A10 Networks - Q4 2023

Transcript

Operator (participant)

Good afternoon, and thank you all for joining. I would like to welcome you all to the A10 Networks Q4 and full year 2023 financial results. My name is Brika, and I will be your moderator coordinating today's call. After the speaker's remarks, we will conduct a question and answer session, and if you would like to ask a question during that time, you may do so at any point by pressing star followed by the number one on your telephone keypad. Should you change your mind and wish to remove your request to speak, please press star and two. Thank you. I would now like to pass the conference over to your host, Tom Baumann at FNK IR, to begin. So, Tom, please go ahead.

Tom Baumann (VP of Investor Relations)

Thank you all for joining us today. This call is being recorded and broadcast 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 Q4, 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 timing, 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, February 6, 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 financial 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. 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 differ 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 (President and CEO)

Thank you, Tom, and thank you all for joining us today. The Q4 demonstrates that we have taken the necessary steps to realign and efficiently allocate resources to find areas of growth and ensure solid profitability amidst revenue headwinds. The headwinds persist but are largely related to a single region and a single customer type. Service providers, especially in North America, continue to delay CapEx investments, as broadly announced by others in the industry. Simultaneously, Enterprise customers are taking longer to make decisions, and their internal approval process has incremental layers due to the same economic headwinds. As discussed during the Q3 call, orders slipped from our Q3 into our Q4 and reduced in size as parts of the project were pushed out into 2024.

We are navigating these longer sales cycles and customer uncertainty. And I'm encouraged by the sequential improvement in both revenue and profitability from the Q3 into the Q4. We agree that service provider customers, in particular, could remain choppy for some time related to the macro environment. In the interim, our focus on revenue diversification continues to benefit our business. Enterprise revenue was up 23% in the Q4, partially mitigating the 24% decrease in service provider revenue and validating our strategy to increase our focus on Enterprise customers in addition to our service provider customers, which will return to strength in the future. Once again, A10 is poised to navigate this challenging cycle better than others in the industry. We have reallocated resources, increasing our concentration on Enterprise customers globally, and this focus has already begun generating positive results.

On a full year basis, revenue from Enterprise customers grew 9%, ahead of many of our peers, and offsetting a 20% decline from service provider customers. This represents an opportunity for us to deliver growth that is increasingly independent of service provider CapEx cycles. Cybersecurity solutions continue to be prioritized. Economic headwinds may mean these investments are delayed, but they are unlikely to be canceled. The threats from hackers, malware, ransomware, and DDoS attacks are growing. These are existential business risks, interrupting service, damaging customer trust, costing affected business millions, and increasingly causing regulatory issues. In response to this growing opportunity, we continue to expand our capabilities, as evidenced by some of our recent product and platform announcements. We maintained our profitability despite the revenue headwinds, matching our long-term stated goals of 80%-82% gross margin and 26%-28% EBITDA margins.

This achievement is a testament to our business model and operational rigor as we reallocated resources, focusing on near-term opportunities and ensuring that we are customer-centric in our sales and support approach. On a constant currency basis, we delivered full-year EPS of $0.74, flat year-over-year, in spite of significant deterioration in the macro environment. We achieved this level of profitability due to a proactive decision to defer certain investments in light of deteriorating market conditions. These deferrals will push those expenses into 2024 and align them with business condition improvements. We still expect to achieve our profitability targets on an ongoing basis. We continue to expect to deliver on our business model objectives, including gross margins of 80%-82%, adjusted EBITDA margins of 26%-28%, and single-digit growth in our full-year non-GAAP EPS. We continue to buyback stock.

We remain focused on preserving growth-oriented investments, including R&D, related to new and enhanced security solutions, while being cognizant of our overall spending. In December 2023, we released our A10 Defend Detector, a new product which integrates our current capabilities and sets the stage to further expand our portfolio of security solutions for our customers. In January this year, we completed our annual sales kickoff event. This intensive multi-day gathering is designed to align our sales team, discuss our strategy, and further strengthen commercial execution. Based on our experience and learnings from 2023, we have made further adjustments to capitalize on key strategic priorities that enable us to maintain strength with service provider customers while growing faster with security and enterprise solutions. The teams remain very excited about the new solutions that drive an even deeper customer-centric approach and one that aligns with their dynamic economic environment.

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

Brian Becker (CFO)

Thank you, Dhrupad. Q4 revenue was $70.4 million, a decrease of 9.3% year-over-year, reflecting the headwinds that Dhrupad described earlier. Sequentially, revenue increased 22% compared to the $57.8 million in the Q3. This reflects some orders that were delayed right at the end of the Q3 and recognized during the Q4, though we continued to see longer than normal sales cycles during the Q4 due to CapEx constraints, particularly with service provider customers. As a result, a number of orders we expected to close during the quarter slipped into 2024. Product revenue for the quarter was $40.6 million, representing 57.6% of total revenue. Services revenue, which includes maintenance and support revenue, was $29.9 million, or 42.4% of total revenue.

Lower product revenue throughout the year continues to impact recurring revenue, but in the Q4, recurring revenue increased 8% year-over-year, and also deferred revenue increased 11%, demonstrating the continued demand for our solutions and validating our confidence that we are not losing opportunities to competitors. As Dhrupad mentioned, for the full year, enterprise revenue was up 9%, while service provider revenue was down 20%. Turning to our balance sheet, as you can see, deferred revenue was $141.3 million as of December 31, 2023, up 11.3% 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 Q4 was 81.8%, in line with our stated goals of 80%-82%, and essentially unchanged from the Q3 of 2023. Adjusted EBITDA was $23.9 million for the quarter, reflecting 34% of total revenue. On a full year basis, our adjusted EBITDA margin was in line with our stated goals of 26%-28% of revenue, and since 2021, we have delivered adjusted EBITDA growth of 14%. Non-GAAP net income for the quarter was $18.5 million, or $0.25 per diluted share, compared to $18.4 million, or $0.24 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 with the A10.

Diluted weighted shares used for computing non-GAAP EPS for the Q4 were approximately 74.9 million shares, compared to 75.4 million shares in the year-ago quarter. On a GAAP basis, net income for the quarter was $17.9 million, or $0.24 per diluted share, compared with net income of $18 million or $0.24 per diluted share in the year-ago quarter. Turning to full year results, revenue was $251.7 million, down 10.22% year-over-year. Product revenue was $141.1 million, representing approximately 56% of total revenue, and service revenue was $110.6 million, representing about 44% of total revenue. Full year non-GAAP gross margin was 81.7%.

Adjusted EBITDA was $71.2 million, reflecting 28.3% of total revenue, in line with our stated goals. Non-GAAP net income for the year was $54.9 million, or $0.73 per diluted share, compared to $57.7 million, or $0.74 per diluted share in the year ago period. On a constant currency basis, our non-GAAP EPS was flat year over year. On a GAAP basis, net income for the year was $40 million, or $0.53 per diluted share, compared with net income of $46.9 million, or $0.60 per diluted share in 2022. During the year, we generated $43.8 million in cash from operations. We expect 2024 cash flow from operations to return to historical levels as the market normalizes.

Turning back to the balance sheet, as of December 31, 2023, we had $159.3 million in total cash, cash equivalents, and marketable securities, compared to $150.9 million at the end of 2022. During the quarter, we paid $4.4 million in cash dividends. We also continue to carry no debt. The board has approved a quarterly cash dividend of $0.06 per share to be paid on March 1, 2024, to shareholders of record on February 16, 2024. As discussed during our last call, the board had approved a new $50 million share repurchase plan in November.

Turning to our 2024 outlook, based on current market conditions and in line with our broader peer group, we expect 2024 revenue and EPS growth in the single digits. We continue to target gross margins of 80%-82% and adjusted EBITDA margins of 26%-28%. We expect to see revenue growth weighted to the second half of 2024 as the markets normalize. I'll now turn the call back over to Dhrupad for closing comments.

Dhrupad Trivedi (President and CEO)

Thank you, Brian. ATEN remains well-positioned, offering a business-critical solution with a customer-centric approach. Our solutions will be prioritized over other investments as they are key to our customers generating revenue and navigating challenging economic environment. We continue to achieve our business model goals in terms of profitability despite the revenue headwinds. Operator, you can now open the call up for questions.

Operator (participant)

Thank you. If you would like to ask a question during this time, please press star followed by one on your telephone keypad now. Should you wish to remove your question, please press star, then two. As a reminder, it's star one to ask a question, and we will pause for a moment just to allow the Q&A session. The first question we have comes from Christian Schwab of Craig-Hallum. You may proceed with your question.

Christian Schwab (Senior Research Analyst)

Hey, guys, just a few quick questions. On the service provider level, you know, I think in the prepared comments, you know, I think you said future and then second half weighted. Would you expect the service provider revenue to improve in the second half of the year, or is the majority of the single-digit growth gonna be, you know, driven by enterprise?

Dhrupad Trivedi (President and CEO)

Yeah, Christian, good question. So I think I would say, the popular belief and expectation in the market is that certainly service provider spending normalizes out in the second half of the year. And, you know, we expect seasonality to be returning to our normal seasonality of 47-53 first half, second half. But beyond that, I think our expectation of growth is not based on an assumption that SP spending sharply picks up in the second half. I think we look at it as a more balanced way of saying, we expect to continue progress in enterprise and security solutions, and as SP spending picks up maybe in the second half, right, it, it should help us with that seasonality and beyond. So, that's maybe the best way to think of it, is it's not purely based on hoping that SP spending comes back in the second half.

Christian Schwab (Senior Research Analyst)

Then as we look further out into 2024, would you know, would you expect, you know, a snapback in service provider revenue after kind of a difficult long period? Or would you anticipate that business to return to, like, flattish plus or minus?

Dhrupad Trivedi (President and CEO)

Yeah, no, that's a good question. So I would say, you know, that it would normalize to their historical levels, which would mean that given how much it has been in a depressed cycle, that in 2025, it could be in a positive cycle. The difficult thing for us, obviously, is, given sort of the movements we see in terms of interest rate actions, and particularly then affected by the fact that there's, you know, some election year and political influences and all of that, it's difficult for us to project. But if you look at it as long-term, we expect that market to be at least growing in high single digits and security, and, you know, mid-teens, if you will.

And so certainly from a depressed base, we should see a positive cycle on SP spending come back. And particularly because our products go into sort of the core of what they need to deliver new services and maintain customer experience, right? As opposed to a dramatic reinvention of the network. So, we do expect that, you know, as it ramps up in 2024, we could see a more positive cycle in 2025, right, and beyond.

Christian Schwab (Senior Research Analyst)

Great. No other questions. Thank you.

Dhrupad Trivedi (President and CEO)

Thank you, Christian.

Operator (participant)

Your next question comes from Anja Soderstrom, from Sidoti. So you may begin.

Anja Soderstrom (Senior Equity Research Analyst)

Hi, and thank you for taking my questions. First of all, is there anything to call out geographically in terms of, of revenue?

Dhrupad Trivedi (President and CEO)

Yeah, good question, Anja. So I think nothing, nothing very unusual for us. As expected, certainly, we saw weakness in North America service provider side. We certainly also saw positive momentum on enterprise growth in North America, right, where we have invested in resources and in some of the new products we released last year. So I would say from that perspective, North America, enterprise, positive, service provider, negative. When I look at our theaters in Japan and Europe, not a significant change versus what we were expecting for the year. A little bit of FX pressure in Japan, and I think, you know, we continue in EMEA to find pockets of strength, and continue to deliver on that. So I would say that's nothing unusual relative to what we have mentioned before.

Anja Soderstrom (Senior Equity Research Analyst)

Okay. Thank you. And, can you just remind me, last year, 2023, the product revenue was a little bit lumpy, and Q2 and Q4 was a lot stronger. I know some—I remember some of it was pulled in from the Q3 to the Q4. Do we have the same happening in the Q2, and how should we think about the quarterly cadence for next year or this year?

Dhrupad Trivedi (President and CEO)

Yeah. So if you, you know, I would say that certainly we saw some movement from Q3 to Q4, and you can see it really in our sequential product revenue growth from that, particularly in service provider segment information that we published. Q1, I think, for us was a little bit unusual, because in addition to the macro environment, right, we also were focusing on strengthening our own cybersecurity posture and our own position on that. Going into 2024 and beyond, I would say we expect to return to our normal seasonality of 47, 53, first half, second half, right? And that should, we don't expect, obviously, to the best of our ability, one-time events to affect that that much.

Anja Soderstrom (Senior Equity Research Analyst)

Okay. Thank you. And in terms of the longer sales cycles that you've been citing, what are you, how are they trending now? Are they, like, becoming even longer, or are they improving, or?

Dhrupad Trivedi (President and CEO)

I don't think they're becoming longer. I think what we have seen is, even in enterprise segment, generally something that needed, you know, five-step, six-step process in sales and signature and approval, in 2023, we saw typically, customers adding one or two more steps in that process, right? Whether they were finance-related or company CapEx or cash management-related. We don't see it getting worse. I would say, you know, it probably takes a couple of quarters before we see it getting better, but we don't see it getting any worse than it was in 2023. But the focus really was on many of our customers adding incremental, layers of approvals to make sure, right, that they are doing what they can to navigate a complex and uncertain macro environment, just like we would have done ourselves.

Anja Soderstrom (Senior Equity Research Analyst)

Okay. Thank you. That was all for me.

Dhrupad Trivedi (President and CEO)

Thank you, Anja.

Operator (participant)

Thank you, Anja. As a reminder, to ask any further questions, please press star followed by one on your telephone keypads now. We have the next question from Hamed Khorsand from BWS Financial. Hamed, you may proceed with your question.

Hamed Khorsand (Principal)

Hi. So first question is, if I look at just revenue on a just simple basis, you were down something like $30 million year-over-year. Is that $30 million lost? You know, you're saying it gets pushed down $24 million, but it just seems like it's never being recouped.

Dhrupad Trivedi (President and CEO)

Yeah, so I would say, Hamed, that, you know, I would probably separate service provider and enterprise in that segment. As if you look at sort of historical cycles for service provider spending, that CapEx is cyclic and, you know, our enterprise revenue has grown every year, right? So that's not a factor here. And on the service provider side, what we saw was pullbacks from handful of large SP customers who had projected plans to add capacity or new services and have subsequently, you know, recut those plans to be over longer periods of time or reduced them. This is very consistent with all the 5G data or reports you will see from many of our peers, partners, and customers, that in general, their projected incremental investments are now slower or deferred over a longer period of time.

So now when we say we don't think we lost, the reality is what we are looking at is, there was not a project where we were the chosen provider and the customer made a decision to go with someone else, which we would call as a competitive loss, right? So, it's more that the customer was spending, planning to spend X million dollars and ended up ultimately spending half of that, like, or saying, "We'll do half this year and a little bit next year, a little bit next year." And the difficult thing is, it's hard for me to say 100% of that reappears in 2024.

And I, you know, I, I think I'll leave that to the economists and our analysts to figure that out. I think to our ability, what we can do is make sure we are aligned with those customers, we are not losing to competitors, and as they gain confidence to invest, we feel that we are in a good position to get that.

Hamed Khorsand (Principal)

Okay. And could you just talk about the sales timing within the quarter? It all happened towards the very end of the quarter?

Dhrupad Trivedi (President and CEO)

No. Actually, no. It was better than what we saw in Q3 phenomenon. And, you know, generally, obviously, we hope the quarter is more balanced just because it reduces the risk and volatility for us on execution as well as cost. And so the Q4, I would say, definitely improved from Q2 and Q3 in terms of what we were able to book and ship in month one, month two, and month three. Yeah.

Hamed Khorsand (Principal)

Do you still have a large accounts receivable with one customer, or is that more diversified?

Dhrupad Trivedi (President and CEO)

It's fairly diversified, but I don't know, Brian, you can add to that idea.

Brian Becker (CFO)

Yeah. No, we did have two large customers in AR, but it's a normal cycle. I think as Dhrupad's mentioned in the past, it does change quarter to quarter. And the two that we had this quarter, I think, did not appear as the same customers in previous quarters.

Hamed Khorsand (Principal)

Okay. Thank you.

Dhrupad Trivedi (President and CEO)

Thank you, Hamed.

Operator (participant)

Thank you. As a reminder to ask any further questions, please ask, please, please press star followed by one on your telephone keypads. We now have Hendi Susanto from Gabelli Funds. Your line is open, Hendi.

Hendi Susanto (Portfolio Manager and Research Analyst)

Good afternoon, Dhrupad and Brian. My first questions are— So, Dhrupad, if we see the sales to, like, service providers from one quarter to another, I saw some sequential improvement in Q4 from Q3. Do you have any insight whether the service provider's segment has seen its bottom, or there— or is there still any risk that it may continue to slide down sequentially?

Dhrupad Trivedi (President and CEO)

So, Hendi, if you remember in the Q3, what we had talked about was the fact that, as we had entered even the third month of that quarter, we had seen a few significant deals that were projected for Q3 move into Q4. And I think the Q4 results really show that, that materializing Q4. In some cases, they were slightly smaller than, you know, what we originally thought in Q3, but in general, you can see fairly significant step up. But it's related to that timing between the two quarters. And, as far as, you know, thinking about calling a bottom, again, as I said, I would leave that to the economists and the Federal Board and analysts to figure that out.

From our perspective, certainly we are very closely aligned with our customers and, making sure we are designing in even more products that as their confidence in spending resumes, that we will be a key part of that strategy going forward, right? And, it, it's hard for us to say, and as I said before, particularly in a year that could be influenced by political factors, it's even more difficult than just purely economic factors.

Hendi Susanto (Portfolio Manager and Research Analyst)

Okay. Then since we have the full year revenue, can you share what percentage of the security solutions?

Brian Becker (CFO)

Yeah. Yeah, I believe it was around 50%, just below that. So in line with our goal of achieving 65%, which we announced 2022.

Dhrupad Trivedi (President and CEO)

In two years, yeah.

Brian Becker (CFO)

Yeah. So it's steadily growing, and we're tracking to plan.

Hendi Susanto (Portfolio Manager and Research Analyst)

Okay. Yeah, and then last question for me. So, Brian, if I look at OpEx, is $35 million-$36 million a good baseline for quarterly run rate of the OpEx?

Brian Becker (CFO)

Good question, Hendi. There's a few factors. Obviously, variable comp is lower than expected, you know, not only because of the changes or at least the misses that we saw in Q3. And then overall, I, you know, we were projecting a little, little bit better result in Q4. But, you know, I'd, I'd say that there's variable comp that's missing from OpEx, both in Q4 as well as the full year results. As we turn to 2024, you know, we'll be expecting to add back that variable comp, you know, maybe like a third of that cost back as a result.

Hendi Susanto (Portfolio Manager and Research Analyst)

Yeah. Okay. Thank you, Brian. Thank you, Dhrupad.

Dhrupad Trivedi (President and CEO)

Yeah. No, Brian. Thank you, Hendi.

Operator (participant)

Thank you. If you would like to ask any further questions, please press star followed by one on your telephone keypads now. We currently have no further questions registered, so I'd like to hand it back to Dhrupad Trivedi for any final remarks.

Dhrupad Trivedi (President and CEO)

Thanks. Thank you, and thank you all of our shareholders for joining us today and for your continued support. I also want to thank all our employees around the world for driving this performance in a very challenging market environment. Thank you.

Operator (participant)

Thank you all for joining today's conference call with A10 Networks. Today's call has now concluded, and you may now disconnect your lines, and please enjoy the rest of your day.