A10 Networks Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 30, 2024

There are 6 speakers on the call.

Operator

Thank you all for joining. I would like to welcome you all to the A10 Networks Second Quarter 2024 Financial Results Conference Call. My name is Prita, and I'll be your moderator for today.

Operator

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 your host, Tom Baumann with FNKI IR. Thank you. You may proceed, Tom.

Speaker 1

Thank you all for joining us today. This call is being recorded and webcast live and may be accessed for at least 90 days via the A10 Networks website ata10networks.com. Hosting the call today are Drew Bacheffetti, 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 2024 financial results. Additionally, ATN published a presentation and supplemental trended financial statements.

Speaker 1

You may access the press release, presentation and trended financial statements on the Investor Relations section of the company's website. During the course of today's call, management will make forward looking statements, including statements regarding projections for future operating results, including timing, including our potential revenue growth, demand, industry and customer trends, our capital allocation strategy, profitability, expenses and investments, our positioning, our repurchase and dividend programs and our market share. These statements are based on current expectations and beliefs as of today, July 30, 2024. These forward looking statements involve a number of risks and uncertainties, some of which are beyond our control that could cause actual results to differ materially, and you should not rely on them as predictions of future events. ATN 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.

Speaker 1

For a more detailed description of these risks and uncertainties, please refer to our most recent 10 ks and quarterly report on Form 10 Q. 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 prepared results 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 and on the trended quarterly financial statements posted on the company's website. Now, I'd like to turn the call over to Rupert Trivedi, President and CEO of A10 Networks.

Speaker 2

Thank you, Tom, and thank you all for joining us today. The North American service provider market remains choppy even as spending is trending positive in an overall direction. The market sentiment improved in the first quarter versus second half of twenty twenty three, but we still saw projects moving across quarters. Year to date, our service provider revenue excluding North America is up 20%, demonstrating that this is largely a North American market issue related to timing of carrier CapEx. Encouragingly, much of these headwinds in the Q2 were offset by improving strength in the Enterprise segment.

Speaker 2

We have been devoting resources both R and D investments and additional sales and marketing muscle to target enterprise opportunities. These investments are bearing fruit. Enterprise related revenue increased 25%, offsetting much of the 25% decline in the Service Provider segment. Additional investments are in process now, and we expect A10's position in the enterprise market to continue to improve. During the quarter, one of the world's largest digital communications technology company with nearly 100,000 employees worldwide chose A10 displacing their previous vendor for their hybrid infrastructure solution.

Speaker 2

Our commitment to technical performance with a reenergized enterprise portfolio, global technical support and alignment with customers' business goals led ATN to secure this win in the quarter and showcases our ability to compete and win in the enterprise space with the most demanding infrastructures. As we look at our pipeline for the second half of the year, this segment is expected to grow faster than Service Providers segment and provides the basis for continued growth in this vertical. Growing the enterprise business is a part of our ongoing strategic focus on driving predictable performance. Diversification remains core to our overall strategy, enabling A10 to navigate challenging conditions better than peers and over the long term driving growth that outpaces the broader market segment. Clearly, 2024 has been a challenging year for North American service providers so far as they navigate market challenges for their own businesses.

Speaker 2

A10 is not alone in this exposure, but our business model and diversification has enabled us to maintain robust profitability in line with our targets despite these headwinds. For the first half of twenty twenty four, we delivered EPS expansion year over year in line with expectations and expect to accomplish this on a full year basis. Longer term, we continue to be built to grow at a low double digit pace faster than the market with our profitability and cash generation helping growth faster than the top line. Simultaneously, we are investing in our next wave of growth products, including initiatives to capitalize on growth tied to new AI solutions, which continue to grow in scope and have some time before they are fully commercialized. As I have discussed in the past, ATN has long used AI in our security solutions, especially those that address DDoS attacks.

Speaker 2

We are increasing the use of AI focused agile solutions to enable our customers to better identify, address and remediate a growing wave of security threats. Bad actors are utilizing AI and we are evolving our technology to address these new threats. These tools are increasingly must have for our customers and we expect to add to our security and AI backed arsenal of solutions in the coming quarters. Security solutions as a percentage of sales continue to trend in line with our long term growth goals. Our new engineering investments are related to developing AI based solutions for customers to better manage and secure their networks.

Speaker 2

This includes better insights to predict network performance as well as new capabilities to address threats in real time that have emerged with AI network traffic. In keeping with our historic strength on understanding network traffic in real time, we are also working with customers to evolve our hardware to support next generation data centers needed to support performance and latency needs for AI traffic in all kinds of new models. We are engaged with customers and channel partners to enable their roadmap as the market matures and moves into commercialization phase in the future. While we invest in new solutions, new technologies and reallocate sales resources, A10 remains solidly profitable even as we navigate near term revenue headwinds. Once again, I'm proud that we have achieved our non GAAP EPS targets even with these investments and market challenges.

Speaker 2

Just a few years ago, these factors would have resulted in significant losses. Today, we are systematically profitable. Our gross margins in the Q2 were in line with stated goal of 80% to 82%, and our adjusted EBITDA margin was nearly 26%, in line with our profitability goals. As revenue conditions normalize, we expect our profitability to improve further. We remain committed to achieving our long term stated goals while driving growth.

Speaker 2

A10's consistent ability to meet profitability targets even amidst revenue challenges underscores the resilience of our business model. The results year to date position us to achieve our full year business model objectives, including targets for gross margin and adjusted EBITDA margin as well as growth in our full year non GAAP EPS. We have continued to buy back stock and our cash flow has more than funded our buyback and dividend programs. With that, I'd like to turn the call over to Brian for a detailed review of the quarter.

Speaker 1

Brian? Thank you, Dhruvit. 2nd quarter revenue was $60,100,000 a decrease of 8.7% year over year. As Dhruvit discussed, quarter to quarter volatility in the North American service provider sector continued to be high, offset by improvements in the Enterprise segment. Product revenue for the quarter was $29,500,000 representing 49 percent of total revenue.

Speaker 1

Services revenue was $30,600,000 or 51 percent of total revenue. 2nd quarter recurring revenue increased 11% compared to the Q2 last year and deferred revenue increased 6% demonstrating stronger product sales for the past several quarters and continued demand for our enterprise solutions. These metrics coupled with a strong pipeline of opportunities further validate our confidence that we are not losing opportunities to competitors. As you can see on our balance sheet, our deferred revenue was $140,000,000 as of June 30, 2024, up 6.3% year over year. With the exception of revenue, all of the metrics discussed on this call are on a non GAAP basis unless otherwise stated.

Speaker 1

A full reconciliation of GAAP to non GAAP results are provided in our press release and on our website. Gross margin in the 2nd quarter was 80.9%, in line with our stated goals of 80% to 82%. Adjusted EBITDA was $15,500,000 for the quarter, reflecting 25.8 percent of total revenue. Non GAAP net income for the quarter was 13,200,000

Speaker 3

dollars or $0.18

Speaker 1

per diluted share compared to $14,500,000 or $0.19 per diluted share in the year ago quarter. Diluted weighted shares used for computing non GAAP EPS for the Q2 were approximately 75,500,000 shares compared to 75,400,000 shares in the year ago quarter. On a GAAP basis, net income for the quarter was 9,500,000

Speaker 3

dollars or $0.13 per diluted

Speaker 1

share compared to net income of $11,600,000 or $0.15 per diluted share in the year ago quarter. Turning to the year to date results. Revenue was $120,800,000 down 2.2% year over year. Product revenue was down 15%, representing approximately 49% of total revenue and services revenue was up 15%, representing about 51% of total revenue. Year to date non GAAP gross margin was 81.4 percent in line with our target range.

Speaker 1

We reported $23,900,000 in non GAAP operating income, down 16% compared with $28,500,000 in the 1st 6 months last year. Adjusted EBITDA was $29,400,000 reflecting 24.3 percent of total revenue. Non GAAP net income for the 1st 6 months was $25,900,000

Speaker 3

or $0.35 per diluted

Speaker 1

share, up from $24,500,000 or $0.32 per diluted share in the year ago quarter. Period. On a GAAP basis, net income for the 1st 6 months was $19,200,000 or $0.26 per diluted share compared with net income of $15,600,000 or $0.20 per diluted share. During the quarter, we generated $11,300,000 in cash from operations. Year to date, cash generated by operations was $43,800,000 in line with our full year targets.

Speaker 1

Turning to the balance sheet. As of June 30, 2024, we had $177,000,000 in total cash, cash equivalents and marketable securities compared to $159,300,000 at the end of 20 23. During the quarter, we paid $4,500,000 in cash dividends and repurchased $11,800,000 worth of shares. We also continue to carry no debt. The Board has approved a quarterly cash dividend of $0.06 per share to be paid on September 3, 20 24 to shareholders of record on August 15, 2024.

Speaker 1

We have $34,800,000 remaining in our $50,000,000 share repurchase authorization as of June 30, 2024. We expect 2024 full year EPS growth in single digits in line with expectations and we continue to target gross margins of 80% to 82% and adjusted EBITDA margins of 26% to 28% on a full year basis. I'll now turn the call back to Dhruvit for closing comments.

Speaker 2

Thank you, Brian. ATN maintains a strong competitive position in the market, supported by durable long term growth catalyst. Short term volatility in the North American service provider market does not alter our long term strategy, and we are making steady progress to enhance our position in the enterprise market. Our strategic diversification remains a key advantage, enabling consistent profitability even during periods of revenue headwinds. We also continue to create shareholder value through the return of meaningful capital to shareholders.

Speaker 2

Operator, you can now open the call up for questions.

Operator

Thank you, Tripad. We will now begin the question and answer session. We have the first question from Anders Stuttgart with Sidoti. You may proceed.

Speaker 4

Hi, good afternoon. This is Stefan Guillaume on for Anja Sturdeschom. Can you guys hear me?

Speaker 2

Yes, we can hear you. Thank you.

Speaker 4

Thank you. I guess my first question is, are you still seeing service providers come back in the second half? And how are your conversations with them?

Speaker 2

Yes. Good question. So I think, first, as I mentioned in the body of the call, our service provider conversation is very much North America specific, right, because we have healthy growth outside of that. So within North America, I think there's 2 things we are seeing. 1 is they continue to manage sort of the spending level, where projects can get scoped differently and moved across periods.

Speaker 2

And our assumption, of course, is a lot of their decisions around making significant capital investments are related to, a, cost of capital, b, market uncertainty, including election period right now. So our conversations with them generally show that they continue to spend a little bit because a lot of the things we do are in the path of either revenue generation or becoming more secure. However, the newer projects tend to be pushed out in time a little bit. When we think of our second half, our assumptions really around delivering results are that we continue to make steady progress on enterprise footprint. 2nd is we continue to see execution that we saw in the first half from service providers outside of North America.

Speaker 2

And then within North America, I think we continue to find ways between the balance of our customers to deliver that growth. At the point at which they get confident and start reinvesting CapEx, of course, we will benefit from that as well, right? But our plan on second half is not predicated on a sharp snapback in spending from them.

Speaker 4

Thank you for the color there. Can you also talk about the competitive environment? In the past, you've said that you're taking share. Are you still doing that?

Speaker 2

Yes. So, I would say, there's 2 ways to look at that, right? So, first is, if you look at the broader market and you look at lot of the growth rates that you're seeing from companies in our sector or industry, they're all kind of plusminus2% kind of range, right? So that's 1. 2nd is the way we think about gaining share is when we are we can trace and point to an actual displacement of a competitive solution.

Speaker 2

And I would say that certainly in the enterprise market, we feel that we are able to replace, some of the solutions. And I would say that's kind of the most basic way we think about gaining share. And if you look at our Enterprise segment growth on a year to date basis, half to half, we grew about 7%, which I would say is at least slightly above market average.

Speaker 4

All right. Thank you. And so what kind of pricing power do you have in this environment?

Speaker 2

So, I would say pricing is a balanced thing. So, obviously, we have input cost inflation, which we try to find ways to offset and we offset that with maybe price increases selectively to customers and then the rest with productivity. But I think we are very selective because we want to do it in a very methodical way versus going up and down on prices, right? So I think for us, it's a mix of overcoming input costs through productivity and selective price increases where we don't have a choice but to pass it on.

Speaker 4

Thank you. And the last one for me is, where are you in the innings of seeing results from the changing of your sales team?

Speaker 2

So I would say, no, if you think of our business, 2 third is service provider, 1 third enterprise, enterprise is a little bit bigger now. On the service provider side, of course, we have a very mature experienced sales team where the focus is on improving our capability to cross sell more products to existing customer base, right? So on that dimension, I think we are making good progress. Some regions obviously are farther ahead than others. So there is still room for us to continue growing through that.

Speaker 2

On the enterprise side, we have brought in obviously new sales talent as well as how we go to market in terms of our portfolio and products as well. And I would characterize that as we are probably somewhere in the 3rd or between 3rd and 4th inning on that journey.

Operator

Your next question comes from Clay Powell with BTIG. You may proceed.

Speaker 5

Okay, great. Thanks. So yes, a few questions on my side. Maybe just to start off, at a high level, can you talk about what you saw in terms of the overall spending environment and macro headwinds? And I mean, I know you've talked about it some in the prepared remarks.

Speaker 5

It sounds like North American service provider may have caught you by surprise. But outside of that, would you say that things were stable? Did anything change positively or negatively? Just any more color you could provide there?

Speaker 2

Yes. No, good question, Gray. So I would say absolutely that, if I think of my 3 regions, I would say APJ is stable on enterprise and service provider side, EMEA is stable on enterprise and service provider side. And North America, I would say, we are making good progress on enterprise, so it offsets maybe some market weakness. And then within North America service provider, I think we were not necessarily surprised, but I think what involved was some of the rescoping of projects, right, versus cancellations or complete push out.

Speaker 2

So that was the only thing where we that's why we feel good about full year. And if you remember, right, Q1, we did slightly better than we got and Q2 is slightly worse, but it's still plusminus $2,000,000 or $3,000,000 right. So that's the sort of volatility or movement we see. And our goal is obviously to use the remaining pieces to offset that, so that when North America ASP spending comes back, right, it only helps us from there.

Speaker 5

Got it. Okay. And then within the context of the full year, should we still be expecting like maybe low single digit growth in revenue or closer to flat now?

Speaker 2

I think we would probably say low single digit still feels right, although it's more back end loaded, so it's always risky. But our plan is obviously if it's slightly below that to that, how do we bridge back to getting out to our non GAAP EPSs on-site, so either way.

Speaker 5

Okay. Okay, great. And then last question, free cash flow in the first half of the year was actually really strong. What drove that? And just any directional pointers you can give us or maybe talk about like free cash flow margins relative to EBITDA margins?

Speaker 5

Any pointers there?

Speaker 2

Yes. Good question. Yes, go ahead, Brandon.

Speaker 1

Yes. No, free cash flow, a number of factors led into that. I mean, last year we had pretty poor linearity. I think we're seeing the benefits of some of that return to cash spending and releasing cash into the market $1,000,000 of free cash flow approximately this quarter. But our full year cash flow target from a free cash flow perspective should be in the 60s if everything continues to go as planned.

Speaker 2

Yes. And Brian, our EBITDA is a good proxy for free cash flow, because there's not too much CapEx variability.

Speaker 5

Understood. Okay. Thank you very much.

Speaker 2

Thanks, Graeme.

Operator

Thank you, Graeme. We now have Hamed Khorsand with BWF Financial. You may proceed.

Speaker 3

Hi. So talking about this North America service provider, this has been a topic for about a year now. So is this given the growth you saw in Q2, it obviously points to actual revenue decline on that part. So are you losing share or are these how are these service providers just cutting back so much spending without you losing share?

Speaker 2

Yes. So I think good question, Hamid. So maybe just level set on a couple of data points, right. So if you look at North American service provider, I think in the last 2 or 3 days, right, I think AT and T, Verizon, they've all published CapEx. And you can see that in 2024, they are projecting CapEx declines of between 6% to 8% year over year, right.

Speaker 2

So and it's all of them, right. And cable companies are projecting slightly less than that. So that's one data point that says it's not that market, it's plus 10% and we are negative. 2nd is the way our products are designed at these customers. We are in their operational workflow to run the network and publish results on SLA achievement and things like that.

Speaker 2

So is it likely they are looking at competitors? Maybe. But we have a pretty good understanding of what is deployed. We track all those devices. Our support team knows every device that is active and how much traffic is going through it.

Speaker 2

So, we that gives us confidence that it's more linked to their CapEx spending cycle versus competitive. And the last data point is when they do approve a data center, we do get the PO, right? So we have a reasonably good correlation of when the project is approved and we are in the mix, we get that deal. So but it is I mean, I think the CapEx plans of these companies are public, right? So you can see those there.

Speaker 2

Okay.

Speaker 3

And then if I heard you right, you're investing more on the enterprise sales side. So does that mean we should see acceleration in enterprise revenue eventually, maybe 2, 3 quarters down the line?

Speaker 2

Yes, you should. And I think the thing I would point to, Hamid, is even now, right, which is very early, is that on a year over year basis, half to half, the enterprise business grew 7%, which you can compare to our peers, right. And even on the SP side, by the way, you can compare to Juniper, for example, to see relatively if we are losing or gaining. So on the enterprise side, certainly, as the teams mature and we get better kind of value proposition, market fit, we expect that to continue to grow. And as I said, if we don't want to do that instead of SP sales, we want to do that as a way to reduce the impact of that volatility.

Speaker 3

Okay. My last question is on that, when you were talking about digital tech company, is how much of an impact does that have on revenue if any in Q2? And will it be how significant of this is it for revenue going forward?

Speaker 2

Yes. So I think, I would say, it was not a 10% customer, but it has the potential to be somewhere between 5% and 10% over time.

Speaker 3

Okay, great. Thank you.

Speaker 2

Thank you, Amit. Appreciate it.

Operator

Thank you, Amit. We have had no further questions registered. So I'd like to hand back to President and CEO at A10 Networks, Dupad Chirivedi for some final remarks.

Speaker 2

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

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