A10 Networks, Inc. Q1 FY2024 Earnings Call

Hello, and welcome to A10 Networks' First Quarter 2024 Financial Results. My name is Elliot, and I will be coordinating your call today. I would now like to hand over to Tom Baumann with FNK IR. The floor is yours. Please go ahead.

Thank you all for joining us today. This call is being recorded, and webcast slides may be accessed for at least 90 days via the 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 first quarter 2024 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 make forward-looking statements, including statements regarding projections for future operating results, including timing, our potential revenue growth, industry and customer trends, our capital allocation strategy, supply chain constraints and expectations, 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, April 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. A10 does not intend to update information contained in these forward-looking statements, whether as a result of new information, future events, or otherwise, unless required by law. For a more detailed description of these risks and uncertainties, please refer to the most recent 10-K. 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 results prepared in accordance with GAAP and may be different from non-GAAP financial metrics 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 would like to turn the call over to Dhrupad Trivedi, President and CEO of A10 Networks.

Thank you, Tom, and thank you all for joining us today. This was a solid quarter for A10, with strong profitability and revenue results that demonstrate continued demand for our solutions. I am proud of the way our team has responded to a volatile economic environment, driving efficiency throughout our organization and enabling us to do what we told investors we would do even as sales cycles elongate and certain buying decisions are delayed. Once again, our differentiation is benefiting our business, enabling us to drive growth. Our customers need higher throughput in networks, especially in the age of AI. Our customers also need to enhance their security posture amidst a growing array of cyber challenges, including new challenges from AI tools. Buying decisions may be delayed, and agreements require additional approvals, but these investments are typically not optional because they directly address revenue generation or risk management for our customers. Of note, our revenue from Service Providers was up 16% year-over-year in the quarter. The slower Service Provider spending of the last few quarters is not reflective of competitive losses nor does it suggest any longer-term trends relative to demand for A10 products. As investments are approved, we are benefiting. During Q1, we saw strong growth in our APJ region as an example of this pattern. On a trailing 12-month basis, Enterprise revenue growth continues to outpace overall revenue growth. As we have said, A10 solutions are integrated into customer workflows, and we are a key part of CapEx plans. On a full-year basis, we expect Enterprise revenue growth to outpace overall revenue growth. We have been investing both in terms of our Enterprise-facing sales and marketing team and in terms of R&D to strengthen our capabilities to effectively target the enterprise segment. These investments are expanding our pipeline, and we are confident that enterprise sales in the second quarter will be better than the first quarter, and we believe the second half of the year will show meaningful improvement compared to the first half. As we increasingly align our solutions with consumption trends in this market, we expect to see growth in deferred revenue, building a stronger recurring base for revenue in the future. Turning to our R&D initiatives, these investments continue to be focused on two key areas: enhancing cybersecurity capabilities and more flexible and efficient consumption models for enterprise customers. We are growing our use of AI, particularly in our security applications in addition to bringing network insights. A10 has been utilizing machine learning and AI for years, but as the technology continues to evolve and improve, we remain at the leading edge of utilizing it to provide the best solutions. The machine learning component is already contributing to faster recognition of new threats, an essential capability as cyberattacks become increasingly sophisticated. We continue to work closely to align our product roadmaps with our strong customer base, who are leading the infrastructure transformation to enable new types of traffic and threats with adoption of AI in their networks. We are actively driving productivity to support our strategic objectives. Our commitment to achieving stated goals of 80% to 82% gross margin and 26% to 28% EBITDA margin remains on plan. In the first quarter, our gross margin continued to exceed 80%, showcasing our sustained operational efficiency. Non-GAAP earnings per share were in line with expectations adjusted for foreign currency. A10's consistent ability to meet profitability targets amidst revenue challenges underscores the resilience of our business model. Looking ahead, we are confident in our ability to maintain profitability and deliver value to our shareholders through capital returns while we continue to invest in innovation. The results of the first quarter position us to achieve our full-year business model objectives, including gross margins of 80% to 82%, adjusted EBITDA margins of 26% to 28%, and single-digit growth in full-year non-GAAP EPS. We continue to buy back stock, and our cash flow more than funds our buyback and dividend. With that, I'd like to turn the call over to Brian for a detailed review of the quarter. Brian?

Thank you, Dhrupad. First quarter revenue was $60.7 million, an increase of 5.2% year-over-year. As Dhrupad described, sales cycles have elongated, and the quarter-to-quarter volatility in both Service Provider and Enterprise sectors continues to be high. Product revenue for the quarter was $30.1 million, representing 50% of total revenue. Services revenue was $30.6 million or 50% of total revenue. First quarter recurring revenue increased 13% compared to the first quarter last year, and deferred revenue increased nearly 10%, demonstrating stronger product sales over the past two quarters and continued demand for our Enterprise solutions, validating our confidence that we are not losing opportunities to competitors. As you can see on our balance sheet, our deferred revenue was $140.9 million as of March 31, 2024, up 9.7% 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. A full reconciliation of GAAP to non-GAAP results is provided in our press release and on our website. Gross margin in the first quarter was 81.9%, in line with our stated goals of 80% to 82% and up slightly from the last three quarters. Adjusted EBITDA was $13.9 million for the quarter, representing 22.9% of revenue. On a trailing 12-month basis, adjusted EBITDA was 28% of revenue, in line with our stated goal of 26% to 28% of revenue. Non-GAAP net income for the quarter was $12.7 million or $0.17 per diluted share, compared to $9.9 million or $0.13 per diluted share in the year-ago quarter. Diluted weighted shares used for computing non-GAAP EPS for the first quarter were approximately 75.3 million shares, compared to 75.5 million shares in the year-ago quarter. On a GAAP basis, net income for the quarter was $9.7 million or $0.13 per diluted share, more than doubling our net income of $4 million or $0.05 per diluted share in the year-ago quarter. During the quarter, we generated $32.4 million in cash from operations. While Q1 had a one-time benefit from better timing of receivables, we expect the full year cash flow to exceed $60 million for 2024. Turning to the balance sheet, as of March 31, 2024, we had $182.1 million in total cash, cash equivalents, and marketable securities, compared to $159.3 million at the end of 2023. During the quarter, we paid $4.5 million in cash dividends and used $3 million for share repurchases. We also continue to carry no debt. The Board has approved a quarterly cash dividend of $0.06 per share to be paid on June 3, 2024, to shareholders of record on May 15, 2024. As discussed during our last call, the Board had approved a new $50 million share repurchase plan in November. Including share repurchases, we returned $7.5 million of capital to shareholders during the quarter. We expect 2024 revenue and EPS growth in single digits, in line with market expectations. 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 turn the call back over to Dhrupad for closing comments.

Thank you, Brian. A10 maintains an enviable position aligned with trends related to the need for cybersecurity and the demand for increased throughput and lower latency. We are investing to strengthen our position with enterprise customers, and we are well aligned with Service Provider customer investment plans. Our business model enables consistent profitability and cash generation, and we are returning meaningful capital to shareholders while investing in innovation for future growth. Operator, you can now open the call up for questions.

First question comes from Anja Soderstrom with Sidoti.

This is Alex Hatman on for Anja. My first question, you mentioned that sales cycles have elongated. I'm curious what inning you think you're in with regard to seeing results from changes in the sales team?

Yes. I would say, certainly, as you know, we made significant changes in investment in our go-to-market about two years ago and one year ago as well. And I would say a typical sales cycle is 6 to 9 months, at least close to 6 months in an enterprise sale as well and a little bit longer for service provider side. So as the new processes and people ramp up fully and you factor in the sales cycle time, I would say we are probably somewhere in the second or third inning of that.

Great. And just curious, how are the conversations going? Do you feel like you still have pricing power in this environment?

I think there's two factors that go into it, right? So certainly, it is well understood and accepted that there is broad inflationary cost pressure on input costs. So I don't think that's necessarily a huge issue. To the degree that we work with our customers to understand that, it's typically a very collaborative conversation. Beyond that, I think our focus is to not necessarily drive our margin through price but more to drive it through efficiency and operational gains. So balancing, obviously, inflationary cost pressure, we look to find that balance where we are also not discouraging customer investment.

Got you. Last question from me. Just around capital allocation priorities. Could you talk a little bit more about how you're thinking about that and maybe even add some context around future room for buybacks?

Sure. The way we talk about it is our first priority is continuing to invest in organic growth of the business. You can see, for example, even in Q1, we increased our investment in R&D because we think that's important for us to ensure that we continue to provide the best solution. Our second priority is finding a balanced way between dividend and buyback as a return to shareholders. We have active buyback programs that we exercise and utilize, but subject to constraints on volume and trading. We continue to look at that as a lever available to us. Historically, in the last few years, we have utilized most of the buyback but not in a monthly manner, but in a more adjustable manner. Our third priority, given that we have no debt and continue to be a healthy cash generation business, is to look for inorganic opportunities that help us expedite our strategy. Our business plan and customer engagements are not predicated on doing that, but it would be a means to accelerate strategy thoughtfully without diluting our business model goals in the long term.

We now turn to Gray Powell with BTIG.

And congratulations on the good results. So yes, maybe I'm reading between the lines too much, but it seems like your tone is a lot better today than it was last quarter and maybe for much of 2023. Do you feel like your business has hit an inflection point here? Can you maybe talk about how you feel about the quality of your pipeline and just your ability to call the business today versus, call it, 6, 12 months ago?

Yes, great question. You are correct, Gray. I would say that compared to 6 to 12 months ago, certainly, we are not seeing things deteriorating. I’m hesitant to use the term inflection point, but I would say, from a trend perspective, we are seeing things not getting as worse as they did in the last 2, 3, 4 quarters. We definitely see our customers more engaged on actual projects, right, in the pipeline and plans. Now does that fluctuate in plus or minus 1 or 2 quarters? Maybe. But certainly, from a trend perspective, we are not in a worse position than Q4 or Q3 last year.

Understood. Okay. Very helpful. And then you answered this to some extent in the prepared remarks. The combined results were better than what we were looking for. It's definitely good to see the growth return to positive territory. I was a little confused on the mix. Service Provider was much stronger than expected. It looks like that happened in APJ. Enterprise declined. Can you just talk about what happened in Q1? Or just can you explain the underlying trends there?

Yes, absolutely. Good question. First, for us, if you look at our Enterprise segment, its service provider on a longer period like trailing 12 months, Enterprise business is still in positive growth territory compared to many others. Service Providers, however, is obviously negative. So that's one data point. Second, Q1 of last year had an unusually strong Enterprise quarter, making the Q1 to Q1 compare a little more challenging because typically, Q4 is very strong, and Q1 drops off. That's the second data point. And third, based on our pipeline and funnel for Enterprise versus Service Provider, we feel that supports the comments we expect that to continue to recover and grow faster than overall revenue. As it relates to Service Provider, some customers have waited or delayed adding costs, even though there was a clear need for capacity. We saw some of that get realized in Q1. That doesn't necessarily mean that's going to be the case every quarter in that region, but it shows that customers want to use more product but delayed spending, which reflects the global spending pattern being somewhat unpredictable. However, due to our geographic exposure, we balanced out for us.

Our next question comes from Hamed Khorsand with BWS Financial.

So the first question I had was, could you just talk about your investment in the sales process? Where you're focused, and why you're not getting any return on your service provider side? Are you underinvesting in the sales process? Or are customers just not buying anything or buying very little?

Thank you, Hamed. I think if I understand the question correctly, the phenomenon is different for us. The Service Provider for us consists of existing customers around the world, many of which we've serviced for over a decade. Our investment focuses on our technical capabilities to support them and investing in engineering projects that align with their future directions. So our focus is on customer engagement and creating business value. On the Enterprise side, our investments are more about hiring people with Enterprise sales experience, especially in security solutions. We have an existing customer base, but here it’s about acquiring and adding new meaningful customers. So it's a different type of investment and phenomenon. Each account, whether it's Service Provider or Enterprise, has its own needs and resource mix.

Could you provide any kind of data regarding what new customers represent to you in terms of revenue?

We don't publish that data, but typically, between Service Provider and Enterprise, about 80% of our revenue is from existing customers, while roughly 20% is new customers or new business, with that percentage being higher within Enterprise.

Okay, great. And then is there any particular reason why service provider remains soft? Can you characterize that a bit?

That's fair. Our security revenue in Q1 continued to account for over 60% of our revenue. However, the macro environment in North America is causing Service Providers to be much more cautious than ever before. Though we are discussing specific projects and engagements, they are weighing the timing of their spending. Even when security leads to quicker traction with enterprise customers, Service Providers face unique requirements since they manage their own networks.

We now turn to Christian Schwab with Craig-Hallum.

My first question is regarding this elongated sales cycle. Assuming that by the end of 2024, can we return to double-digit growth in 2025?

Good question. Just to decouple the two concepts, I was answering the previous question about the sales transformation and where we are in that process. In terms of timing, as we continue to improve in the Enterprise segments, while also seeing Service Provider spending return to normalized levels, it should bring us back to that growth level, yes.

Our next question comes from Hendi Susanto with Gabelli Funds.

Dhrupad and Brian, I have several questions. My first question, service revenue grew 15%. That is impressive. Could you share more color on the strength of service growth and how much of that can be attributed to the security solution?

If you look at our year-over-year growth, security solutions now represent a slightly higher percentage of revenue. Having those solutions enables us to open the door to broader conversations as well, leading to sales of other products. This has been a significant driver of that growth.

The presentation mentioned service provider customer investment plans. Could you provide more insight among different Service Provider investment plans? Which are the higher priority ones and which can be postponed indefinitely?

I would categorize it in three areas. One is when they need to add capacity or products to help generate or maintain revenue; that is usually a number one priority. Second, making the network more resilient and secure, which is close to number one as well. These two categories cannot be delayed indefinitely. Conversely, solutions related to rebuilding a new network or changing application methods are at the highest risk of delay because they are not directly aligned with operations but more about modernization.

Do you have insights into the penetration rate of security solutions among your customer installed base? How many of your installed base have not adopted the security solutions? How much more opportunity is there?

It's difficult to quantify, but there are two reasons why people spend more on security. One is that they realize they need to do more. The second is when they hear about public breaches, prompting them to take action. For our existing customers, there's no quantitative benchmark dictating how much they must spend on security; it depends on their vertical and risk perceptions. However, we see this as a significant opportunity for us for many years to come.

If I look at the list of A10 Network Solutions, which has stronger momentum, security or hybrid cloud solutions? What offers more potential upside this year?

I would rate both as critical areas for us. Our R&D and everything is aligned that way. Supporting more hybrid infrastructure is becoming increasingly popular and will help us with growth in the enterprise and some service providers. Our security initiatives with new capabilities are also broad-based, affecting the SDN enterprise and every region. Those are our two main investment areas.

Is there any impact of Japanese yen exchange rates in Q1? Or any anticipated impact?

There were a couple of points regarding that. The Japanese yen declined over the quarter, starting out with a JPY 140 exchange rate of the U.S. dollar to the JPY 150s, and even today, it's trading higher. We don't plan our budget based on the U.S. dollar outcome. Our Japanese team continues to meet our plans. There was some FX adjustment, but we typically cover gaps or offset risks through other regions. We did see a modest impact in revenue, but nothing significant.

This concludes our Q&A. I'll now hand back to Dhrupad Trivedi for final remarks.

Thank you, and thank you to all of our shareholders for joining us today and for your support. Thanks to all the A10 employees around the world that continue to help drive our business forward. Thank you.

Ladies and gentlemen, today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines.