A10 Networks, Inc. Q4 FY2022 Earnings Call

Good afternoon. Thank you for joining A10 Networks’ Fourth Quarter and Full-Year 2022 Earnings Conference Call. My name is Tamiya, and I will be your moderator today. All lines will be muted during the presentation, with an opportunity for questions at the end. I would now like to pass the conference over to your host, Rob Fink. Please proceed.

Thank you, operator, and thank you all for joining us today. This call is being recorded and may be accessed for at least 90 days via the A10 Networks’ website at 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 fourth quarter and full-year 2022 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. 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 be making 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, expectations, company's positioning, and repurchase and dividend programs along with its market share. These statements are based on current expectations and beliefs as of today, February 7, 2023. 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 on the business and operations that could cause actual results to differ materially, and you should not rely on them as predictions for future events. A10 does not intend to update information contained in the 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 company's most recent 10-K. 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 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 and on the trended quarterly financial statements posted on the company's website. With all that said, I'd like to turn the call over to Dhrupad Trivedi. Dhrupad, the call is yours.

Thank you all for joining us today. This was another record year for A10 with top and bottom-line performance that validates A10's solid position in the marketplace and the earning power of our business. We continue to deliver revenue growth that exceeds the growth rate of the industry as we gain market share with best-in-class proprietary solutions. With strong gross margin and rigorous expense management, our bottom line grew faster than our top line, and we utilized our robust cash generation to invest in technology for future growth and return capital to shareholders. Our management team has delivered consistent financial and operational results despite macro challenges. This is a testament to our team, our focus on execution, and our loyal global customer base that continues to embrace our solutions. The part of our business related to cybersecurity and revenue-generating solutions for customers is increasingly durable while we navigate increased volatility in areas of our business related to modernization. Our focus on critical network infrastructure and security solutions continues to drive our growth. Even when CapEx investments are moderated due to the economy or interest rates, our solutions are prioritized. This is evident in the 14% product revenue growth in the quarter and the fact that we delivered strong growth in key regions such as the Americas and Asia Pacific. On a trailing 12-month basis, our product revenue is up 17%. As we have said in the past, and evidenced by performance in the fourth quarter, we are not reliant on any single geographic region, and in fact, we are generating growth on a constant currency basis in nearly every region of the world where we operate. We have done our best to build a risk-mitigated business model, which we believe is largely insulated from volatility in any specific region, product category, or customer type. This diversification is evident in our top customers. Looking at our top customers by quarter, only three companies appeared on that list in 2022. In fact, 22 different customers contributed revenue that could then be seen in our top 10 at least once. I'd like to highlight two wins that demonstrate A10's successful land and expand commercial strategy. Rooted in our ability to capture market share through our technical superiority and performance criteria in head-to-head testing for critical customer needs, we were able to displace a competitive security incumbent in Japan with our DDoS protection solution. Having a long-proven track record with the customer with our ADC and CGN solutions, a cloud service provider in Japan chose our DDoS protection to protect their environment while providing significant zero-day automated protection, which was a differentiator for the sale. We discussed last quarter a deal with one of the world's top digital advertising platform companies. As a reminder, this customer had an urgent need to rapidly upgrade their infrastructure in order to support added features and enhanced functionality, including efficient and rapid infrastructure build-up. As a result, our high throughput, low latency solution was chosen to help ensure the customers’ existing revenue streams while expanding their ability to generate new revenue streams. These expansion orders are a reflection of our ability to continue growing with our large installed base, representing the most significant durable opportunity for continued growth. Diversification does not make us immune from economic challenges, but we believe we are positioned to navigate these situations better than our peers. Like many, we are seeing extended cycles. In addition, while many of our peers are reporting results that compare to low growth periods last year, our team has continued to deliver several quarters of consecutively robust growth. Most importantly, we are increasingly confident in our ability to achieve our profitability targets. Our EPS performance in the fourth quarter is also due in part to our ability to react quickly to increased volatility by managing expenses and allocating resources to ensure consistent and predictable profitability. Our differentiation and technical strength enable us to maintain non-GAAP gross margins exceeding 80% for the full year; this was 80.3%. In addition, we are effectively allocating our operating expenses while continuing to invest in the business, especially in our technology. In the fourth quarter, our operating expenses increased by 7.7% compared to the prior year, and for the full year, our operating expenses increased by $13.2 million or 9.1%, against a 12.1% revenue growth. The result is accelerating profitability and EPS growth. Our adjusted EBITDA was a record $22.3 million for the fourth quarter and $75.1 million for the year. A10's earning power is clear. During 2022, we returned more than $95 million to shareholders in the form of cash dividends and stock repurchases and ended the year with nearly $151 million in cash and no debt. This is approximately $2 in cash per share. We continue to manage and maintain a strong balance sheet. We also continue to maintain a disciplined, flexible, and opportunistic capital allocation strategy. Today, our Board approved a quarterly dividend of $0.06 per share. We enter 2023 expecting full-year revenue growth that outpaces our peer set while still delivering on our profitability goals in terms of adjusted EBITDA and EPS. With that, I'd like to turn the call over to Brian for a detailed review of the quarter and the year.

Thank you, Dhrupad. Fourth quarter revenue was a record $77.6 million, up 9.9% year-over-year. Product revenue for the quarter was $49.6 million, representing 63.9% of total revenue, up 13.5% year-over-year. Services revenue, which includes maintenance and support revenue, was $28.1 million or 36.1% of total revenue. Moving to our revenue from a geographic standpoint, revenue from North America was $41.2 million, up 21.8%. On a constant currency basis, revenue in Japan increased approximately 8% year-over-year in Q4. As you can see on our balance sheet, our deferred revenue was $127 million as of December 31, 2022, up 45% year-over-year. On a constant currency basis, deferred revenue would have increased 8% year-over-year. This is a result of the geographic mix and the alignment with our global growth targets. For the exception of revenue, all of the metrics discussed on this call are on a non-GAAP basis unless otherwise stated. A full reconciliation of GAAP to non-GAAP results is provided in our press release and on our website. Gross margin in the fourth quarter was 80.3%. As Dhrupad mentioned, we believe we successfully mitigated the impact of industry-wide global supply chain constraints and input cost increases during Q4. We reported $19.8 million in non-GAAP operating income, a record result, up 13% compared with $17.6 million in the year-ago quarter. Adjusted EBITDA was $22.3 million for the quarter, also a record reflecting 28.7% of revenue. Non-GAAP net income for the quarter was up 12% year-over-year to $18.4 million or $0.24 on a per share basis, compared with net income of $16.4 million or $0.20 per share in the fourth quarter last year. Diluted weighted shares used for computing non-GAAP EPS for the fourth quarter were approximately 75.4 million shares, compared to 80.3 million shares in the year-ago quarter. On a GAAP basis, net income for the quarter was $18 million or $0.24 per share, compared with net income of $10.7 million or $0.13 per share in the year-ago quarter. Turning to the full-year results, revenue was a record $280.3 million, up 12.1% year-over-year. Product revenue for the year was $173.2 million, representing 61.8% of total revenue. Services revenue, which includes maintenance and support revenue, was $107.1 million or 38.2% of total revenue. Non-GAAP gross margin for the year was 80.3%. We reported $67 million in non-GAAP operating income compared to $54 million last year. Adjusted EBITDA was $75.1 million for the year, compared to $62.4 million last year. Non-GAAP net income for the year was $57.7 million or $0.74 on a per share basis, compared to net income of $50.1 million or $0.63 per share last year. With Q3 2022 non-GAAP EPS of $0.20 and Q4 2022 non-GAAP EPS of $0.24. A10 generated $0.44 of non-GAAP EPS in the second half of 2022, up from $0.37 in the second half of 2021. Non-GAAP EPS exceeded consensus in all fourth quarters of 2022. Full-year 2022 non-GAAP EPS was $0.74 versus $0.63 last year. Excluding the non-recurring income tax benefit of $65.4 million, which represented approximately $0.82 on a per share basis for non-GAAP. On a GAAP basis, net income for the year was $46.9 million or $0.60 per share, compared with net income of $94.9 million or $1.19 per share last year. Turning to the balance sheet, as of December 31, 2022, we had $151 million in total cash and cash equivalents, compared to $185 million at the end of 2021. During the year, we repurchased 6.1 million shares at an average price of $13.01 for a total of $79.3 million and repaid $15.9 million in cash dividends. We continue to carry no debt. The Board has approved a quarterly cash dividend of $0.06 per share to be paid on March 1, 2023, to shareholders on record as of February 17, 2023. As Dhrupad mentioned, we expect full-year 2023 revenue growth to be faster than our peer set average, and that we will deliver on our profitability targets. I'll now turn the call back over to Dhrupad for closing comments.

Thank you, Brian. A10 is a diversified, differentiated company with significant earnings power. Our revenue growth outpaces that of our market. Revenue growth also significantly exceeds expense growth, leading to acceleration of EBITDA, net income, and cash flow. We continue to navigate economic headwinds and supply chain constraints. Our highly differentiated technical platform combined with our ability to achieve diversification in all aspects of our business has mitigated these impacts on our business, enabling us to deliver consistent performance. Our solutions are exceedingly well aligned with durable secular catalysts, which results in sustainable performance. I'm excited about A10's future and want to thank all our investors, customers, and employees for their support. Operator, you can now open the call up for questions.

We will now begin the question-and-answer session. Our first question comes from Hamed Khorsand with BWS Financial. You may proceed.

Hi. So first off, I just wanted to get a good understanding of what you are seeing as far as these extended cycles that are causing you to deviate from actually providing a target range for revenue beyond just the commentary?

Yes. No, good question, Hamed. So I think what we are seeing varies a little bit by regions, right? So as you can see in the numbers, we have seen improvement in the backdrop and the macro environment, certainly in Asia, Japan, and a little bit in Europe as well. I think where we are seeing that extended cycle is probably most specifically applicable to North American customers, who continue to remain a little bit concerned, whether it's due to the economy, interest rate, CapEx cost, and are not canceling any project or planned investments, but we are seeing them be less visible than we are used to seeing, right? So I would say that's how I would characterize it. They still plan to do that, but what is extending the cycle is there's a little bit more extra process and a little bit more, kind of, concern around moving faster, if you will. So I think that's probably the most specific connection point.

Are you seeing increased competition that's creating some of this hesitation on customers' end? Are you seeing pricing pressure as well?

Yes. So good question, it's not pricing pressure per se, and I think our customers typically look at us from a total cost of ownership perspective and I think economically we are pretty well aligned and compelling for them. We are not necessarily also seeing a change in the competitive landscape because in many of these cases, right, we don't typically go after the SMB segment, which has a lot of qualified suppliers who are constantly adjusting share position. In many of our cases, the customer spends six to nine months plus integrating us into their operating system then their procedures and so forth. So I think that's not necessarily what is changing that pattern. It's more around their CapEx buying cycles that can fluctuate on timing and their own risk perception, and we are seeing companies doing layoffs and trimming their cost position to be more conservative, right? So it's more to do with navigating through that uncertain period. It’s certainly we are not seeing any increase in losses or any of those items.

You were able to post revenue, which, at least from my perspective, was a little bit higher than what I was projecting. So when did you see this slowdown or extended cycles developing for you?

Yes. So I think we started seeing it probably towards the end of December going into the January period. I would say that's why I was connecting it more so to North American customer base more than anything else. I think that's a little bit coincidental with quite a lot of companies trimming position, due to inflation, interest rate concerns, and so forth. So I think it’s – we haven’t had to do anything along those lines, but obviously a lot of our peers and larger companies have made those adjustments typically at the end of December or in the January timeframe.

Okay. Thank you.

Yes. Thank you. Appreciate it.

Thank you. Our next question comes from Anja Soderstrom with Sidoti. You may proceed.

Hi, Anja.

Hi. This is Stefan Gill in for Anja Soderstrom. My first question is how much of the expenses are within your control? And how does that affect your ability to control your margins?

Yes. So I think, you know, if you look at the last 10 or 12 quarters of our business, we are able to flex our cost structure where the expense growth or OpEx growth is always lower than the top line growth. So even when the revenue growth is lower, OpEx growth is even lower. And I think that has enabled us to deliver consistently expanding EBITDA margin, right? And if you think of the variables, our gross margin is pretty stable. And so we take actions to make sure we are offsetting costs and price. But beyond that, on the OpEx perspective, we remain flexible and plan full around being able to accommodate that level of revenue mediation. Obviously, we cannot switch completely on and off, but we build in a lot of levers to our operating cost, whether it's in R&D, sales and marketing, or G&A, that enables us to flex it as needed.

Alright. Thank you. And my second question is have you seen any changes in your customers' decision-making process given the uncertain macro environment?

Yes, what we're observing is a typical cycle in behavior change. There's a bit more scrutiny or investment, which makes it challenging. For instance, instead of five people being involved in the purchasing process, there are now seven. Consequently, we see that customers are being cautious before committing to spending. However, related to modernizing their digital infrastructure, they may be more careful. In contrast, when it comes to generating new types of revenue, they are moving as quickly as before. I would say that the part of the business focused on modernization and transforming their IT is under the most scrutiny.

Are you actively looking for any M&A opportunities? What is the current M&A landscape like?

Yes. No, good question, Stefan. So, as we mentioned before, we continue to evaluate opportunities and there's all kinds that come across the wire. We are pretty well understood in the industry in terms of what is our strict profile for what we are looking for. But we look for two factors: One, does it accelerate our growth in terms of our strategic areas of growth? And second, can we make the financials work consistent with our business model and long-term goals as well? So we continue to evaluate it, but our primary focus is investing in the business for organic growth first, and we'll be opportunistic if there are opportunities to do anything inorganic.

Thank you so much for taking my questions.

Thank you, Stefan.

Thank you. Our next question comes from Tyler Burmeister with Craig-Hallum Capital. You may proceed.

Hey, guys. Thanks for letting us ask a couple of questions. So first, I guess, if you guys could provide any additional color, I understand that you gave a number for revenue growth next year, but just some maybe seasonality or linearity through the year. I would suspect maybe the first half is going to be even softer than it typically is, and you talked about kind of a six-month sales process to some customers. So do you have pretty good visibility in the first half, and just maybe lacking visibility in the second half? Is that some of the uncertainty around that provided number?

Yes, good question, Tyler. The dynamic we're observing relates more to customer spending delays rather than losing to competitors. Our pipeline does show signs of stronger seasonality than usual. We typically see a 48% to 52% seasonal split, but based on the movement in our pipeline, we believe that some larger deals might shift to the latter part of the year. In terms of net revenue, we have a good outlook for the year, but we expect some projects to be deferred. This isn't about competition; it's strictly a deployment decision. We are definitely noticing that some activities are moving more to the second half of the year. Brian, anything you would like to add?

Yes. I mean, we typically see a 52%, 48% mix being 48% first half, 52% second half. I think what we're seeing is similar behavior that we saw in 2021, when there was a lot of uncertainty and a lot of closures from the pandemic. I think not related to closures, but related more to FX and interest rates. We're seeing it's just a similar pattern or it's a little slower outlook for the year than I think we saw this past year, 2022. Similar to 2021, but we don't think we're seeing a loss of the opportunities. It's just simply a timing issue.

So it's looking more like 2021 than 2022, right at this point.

I appreciate that color. That's very helpful. And then last, I just wanted to give you an opportunity. You announced a security breach internally. Just want to give you an opportunity to comment on that? I think you said it was internal; it wasn't your products, it wasn't with customers, just any other color you'd like to give there?

Sure. Sure. Yes. So I think that is a good point, Tyler, and I think obviously the first point is as a company that is involved with customers and doing security, we felt it appropriate to be transparent and open with our investors, customers, and employees. And, as we said, right, what we do know is, like many, many other companies, we had some kind of a cyber incident, and we use external experts, and this was obviously not subsequent to the end of the year. We use experts, and what we know based on all of that analysis is this is not related to any of the products or solutions that our customers use for security; it was related to more of something within our corporate IT infrastructure. And so we launched the investigation, engaged experts and advisers. And, obviously, we are working with the right authorities. But, you know, we felt it also critical to inform in a transparent way all of our stakeholders as we navigate this, right? So the issue, as far as we understand, is contained, but we obviously are going to learn to continue to strengthen our own security posture while we engage our customers deeply to more things for them. But this was not connected at all with any of our products that they use.

That sounds perfect. That's all for me. Thanks, guys.

Very good. Thank you, Tyler.

Thank you. There are no further questions waiting at this time. I will now pass it back to Dhrupad for closing remarks.

Thank you. Thanks to all our shareholders for joining us today and for your continued support. Thank you.

This concludes the conference call. Thank you for your participation. You may now disconnect your lines.