A10 Networks, Inc. Q3 FY2024 Earnings Call

Hello, everyone, and welcome to the A10 Networks Third Quarter 2024 Financial Results Call. My name is Lydia, and I'll be your operator today. I'll now hand you over to Tom Baumann to begin. Please go ahead.

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 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 third 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, demand, industry and customer trends, strategy, potential new products and solutions, our capital allocation strategy, profitability, expenses and investments, positioning and our repurchase and dividend programs. These statements are based on current expectations and beliefs as of today, November 7, 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 our most recent 10-K 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 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. 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 balanced quarter for A10 with improved performance from both enterprise and service provider sectors. Enterprise revenue increased 5% year-to-date and is up 9% on a trailing 12-month basis, validating our new roadmap and increased focus on these customers. Growth with enterprise customers is part of our ongoing strategic focus on driving predictable performance through diversification. Indeed, diversification remains core to our overall strategy, enabling A10 to navigate challenging conditions more consistently than peers and over the long term, driving growth that outpaces the broader market segment. Service provider revenue was up 2% year-to-date after being down in the first half of 2024. While the North American segment of this business remains volatile, the overall trend is encouraging. For the past several quarters, we have communicated that the short-term headwinds impacting our service provider customers will likely pose less of a long-term challenge for A10 as our security-led solutions are increasingly essential even when macro uncertainties force customers to spend more cautiously. We communicated in Q2 that opportunities in the pipeline were not lost, just delayed. This quarter validated those expectations. We do not yet have sufficient visibility to state that the North American service provider market has stabilized, but we are cautiously optimistic that the worst is behind us. Our strong competitive position is due to our focus on security solutions. Our security-led revenue increased 10% year-to-date. Customer decisions to bolster security may be delayed, but they cannot be canceled. This is true both of enterprises who face more cybersecurity threats every day and service providers who must safeguard critical networks to service existing customers and to add new ones. We recently announced that we are expanding our security-led offerings and laid out a longer-term blueprint for further expansion, including the integration of AI capabilities throughout the portfolio. These new solutions leverage our existing presence and our two-decade-long track record of enabling best-in-class throughput, low latency, and high levels of cybersecurity, all while focusing on industry-leading low total cost of ownership. Over the next few months, A10 will continue to introduce additional tools, solutions, and capabilities to better enable positive business outcomes for our customers. Our goal is to create an integrated solution that reduces cybersecurity risk, improves the user experience and simplifies the IT infrastructure of our customers, including AI build-outs. Overall, we anticipate adding new AI-based capabilities, harnessing machine learning to better identify and mitigate threats. We are also creating solutions specifically targeting threats and vulnerabilities that AI deployments can create, launching new approaches to address these threats. Our infrastructure solutions help customers improve the performance and resiliency of their applications. From an infrastructure standpoint, we will integrate AI to predict future network performance. With A10 Control, we will enable centralized management for all A10 products, including partner products. With A10 Defend, we are developing solutions that will help our customers protect their mission-critical applications and infrastructure from an ever-growing number of cyber threats. This includes protecting web applications, providing AI-enabled protection from bots and DDoS attacks, and threat intelligence to proactively identify potential threats. Our priorities continue to be a mix of internal investments to support innovation, returning capital to shareholders, and evaluating strategic opportunities to accelerate growth. You are seeing the results of our internal investment reflected in this blueprint, and we continue to consistently return capital to shareholders. Our strong third quarter performance demonstrates the upside that is built into our business model. We maintained robust profitability in line and slightly ahead of our targets in the quarter. During the third quarter, we expanded operating margins, EBITDA margins and net margins as incremental revenue disproportionately fell to the bottom line. At the same time, it is important to note that we have increased our R&D investment more than 15% year-over-year. We generated more than $21 million in cash from operations, keeping us on track for full year targets. Our EPS in the quarter benefited from nonrecurring foreign currency factors. But even excluding these benefits, our net margin and operating income expansion demonstrate the leverage and systemic profitability built into our operating model. 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.

Thank you, Dhrupad. Third quarter revenue was $66.7 million, an increase of 15.5% year-over-year. As Dhrupad described, quarter-to-quarter volatility in the North American service provider sector persists, but we delivered meaningful growth in sales to both service provider and enterprise customers. Product revenue for the quarter was $36.9 million, representing 55% of total revenue. Services revenue was $29.9 million or 45% of total revenue. Third quarter recurring revenue increased 6% compared to the third quarter last year. Deferred revenue increased 6%, demonstrating stronger product sales in the third quarter and continued demand for our cyber-led solutions. As you can see on our balance sheet, deferred revenue was $144.2 million as of September 30, 2024, as I mentioned, up 6% year-over-year and as Dhrupad indicated in his opening remarks. 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 third quarter was 81.3%, in line with our stated goal of 80% to 82%. Adjusted EBITDA was $17.8 million for the quarter, reflecting 26.7% of revenue, in line with our goal of 26% to 28%. Non-GAAP net income for the quarter was $15.9 million or $0.21 per diluted share compared to $12 million or $0.16 per diluted share in the year ago quarter. Diluted weighted shares used for computing non-GAAP EPS for the third quarter were approximately 74.8 million shares compared to 75.8 million shares in the year ago quarter. On a GAAP basis, net income for the quarter was $12.6 million or $0.17 per diluted share compared to net income of $6.5 million or $0.09 per diluted share in the year ago quarter. As Dhrupad mentioned, several nonrecurring and nonoperational benefits resulted in higher-than-normal earnings per share. This was largely related to foreign currency exchange rates and interest income. Turning to the year-to-date results. Revenue was $187.5 million, up 3.4% year-over-year. Year-to-date non-GAAP gross margin was 81.4%, in line with our target range. We reported $39 million in non-GAAP operating income, down 3.6% compared with $40.4 million in the first 9 months last year. Adjusted EBITDA was $47.2 million, reflecting 25.2% of revenue. Non-GAAP net income for the first 9 months was $41.9 million or $0.56 per diluted share, up from $36.5 million or $0.48 per diluted share in the year ago period. On a GAAP basis, net income for the first 9 months was $31.8 million or $0.42 per diluted share compared with net income of $22 million or $0.29 per diluted share. During the quarter, we generated $21 million in cash from operations, as Dhrupad mentioned earlier, and year-to-date, cash generated by operations was $64.8 million, in line with our full year targets. Turning to the balance sheet. As of September 30, 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 $4.4 million in cash dividends and repurchased $9.4 million 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 December 2, 2024, to shareholders of record on November 18, 2024. We have $25.4 million remaining in our $50 million share repurchase authorization as of September 30. 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 over to Dhrupad for closing comments.

Thank you, Brian. Increasingly, A10 is outperforming our peer set amidst ongoing market volatility. The buying cadence from service providers is improving and our ability to execute in driving demand from enterprise is improving simultaneously. Additionally, our investments in R&D are expected to result in additional solutions, leveraging our growing position in cybersecurity, further enhancing our growth profile. And we have proven the ability to translate incremental revenue into significantly higher profitability levels. I am confident we have the right strategy, delivering the most important business outcomes for our customers and a durable business model. Operator, you can now open the call up for questions.

Our first question comes from Trevor Rambo with BTIG.

It's Trevor on for Gray Powell. Congrats on some nice results in the quarter. So to start, it was good to see SP spending come back and to see some strength in that segment. How should we expect demand there to continue throughout the rest of the year and maybe into next year? Just any more color on what you're seeing in that segment would be great.

Sure, yes. So I would say that as we noted earlier, we expect to see some level of volatility in the space, but the overall trend is improving and stabilizing more. Given sort of post-election outcomes on things like interest rates, that can get modulated a little bit up or down, right? But overall, I would say that we certainly feel from a customer demand perspective, we are seeing more positive signs where they are beginning to resume investments and plans for infrastructure growth, whether it's to support AI or just cloud and so forth. So overall, I would say we feel that it's trending towards what we expect long term from that segment. It’s hard to say whether every next quarter will be perfect. But certainly, the trend line is turning in a different direction than before.

Awesome. That's good color. And maybe on the other segment with enterprise revenue, I know you guys said it was more in line with your expectations, but only up 3% about year-over-year, which was down from the previous year and last quarter. Just any puts and takes of what you're seeing in that segment? Anything you want to call out that's onetime or just overall, what you're seeing for demand there would be great.

Yes. Great question. So I think a couple of points to note, right? So one is, remember, for us, the focus in the enterprise segment is predominantly on large enterprises and not necessarily small and mid-enterprises, right? So what this is reflective of is when we look at our funnel and opportunities in front of us, we see this line continuing to improve on a dollar basis, not just as a percent of total revenue. And you are correct, I think we had a good quarter in enterprise last year. But if you look at from a year-to-date or trailing 12-month perspective, I would say those numbers compare favorably to what you might be seeing from the industry overall and certainly, right, some of the larger enterprise companies. So that's the basis for us to say that our view is we continue to make progress in that segment. And the sign of that is our trailing 12-month or 9-month growth is above industry average and that we continue to grow on a dollar basis, right? That's probably how to think about it.

Our next question comes from Hamed Khorsand with BWS Financial.

So first question I had was your accounts receivable went up quite a bit this quarter compared to Q2. What's the plan there to manage that? And are you seeing any delays as far as getting paid?

Yes, that's a good question and you're right. We're not worried about the trend. What we're observing is some linearity during this period, but the results are still positive. On the statement of cash flows, we are experiencing a period-over-period improvement at this time of year, which reflects the timing of the season. Typically, we notice a slight slowdown in order placements in Q2, but as we move into Q3, we anticipate seeing improvements and hope that linearity returns to normal. As we've mentioned before, when looking at it as a percentage of revenue, the reserve against income is very small, indicating the overall health of aging receivables.

Yes, exactly. And I think, Hamed, the easiest way to think about it is the aging of our receivables is in line or better than we normally see. So there's no concern in that regard.

Could you explain how your comments about the ongoing volatility in the service provider sector relate to your optimism that the worst is behind us? Please connect the two for me.

Yes, no problem. No, good observation. So what I meant by that, Hamed, is if you remember in Q2, we had said after the call that because we still see a little bit of caution on spending by service providers, we can see movements of a few million dollars between quarters. But that when you look at it from a longer trend perspective, we do not see that as a concern. So I would say the way to bridge it is our service provider business outside of North America was already doing fine and is still doing fine. Our North America business is a little bit volatile. As you can see that if you look at Q2 and Q3, there's a slight movement between them. But if we do a trend line of what we are seeing in the funnel, the opportunities, and close rates, and so forth, as well as customer conversations around their plans to use capital, that is more favorable than, say, 6 months ago or 12 months ago, right? So that's the combination of factors to bridge that.

Okay. And do you think that you can grow from here? Or it's just you don't have that clarity yet?

I believe we can grow from here, but it's challenging to determine a specific percentage on a quarterly basis. However, the overall trend looks positive.

Our next question comes from Christian Schwab with Craig-Hallum Capital Group.

Great. I'm sorry, I kind of missed it. I thought you mentioned that your security-led business in the quarter grew 10%. Did I hear that correctly?

Yes. No, that is correct. Security-led on a complete basis grew from 59% of total revenue to 69% revenue.

On a year-to-date basis, Christian, not in the quarter.

And on a year-to-date basis, 10%, yes.

Okay. And then what is your future expectation for that portion of your business? Is 10% the new normal? Or do you think it could be higher than that?

Yes. I think in the near future, we think 10% to 12% is appropriate. But yes, that's baked into our plan, and we think that that's a reasonable expectation.

Okay. Great. And then my last question just is regarding potential strategic alternatives or initiatives regarding M&A. Is there anything new to report on opportunities for you to layer in other businesses? Or is there really not much effort there right now?

Yes. I would say that there is effort happening right now. Throughout the year, we have been focusing on scalable assets that are more oriented toward consolidation, as well as those that enhance our security portfolio. We plan to keep pursuing this. We are active but also very careful about how we use capital to protect our long-term business model while also driving growth. So, we are quite engaged. We have partnerships and are exploring various discussions. It's not a secondary priority, but we are very aware of how we decide to allocate capital for these purposes.

And our next question comes from Anja Soderstrom with Sidoti.

Congratulations on the nice progress here. I'm curious about the new solutions or capabilities you are about to release and the increase in R&D. Will those capabilities be an upsell? Additionally, how should we think about the margin profile going forward?

Good question, Anja. We are confident that we can maintain a gross margin of 80% to 82%, which is a solid figure even for a SaaS company. We believe this is achievable through a combination of product mix and various productivity improvements we have implemented. Our focus with the new products and solutions is to broaden the categories and products we offer to both existing and new customers. From a margin standpoint, in alignment with our customer objectives, we will support a variety of hardware, software, or other consumption models. As we plan for the future, we are optimistic about continuing to achieve an 80% to 82% gross margin.

Okay. And in terms of your cash position, it was a nice increase there. Could you become more aggressive on buybacks? Or how do you think about the buybacks?

Yes. I mean we continue to be consistent about our priorities around cash and capital. Our first priority is to reinvest in the business to drive growth. As Dhrupad mentioned, we see a good increase of over 15% from an R&D perspective on a non-GAAP basis. But yes, we continue to look at ways to return value to shareholders through the share repurchase program and the dividend. Obviously, the repurchase program is not an accelerated program that we filed a protection against. So it's an opportunistic endeavor, which requires us to be mindful of guardrails around volume and pricing. So we do what we can when we can. But yes, those are our main priorities around cash deployment.

Yes, we will continue to engage in buybacks, which we believe is a strong use of our capital. At the same time, we aim to strike the right balance between buybacks, organic investments, and strategic investments. This balance can sometimes be influenced by volume and capacity limits that dictate what we can achieve in a certain timeframe. Nonetheless, we consider this an essential aspect of our capital strategy.

We have no further questions. So I’ll pass you back to Dhrupad Trivedi for any closing comments.

Thank you to all of our shareholders for joining us today and to all the A10 employees worldwide for your continued support. We look forward to a great quarter ahead. Thank you.

This concludes our call. Thank you for joining. You may now disconnect your lines.