Q3 2023 A10 Networks Inc Earnings Call

Participants

Brian Becker; CFO; A10 Networks, Inc.

Dhrupad Trivedi; Board Chair, President & CEO; A10 Networks, Inc.

Anja Marie Theresa Soderstrom; Senior Equity Research Analyst; Sidoti & Company, LLC

Christian David Schwab; Senior Research Analyst & Partner; Craig-Hallum Capital Group LLC, Research Division

Gray Wilson Powell; MD & Security and Infrastructure Software Analyst; BTIG, LLC, Research Division

Hamed Khorsand; Principal & Research Analyst; BWS Financial Inc.

Hendi Susanto; Portfolio Manager; Gabelli Funds, LLC

Rob Fink; Managing Partner; FNK IR LLC

Presentation

Operator

Hello, and welcome to the A10 Networks Third Quarter 2023 Earnings Conference Call. My name is Elliot, and I'll be coordinating your call today. (Operator Instructions)
I would now like to hand over to Rob Fink with FNK IR. Floor is yours. Please go ahead.

Rob Fink

Thank you, operator, and 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 the A10 Networks website at a10networks.com. Hosting the call today are Dhrupad Trivedi, A10's President and CEO; and Brian Becker, CFO.
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 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 or future operating results, including their potential revenue share, revenue growth, industry and customer trends and capital allocation strategy, supply chain constraints and expectations positioning, the repurchase and dividend programs and market share. These statements are based on current expectations and beliefs as of today, November 7, 2023.
These forward-looking statements involve a number of risks and uncertainties, some which are beyond management's control, such as the potential impact of the COVID-19 pandemic. And these could cause actual results to differ materially, and you should not rely on those predictions for 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 company's 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 or considered in isolation or a substitute for results prepared in accordance with GAAP, and they 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 that was issued today and 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

Thank you, Rob, and thank you all for joining us today. The industry headwinds we discussed on our previous earnings call impacted our results in the third quarter resulting in revenue of $57.8 million, which is in line with our preliminary results. Despite these headwinds, year-to-date we have achieved our stated EBITDA goal of 26% to 28%, and we continue to generate cash.
For the past 3 years, we have been speaking about the importance of our diversified business model and its structural profitability. This diversification has enabled us to outperform the market, transition to consistent profitability, and support a buyback program and then a cash dividend. But the real value of our business model, both in terms of diversification and resource allocation relates to how we adapt to challenging macroeconomic circumstances.
In February 2021, we had guided to a business model of 80% to 82% gross margin, 26% to 28% EBITDA, and expanding EPS. In spite of a challenging top line environment, we are on track year-to-date to deliver on these as a result of our focus on execution and being customer-centric. To put it in perspective, our non-GAAP EPS for Q3 2023 of $0.16 was higher than our full year non-GAAP EPS in 2018 and 2019. This demonstrates the progress we have made in establishing durable earnings power, building upon a strong technical foundation.
We monitor growth opportunities and our sales cycles closely using multiple points of view. During the quarter, and the first few weeks of the third quarter, we saw improving market conditions. But as the quarter progressed, decisions were delayed and our visibility decreased. Even so, we expected higher revenue levels based on several late-stage opportunities that we expected to close in the last few weeks of the third quarter. As conditions worsened, these orders shifted from the third quarter into future periods during the last 2 weeks of the quarter. As a result, we made the decision to preannounce our revenue just after the quarter ended.
As has been widely reported, subsequent to our announcement, the North American market, especially with service providers, has been difficult for all of our peers. Buying decisions are being delayed, projects are being pushed, and inventory gluts are being worked through in response to rising interest rates and inflation concerns. A10 has not been completely immune to these headwinds despite enterprise segment growth both year-to-date and in the quarter.
Visibility is reduced, customer cycles are elongated, and quarter-to-quarter volatility has increased. However, our global reach, customer diversification and effective supply chain management has enabled us to navigate these challenges as evidenced by performance viewed over longer time periods. And we are confident that, as the market normalizes, our solid foundation and commitment to execution will help us to drive sustainable financial results.
Our business model enables profitability even when we experience revenue challenges. A few years ago, such challenges would have resulted in significant losses and cash burn. Today, that is clearly not the case as we reported GAAP profitability and generated cash even as we continue to return capital to shareholders while driving innovation.
In the last 12 months, we have returned $95.2 million to shareholders in the form of dividends and repurchases. In part, we have adjusted our business priorities to aggressively reallocate and reduce spending amidst a challenging revenue environment. We remain focused on preserving growth-oriented investments while being cognizant of our overall spending.
Subsequent to the end of the quarter, we launched a new component of our already strong security product portfolio. Our new A10 Defend Detector, available as part of A10 solution portfolio, provides early warning capabilities to facilitate even more effective and advanced threat mitigation. This product targets the growing threat of DDoS attacks. A10 Defend Detector helps customers build DDoS defenses before attacks occur.
We believe that our portfolio, including A10 Defend Detector, Orchestrator and Mitigator, provides the highest levels of scalability and efficacy available in the market today, delivering automated DDoS defenses for the most demanding service provider and enterprise environments. We are also in early trials with enterprise customers for our new DDoS threat intelligence service, and we plan to integrate this into our solution portfolio in early 2024. Our security research team already tracked more than 15.4 million DDoS weapons globally. Our threat intelligence service leverages this expertise.
Our global pipeline of opportunities remained strong in both service provider and enterprise segments. Projects have been delayed, but revenue has not been lost. In reality, security and network expansion remains business-critical investments. And while higher interest rates and broad economic uncertainties impacting the sales cycle, these projects cannot be permanently deferred. Our visibility has been reduced, but we continue to believe that we are well positioned to navigate these challenges and poised to rebound as the market normalizes. This is based on a customer-centric approach, combined with innovation.
With that, I'd like to turn the call over to Brian for a detailed review of the quarter and the first 9 months of the year. Brian?

Brian Becker

Thank you, Dhrupad. The results we are announcing today are in line with preliminary results reported on October 3. Third quarter revenue was $57.8 million, a decrease of 20% year-over-year, reflecting the headwinds Dhrupad described earlier. Product revenue for the quarter was $30.3 million, representing 52.4% of total revenue. After modest improvements in the second quarter, market conditions deteriorated, with several projects we expected to close at the end of the quarter being pushed into future periods during the last months. Services revenue, which includes maintenance and support revenue, was $27.5 million or 47.6% of total revenue.
Moving to our revenue from a geographic standpoint. Revenue from the Americas, including Latin America, was $25.8 million, down 28% year-over-year. This reflects slowing purchasing from large customers, primarily service providers, due to economic concerns. Revenue from the Americas was down 36%, primarily related to reduced spending from Tier 1 service providers. As you can see on our balance sheet, our deferred revenue was $135.7 million as of September 30, 2023, up 8% year-over-year.
With the exception of revenue, all the metrics discussed on this call are on a non-GAAP basis, unless otherwise stated. A full reconciliation of GAAP to non-GAAP results are provided in our press release and on our website.
Gross margin in the third quarter was 81.8%, in line with our expectations. Adjusted EBITDA was $14.4 million for the quarter, reflecting 24.9% of revenue. I'd like to note that we were able to maintain EBITDA margins in excess of 20%, even as revenues declined by 20% in the quarter.
Non-GAAP net income for the quarter was $12 million or $0.16 per diluted share, down from $15.9 million or $0.20 per diluted share in the year-ago quarter. Maintaining our non-GAAP net income on lower revenue is a significant accomplishment, demonstrating the earnings power we have built into A10. Diluted weighted shares used for computing non-GAAP EPS for the third quarter were approximately 75.8 million shares, compared to 77.7 million shares in the year-ago quarter.
On a GAAP basis, net income for the quarter was $6.5 million or $0.09 per diluted share, compared with net income of $12.1 million or $0.16 per diluted share in the year-ago quarter.
Turning to the year-to-date results. Revenue was $181.2 million, down 10.6% year-over-year. Product revenue was down 18.7%, representing approximately 55.5% of total revenue. And services revenue was up 2%, representing about 44.5% of total revenue.
Year-to-date non-GAAP gross margin was 81.6%. Adjusted EBITDA was $47.2 million, reflecting 26.1% of total revenue, in line with our profitability targets. Non-GAAP net income for the first 9 months was $36.5 million or $0.48 per diluted share, compared to $39.3 million or $0.50 per diluted share in the year-ago period.
On a GAAP basis, net income for the first 9 months was $22.1 million or $0.29 per diluted share, compared with net income of $28.9 million or $0.37 per diluted share in 2022. Year-to-date, we have generated $41.8 million in cash from operations.
Turning to the balance sheet. As of September 30, 2023, we had $169 million in total cash, cash equivalents and marketable securities, compared to $150.9 million at the end of 2022, an increase of 12% compared to the end of 2022. In the quarter, we paid $4.5 million in cash dividends and repurchased 168,000 shares at an average price of $14.52, for a total of $2.4 million. We continue to carry no debt.
The Board has approved a quarterly cash dividend of $0.06 per share to be paid on December 1, 2023 to shareholders of record on November 17, 2023. The Board also approved a new $50 million share repurchase plan.
As discussed in our preliminary results, we expect Q4 2023 revenue to be between $70 million and $80 million, and year-over-year growth in full year 2023 non-GAAP EPS. Based on current market conditions and in line with our broader peer group, we expect 2024 revenue and EPS growth.
I'll now turn the call back over to Dhrupad for closing comments.

Dhrupad Trivedi

Thank you, Brian. A10 remains well positioned to generate improved results as market conditions improve, and we expect our performance to benefit from our diversification and global presence. Our security-led solutions remain in high demand, aligned with durable secular catalyst. Additionally, our investments in supporting hybrid solutions that work on-prem and in the cloud are well-aligned with customers' business outcomes.
Operator, you can now open the call up for questions.

Question and Answer Session

Operator

(Operator Instructions) First question today comes from Gray Powell with BTIG.

Gray Wilson Powell

Okay. Great. So I had a couple here. So I just look at some of my companies on the network security side of the world, some companies like Fortinet are talking about how a portion of growth the last couple of years have been driven by temporary factors like COVID and supply chain. And now we're in sort of this digestion phase. I know you all are a little bit different, but how long do you think this digestion phase lasts? And admittedly a tough question, but what do you think growth looks like when we do come out of it?

Dhrupad Trivedi

Sure. So thank you, Gray. So maybe I'll address those separately. So first, as it relates to supply chain, you are correct, right? I think if you look at some of the networking infrastructure as well as security companies in the last 12 to 18 months, a lot of them went through this kind of inventory correction cycle, if you will, where they could not supply for a while, had a lot of backlog, built up a lot of it, and then are now kind of working through it and normalizing it.
For A10, I think because of our footprint and the way we manage some of these operational items, we were never in a situation of having excessive backlog either direction, right? So in some ways, for us, it's more reflective of the actual market opportunity because most of our business is book and turn, and so it gets affected quickly. So we don't expect or we are not -- the Q3 challenges for us had very little or nothing to do with supply chain or inventory levels. But certainly, that's a phenomenon we are mindful of. And indirectly right, we, of course, always look at the equipment customers that purchase, what is the utilization. And because our customer base is predominantly service provider or large enterprise rather than, say, small enterprise, we are very well-integrated technically to track those things.
So I do think that in itself is not a major factor. Certainly where customers will be lower to use inventory they've already purchased in the past, it's harder to predict. But I think we see deferral of new CapEx projects like building new data centers more so than kind of the cancellation of that, right? So that's sort of the supply chain perspective.
And if you see some of the peer companies, you see their growth over the last 3 years. Year-over-year, you can see that bubble, right, and then it normalizes out. So that's something we are mindful of. But unknown products would be more customers taking longer to consume what they had, not that they have so much that they don't plan to buy anything.
As it relates to COVID, I think we had mentioned this earlier, right? But because our business is predominantly in the core of the network, when things move to more remote or more distributed working models, it had a much more profound impact on companies that supported sort of work-from-home or remote applications and things like that. For us ultimately what mattered was that, that data gets aggregated into a core network. And so for us, we didn't see a dramatic demand change, again, because of the customers that we are exposed to, right, who would see more data, whether it was from home or the office, for example.
But those are factors we certainly think are germane. And it's hard for me, Gray, to differentiate that from normal CapEx cyclic behavior that you see from those customers, right? So how it is due to these factors versus their normal cycles, hard to know. But hopefully, that gives you a flavor for at least what A10 is facing.
And your next question around how do we think growth resumes. So if you think of our business, 2/3 service provider, 1/3 enterprise. Enterprise is predominantly large enterprise. And I would say that is certainly becoming more stable and not on a negative trajectory. And if you see our segment results, right, you'll see that as well.
We expect that to be driven more for us in two ways. One is they are supporting more complex configurations where more and more of their larger customers want a mixed operating environment, on-prem and cloud. And we have invested a lot in those products and commercial activities, right? So that we expect to be stable. And I think year-to-date, our enterprise segment is growing like 5%, 6%, and in quarter slightly better than that, so, even though overall is still negative.
On the service provider side, I think we made some progress with tier 2 and tier 3 a little bit, which is more or less volatile. And with tier 1 service provider, our assumption and the signs we see are it will resume towards a growth period, but it's not going to suddenly snap back to where they were. So we are projecting to have a slow recovery in the beginning of the year. And then as they see a bigger supply/demand imbalance, right, they will spend more.

Gray Wilson Powell

Understood. Okay. Great. And I guess just one follow-up question. I mean, you guys have -- you've always done a good job controlling costs. How much more room do you have to squeeze on the OpEx side and grow EBITDA and EPS in excess of revenue growth?

Dhrupad Trivedi

Yes. I think a great question, Gray. And of course, EPS growth is always more fun with revenue growth. The -- so for us, I think this year, because of the revenue impact versus last year, obviously, there are temporary cost changes that will resume when we are back in growth mode, such as right variable, selling costs, commission, channel, all of that. So we expect that obviously to float up again with revenue growth.
On G&A side, I think we continue to look for efficiencies. So nothing dramatically different, but it will always be better as a percent of revenue. And all OpEx will grow slower than revenue growth, right? The part that, I think, obviously comes back fastest would be variable comp on sales side with revenue growth.
On R&D, I would say the biggest focus for us is reallocating resources to where we see the most growth opportunities, right? So a lot of our new announcements around capabilities and products will be not more engineers per se, but the ones who are there are working on the most important things, right? So that's the way we balance it, and when growth resumes, we grow OpEx, but not as fast.

Operator

We now turn to Hamed Khorsand with BWS Financial.

Hamed Khorsand

I was -- just want to understand the conversations you're having with your service provider customers. How does that relate to your guidance commentary about 2024, when it sounds like early in your comments that you still don't have enough visibility even for Q4?

Dhrupad Trivedi

Yes. No, good question. So I think we are -- obviously, I think we are not giving guidance for 2024, right? I think what I was explaining before is -- so specific, Hamed, to the service provider customers. I would say, difference between North America and rest, so speaking about North America maybe the most, our conversations are around projects that are planned but are getting postponed, as opposed to them not needing the product anymore or scaling back their plans.
Second element is some of those customers specifically cite the cost of capital and concerns about their ability to get a rate of return when they are borrowing at those levels. And I think as those things not necessarily decline but normalize out, they will have to fulfill demand, right? So they can postpone it, but they are planning to add capacity to support new services and new data. So that's the second element of it.
And third, I think, obviously, in North America, some of the service providers have structural CapEx and capital complexity and challenges, so we are not assuming those go away, right? This is more around customers that were planning something in Q3. We know they are still planning it because we are working with them on testing and deployment, is more from that perspective than assuming that some large customers that completely shut off suddenly turns on.

Hamed Khorsand

Okay. And my other question was you've always been a service provider-centric company. What are you doing to expand your presence and market share in enterprise and how fast could that segment grow for you?

Dhrupad Trivedi

Yes. So good question. And I think if you look at our trended financials, right, and as I said before, enterprise segment actually, even in this year, is growing 5% to 7% for us. Globally, obviously, right, it's -- revenue-wise, it's still not as big or close to the SP segment. But I would say Q3, our enterprise revenue was roughly $29 million out of that. So that's a pretty good mix, if you will. Now we don't want it to grow because SP is declining, right? But that is a pretty high mark for us so far in the last 7, 8 quarters, right?
And the connection for us really there is a lot of the large enterprise customers have concluded that it is more efficient and, risk management-wise, better for them to operate on-prem and cloud, and our ability to provide that, right, is what is helping us regain growth in that market and be credible for those customers.

Operator

(Operator Instructions) We now turn to Christian Schwab with Craig-Hallum Capital.

Christian David Schwab

Just looking at your generic guidance then, if we assume enterprise remained stable at 5%, and service provider, not sure when it's going to come back, but it should come back eventually, just -- does that kind of mean that's a flat year-over-year? Or it kind of sounds like it should be up modestly, maybe like 5%. Is that kind of given the visibility at hand, I know you're not giving guidance, but it kind of seems what you're implying? But did I hear that right or did I not hear that right at all?

Dhrupad Trivedi

Good question, Christian. So obviously, we've talked about Q4, so put that aside. One of the principles we talk about, right, is we plan to always overperform versus our peer group by a couple of hundred basis points with execution and strategy. And I think if you look at all the earnings that have already come out, and you look at our peer group right now, you are correct, right, it would put the zip code for that group next year year-over-year to be 3% to 4%. And we obviously expect to do better. So we are not giving guidance, but we certainly are mindful of where the market is and working on things that help us do a little bit better than that.

Christian David Schwab

Okay. And then how long would -- at these type of growth rates versus kind of our hope to be a double-digit growth company, I don't know how many quarters ago, how long would it take before you would maybe have to readjust the cost structure of the company permanently, if you would, if the business is reverting back to kind of, call it, a mid- to high single-digit growth company?

Dhrupad Trivedi

Yes. Good question. So I think right now, obviously, we are taking actions where we can deliver results even without that high double-digit growth number. My expectation is our new products and security-led offerings obviously can grow in that zip code. Our ability to drive enterprise, although it's a smaller number, is also in that zip code.
Service provider, we are continuing to derisk. That spending is not going to snap back, but we are trying to derisk by going more to also regional providers around the world. And I would say a lot of the other people in our sector have talked about it, that they expect service provider spending to resume in the first half, but be at a more normal clip by second half of '24, right? So I think we -- obviously, we'll continue to monitor it. But our goal is obviously to get back to the double-digit growth without necessarily calling a date, right, which I can't do.

Operator

Our next question comes from Anja Soderstrom with Sidoti.

Anja Marie Theresa Soderstrom

Thank you for taking my questions. Most of them have been addressed already, but are you starting to see any lost deals? Or is it just a matter of them being pushed out, you think?

Dhrupad Trivedi

So I think what we see, Anja, predominantly is pushout. And the reason I say that is, with the nature of customers we have, right, the design cycle is 6 to 9 months. And we would have a pretty good idea if they were planning to switch, right? And we support those products for multiyears on a highly frequent basis. So we do see pushouts, and it's not in the category of like a modernization project that they canceled, right? It's more to support some subscriber growth, they are planning to invest x dollars, and now they are going to wait another quarter or 2 quarters to see where that is. So we do continue to see that.
We obviously closely look for win-loss analysis and, of course, around the world there are deals we do lose once in a while. But majority of what impacts our results is not -- is in the deferment or CapEx slowdown category than anything.

Anja Marie Theresa Soderstrom

Okay. And then just maybe touch on capital allocation and returning cash to shareholders. Have you changed anything in your strategy on buybacks?

Dhrupad Trivedi

No. I think we talked about it, right? So the Board has approved another new buyback for $50 million, and we continue to be active in the market. Of course, right, there are some constraints for us around volumes and kind of results and dates and all that, but we expect to be active in buyback. And as I noted earlier, right, we have invested a lot in buyback and dividend activity even in the last 12 months.

Operator

We now turn to Hendi Susanto with Gabelli Funds.

Hendi Susanto

Dhrupad, I have a question. So in terms of when the telco service provider demand will recover, I have several questions. The first one is, do you think they will recover at around the same time across different geography or one who may see softness first may recover earlier? And then -- yes, so let me ask that first.

Dhrupad Trivedi

Yes. So I think good question. And I would say from what we see around the world, right, we saw the most impact in North America service products, right? And that is where, obviously, that is the most kind of mix of things around CapEx as well as inflation and interest rates and everything else. We did see some slowdown in parts of Europe, but in a couple of like large territories, right, with large providers.
Beyond that, I think we saw a sort of a general slowdown, but nothing dramatic. So I think outside of North America, we will see that being stable or in line with expectations. And in North America, I think is where we continue to monitor sort of a bigger macro market environment impact on when that returns, right? And -- but certainly, I think the deepest issue for us is North America, and that's where we have the least visibility. I think the other regions are not as far off, on plan.

Hendi Susanto

Okay. And then as far as the market recovery and telco service providers, what can trigger the resumption of the demand? I think one, maybe the capacity you can only hold on like existing capacity until a certain point. But I'm wondering like what else, I'd say, if interest rates remain high, the concern on inflation is growing, I'm wondering what can trigger the demand resumption.

Dhrupad Trivedi

Yes. So I think there's two elements to that answer, right? So one is, as you said, which is a pure business case around the products that they used to buy from us. And I think one is obviously customer demand and network traffic growth, which requires them to invest more to support that traffic. And that I think is harder to predict because it comes down to their priorities, and even if their budget is cut, they still have to choose like what is not cut or funded. So that's harder.
The second part of it, right, that we have talked about before is we are also, with those existing customers, continuously trying to expand the number of categories we sell to them, as well as the different parts of those businesses where we sell, right? So in that case, we are not dependent on a single business unit, who does certain things in a big company. But it's more distributed around their mobile network, their wireline network, their security, infrastructure, all of those.
So for us, from what we can control and execute, ability to sell them more categories even if there is depressed spending is an important driver. And in terms of when they resume reinvestment, I think it's a function of where the network traffic growth is -- to a point where they cannot sustain the service level to their customers.

Hendi Susanto

I see. And then a question for Brian. Brian, product gross margin is outstanding despite of the revenue decline. I'm wondering what contributed to the strong gross margin primarily. I'm wondering whether that also reflect the -- like a more favorable mix of enterprise versus service providers? And then I'm wondering like how much cost discipline, cost cutting, supply chain improvement play into generating that strong gross margin?

Brian Becker

Yes. Thanks for the question, Hendi. Yes, I think you're exactly right. First of all, the gross margin improvement is not a function of mix of service provider, enterprise. It's more of a function of our execution and demand planning. We've done a lot of work to build different avenues to gain product and to maintain our cost structure even despite the growing input costs that we see.
But yes, it's -- again, it's being able to execute on plan, it's a mix of certain products and services, not services to subscription, and really managing and monitoring our supply chain and executing on our plans.

Dhrupad Trivedi

And I think in a different way, Hendi, think of it as, right, we said we will have gross margins of 80% to 82%. And that is in the category of things we can control, right? So, interest rates, we cannot control so much, but what we can control, we'll do our best to do what we can.

Hendi Susanto

And then, Brian, if I'm not mistaken, I think you mentioned earnings growth remains impact for 2023, which means that full year earnings will be above $0.73 of last year. May I verify that? .

Brian Becker

That's correct. Yes, we continue to drive business. We have a...

Dhrupad Trivedi

That's fully a non-GAAP EPS.

Brian Becker

Full non-GAAP EPS. As I mentioned, we expect to do $70 million to $80 million in revenue in Q4, and we'll continue to maintain our margins of 80% to 82%, which will fall through and expand EPS year-over-year for the full year.

Operator

This concludes our Q&A. I'll now hand back to Dhrupad Trivedi, President and CEO, for closing remarks.

Dhrupad Trivedi

Thank you. Thanks to all of you and to all of our shareholders for joining us today and your continued support of A10. Thanks.

Operator

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