A10 Networks Inc

NYSE:ATEN

Earnings Call Transcript 2023-Q1

[Operator]

Hello, and welcome to the A10 Networks First Quarter 2023 Financial Results Conference Call. My name is Alex, and I'll be coordinating the call today. [Operator Instructions] I'll now hand over to Tom Baumann of FNK IR. Please go ahead.

[Tom Baumann]

Thank you, and 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 first quarter 2023 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 our potential revenue growth, industry and customer trends, our capital allocation strategy, supply chain constraints and expectations, our positioning, our repurchase and dividend programs, and our market share. These statements are based on current expectations and beliefs as of today, May 4, 2023.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, such as the potential impact of the COVID-19 pandemic on our business and operations 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 the 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-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.

[Dhrupad Trivedi, executive]

Thank you, Tom, and thank you all for joining us today. Our first quarter results were in line with the estimates we shared on April 3. While revenue was impacted by the economy and slowing purchasing decisions, the team moved quickly to respond to these changes, and we maintain our profitability at historical levels, better positioning us to achieve our full year targets for non-GAAP EPS. This was due in large part to the focus on driving a more resilient and durable business model. As previously communicated, we believe the first quarter will represent a floor for our results this year, and we expect sequential improvements as we move through the balance of 2023.

While large enterprises and especially Tier 1 service providers are more carefully considering investments due to the economy, security solutions remain a priority and are increasingly not a discretionary consideration. Companies around the world, even those with robust security processes and controls, are experiencing an ever-growing threat of cyber-attack.

During the first quarter, we further augmented our already robust security infrastructure to enable us to better support our customers against these threats.

Cyber-attacks are simply a business reality for even the most prepared organization and that deploying solutions to mitigate this risk and the associated disruptions they cause is a priority even during challenging times.

Like others, we are seeing longer sales cycles, particularly among larger North American customers due to concerns about the economy. We do not believe we have lost any meaningful forecasted deals to competitors, but they are taking longer to close, impacting our normal revenue cadence.

Indeed, North America declined 9% in the first quarter compared to last year, and revenue in the rest of the world was down 7% year-over-year. Effectively, all of this revenue decline was due to Tier 1 customers who paused plan buying in the quarter with expectations of resumption in the second half of the year.

Our diversification, both in terms of geography and customers, helped us mitigate the macro environment as we believe we are navigating the economy better than most, but we were not immune from the conditions.

Proactively, we have taken steps to align our cost structure. We deployed select austerity measures to reduce operating expenses by 10.3% year-over-year in Q1 in light of these macro headwinds. I want to note that we were mindful of our long-term goals, particularly related to growth as we reviewed our near-term spending. Over the long term, I don't believe this effort will materially impact our business trajectory, our ability to achieve multiyear targets as market conditions normalize.

In reality, our ability to maintain solid profitability and cash generation even during a quarter with significant revenue challenges speaks to the durability of our business model and execution.

As a result, we maintained our gross margins in excess of 80% and significantly expanded our adjusted EBITDA margin to 26.8% versus 21.6% in last year's first quarter. This is in line with our business model goals of achieving 26% to 28% EBITDA and 80% gross margin.

As we have previously communicated, our ability to proactively manage investments and certain expenses enables us to maintain robust profitability even when revenues are under external pressure. We have continued to methodically plan these actions, including supply chain, sales and marketing investment, and selected strategic investments in R&D.

In an effort to improve the security and resiliency of our hybrid cloud offering, we recently announced a strategic partnership with Fastly, an industry leader in next-generation web application firewalls or WAF. By combining our leading ADC solution with their next-generation WAF, this first-to-market integrated solution can provide our large enterprise customers a single solution to enhance web defenses across software and hardware appliances within their hybrid cloud environment. We believe this partnership strengthens our portfolio and unlocks further diversification of our revenue stream.

Additionally, our collaboration should broaden our go-to-market strategy for this type of solution as we leverage the reach and capability of both A10 and Fastly teams.

Additionally, in Q1 and in line with these diversification efforts, a large partner in Japan introduced A10's cloud access controller into their security operations center service package. A10 Networks Cloud Access Proxy is a complete enterprise solution designed specifically to help organizations optimize the performance and security of their SaaS applications, enhance user experience and provide comprehensive visibility into branch offices and the cloud. With a partner enabling this as a service, it is further proof that we continue to invest in comprehensive security solutions delivered through multiple form factors for our customers.

In the first quarter, our revenue was negatively impacted by the combination of macroeconomic headwinds and internal company priorities to strengthen our security posture, but our business model and focus on execution enabled us to preserve our profitability. We are confident that we will show improvements as we move through the year and we continue to expect full year EPS expansion. We also continue to maintain a disciplined, flexible and opportunistic capital allocation strategy. Today, our Board approved a quarterly dividend of $0.06 per share.

With that, I'd like to turn the call over to Brian for a detailed review of the quarter. Brian?

[Brian Becker, executive]

Thank you, Dhrupad. First quarter revenue was $57.7 million, a decrease of 7.9% year-over-year, reflecting the headwinds Dhrupad described earlier. Product revenue for the quarter was $31.2 million, representing 54% of total revenue. Services revenue, which includes maintenance and support revenue, was $26.5 million or 46% of total revenue.

Moving to revenue from a geographic standpoint. Revenue from the Americas was $30 million, down 9.1%. As Dhrupad described, this reflects slowing purchasing from larger customers, primarily service providers due to the economic concerns.

As you can see on our balance sheet, our deferred revenue was $128.5 million as of March 31, 2023, up 5.9% year-over-year. On a constant currency basis, deferred revenue would have increased 8.3% 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 are provided in our press release and on our website.

Gross margin for the first quarter was 83.1%. This reflects strong execution overcoming input cost pressures and due to our product mix. We expect our revenue mix to normalize in future quarters.

We reported $13.4 million in non-GAAP operating income, up 14.3% compared with $11.7 million in the year ago quarter.

Adjusted EBITDA was $15.5 million for the quarter, reflecting 26.8% of revenue. We were able to achieve our targeted adjusted EBITDA margins even as revenue declined by nearly 8%.

Non-GAAP net income for the quarter was $9.9 million or $0.13 per share, which is relatively flat compared to $10 million or $0.13 per share in the year ago quarter. Maintaining our non-GAAP net income on 8% lower revenue is a significant accomplishment, demonstrating the earnings power we have built into the business.

Diluted weighted shares used for computing non-GAAP EPS for the first quarter were approximately 75.5 million shares compared to 79.3 million shares in the year ago quarter.

On a GAAP basis, net income for the quarter was $4 million or $0.05 per share, compared with net income of $6.3 million or $0.08 per share in the year ago quarter.

Turning to the balance sheet. As of March 31, 2023, we had $144.5 million in total cash and marketable securities compared to $150.9 million at the end of 2022. During the quarter, we paid $4.4 million in cash dividends, and we continue to carry no debt.

As Dhrupad mentioned, the Board approved a quarterly cash dividend of $0.06 per share to be paid on June 1, 2023, to shareholders of record on May 15, 2023.

As Dhrupad indicated, we believe the first quarter represents the floor for our financial results, and we anticipate sequential improvements throughout the year.

I'll now turn the call back over to Dhrupad for closing comments.

[Dhrupad Trivedi, executive]

Thank you, Brian. There is no doubt this was a challenging start to the year, but our team responded effectively, delivering strong execution and solid profitability despite revenue headwinds. Our security-led solutions are in demand across all customer segments and in each of our target geographies, and our solutions are aligned with durable secular catalysts.

Operator, you can now open the call up for questions.

[Operator]

[Operator Instructions] Our first question for today comes from Christian Schwab of Craig-Hallum.

[Christian Schwab, analyst]

So as we think about sequential revenue growth from here to the rest of the year, would you expect that to be kind of a linear event? Or how should we think about that?

[Dhrupad Trivedi, executive]

Yes. I think I'll let Brian add context to that, right? So as we noted in the last call, our normal seasonality is being impacted certainly by the economy. And so I think our results for this year from first half to second half are likely to be more back-end loaded. So we certainly see that as reflecting some of the orders that are now scheduled or planned at least by the second half, right, if not earlier. And so I would say from that perspective, we certainly expect sequential improvements into Q3 and beyond and probably sequential improvements that are in line or slightly better than historic seasonality. I don't know, Brian.

[Brian Becker, executive]

Yes. I think we've talked about 2021 was a similar pattern where we had the pandemic with challenging revenue growth in the first half of the year. Last year, I think we saw 48%, 52% mix first half to second half in terms of how much revenue was recognized first half to second half. And we believe this year will be a similar pattern we saw in '21 with a little bit of a slow start. But as Dhrupad mentioned and as I said in the script, we haven't seen any meaningful cancellations or pull back. So we think it will be a sequential growth quarter.

[Christian Schwab, analyst]

Okay. Great. And then some of the things that you mentioned and highlighted partnerships, Fastly, and a large partnership in Japan, is that directionally helpful? Or is that material revenue that could come this year?

[Dhrupad Trivedi, executive]

Yes, good question, Christian. I would think of it in two different ways. One is, obviously, we continue to maintain and invest in differentiating solutions for large service providers around the world. But at the same time, as we see maybe more uncertainty or pause in their spending related to economy, we are also accelerating our efforts to be more relevant to large enterprise customers, right? So that's an example of where we are partnering so we have a compelling value proposition. Typical sales cycle could be 6 months kind of time frame in an enterprise or large enterprise sales. So we are certainly in the mode of building the pipeline, and that certainly makes us optimistic to call that out as a meaningful partnership that gives us also more durability and broadening of revenue, but in line with our differentiation.

And the example related to Japan highlights that our progress in terms of supporting customers in hybrid environments, which could be on-prem, cloud, any other mode of consumption, and that we are able to deliver kind of cloud leading applications as well, right? So that diversification, but in the sort of vertical sense of where we are gaining more customers and partners. And we expect, again, that to be more relevant in pipeline generation in the near term, but certainly not irrelevant on revenue either for the year.

[Christian Schwab, analyst]

Okay. Great. And then just one last question. The tight controls on operating expenses. Should we anticipate that operating expenses will grow with revenue on a sequential basis? How should we be thinking about either operating expenses to revenue growth on a sequential basis going up? Or do you have a level of operating expenses you're targeting here?

[Dhrupad Trivedi, executive]

Yes. So I think there's two reasons, right? So one is, obviously, with our shortfall in revenue, there's natural reduction in commission expenses and partner costs and things like that, right, on sales and marketing side. Second is, we are able to adjust discretionary spending more to be in line with revenue and pipeline potential versus just kind of doing it linearly or spreading it equally.

And the third is, I think the decisions we are making as it relates to investments in product is more driven by ensuring that we are protecting our long-term growth and security portfolio and hybrid solutions completely and maybe being a little bit more prudent on how much we spend and how on some of the older product side.

So we are doing it in a way that we think flexes, and our business model philosophy really is, when revenue grows, a certain percentage, our OpEx growth is lower than that. And in the opposite direction, unfortunately, when revenue drops, a certain percent of our OpEx went lower than that too, right? So I think we still are focused on delivering 80% gross margin, 26% to 28% EBITDA, and flexing our cost structure with those kind of business model goals.

[Operator]

Our next question comes from Gray Powell of BTIG.

[Gray Powell, analyst]

Okay. Great. Just a couple on my side. So I think you hit on this already, but can you maybe talk about the linearity you saw throughout Q1? And did you see any material improvement in activity over the course of April or any deals that slipped from March into April that have since closed?

[Dhrupad Trivedi, executive]

Yes, good question, I think. So in terms of linearity in Q1, what we saw was probably slower January than we expected, which we had been worried about in Q4, and probably by March and being more in line with what we would have expected. So I would say, as we exited the quarter, certainly from a linearity, order rate perspective, et cetera, things were better than beginning of the quarter, which is not to suggest everything is completely normal, but certainly we saw that trend where, from what we would have expected, January start to linearity was a little worse and March was probably in line. So that's kind of entering into the quarter.

Certainly, as we have gone through the quarter so far, we have been in line with what we are expecting and not seeing a worsening versus that expectation. And we'll continue to monitor it, obviously, as the quarter goes on.

[Gray Powell, analyst]

Okay. Really helpful. And then just high level, if we were to take sort of a blended average across your primary target markets, what do you think the growth is this year? And then how should it shake out once things normalize?

[Dhrupad Trivedi, executive]

So I think, Gray, just so I'm clear on the question, you are thinking of that relative to our infrastructure market and cybersecurity markets or geographically. What that...

[Gray Powell, analyst]

Yes, exactly.

[Dhrupad Trivedi, executive]

Okay. So I think, certainly, what we are seeing now is our security-driven portfolio continues to be the lead for conversations right now. And that is where we are seeing probably some adjustment of budget, but much more resilient than the rest of the portfolio, where that discretionary is not sort of the approach there. It's more of we need to do x and maybe we can push it a month or 2, But it's not being rescoped significantly or canceled.

On the infrastructure side, projects that tie to customer revenue generation, I think, are moving along slightly slower and a little bit more scrutiny around them, but still moving along. And I would say the most affected category negatively is related to new project to replace infrastructure and nice to have projects. And so relative to those, when I look at the growth rates near term and long term, I think on the security portfolio, we still expect that to be unchanged, slightly shifting from first half to second half, maybe, but on an annual basis, still supporting low single digits or better.

And on our infrastructure side, I think the first half looks challenging more so. We have projects where we have line of sight to the second half of the year. But certainly, with inflation, concerns of recession, cost of capital, all of that, North America infrastructure is where we see the most impact. So our projects in EMEA and Asia are less impacted by that phenomenon. So that's an area where we certainly expect it to resume to mid-single-digit or better growth. But that's the one where we would say that's probably a second half phenomenon at this point and then gets us back to kind of our long-term perspective on the blended market.

[Gray Powell, analyst]

Okay. That's a lot of color.

[Dhrupad Trivedi, executive]

Yes. And Gray, sorry, just one last thing to add. Obviously, you look at those as market growth rates, but expect to do a little better with commercial execution, so slightly better than those rates there.

[Operator]

Our next question comes from Hamed Khorsand from BWS Financial.

[Hamed Khorsand, analyst]

Could you just be a little bit more specific as to the cost levers that you pulled in the quarter, and why is it that you waited until revenue is starting to slow to pull those levers instead of in a good environment?

[Dhrupad Trivedi, executive]

Yes. So good question, Hamed. And obviously, I would say if you look at our trajectory for the last 12 quarters, we certainly have improved EBITDA continuously, right? So it's not a matter of not.

I think the way to think about it really is we are responding to a changing market environment, right? So 1 year ago, our spending profile was linked to a market environment that supported a certain growth rate. And so we flexed our spending to grow slower than that, but help us continue to support that growth rate. When we are faced with a change in external circumstance on market and customer spending, I think it's responsible for us to respond to maintain our commitments on profitability and EBITDA. So the nature of reductions, I think, obviously, if revenue is less, it saves us on commissions and partners and rebates and all of that.

Discretionary events and marketing and other spending, we basically deferred it to outer quarters when it is more in line with where we see growth and actually customer receptivity to that translating into pipeline and spending.

And I think on the R&D side, it's continuing to be more and more sharper on what our portfolio focus is. And I fully expect that as revenue improves, we will continue investing in those priorities, but now they will be even more aligned with long-term goals for us.

[Hamed Khorsand, analyst]

Okay. And then has the average sales or request for quote declined in the quarter?

[Brian Becker, executive]

Average, no. If anything, it's improved. I mean, we see that in our margins, but it's not a meaningful improvement. I think it is as expected.

[Dhrupad Trivedi, executive]

Yes. It's not a deterioration in the packet size or sales size there?

[Brian Becker, executive]

Yes. We weren't getting pressure in competitive situations. We were just seeing delays.

[Hamed Khorsand, analyst]

And the size of the spend is not really declining either from the customers. They're still spending the same amount, just taking longer?

[Dhrupad Trivedi, executive]

Yes, yes, exactly.

[Brian Becker, executive]

Correct.

[Hamed Khorsand, analyst]

Okay. And then as far as your commentary about the sequential improvement, what gives you the confidence that you could see that further into Q3 and Q4 given the hiccup that happened in January?

[Dhrupad Trivedi, executive]

Yes. So I mean, I think that's a good question. And I think, if you connect back, our sales cycle is 6 to 8 months, typically in big deals on the longer side. And that is the reason why when we were looking at Q4 pipeline and projected like deals coming out and when and which customers and regions, that is when we had started seeing concern about Q1 and the environment, right? So right now, when we look at our customer mix and pipeline as it is projected out into Q3, Q4, certainly Q3, we have higher confidence that, that is based on a broad set of customers and solutions and not driven by 1 region or 1 product per se, right? So I think as we have continued to diversify with more security-led sales, we think that, that continues to add to our confidence where a lot of the wins could be in EMEA or Asia or Japan as well.

[Operator]

Our next question comes from Anja Soderstrom from Sidoti.

[Unknown Analyst]

All right. This is Stephan on for Anja Soderstrom. My first question is, has the customer sentiment changed over the last couple of weeks?

[Brian Becker, executive]

So yes, let me see if I can answer the question. Customer sentiment behavior over the last number of weeks. So entering into Q2, have we seen a change? I'd say what we have seen is a little bit more clarity around budget cycle. I think as we walked through Q1, we were having a difficult time on visibility into customers' budgeting cycles just because of delays in their own processes. I think now we're seeing a lot more clarity and visibility.

Also to Hamed's point, what's different now versus last quarter. I think we have a little bit better visibility. We think the pipeline is shaping up pretty nicely to deliver on our internal plans over the next few quarters. But that's really the biggest shift that we've seen this quarter. It's just a little bit more visibility and clarity coming out of the budget cycles our customers have gone through.

[Dhrupad Trivedi, executive]

And I think, Brian, good point. And just to add, typically, we would have had that clarity in January or February, but with a lot of the customers themselves going through size reductions and other events, those got pushed out to where there was not that clarity in that normal time, right? And we are seeing a little more of that now.

[Unknown Analyst]

And can you speak about your capital allocation priorities?

[Brian Becker, executive]

Sure. Unchanged really largely. We continue to look at our priorities. We want to fund organic growth, first and foremost. We're looking long term to ensure that we continue to hit the growth targets that we've outlined in our Investor Day presentation back in February of 2022. Obviously, things are shaping up a little bit differently in this year. But again, investing in organic growth is first priority. Second is to return value to shareholders and employees through repurchases and dividends, which continues. As I mentioned, Board approved another $0.06 dividend for this quarter. And then lastly, we're always being opportunistic about what we do with our cash on hand.

[Operator]

At this time, we have no further questions. So I'll hand back to Dhrupad Trivedi for any further remarks.

[Dhrupad Trivedi, executive]

Great. Thank you, and thank you to all of our shareholders for joining us today and for your ongoing support. Thanks.

[Operator]

Thank you for joining today's call. You may now disconnect your lines.