Earnings Call Transcript - ATEN Q2 2023

Operator, 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 A10. Please go ahead.

Rob Fink, Host

Thank you, Cole. Thank you all for joining us today. 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 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 second quarter 2023 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. 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 26th, 2023. These forward-looking statements involve a number of risks and uncertainties some of which are beyond the company's 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 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-Ks. 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 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 Dhrupad. Dhrupad the call is yours.

Dhrupad Trivedi, President and CEO

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 comparison. This performance supports our belief that the first quarter represented the floor for our results with the expectation of sequential improvement 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 first six months of 2023 was a record 26.6%, up 248 basis points compared to the first six months of 2022, demonstrating the earnings power of our business model. 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 second quarter 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. 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 faced a challenging macro environment right now. Our strong presence in Asia Pacific in particular helped us mitigate the North American headwinds in the second 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%. 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. 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. 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&D dedicated to security products increased 3% year-over-year and is up nearly 8% from two years ago, demonstrating our commitment to investing in organic growth opportunities. Recently we highlighted how A10 carrier-grade networking and DDoS protection solutions helped deliver a secure and consistent subscriber experience for businesses and consumers interest, one of the nation's largest telecom operators with over 50 million subscribers, chose A10 to help facilitate their networks 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 ill-estimated traffic. Our new solution, enabling hybrid infrastructure directly helped create customer value in this case. A10’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 five years now. Our consistent profitability fuels our capital allocation strategy. During the quarter, we paid $4.4 million in cash dividends and repurchased $6.2 million worth of our shares, all while growing our cash balance. We continue to focus on our three-pronged strategy for capital allocation. First, investing in our business for future growth. Second, returning capital to shareholders; and third, continuing to explore strategic and accretive acquisitions. With that, I'd like to turn the call over to Brian for a detailed review of the quarter and the first six months of the year. Brian?

Brian Becker, CFO

Thank you, Dhrupad. Second quarter revenue was $65.8 million, a decrease of 3.2% year-over-year, but in line with expectations. Product revenue for the quarter was $39.1 million, representing 59.4% of total revenue. It's worth noting that sequentially, product revenue increased 25.4% compared to the first quarter of this year, reflecting the improving conditions Dhrupad mentioned. Services revenue, which includes maintenance and support revenue was $26.7 million or 40.6% of total revenue. Moving to our revenue from a geographic standpoint. Revenue from the Americas, including Latin America, was $36.9 million, 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 million, as of June 30, 2023, up 3% year-over-year. 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 $15.2 million in non-GAAP operating income, down 5.7% compared with $16.1 million in the year ago quarter. Adjusted EBITDA was $17.4 million for the quarter, reflecting 26.4% of revenue. 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 $14.5 million or $0.19 per share on a diluted basis up from $13.4 million or $0.17 per diluted share in the year ago quarter. Diluted weighted shares used for computing non-GAAP EPS for the second quarter were approximately 75.4 million shares compared to 78.3 million shares in the year ago quarter. On a GAAP basis net income for the quarter was $11.6 million or $0.15 per diluted share compared with net income of $10.4 million 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. Turning to year-to-date results. Revenue was $123.5 million 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% in line with our target. We reported $28.5 million in non-GAAP operating income up 2.7% compared with $27.8 million in the first six months last year. Adjusted EBITDA was $32.8 million reflecting 26.6% of revenue. Non-GAAP net income for the first six months was $24.5 million or $0.32 per diluted share up from $23.4 million or $0.30 per diluted share in the year ago period. On a GAAP basis net income for the first six months was $15.6 million or $0.21 per diluted share compared with net income of $16.8 million or $0.21 per diluted share. Turning to the balance sheet. As of June 30, 2023, we had $153.9 million in total cash, cash equivalents, the marketable securities compared to $150.9 million at the end of 2022. In addition, accounts receivable has increased slightly sequentially and DSOs remained healthy decreasing sequentially. This is a function of delayed customer buying decisions with orders coming in at the end of the quarter. Our receivables remain very small and in line with our historical levels. During the quarter we paid $4.4 million in cash dividends and also repurchased approximately 43,700 shares at an average price of $14.27 totaling $6.2 million 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. 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 Dhrupad mentioned, the Board has approved a quarterly cash dividend of $0.06 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 Dhrupad for closing remarks.

Dhrupad Trivedi, President and CEO

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, where 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, Operator

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

Gray Powell, Analyst

Great. Thank you for taking the question. Just a couple on my side. So it's good to see the decline in product revenue improved 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 six 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.

Dhrupad Trivedi, President and CEO

Yeah, no, good question, Gray, and I'll start and Brian can add to it. So I think in Q1 obviously, we had talked about an 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. I think in Q2 we are seeing improving visibility and potentially improving confidence in North American spending resumption. So I would say, a 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 markets normalizing 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 programs that we have adjusted and put in place now to kind of resume that.

Gray Powell, Analyst

Understood. Okay. Great. And then I guess my follow-up question would be on the cost side. So, the controls on OpEx year-to-date has been impressive and it seems like visibility on demand is improving. 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 be investing on the sales and marketing side lag or recovery in top line growth? Thanks.

Dhrupad Trivedi, President and CEO

Yeah, good question. So I think, the way I would separate two components of that, right? So there's probably a more mechanical component of where sales and marketing spend, which is commissions and rebates and things like that, flex is pretty obviously with revenue levels, right? So that's one component. So as revenues are higher, just proportionally the commissioned 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 in regions, which are relevant to us or negative to us and reflect our sales and marketing spend outside of commissions to that type. I think you would see not an increase in sales spending followed in six 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 the revenue.

Gray Powell, Analyst

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

Hamed Khorsand, Analyst

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

Dhrupad Trivedi, President and CEO

Yes. Good question, Hamed. 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. The 50% in the Americas, where it typically relates to large customers 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 planned 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 adjustments 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 in places where it was related to modernization. Those projects are generally pushed out six to nine 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 they're going to hold off till we review all our CapEx again and maybe it's going to be July. So that's again because it's generating revenue for the customers, it's deferred but not canceled. So I don't know if that gives you more color on Hamed.

Hamed Khorsand, Analyst

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?

Dhrupad Trivedi, President and CEO

I believe that the category of security spending is fundamentally different from one-time IT expenses because it is closely linked to enterprise decisions and business operation risks. It is not solely focused on upgrading IT; it also involves risk management. In the current climate, the increasing volume and complexity of cyberattacks reported in the news have heightened awareness and urgency among organizations to enhance their security measures. This trend is likely benefiting most security companies, including us. There seems to be minimal churn in this market, as our customer base mainly comprises larger companies that invest substantial time and resources into integrating these products. We observe demand reflecting their growing concerns regarding the types of organizations being targeted and the subsequent impacts highlighted in the media.

Hamed Khorsand, Analyst

Okay. Thank you.

Anja Soderstrom, Analyst

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

Dhrupad Trivedi, President and CEO

Yes. Yes, good question Anja. 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 into different ways of consuming IT and so forth. 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. So, I think said differently, I would say they are making decisions that are more economic-driven than technology-driven.

Anja Soderstrom, Analyst

Okay. Thank you. And in the past year you've been talking about UK displacing some competitors. Have there been anything to call out in the competitive environment?

Dhrupad Trivedi, President and CEO

No, I don't believe there has been any significant change in the competitive environment over the last three to six months. I would say that market demand from customers is stronger, but there hasn't been a real change in our competitive strategy or the reasons for our success.

Anja Soderstrom, Analyst

Okay. Thank you. That was all for me.

Hendi Susanto, Analyst

Good evening Dhrupad and Brian.

Dhrupad Trivedi, President and CEO

Hi, Hendi.

Hendi Susanto, Analyst

Dhrupad, may I inquire your insight on business outside of North America, I think specifically I'm wondering like how similar, how different? And then if let's say if certain purchase orders or delays maybe lagging outside of America, meaning that we may see those trends later?

Dhrupad Trivedi, President and CEO

That's a good question. In North America, we have a unique combination of factors including concerns about inflation and interest rates. Companies are responding to these issues by managing demand, resulting in restructuring efforts. This level of challenge is not as prevalent in other regions. In Europe and Asia, while there are concerns about the global outlook, they aren't experiencing the same escalating costs of capital or unmanageable inflation pressures that necessitate significant restructuring. We have seen some examples of large telecommunications companies in Europe going through restructuring, but overall, purchasing decisions in those regions seem to have normalized. Customers are making decisions primarily when they need to increase capacity or add new security features. There may be more inquiries and a few extra approvals involved, but it's not at the scale we witnessed in the first quarter when U.S. companies were undergoing massive layoffs and restructuring. The North American environment is distinct due to these combined factors, even amidst general global pessimism. Additionally, many regions outside North America have been more focused on optimizing their existing infrastructure and upgrading technology, rather than replacing it entirely. Thus, the changes they face aren't as severe, and we believe that our ability to assist them with upgrades will best serve their needs moving forward. While some restructuring has occurred in certain European telecommunications companies, we don't see the same issues unfolding elsewhere as we do in North America.

Hendi Susanto, Analyst

And then Dhrupad, any update on product development and product roadmap for this year?

Dhrupad Trivedi, President and CEO

We have previously discussed our focus on enhancing cybersecurity capabilities and infrastructure to support hybrid operating environments. We are transitioning to a more agile methodology, allowing for continuous releases rather than a single major release every six months. We do have a roadmap in place, having launched a new hardware platform last December, with another expected in the Q3-Q4 timeframe. Most of our R&D efforts are directed towards expanding our software security portfolio and facilitating hybrid operating environments.

Hendi Susanto, Analyst

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

Brian Becker, CFO

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. 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 Dhrupad 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 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 a function of profit before tax. It's approximately EBITDA but it's a little bit different. Obviously, our GAAP tax rate is a little bit different but we try to align with both of them and we continue to invest in tax saving strategies to maintain that outlook.

Hendi Susanto, Analyst

Thank you, Dhrupad. Thank you, Brian.

Dhrupad Trivedi, President and CEO

Thanks, Hendi.

Operator, Operator

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

Dhrupad Trivedi, President and CEO

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.

Operator, Operator

That concludes the conference call. Thank you for your participation. You may now disconnect your line.