A10 Networks Inc

NYSE:ATEN

Earnings Call Analysis

A10 Networks Maintains Stability Despite Revenue Drop

In Q2 2024, A10 Networks reported $60.1 million in revenue, down 8.7% year-over-year. Despite this, services revenue rose 15%, making up for a 15% drop in product revenue. The company's gross margin remained strong at 80.9%, meeting their 80-82% target range. Adjusted EBITDA was $15.5 million, representing 25.8% of total revenue. Non-GAAP net income was $13.2 million, or $0.18 per share, slightly down from last year. For the first half of 2024, A10 generated $43.8 million in cash from operations and expects full-year EPS growth in single digits, maintaining robust profitability even amid a challenging North American market.

Navigating Choppy Waters: Revenue Performance and Market Dynamics

In the second quarter of 2024, A10 Networks reported revenues of $60.1 million, reflecting an 8.7% drop compared to the same quarter last year. This decline was attributed to ongoing volatility within the North American service provider sector. However, A10 noted resilience in its Enterprise segment, which saw significant growth, counterbalancing some of the downturn in the service provider space. The product revenue stood at $29.5 million (49% of total revenue), while services revenue accounted for $30.6 million (51%). An encouraging statistic was the 11% increase in recurring revenue year-over-year, coupled with a 6% rise in deferred revenue, indicating a strong demand for enterprise solutions.

Profitability Remains Solid Despite Revenue Headwinds

A10 maintained a gross margin of 80.9%, aligning well with its target range of 80% to 82%. The adjusted EBITDA was reported at $15.5 million, making up 25.8% of total revenue. Non-GAAP net income for the quarter decreased to $13.2 million ($0.18 per diluted share), compared to $14.5 million ($0.19 per diluted share) in the previous year. However, despite the challenges faced, A10 successfully navigated the situation, continuing to generate positive free cash flow, with $11.3 million generated from operations in Q2.

Strategic Diversification: Focusing on Enterprise Growth

A10's CEO, Dhrupad Trivedi, emphasized a strong diversification strategy enabling the company to remain profitable amidst fluctuating revenue. Particularly, the Enterprise segment showed remarkable growth of 25%, providing some relief to the declines experienced in the service provider revenues. A tenacious commitment to R&D and sales investments within the Enterprise market is expected to yield further benefits as these initiatives mature over the following quarters, supporting projected profitability as revenue conditions stabilize.

Forward Guidance: Positive Outlook Amidst Challenges

Looking ahead, A10 expects low single-digit revenue growth for the full year, along with consistent non-GAAP earnings per share (EPS) growth in the single digits. Throughout 2024, the company aims to maintain gross margins within the targeted range of 80-82% and to achieve adjusted EBITDA margins of 26-28%. The CEO indicated that the Enterprise business, projected to continue performing well, is set to grow faster than the service provider segment and drive future growth.

Strengthening Cash Position and Shareholder Returns

As of June 30, A10 reported $177 million in cash, cash equivalents, and marketable securities, up from $159.3 million at year-end 2023. The company executed a disciplined capital allocation strategy, with cash dividends totaling $4.5 million and $11.8 million allocated for share repurchases during the quarter. Importantly, A10 carries no debt, showcasing its solid financial footing and commitment to enhancing shareholder value.

Investment in Future Technologies: AI and Security Solutions

A significant focus of A10's strategic initiatives includes investing in artificial intelligence and network security solutions. With increasing requirements for customers to manage network security effectively, A10 plans to leverage its expertise in AI to bolster its service offerings. The introduction of new AI-based solutions is expected to meet the rising threat of security challenges, positioning A10 to capture new market opportunities while enhancing customer engagement.

Earnings Call Transcript 2024-Q2

[Operator]

Thank you for joining. I would like to welcome you all to the A10 Networks Second Quarter 2024 Financial Results Conference Call. My name is Brika, and I'll be your moderator for today. [Operator Instructions]

I would now like to pass the conference over to your host, Tom Baumann with FNK IR. You may proceed, Tom.

[Tom Baumann]

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 second-quarter 2024 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. You may access the press release, presentation, and trended financial statements on the Investor Relations section of the company's website.

During the course of today's call, management will make forward-looking statements, including statements regarding projections for future operating results, including timing, including our potential revenue growth, demand, industry, and customer trends, our capital allocation strategy, profitability, expenses, and investments, our positioning, our repurchase and dividend programs and our market share. These statements are based on current expectations and beliefs as of today, July 30, 2024.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control that could cause actual results to differ materially, and you should not rely on them as predictions of future events. A10 does not intend to update information contained in these forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law. For a more detailed description of these risks and uncertainties, please refer to 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 prepared results 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'd 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. The North American service provider market remains choppy even as spending is trending positive in an overall direction. The market sentiment improved in the first quarter versus the second half of 2023, but we still saw projects moving across quarters. Year-to-date, our service provider revenue, excluding North America, is up 20%, demonstrating that this is largely a North American market issue related to the timing of carrier CapEx. Encouragingly, much of these headwinds in the second quarter were offset by improving strength in the enterprise segment. We have been devoting resources, both R&D investments and additional sales and marketing muscle to target enterprise opportunities. These investments are bearing fruit. Enterprise-related revenue increased 25%, offsetting much of the 25% decline in the service provider segment.

Additional investments are in process now, and we expect A10's position in the enterprise market to continue to improve.

During the quarter, one of the world's largest digital communications technology company with nearly 100,000 employees worldwide, chose A10, displacing their previous vendor for their hybrid infrastructure solution. Our commitment to technical performance with a reenergized enterprise portfolio, global technical support and alignment with customers' business goals, led A10 to secure this win in the quarter and showcased our ability to compete and win in the enterprise space with the most demanding infrastructure. As we look at our pipeline for the second half of the year, this segment is expected to grow faster than service provider segment and provides the basis for continued growth in this vertical.

Growing the enterprise business is a part of our ongoing strategic focus on driving predictable performance. Diversification remains core to our overall strategy, enabling A10 to navigate challenging conditions better than peers and over the long term, driving growth that outpaces the broader market segment. Clearly, 2024 has been a challenging year for North American service providers so far as they navigate market challenges for their own businesses. A10 is not alone in this exposure, but our business model and diversification have enabled us to maintain robust profitability in line with our targets despite these headwinds.

For the first half of 2024, we delivered EPS expansion year-over-year in line with expectations and expect to accomplish this on a full-year basis. Longer term, we continue to be built to grow at a low double-digit pace faster than the market with our profitability and cash generation, helping growth faster than the top line. Simultaneously, we are investing in our next wave of growth products, including initiatives to capitalize on growth tied to new AI solutions, which continue to grow in scope and have some time before they're fully commercialized. As I have discussed in the past, A10 has long used AI in our security solutions, especially those that address DDoS attacks. We are increasing the use of AI-focused agile solutions to enable our customers to better identify, address, and remediate a growing wave of security threats.

Bad actors are utilizing AI, and we are evolving our technology to address these new threats. These tools are increasingly a must-have for our customers, and we expect to add to our security and AI-backed arsenal of solutions in the coming quarters. Security solutions as a percentage of sales continue to trend in line with our long-term growth goals. Our new engineering investments are related to developing AI-based solutions for customers to better manage and secure their networks. This includes better insights, to predict network performance as well as new capabilities to address threats in real time that have emerged with AI network traffic. In keeping with our historic strength on understanding network traffic in real-time, we are also working with customers to evolve our hardware to support next-generation data centers needed to support performance and latency needs for AI traffic in all kinds of new models. We are engaged with customers and channel partners to enable their road map as the market matures and moves into the commercialization phase in the future.

While we invest in new solutions, new technologies and reallocate sales resources, A10 remains solidly profitable even as we navigate near-term revenue headwinds. Once again, I'm proud that we have achieved our non-GAAP EPS targets even with these investments and market challenges. Just a few years ago, these factors would have resulted in significant losses. Today, we are systematically profitable. Our gross margins in the second quarter were in line with the stated goal of 80% to 82%, and our adjusted EBITDA margin was nearly 26%, in line with our profitability goals.

As revenue conditions normalize, we expect our profitability to improve further. We remain committed to achieving our long-term stated goals while driving growth. A10's consistent ability to meet profitability targets even amidst revenue challenges underscores the resilience of our business model. The results year-to-date position us to achieve our full-year business model objectives, including targets for gross margin and adjusted EBITDA margin as well as growth in our full-year non-GAAP EPS. 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. Brian?

[Brian Becker, executive]

Thank you, Dhrupad. Second quarter revenue was $60.1 million, a decrease of 8.7% year-over-year. As Dhrupad described, quarter-to-quarter volatility in the North American service provider sector continued to be high, offset by improvements in the Enterprise segment. Product revenue for the quarter was $29.5 million, representing 49% of total revenue. Services revenue was $30.6 million or 51% of total revenue. Second-quarter recurring revenue increased 11% compared to the second quarter last year, and deferred revenue increased 6%, demonstrating stronger product sales for the past several quarters and continued demand for our enterprise solutions. These metrics, coupled with a strong pipeline of opportunities, further validate our confidence that we are not losing opportunities to competitors.

As you can see on our balance sheet, our deferred revenue was $140 million as of June 30, 2024, up 6.3% 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 in the second quarter was 80.9%, in line with our stated goals of 80% to 82%.

Adjusted EBITDA was $15.5 million for the quarter, reflecting 25.8% of total revenue. Non-GAAP net income for the quarter was $13.2 million or $0.18 per diluted share compared to $14.5 million or $0.19 per diluted share in the year-ago quarter. Diluted weighted shares used for computing non-GAAP EPS for the second quarter were approximately 75.5 million shares compared to 75.4 million shares in the year-ago quarter.

On a GAAP basis, net income for the quarter was $9.5 million or $0.13 per diluted share compared to net income of $11.6 million or $0.15 per diluted share in the year-ago quarter.

Turning to the year-to-date results. Revenue was $120.8 million, down 2.2% year-over-year. Product revenue was down 15%, representing approximately 49% of total revenue, and services revenue was up 15%, representing about 51% of total revenue.

Year-to-date non-GAAP gross margin was 81.4% in line with our target range. We reported $23.9 million in non-GAAP operating income, down 16% compared with $28.5 million in the first 6 months last year. Adjusted EBITDA was $29.4 million, reflecting 24.3% of total revenue. Non-GAAP net income for the first 6 months was $25.9 million or $0.35 per diluted share, up from $24.5 million or $0.32 per diluted share in the year-ago quarter period.

On a GAAP basis, net income for the first 6 months was $19.2 million or $0.26 per diluted share compared with net income of $15.6 million or $0.20 per diluted share. During the quarter, we generated $11.3 million in cash from operations. Year-to-date, cash generated by operations was $43.8 million, in line with our full-year targets.

Turning to the balance sheet. As of June 30, 2024, we had $177 million in total cash, cash equivalents, and marketable securities compared to $159.3 million at the end of 2023. During the quarter, we paid $4.5 million in cash dividends and repurchased $11.8 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 September 3, 2024, to shareholders of record on August 15, 2024. We have $34.8 million remaining in our $50 million share repurchase authorization as of June 30, 2024. We expect 2024 full-year EPS growth in single digits, in line with expectations, and 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 to Dhrupad for closing comments.

[Dhrupad Trivedi, executive]

Thank you, Brian. A10 maintains a strong competitive position in the market, supported by durable long-term growth catalysts. Short-term volatility in the North American service provider market does not alter our long-term strategy, and we are making steady progress to enhance our position in the enterprise market. Our strategic diversification remains a key advantage, enabling consistent profitability even during periods of revenue headwinds. We also continue to create shareholder value through the return of meaningful capital to shareholders.

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

[Operator]

[Operator Instructions] You have the first question from Anja Soderstrom with Sidoti.

[Stephan Guillaume, analyst]

This is Stephan Guillaume on for Anja Soderstrom. I guess my first question is, are you still seeing service providers come back in the second half? And how are your conversations with them?

[Dhrupad Trivedi, executive]

Yes. Good question. So I think, first, as I mentioned in the body of the call, our service provider conversation is very much North America-specific, right, because we have healthy growth outside of that. So within North America, I think there are 2 things we are seeing. One is they continue to manage sort of the spending level, well projects can get scoped differently and move across periods. And our assumption, of course, is a lot of their decisions around making significant capital investments are related to A, cost of capital, and B, market uncertainty, including an election period right now. So our conversations with them generally show that they continue to spend a little bit because a lot of the things we do are in the path of either revenue generation or becoming more secure.

However, the newer projects tend to be pushed out in time a little bit. When we think of our second half, our assumptions really around delivering results are that we continue to make steady progress on the enterprise footprint. Second is we continue to see execution that we saw in the first half from service providers outside of North America. And then within North America, I think we continue to find ways between the balance of our customers to deliver that growth. At the point at which they get confident and start reinvesting CapEx. Of course, we will benefit from that as well, right? But our plan on the second half is not predicated on a sharp snapback in spending from them.

[Stephan Guillaume, analyst]

Can you also talk about the competitive environment? In the past, you've said that you're taking share? Are you still doing that?

[Dhrupad Trivedi, executive]

Yes. So I would say there are 2 ways to look at that, right? So first is if you look at the broader market and you look at a lot of the growth rates that you're seeing from companies in our sector or industry, they're all kind of plus/minus 2% kind of range, right? So that's one. Second is the way we think about gaining share is when we are -- we can trace and point to an actual displacement of a competitive solution. And I would say that certainly in the enterprise market, we feel that we are able to replace some of the solutions. And I would say that's kind of the most basic way we think about gaining share. And if you look at our Enterprise segment growth on a year-to-date basis, half to half, we grew about 7%, which I would say is at least slightly above the market average.

[Stephan Guillaume, analyst]

All right. And so what kind of pricing power do you have in this environment?

[Dhrupad Trivedi, executive]

So I would say pricing is a balanced thing. So obviously, we have input cost inflation, which we try to find ways to offset and we offset that with maybe price increases selectively to customers and then the rest with productivity. But I think we are very selective because we want to do it in a very methodical way versus going up and down on prices, right? So I think for us, it's a mix of overcoming input costs through productivity and selective price increases where we don't have a choice but to pass it on.

[Stephan Guillaume, analyst]

And the last one for me is, where are you in the beginning of seeing results from the changing of your sales team?

[Dhrupad Trivedi, executive]

So I would say if you think of our business, 2/3 service provider, 1/3 enterprise. Enterprise is a little bit bigger now. On the service provider side, of course, we have a very mature experienced sales team, where the focus is on improving our capability to cross-sell more products to existing customer base, right? So on that dimension, I think we are making good progress. Some regions obviously are farther ahead than others. So there is still room for us to continue growing through that.

On the enterprise side, we have brought in, obviously, new sales talent as well as how we go to market in terms of our portfolio and products as well. And I would characterize that as we are probably somewhere in the third -- between third and fourth inning on that journey.

[Operator]

Your next question comes from Gray Powell with BTIG.

[Gray Powell, analyst]

Okay. Great. So yes, a few questions on my side. Maybe just to start off at a high level, can you talk about what you saw in terms of the overall spending environment and macro headwinds? And I know you've talked about it some in the prepared remarks, it sounds like a North American service provider may have caught you by surprise. But outside of that, would you say that things were stable? Did anything change positively or negatively? Just on any more color you could provide there?

[Dhrupad Trivedi, executive]

Yes. No, good question, Gray. So I would say absolutely that if I think of my 3 regions, I would say, APJ is stable on enterprise and service provider side, EMEA is stable on enterprise and service provider side. And North America, I would say, we are making good progress on enterprise, so it offsets maybe some market weakness. And then within North America service provider, I think we were not necessarily surprised, but I think what involved was some of the rescoping of projects, right, versus cancellations or complete push out. So that was the only thing where we -- that's why we feel good about full year. And if you remember, right, Q1, we did slightly better than we got and Q2 is slightly worse, but it's still plus/minus $2 million or $3 million, right? So that's the sort of volatility or movement we see. And our goal is obviously to use the remaining pieces to offset that so that when North America, [ as the ] spending comes back, right, it only helps us from there.

[Gray Powell, analyst]

And then within the context of the full year, should we still be expecting like maybe low single-digit growth in revenue or closer to flat now?

[Dhrupad Trivedi, executive]

I think we would probably say low single digit still feels right, although it's more back-end loaded, so it's always risky. But our plan is, obviously, if it's slightly below that to that how do we bridge back to getting out to our non-GAAP EPS results, right, so either way.

[Gray Powell, analyst]

And then the last question. Free cash flow in the first half of the year was actually really strong. What drove that? And just any directional pointers you can give us or maybe talk about like free cash flow margins relative to EBITDA margins, any pointers there.

[Dhrupad Trivedi, executive]

Yes. Good question. Yes, go ahead, Brian.

[Brian Becker, executive]

Yes. No, free cash flow. A number of factors led into that. I mean, last year, we had pretty poor linearity. I think we're seeing the benefits of some of that return to cash spending and releasing cash into the market, benefiting our free cash flow. As you pointed out, we've talked about free cash flow being really strong last quarter at nearly $30 million. So we've got another $10 million of free cash flow approximately this quarter. But our full-year cash flow target from a free cash flow perspective should be in the 60s if everything continues to go as planned.

[Dhrupad Trivedi, executive]

And Brian, our EBITDA is a good proxy for free cash flow because there's not too much CapEx variability.

[Operator]

[Operator Instructions] We now have Hamed Khorsand with BWS Financial.

[Hamed Khorsand, analyst]

So talking about this North American service provider. This has been a topic for about a year now. So is this -- given the growth you saw in Q2, it obviously points to actual revenue decline on that part. So are you losing share? Or are these hare service providers just cutting back so much spending without you losing share?

[Dhrupad Trivedi, executive]

Yes. So I think good question, Hamed. So maybe just level set on a couple of data points, right? So if you look at North American service providers, I think in the last 2 or 3 days, right, I think AT&T, Verizon, they've all published CapEx. And you can see that in 2024, they're projecting CapEx declines of between 6% to 8% year-over-year, right? And it's all of that, right? And the cable companies are projecting slightly less than that. So that's one data point. It's not that market is plus 10%, and we are negative. Second is the way our products are designed at these customers. We are in their operational workflow to run the network and publish results on SLA achievement and things like that.

So is it likely they are looking at competitors, maybe, but we have a pretty good understanding of what is deployed. We track all those devices, our support team knows every device that is active and how much traffic is going through it. So that gives us confidence that it's more linked to the CapEx spending cycle versus competitive. And the last data point is when they do approve a data center, we do get the PO, right? So we have a reasonably good correlation of when the project is approved, and we are in the mix, we get that view. So -- but it is -- I mean, I think the CapEx plans for these companies are public, right? So you can see those here.

[Hamed Khorsand, analyst]

Okay. And then if I heard you right, you're investing more on the enterprise sales side. So does that mean we should see an acceleration in enterprise revenue eventually, maybe 2, 3 quarters down the line?

[Dhrupad Trivedi, executive]

Yes, you should. And I think the thing I would point to, Hamed, is even now, right, which is very early, is that on a year-over-year basis, half-to-half, the enterprise business grew 7%, which you can compare to our peers, right? And even on the SP side, by the way, you can compare to Juniper, for example, to see relatively if we are losing or gaining. So on the enterprise side, certainly, as the teams mature and we get a better kind of value proposition market fit, we expect that to continue to grow. And as I said, if we don't want to do that instead of SP sales, we want to do that as a way to reduce the impact of that volatility.

[Hamed Khorsand, analyst]

Okay. And my last question is on that when you were talking about digital tech company. How much of an impact does that have on revenue in Q2, if any, and will it be -- how significant is it for revenue going forward?

[Dhrupad Trivedi, executive]

Yes. So I think I would say it was not a 10% customer, but it has the potential to be somewhere between 5% and 10% over time.

[Operator]

[Operator Instructions] We have no further questions registered. I would like to hand back to President and CEO at A10 Networks, Dhrupad Trivedi, for some final remarks.

[Dhrupad Trivedi, executive]

Thank you, and thank you to all of our shareholders for joining us today and for your continued support, and thanks to also all the A10 employees around the world. Thank you.

[Operator]

Thank you for joining today's call [indiscernible]. You may now disconnect, and please enjoy the rest of your day.