A10 Networks Q2 2023 Earnings Call Transcript

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July 26, 2023

There are 8 speakers on the call.

Operator

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. I would now like to pass the conference over to our host, Rob Fink with ATN.

Operator

Please go ahead.

Speaker 1

Thank you, Paul, and thank you all for joining us tonight. 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 Drew Petrivetti, 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 Q2 2023 financial results. Additionally, ATN published a presentation and supplemental trended financial statements.

Speaker 1

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 26, 2023. These forward looking statements involve a number of risks and uncertainties, some of which are beyond the company's 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.

Speaker 1

For a more detailed description of these risks Please note with the exception of revenue, financial measures discussed today are on a non GAAP Aces that 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 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 Drew Ped. Drew Ped, the call is yours.

Speaker 2

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 Q1 represented the flow for our results with the expectation of sequential improvements 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 to A10's business model. Our adjusted EBITDA margin for the 1st 6 months of 2023 was a record 26.6 percent, up 248 basis points compared to the 1st 6 months of 2022, demonstrating the earnings power of our business model.

Speaker 2

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 Q2, 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.

Speaker 2

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 face a challenging macro environment right now. Our strong presence in Asia Pacific in particular helped us mitigate the North American headwinds in the 2nd 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%.

Speaker 2

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 acts 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.

Speaker 2

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 aligns 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.

Speaker 2

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 and D dedicated to security products increased 3% year over year and is up nearly 8% from 2 years ago, demonstrating our commitment to investing in organic Growth opportunity. Recently, we highlighted how A10's carrier grade networking and DDoS protection solution Help deliver a secure and consistent subscriber experience for businesses and consumers in turn. 1 of the nation's largest telecom operators with over 50,000,000 subscribers chose A10 to help facilitate their network's 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 illegitimate traffic.

Speaker 2

Our new solution enabling hybrid infrastructure directly helped created customer value in this case. Agen'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 5 years. Our consistent profitability fuels our capital allocation strategy.

Speaker 2

During the quarter, we paid $4,400,000 in cash dividends and repurchased $6,200,000 worth of our shares, all while growing our cash balance. We continue to focus on our 3 pronged strategy for capital allocation. 1st, investing in our business for future growth. 2nd, returning capital to shareholders and third, continuing to explore strategic and accretive acquisition. With that, I'd like to turn the call over to Brian for a detailed review of the quarter and the 1st 6 months of the year.

Speaker 2

Brian?

Speaker 3

Thank you, Dhruvad. 2nd quarter revenue was $65,800,000 a decrease of 3.2% year over year, but in line with expectations. Product revenue for the quarter was $39,100,000 representing 59.4 percent of total revenue. It's worth noting that sequentially, product revenue increased 25.4% compared to the Q1 of this year, reflecting the improving conditions Dhruv had mentioned. Services revenue, which includes maintenance and support revenue, was $26,700,000 or 40.6 percent of total revenue.

Speaker 3

Moving to our revenue from a geographic standpoint. Revenue from the Americas, including Latin America, was $36,900,000 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 $132,000,000 as of June 30, 2023, up 3% year over year.

Speaker 3

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 $15,200,000 in non GAAP operating income, down 5.7 percent compared with $16,100,000 in the year ago quarter. Adjusted EBITDA was $17,400,000 for the quarter, reflecting 26.4 percent of revenue.

Speaker 3

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 $14,500,000 or $0.19 per share on a diluted basis, up from $13,400,000 or $0.17 per diluted share in the year ago quarter. Diluted weighted shares used for computing non GAAP EPS the Q2 were approximately 75,400,000 shares compared to 78,300,000 shares in the year ago quarter. On a GAAP basis, net income for the quarter was $11,600,000 or $0.15 per diluted share compared with net income of 10,400,000 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.

Speaker 3

Turning to year to date results, revenue was 123,500,000 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 percent in line with our target. We reported $28,500,000 in non GAAP operating income, up 2.7% compared with $27,800,000 in the 1st 6 months last year. Adjusted EBITDA was 32,800,000 reflecting 26.6 percent of revenue.

Speaker 3

Non GAAP net income for the 1st 6 months was $24,500,000 or $0.32 per diluted share, up from $23,400,000 or $0.30 per diluted share in the year ago period. On a GAAP basis, Net income for the 1st 6 months was $15,600,000 or $0.21 per diluted share compared with net income of 16,800,000 for $0.21 per diluted share. Turning to the balance sheet. As of June 30, 2023, We had $153,900,000 in total cash, cash equivalents and marketable securities compared to $150,900,000 at the end of 2022. In addition, accounts receivable has increased slightly sequentially and DSOs remained healthy, decreasing sequentially.

Speaker 3

This is a function of delayed customer buying decisions with orders coming in at the end of the quarter. Our age receivables remain very small and in line with our historical levels despite. During the quarter, we paid $4,400,000 in cash dividends and also repurchased approximately 437,000 shares at an average price of 14 $0.27 totaling $6,200,000 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.

Speaker 3

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 Dhruv had mentioned, the Board has approved a quarterly cash dividend of 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 Dhruvad for closing remarks.

Speaker 2

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. Our 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.

Operator

Thank you. We will now begin the Q and A session. Our first question is from Gray Powell with BTIG. Your line is now open.

Speaker 4

Great. Thank you for taking the questions. Just a couple on my side.

Speaker 1

So it's

Speaker 4

good to see the decline in product revenue improve 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 6 months or 6 to 12 months. It just sounds like you have better visibility on things there. So would be curious how that should trend.

Speaker 2

Yes. No, good question, Gray, and I'll start and Bryan 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.

Speaker 2

So I would say 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 market slightly Normalizing, right, 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 Program that we have adjusted and put in place now to kind of resume that.

Speaker 4

Understood. Okay, great. And I guess my follow-up question would be on the cost side. So the controls on OpEx year to date have been impressive. And it seems like visibility on demand is improving.

Speaker 4

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 reinvesting on the sales and marketing side lag a recovery in top line growth? Thanks.

Speaker 2

Yes. Good question. So I think the way I would separate 2 components of that, right? So there is probably a more mechanical component of where Sales and marketing spend, which is commissions and rebates and things like that is flex is really Yes. Obviously, with revenue levels, right?

Speaker 2

So that's one component. So as revenue is higher, just proportionally commission 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 and regions which are relevant to us or Negative to us and flex our sales and marketing spend outside of commissions to that, right.

Speaker 2

So I think You would see not an increase in sales spending followed Even 6 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 that added.

Speaker 4

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

Speaker 2

Thanks. Thank you.

Operator

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

Speaker 5

Hi. I was hoping you would be able to go in 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 Comfortable delaying these purchases. If you could just provide a little bit more understanding what's going on there?

Speaker 2

Yes. Good question, Amit. 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.

Speaker 2

The 50% in the Americas where it typically relates to a large customer who could be a telco or a cable company. The nature of what we see is they have annual budget cycles, which reflect investments planned for the year and projects Plan 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 adjustment 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.

Speaker 2

In places where it was related to modernization, Those projects are generally pushed out 6, 9 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 we are going to hold off until we review all of 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.

Speaker 2

So I don't know if that gives you more color on it.

Speaker 5

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?

Speaker 2

I think that generally the security spending category is not the same as 1 of And IT spending categories, right? Because security spending category also ties back into enterprise risk 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.

Speaker 2

Certainly increase 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.

Speaker 3

Okay. Thank you.

Operator

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

Speaker 6

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

Speaker 2

Yes. Good question, Anya. 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 things Different ways of consuming IT and so forth.

Speaker 2

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 economics driven than technology driven.

Speaker 6

Okay. Thank you. And in the past, you have been talking about you Displacing some competitors, have there been any anything to call out in the competitive environment?

Speaker 2

No, I don't think certainly in the last 3, 6 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.

Speaker 6

Okay. Thank you. That was all for me.

Speaker 2

Thank you, Anja.

Operator

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

Speaker 7

Good evening, Dhrupat and Brian.

Speaker 2

Hello, Andy.

Speaker 7

Yes. Dhrupat, may I inquire your insight on business outside of North America? I think specifically, Lee, I'm wondering, like how similar, how different and then if let's say, if Certain purchase orders or like let's say like purchase delays maybe lagging like outside of America, Meaning that we may see those trends later?

Speaker 2

Yes. Good question. So I think, Andy, what is unique is in North America, We have a combination of factors, right, which is concern about inflation, interested movements in response to try to manage that, Companies themselves, therefore, seeing a reduction in their demand, therefore, restructuring on the new side, etcetera. So that The scale of all those issues combined is certainly not true elsewhere, right? 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 costs on their input side being unmanageable and having to do big restructuring, right?

Speaker 2

So we saw a couple of examples of those in 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 yes, there's more Questions asked and more signatures, but it's not to the degree where we saw in the Q1 certainly, right, That U. S. Companies were themselves going through massive restructuring, layoffs and all of that.

Speaker 2

So I think the North America environment it is unique in that combination of factors, even though, yes, 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 We're 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.

Speaker 2

So I think we see that not as a concern that they are 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 Automatt.

Speaker 7

And then Dhrupat, any update on product development and product

Speaker 5

[SPEAKER PIERRE YVES

Speaker 6

LESAICHERRE:] Roadmap for this year?

Speaker 2

Yes. So I think the what we have discussed before, right, 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 Continue to move to a more agile methodology. So our releases are more continuous versus sort of one big box every 6 months. So yes, we have a road map and we released a new hardware platform last December and probably another one this Q3, Q4 timeframe, but predominantly our R and D on software side and either driving more security Portfolio or supporting more hybrid operating environments.

Speaker 7

Yes. And then 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.

Speaker 7

I think the tax rate is somewhat closer to like 18% higher than last year.

Speaker 3

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.

Speaker 3

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 Dhruv had 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.

Speaker 3

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 as a function of profit before tax. It's approximately EBITDA, but it's a little bit different.

Speaker 3

Obviously, our GAAP tax rate is a little bit But we tried to align the both of them and we continue to invest in tax saving strategies to maintain that outlook.

Speaker 7

Thank you, Dhruvat. Thank you, Brian.

Speaker 2

Thanks, Hendi.

Operator

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

Speaker 2

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.

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