you would be able to go a little bit more deeper as to these purchasing decisions you're encountering these delays. What are the customers doing as far as what they have already infrastructure that allows them to be comfortable delaying these purchases? If you could just provide a little bit more understanding what's going on there?

Yes. Good question, Hamed. So first I would maybe differentiate, right? So our business is 50% in the Americas, 50% that were not in the Americas. The 50% not in the Americas is much more normalized already. The 50% in the Americas, where it typically relates to a large – large customer who could be a telco or a cable company, the nature of what we see is they have annual budget cycles, which reflects investments planned for the year and projects planned for the year typically around maintenance CapEx, capacity expansion CapEx and then new projects that they are funding to generate new sources of revenue. The nature of what we are seeing is as many of these companies themselves went through significant restructuring and cost adjustments in Q1 of this year and increasingly including today, right they continue to see cost of capital being a headwind. What they are doing? So in security type of products more often we will see a rescaling, where they will do half of the project now and half of the project later if you will, but not cancel it because it's critical in places where it was related to modernization. Those projects are generally pushed out six to nine months or more as in not critical to today's revenue or today's security. And I think in between the two is where our products are in line of customers generating revenue, we are seeing maybe push out in terms of their decision-making, where they have planned to spend something in June. Now they are saying they're going to hold off till we review all our CapEx again and maybe it's going to be July, right? So that's again because it's generating revenue for the customers, it's deferred but not canceled. So I don't know if that gives you more color on Hamed.

That's helpful. And are you seeing any of your customers reevaluate their security needs and maybe design you out or design you in based upon those? And how is that trend going?

I think that generally, the security spending category is not the same as one-off than IT spending categories right? Because security spending category also ties back into enterprise decisions and business operations risks and things like that. So, it's not just about upgrading IT. It's kind of a risk management as much as anything. So, as we see this environment I would say certainly the volume and complexity of attacks you keep hearing about in the press certainly increased their awareness and sensitivity to doing more things to make themselves secure. So, that trend is probably a tailwind for most security companies including for us. There's -- I don't think there is a lot of churn in that market because our customer base generally is larger companies and they spend a lot of their own time effort and integration into using these products, right? So, we don't see a lot of churn in that context, but we certainly see demand reflecting their increasing concerns in terms of what they see in the news right about the types of organizations being attacked and what the impact is.

Okay. Thank you.

Thank you, Hamed. Our next question is from Anja Soderstrom with Sidoti. Your line is now open.

Hi, thank you for taking my questions. So, congratulations on the good progress for the quarter. I'm just curious for what you see in terms of your customers and you said a lot of them have been going through restructuring themselves. And do you think that might have accelerated their digital transformation and their need for more services from you in terms of building that out for them?

Yes. Yes, good question Anja. So, I would say generally what that has meant for us or what we hear from them is they are more thoughtful about leveraging their existing infrastructure more efficiently and longer and more effectively. They are more concerned than before about being more secure and managing that risk better. I think where they are more thoughtful or cautious is really around big projects that originally required them to move in to different ways of consuming IT and so forth. So, I think there is a more balanced view of many of our customers who plan to use their on-prem networks along with cloud versus sudden change and put everything in a different place, right? So, I think said differently, I would say they are making decisions that are more economic-driven than technology-driven.

Okay. Thank you. And in the past year you've been talking about UK displacing some competitors. Have there been anything to call out in the competitive environment?

No, I don't think certainly in the last three, six months, we have seen any significant change in the competitive environment. I think the -- I would say the market force in terms of demand and customers is stronger, but no real change on how we compete and why we win and all of those things.

Okay. Thank you. That was all for me.

Thank you, Anja. Our next question is from Hendi Susanto with Gabelli Funds. Your line is now open.

Good evening Dhrupad and Brian.

Hi, Hendi.

Dhrupad, may I inquire your insight on business outside of North America, I think specifically I'm wondering like how similar, how different? And then if let's say if certain purchase orders or let's see purchase delays maybe lagging like outside of America, meaning that we may see those trends later?

Yeah, good question. So I think, Hendi, what is unique is in North America we have a combination of factors, right, which is concern about inflation, interest and movements in response to try to manage that companies themselves, therefore, seeing a reduction in their demand, therefore, restructuring on the new size et cetera. So that the scale of all those issues combined is certainly not true elsewhere. So outside of North America when you look at Europe as well as Asia, yes people are concerned about global outlook but not to the degree where their cost of capital is escalating and they are worried about inflation cost on the input side being unmanageable and having to do big restructuring. So we saw a couple of examples of those in a couple of big telcos in Europe. But outside of that I think we see the environment more normalized in the sense of purchasing decisions are made when they need to add capacity or they plan to add new security features. And, yeah, there's more questions asked and more signatures but it's not to the degree where we saw in the first quarter certainly right that US companies were themselves going through massive restructuring layoffs and all of that. So I think the North American environment is unique in that combination of factors even though yeah there is global pessimism and so forth. So that's probably one element of it. The second element I would say is that a lot of the regions outside of North America were probably already more focused on using their infrastructure better while upgrading technology and less focused on wholesale replacement of technologies, right? So in that case the shift is not that drastic up or down. And so, therefore, I think we see -- to the degree that we can help them do the things that they need to do by upgrading is the best path for them. So I think we see that not as a concern that they're going to see something dramatic later. You did see some of that right in a couple of European telcos going through big restructuring. But beyond that I think we don't see anything similar to the combination of factors we are seeing in North America.

And then Dhrupad, any update on product development and product road map for this year?

Yeah. So I think the -- what we have discussed before, so consistently our investments are heavily around supporting more cybersecurity capabilities and features and on the infrastructure side around enabling more and more hybrid operating environment. So if you see -- and we have continued to move to a more agile methodology. So our releases are more continuous versus sort of one big box every six months. So yes, we have a road map and we released a new hardware platform last December and probably another one this Q3 Q4 time frame. But predominantly our R&D on software side and either driving more security portfolio or supporting more hybrid operating environments.

And a question for Brian. Brian how should we anticipate like OpEx is Q2 OpEx a good run rate for the remainder of the year? And then additionally, if I look at the tax rate maybe you can give us some insight in terms of the business mix. I think the tax rate is somewhat closer to like 18% higher than last year?

Yes. No great question Hendi. Thanks for your questions both. OpEx currently is about as lean as we get on variable comp. I mean we're not on course to achieve, what is our expectations. So my plan is to continue to monitor our progress and to flex our OpEx accordingly. But yes, a lot of things you could expect as sales go up and I think Dhrupad mentioned this earlier then we pay more commissions. So that's basically what is the variable. Currently the last two quarters is what you're seeing is probably about the run rate you could expect. And then as we continue to grow and to meet our targets on growth rates or at least attempt to achieve them for the year we'll see OpEx run up accordingly. As far as tax rate I mean you're spot on. We're running at about 18% non-GAAP effective tax rate. That's a function of profit before tax. It's approximately EBITDA but it's a little bit different. Obviously, our GAAP tax rate is a little bit different but we try to align with both of them and we continue to invest in tax saving strategies to maintain that outlook.

Thank you, Dhrupad. Thank you, Brian.

Thanks, Hendi.

Thank you, Hendi. We have now reached our allotted time and now turning the call back over to the management team for closing remarks.

Thank you. And thank you to all of our shareholders for joining us today and for your continued support and to all A10 employees around the world. Thank you.

That concludes the conference call. Thank you for your participation. You may now disconnect your line.