Q1 2024 A10 Networks Inc Earnings Call

Participants

Tom Baumann; IR; FNK IR

Dhrupad Trivedi; President & CEO; A10 Networks Inc

Brian Becker; CFO; A10 Networks Inc

Alex Hantman; Analyst; Sidoti & Company, LLC

Gray Powell; Analyst; BTIG

Hamed Khorsand; Analyst; BWS Financial

Christian Schwab; Analyst; Craig-Hallum

Hendi Susanto; Analyst; Gabelli & Company

Presentation

Operator

Hello, and welcome to A10 Networks' First Quarter 2024 Financial Results. My name is Elliot, and I will be coordinating your call today. (Operator Instructions) I would now like to hand over to Tom Baumann with FNK IR. The floor is yours. Please go ahead.

Tom Baumann

Thank you all for joining us today. This call is being recorded and webcast slides may be accessed for at least 90 days via the 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 first 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, industry and customer trends, our capital allocation strategy, supply chain constraints and expectations, 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, April 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 the 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 considered in isolation or as a substitute for results prepared in accordance with GAAP may be different from non-GAAP financial metrics 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

Thank you, Tom, and thank you all for joining us today. This was a solid quarter for A10, with strong profitability and revenue results that demonstrate continued demand for our solutions. I am proud of the way our team has responded to a volatile economic environment, driving efficiency throughout our organization and enabling us to do what we told investors we would do even as sales cycles elongate and certain buying decisions are delayed. Once again, our differentiation is benefiting our business, enabling us to drive growth. Our customers need higher throughput in networks, especially in the age of AI.
Our customers also need to enhance their security posture amidst a growing array of cyber challenges, including new challenges from AI tools. Buying decisions may be delayed, and agreements require additional approvals, but these investments are typically not optional because they directly address revenue generation or risk management for our customers.
Of note, our revenue from Service Providers was up 16% year-over-year in the quarter. The slower Service Provider spending of the last few quarters is not reflective of competitive losses nor does it suggest any longer-term trends relative to demand for A10 products.
As investments are grilled, we are benefiting. During Q1, we saw strong growth in our APJ region as an example of this pattern. On a trailing 12-month basis, Enterprise revenue growth continues to outpace overall revenue growth. As we have said, A10 solutions are designed into customer workflows. And we are a key part of CapEx plans.
On a full year basis, we expect Enterprise revenue growth to outpace overall revenue growth. We have been investing both in terms of our Enterprise-facing sales and marketing team and in terms of R&D to strengthen our capabilities to effectively target the enterprise segment. These investments are expanding our pipeline, and we are confident that enterprise sales in the second quarter will be better than the first quarter, and we believe the second half of the year will be a meaningful improvement compared to the first half.
As we increasingly align our solutions to consumption trends in this market, we expect to see growth in deferred revenue, building a stronger recurring base for revenue in the future.
Turning to our R&D initiatives. These investments continue to be focused on 2 key areas. Enhance cybersecurity capabilities and more flexible and efficient consumption models for Enterprise customers. We are growing our use of AI, particularly in our security applications in addition to bringing network insights.
A10 has been using machine learning and AI for years. But as the technology continues to evolve and improve, we continue to remain at the leading edge of utilizing it to provide the best solutions. The machine learning component is already contributing to faster recognition of new threats and important capability, as cyber attacks become increasingly sophisticated.
We continue to work closely on aligning our product road maps, strong customer base, who is leading the infrastructure transformation to enable new types of traffic and threats with adoption of AI in their networks. We are actively driving productivity to support our strategic objectives.
Our commitment to achieving stated goals of 80% to 82% gross margin and 26% to 28% EBITDA margin remains on plan. In the first quarter, our gross margin continued to exceed 80%, showcasing our sustained operations efficiency. Non-GAAP earnings per share were in line with expectations adjusted for foreign currency. A10's consistent ability to meet profitability targets amidst revenue challenges underscores the resilience of our business model.
Looking ahead, we are confident in our ability to maintain profitability and deliver value to our shareholders through capital returns, while we continue to invest in innovation. The results of the first quarter position us to achieve our full year business model objectives, including gross margins of 80% to 82%, adjusted EBITDA margins of 26% to 28% and single-digit growth in full year non-GAAP EPS. We continue to buy back stock and our cash flow more than funds our buyback and dividend.
With that, I'd like to turn the call over to Brian for a detailed review of the quarter. Brian?

Brian Becker

Thank you, Dhrupad. First quarter revenue was $60.7 million, an increase of 5.2% year-over-year. As Dhrupad described, sales cycles have elongated and the quarter-to-quarter volatility in both Service Provider and Enterprise sectors continue to be high.
Product revenue for the quarter was $30.1 million, representing 50% of total revenue. Services revenue was $30.6 million or 50% of total revenue. First quarter recurring revenue increased 13% compared to the first quarter last year and deferred revenue increased nearly 10%, demonstrating stronger product sales for the past 2 quarters and continued demand for our Enterprise Solutions, validating our confidence that we are not losing opportunities to competitors.
As you can see on our balance sheet, our deferred revenue was $140.9 million as of March 31, 2024, up 9.7% 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 first quarter was 81.9%, in line with our stated goals of 80% to 82% and up slightly from the last 3 quarters. Adjusted EBITDA was $13.9 million for the quarter, representing 22.9% of revenue. On a trailing 12-month basis, adjusted EBITDA was 28% of revenue, in line with our stated goal of 26% to 28% of revenue.
Non-GAAP net income for the quarter was $12.7 million or $0.17 per diluted share, compared to $9.9 million or $0.13 per diluted share in the year ago quarter. Diluted weighted shares used for computing non-GAAP EPS for the first quarter were approximately 75.3 million shares, compared to 75.5 million shares in the year ago quarter.
On a GAAP basis, net income for the quarter was $9.7 million or $0.13 per diluted share, more than doubling our net income of $4 million or $0.05 per diluted share in the year ago quarter. During the quarter, we generated $32.4 million in cash from operations. While Q1 had onetime benefit of better timing of receivables, we expect the full year cash flow to be in excess of $60 million for 2024.
Turning to the balance sheet. As of March 31, 2024, we had $182.1 million in total cash, cash equivalents and marketable securities, compared to $159.3 million at the end of 2023. During the quarter, we paid $4.5 million in cash dividends and used $3 million in share repurchases. We also continue to carry no debt. The Board has approved a quarterly cash dividend of $0.06 per share to be paid on June 3, 2024, to shareholders of record on May 15, 2024.
As discussed during our last call, the Board had approved a new $50 million share repurchase plan in November, inclusive of share repurchases, we returned $7.5 million of capital to shareholders during the quarter. We expect 2024 revenue and EPS growth in the single digits, in line with market expectations. 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 turn the call back over to Dhrupad for closing comments.

Dhrupad Trivedi

Thank you, Brian. A10 maintains an enviable position aligned with trends related to the need for cybersecurity and the demand for increased throughput and lower latency. We are investing to strengthen our position with Enterprise customers and we are well aligned with Service Provider customer investment plans.
Our business model enables consistent profitability and cash generation, and we are returning meaningful capital to shareholders while investing in innovation for future growth.
Operator, you can now open the call up for questions.

Question and Answer Session

Operator

(Operator Instructions) Anja Soderstrom, Sidoti.

Alex Hantman

This is Alex Hantman on for Anja. My first question, you mentioned that sales cycles have elongated curious what inning you think you're in, in terms of seeing results from changes in the sales team?

Dhrupad Trivedi

Yes. So I think I would say, certainly, as you know, we made significant changes in investment in our go-to-market about 2 years ago and 1 year ago as well. And I would say it's a typical sales cycle is 6 to 9 months in any time, at least close to 6 in an enterprise sale as well and a little bit longer for service provider side.
So as the new processes and people ramp up fully and you factor in the sales cycle time, I would say, right, we are probably somewhere like in the third, second or third inning of that.

Alex Hantman

Great. And just curious, how are the conversations going? Do you feel like you still have pricing power in this environment?

Dhrupad Trivedi

I think there's two factors that go into it, right? So certainly, it is well understood and accepted that there is broad inflationary cost pressure on input costs. So I don't think that's necessarily a huge issue.
To the degree that we work with our customers to understand that, it's typically a very collaborative conversation. And beyond that, I think our focus is to not necessarily drive our margin through price but more to drive it through efficiency and operational gains, right? So balancing, obviously, inflationary cost pressure, we look to find that balance where we are also not discouraging customer investment.

Alex Hantman

Got you. Last question from me. just around capital allocation priorities. Could you talk a little bit more about how you're thinking about that and maybe even you'll add some context around future room for buybacks?

Dhrupad Trivedi

Sure. So I mean I think the way we talk about it, right, is our first priority is continuing to invest in organic growth of the business. And you can see, for example, even in Q1, we increased our investment in R&D because we think that's important for us to ensure that, right? We continue to provide the best solution.
So first priority is funding organic growth. Second priority is we find a balanced way between dividend and buyback on return to shareholders, right? And, certainly, we have active buyback programs that we exercise and utilize. But subject to obviously constraints on volume and trading and all of that. So we continue to look at that as a lever available to us.
And historically, right, in the last few years, we have utilized most of the buyback but not in a monthly manner, but in a more adjustable manner. So that's the second. And obviously, the third, given that we have no debt and continue to be a healthy cash generation business in the current market and even before we always look for inorganic opportunities that help us accelerate our strategy.
But our business plan and customer engagements are not dependent on or predicated on us doing that, right? So that would be a means for us to accelerate strategy but do it in a thoughtful way that also does not dilute our business model goals in the long term.

Operator

Gray Powell, BTIG.

Gray Powell

And congratulations on the good results. So -- okay. So yes, maybe I'm reading between the lines too much, but it seems like your tone is a lot better today than it was last quarter and maybe for much os 2023. Do you feel like your business has hit an inflection point here? And just can you maybe talk about how you feel about the quality of your pipeline and just your ability to call the business today versus, call it, 6, 12 months ago?

Dhrupad Trivedi

Yes.Great question. So I think you are correct, Gray. I would say that compared to 6 to 12 months ago, certainly, we are not seeing things deteriorating. I I'm nervous to use the word like inflection point. But I would say, from a trend perspective, we certainly see things not getting as bad as we saw in the last 2, 3, 4 quarters, if you will, right, and in terms of the volatility.
So we definitely see that as a phenomenon where still there is activity that's maybe sporadic, but we certainly see our customers more engaged on actual projects, right, in the pipeline and plans. Now does that flex plus/minus 1 or 2 quarters? Maybe. But certainly, I would say, from a trend perspective, we are certainly not worse than Q4 or what's than Q3 last year.

Gray Powell

Understood. Okay. Very helpful. And then you answered this to some extent in the prepared remarks. The combined results were better than what we were looking for. It's definitely good to see the growth return to positive territory. I was a little confused on the mix. So Service Provider was much stronger than expected. It looks like that happened in APJ. Enterprise declined. Can you just -- I mean, you talked about the mix for the year. Can you just kind of talk about what happened in Q1? Or just -- yes, can you help us explain the underlying trends there?

Dhrupad Trivedi

Yes, absolutely. No, good question. So I think, first, maybe Enterprise, right? So for us, if you look at our Enterprise segment, what's the service provider on a little bit longer period like trailing 12 months. Enterprise business is still in positive growth territory compared to many others.
And Service Providers is obviously negative, right? So that's one data point. Second data point I would say is that Q1 of last year had an unusually strong Enterprise quarter, and I think that obviously made the Q1 to Q1 compare maybe a little bit more challenging, right? Because in the Enterprise segment, typically, Q4 is very strong. Q1 drops off.
And so I think a little bit of that Q1 to Q1 is a function of last year's jumping off point, right? So that's second data point. And third, I would say is our expectation from the year is based on when we look at our pipeline and funnel for Enterprise versus Service Provider we certainly feel that it supports the comments that we expect that to continue to recover and overall grow faster than revenue.
As it relates to Service Provider, I think you are correct. We -- to the phenomenon I mentioned in the prepared comments, in the last 2, 3 years, right, we have had customers where they had waited or delayed on adding cost, even though there was a clear need for capacity. And I think we saw some of that get realized in Q1. That doesn't necessarily mean that's going to be the case every quarter in that region. But that's an example of where -- it's -- the customer wants to use more product, but was delaying spending and it happened in Q1.
So that's more a function of sort of that global ST spending pattern being not exactly very predictable. But because of our geographic exposure, it kind of netted out for us.

Operator

Hamed Khorsand, BWS Financial.

Hamed Khorsand

So the first question I had was, could you just talk about your investment in the sales process? Where you're focused on? And why you're not getting any kind of return as far as your Service Provider side goes? Are you underinvesting in the sales process? Or just the customers just don't care, they're just not buying anything or buying very little?

Dhrupad Trivedi

Yes. So I think -- thank you, Hamed. I think if I understand the question correctly, I would say the phenomenon is different for us. So Service Provider for us is existing customers around the world.
And we, in many cases, 10-plus years, customers in many 4, 5. And so these are not customers where we are trying to prospect the customer, understand the account, find ways to get in. The idea is that customers are where we see them every week, every month. We are deeply aligned with them on that network planning and rollout and support once they are deployed.
So the investment there is more on our technical capabilities to support them well to invest in engineering projects that are aligned with the direction they want to go in the future and being seen as the company that is solving their business problems, right?
So the investment there is more on keeping your customers engaged and happy in doing things for them that increase their kind of business value. On the Enterprise side, it's a little different phenomenon because of our relative presence in the market. Our investments are more around hiring people with Enterprise sales experience, more experience selling security solutions more experience selling to CIOs.
And there, obviously, we have an existing customer base, but it's more about acquiring and adding new meaningful customers, right? So it's a different type of investment, it's a different phenomenon. I would say there's no -- we basically look at it as every sort of account, whether it's Service Provider or Enterprise has its own unique profile and needs and we find the right resource mix for that, right? And then on the Enterprise side, it's in addition to that, bringing in new customers.

Hamed Khorsand

And could you provide any kind of data as to what new customers represent to you, as far as revenue is concerned?

Dhrupad Trivedi

I think, we don't publish that data but typically -- so typically, between Service Provider and Enterprise combined basis, 80% of our revenue is probably existing customers and probably roughly 20% is new customers or new business and probably that percentage is higher within Enterprise, right? But we can follow up subjectively on that.

Hamed Khorsand

Okay. Great. And then -- any particular reason why service provider remains as far as it is soft and to characterize a little bit there. I guess you're in security, I mean, security should be the last investment they should be skimming on.

Dhrupad Trivedi

Yes. No, fair. So -- and I think we noted tried out security in Q1 period for us continue to be more than 60% of revenue. So we do think that's true. I think that in Service Provider case, like every other company has talked about, in North America, particularly the macro environment, is causing them to be much, much more cautious than ever before.
So while we are discussing specific projects and kind of engagement, they continue to weigh on the kind of timing of when they spend, right? So that's just the reality of it. And I think we see. Even when a security led that is probably faster traction with Enterprise customers, where the Service Providers who are running their own networks, right? So their needs are a little bit different. But I would say our security growth within Service Providers is probably the much bigger part of SP growth, more so than them just building new network side. So -- and certainly, that was the case in Q1.

Operator

Christian Schwab, Craig-Hallum.

Christian Schwab

My first question is regarding this elongated sales cycle, second or third inning, assuming that we're kind of at the end of this by the end of '24, can we return to double-digit growth in '25?

Dhrupad Trivedi

Yes. No, good question. And maybe, Chris, and I think just to maybe decouple the two concepts, right? So I was -- the question originally before was on the sales transformation where you are, right? And I think I was answering that question as being in the second or third inning of us being able to fully leverage that new capability.
In terms of the timing, I would say that is our assumption and our model as well that as we continue to improve our position on Enterprise segments, while -- and then SP spending returns to more normalized level, it should bring us back to that growth level, yes.

Operator

Hendi Susanto, Gabelli Funds.

Hendi Susanto

Dhrupad and Brian, I have several questions. My first question, service revenue grew 15%, I think that is impressive. Could you share more color on the strength of service growth and how much of that can be attributed to security solution?

Dhrupad Trivedi

I think that if you look at our year-over-year growth and you look at security solutions as a percent of revenue, currently, that's probably slightly higher. But I think more importantly, having those solutions is enabling us to open the door to broader conversations, which also lead to sales of other products, right? So I think if you look at what is a result of driving those solutions and engaging customers in that way. That is probably a pretty meaningful driver of that growth.

Hendi Susanto

I see. And Dhrupad, the presentation mentioned surface provider customer investment plans. Could you share more -- could you share more insight and light let's say, among like different Service Provider investment plans, which investment plans are the higher priority ones? Which one can be postponed indefinitely and which one cannot be postponed?

Dhrupad Trivedi

Yes. So I think I would say probably think of it as 3 categories, right? So where it is something related to them needing to add capacity or products to help actually generate or maintain revenue that is usually #1 priority. I think where it relates to making that network more resilient and more secure. It's close to #1, right? So those 2 are the categories that they would typically hold on as long as they can, but they cannot do that forever. I think industry-wide, when you look at solutions that are more about rebuilding a completely new type of network, changing how you do applications, things like that, are the ones that have the highest risk of being delayed because they are not directly in line of operations. They are more in line of sort of modernization.

Hendi Susanto

That's very helpful Dhrupad. And then Dhrupad, any insight into penetration rate of security solution among your customer installed base, like qualitatively speaking, how much more of your installed base still has not adopt the security solutions? Or in other words, how much more opportunity out there for penetration among your installed base?

Dhrupad Trivedi

Yes, I think that difficult to quantify, but I'll give you the reason why, right? So I think there are 2 reasons why people spend more on security. One is they're doing something today and they realize they need to do more, right? So it's not that they don't do anything, but they need to do more.
And second is when people hear about kind of public breaches and incidents it oftentimes prompts them to do something when they were not doing anything, right? So in the first case, it's an expansion of demand. In the second case, it's actually creation of demand, right?
And I would say, certainly, with our existing customers, there's no quantitative benchmark that says you must spend x percent on security. So it depends on the vertical, like a financial firm is going to spend more, and it depends on kind of the scale of the company and their own view of what risk they face, right? So, but having said that, I think certainly for a company of our size, we think that's a very meaningful opportunity for us for many years to come.

Hendi Susanto

Okay. Yes. And then Dhrupad, if I look at the list of A10 Network Solutions, let's say, with the security and within hybrid cloud solutions, and then looking back, let's say, like 12 months ago, which one has gained like a stronger momentum or in other words which one offers like more potential upside this year?

Dhrupad Trivedi

I think that probably Hendi, I would rate both of them as the main things we are trying to do, and that's why our R&D and everything is aligned that way. So I think what we are doing in terms of supporting more hybrid infrastructure, which is on-prem plus cloud, which you're more and more is becoming more popular. -- is directly going to help us, right, with growth in enterprise as well as some service providers. And I think what we are doing in security is with new capabilities is much broader based, it's SDN enterprise, and it's every region.
So I would say those are the 2 main investment areas for us, which hopefully you can see are 100% aligned with where we are investing. So...

Hendi Susanto

And then one more question. Brian, is there any impact of Japanese yen exchange rates in Q1? Or any anticipated impact?

Brian Becker

Yes. there's a couple of points to make about that. I mean as everyone has seen, the Japanese yen declined over the quarter, starting out a little 140 exchange rate of U.S. dollar to 150s and even today, trading higher. We don't really plan our budget based on U.S. dollar outcome. And so our Japanese team continues to meet plan.
There was some FX adjustment, but we don't really disclose that because it's consuming both ways and we typically will cover gaps or take the benefit as it comes through other regions and/or to help offset other risks. But yes, modest impact in the quarter in terms of revenue, but nothing to speak of. And then you probably see in the OI&E line, there was some pickup in FX just based on our hedged receivables.

Operator

This concludes our Q&A. I'll now hand back to Dhrupad Trivedi for final remarks.

Dhrupad Trivedi

Thank you. and thank you to all of our shareholders for joining us today and for your support. And thanks to all the A10 employees around the world that continue to help drive our business forward. Thank you.

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.