A10 Networks, Inc. (NYSE:ATEN) Q3 2022 Earnings Conference Call November 1, 2022 4:30 PM ET
Company Participants
Rob Fink – Managing Partner, FNK Investor Relations
Dhrupad Trivedi – President & Chief Executive Officer
Brian Becker – Chief Financial Officer
Conference Call Participants
Christian Schwab – Craig-Hallum
Hamed Khorsand – BWS Financial
Hendi Susanto – Gabelli Funds
Operator
Good afternoon, and thank you for attending today’s A10 Third Quarter 2022 Financial Results Conference Call. My name is Austin, and I shall be your moderator for today. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. [Operator Instructions]
I would now like to pass the conference over to our host, Rob Fink. Rob,you may proceed.
Rob Fink
Thank you, operator and thank you all for joining us today. This call is being recorded and webcasted live, and may be accessed for at least 90 days via the A10 Networks Investor Relations 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 third quarter 2022 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 revenue growth; industry and customer trends; focus on an investment in the go-to-market strategy and infrastructure; its capital allocation strategy; M&A opportunities; supply chain constraints and expectations; positioning for the repurchase and dividend programs and its market share.
These statements are based on current expectations and beliefs as of today November 1, 2022. 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 business and operations that could cause actual results to differ materially. 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 A10’s most recent 10-K.
Please note that with the exception of revenue financial measures discussed today are on a non-GAAP basis and have been adjusted to exclude certain charges. The non-GAAP financial measures are not intended to be 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 that’s posted on the company’s website.
Now I would like to turn the call over to Dhrupad Trivedi. Dhrupad, the call is yours.
Dhrupad Trivedi
Thank you, Rob and thank you all for joining us today. A10 continues to deliver strong revenue growth and earnings power. The third quarter was our 11th consecutive quarter of meeting revenue and EPS consensus expectations. We are achieving this consistency despite a global pandemic, economic volatility, higher interest rates and supply chain challenges. This is a testament to the business we have built upon a great technical foundation and to a team that relentlessly delivers excellence.
We have proven that our business can be durable, leveraging differentiators to drive success even amidst unprecedented challenges. Today A10 is a security-focused organization, building cyber security into everything we do, while building upon our deep networking expertise and global customer footprint. This positioning is evident in our business model as our gross and operating margins reflect proprietary security-led solutions and strong customer demand for cybersecurity and infrastructure solutions.
By design, we are not reliant on any single geographic region and in fact we are generating growth in nearly every region of the world despite foreign currency headwinds. To the best of our ability, we have built a risk-mitigated business model largely insulated from volatility in any specific region, product category or customer consumption model.
We sell to two main customer groups, Enterprises and Service Providers. And within these two groups, our business is aligned with two secular tailwinds, infrastructure and cybersecurity. In the first half of 2022, the economy impacted Enterprise spending, while Service Provider revenue continued to grow providing a balanced model.
In the third quarter, revenue from Enterprise customers represented our faster-growing customer segment, demonstrating that balance in our strategy. Both Enterprise and Service Provider segments grew in the third quarter and we continue to see demand from US large enterprises, aligned with the secular tailwind for our security-led solutions.
I’d like to highlight two wins that came from our Enterprise segment, where A10 is gaining market share by delivering a superior solution for the customer, and exceeding performance criteria in head-to-head testing for critical customer needs. One of A10’s largest transactions for Q3 came via one of the world’s top digital advertising platform companies.
Our customer had an urgent need to rapidly upgrade its infrastructure, in order to support added features and enhanced functionality, including security for its end customers. A10’s high-throughput low-latency solution, which also supports security encryption across this customer’s network infrastructure, ensure the customer’s existing revenue streams, while expanding their ability to generate new revenue streams.
Another key customer win came from one of the largest government agencies in Europe. This existing customer had a relatively small product footprint with A10, but had an urgent need to expand its deployment in support of a new online filing mandate on the country’s citizens and businesses, with a very tight deadline.
A10 was able to service this customer’s critical technological need for high volume and security, and we were able to deliver this solution within their required time frame. Similar to the first example, our solution helped this enterprise to ensure the ability to expand and capture new revenue streams, while actually improving their network performance.
Today, A10 works with nine of the top 10 wireless carriers, four of the top six banks, three of the top five web giant’s, dozens of financials and educational institutions and several government agencies. Our customer base is clearly diversified. We are not reliant on any single customer, or small group of customers, to achieve our results.
Our revenue growth continues to be driven by our proprietary security-led product revenue, which on a trailing 12-month basis is now up 21% backed by secular tailwinds and a series of product innovations which were continually delivered by A10.
Overall, product revenue, which is a leading indicator of future recurring revenue increased 13% versus Q3 of 2021. This success is due to our ability to combine networking expertise with the security needs of our customers. The need for cybersecurity infrastructure continues to evolve and grow. Global geopolitical events serve as a near-term catalyst for this growth.
Cybersecurity solutions are being prioritized, even amidst higher interest rates and ongoing economic challenges, because these threats are now viewed as an enterprise level risk. Our product and technology roadmap deeply integrates infrastructure and security needs on a common platform, delivering increasing efficacy and value to our customers.
Our quarterly revenues increased 10.2% year-over-year in line with our target ranges. And non-GAAP operating gross margin was better than 80% driving record levels of operating income and non-GAAP EBITDA of 29.5%. This is a result of our focus on customer-centric innovation and delivering productivity across all functional areas.
We ended the quarter with nearly $128 million in cash, even after repurchasing more than $47.5 million in stock in the quarter. We continue to maintain a fortress balance sheet. We have also demonstrated a proven business model with the bottom line growing faster than our top line.
We continue to maintain a disciplined flexible and opportunistic capital allocation strategy. The share purchase in this quarter was an example of this. Our quarterly dividend is another example. Today we announced that our Board approved a 20% increase in our quarterly dividend from $0.05 per share to $0.06 per share. Additionally, we announced a new $50 million share repurchase authorization.
At the same time, we continue to increase our investments for organic growth in R&D and sales and marketing. Our year-to-date performance and customer traction reinforces our expectation that we can achieve our full year target of revenue growth of 10% to 12% and EBITDA in the range of 26% to 28%. This outlook fully incorporates foreign currency headwinds.
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. Third quarter revenue was a record $72.1 million, up 10.2% year-over-year. Product revenue for the quarter was $45.1 million representing 62.6% of total revenue, up 13.3% year-over-year. Services revenue, which includes maintenance and support revenue, was $27 million or 37.4% of total revenue.
Moving to our revenue from a geographic standpoint. Revenue from the Americas, including Latin America was $36 million, up 11.6%. Revenue from EMEA was $11.2 million compared to $11 million last year, up 2%. Revenue from Asia-Pacific including Japan was $24.9 million, up 12.4% compared to $22.1 million in the third quarter last year.
On a constant currency basis, revenue in Japan increased 15% year-over-year in Q3. For reference, on a constant currency basis, A10 consolidated revenue has grown approximately 16% year-to-date. As you can see on our balance sheet, our deferred revenue was $126 million as of September 30, 2022, up 8% year-over-year. On a constant currency basis, deferred revenue would have increased 10% year-over-year in line with overall revenue growth.
With the exception of revenue, all the metrics discussed on this call are on a non-GAAP basis unless otherwise stated. A full reconciliation of GAAP to non-GAAP results are provided in our press release and on our website.
Gross margin in the third quarter was 80.2%. As Dhrupad mentioned, we continue to successfully mitigate the impact of industry-wide global supply chain constraints and input cost increases. Non-GAAP operating expenses in Q3 were $38.3 million compared to $38.1 million in the third quarter last year, reflecting strategic investments in our growth priorities including cybersecurity technology and commercial execution.
We reported $19.5 million in non-GAAP operating income, our highest quarterly result to-date, up 34.2% compared with $14.5 million in the year ago quarter. Adjusted EBITDA was $21.3 million for the quarter, also a record, reflecting 29.5% of revenue. Non-GAAP net income for the quarter was $15.9 million or $0.20 on a per share basis, up 18% from $0.17 per share in the third quarter of 2021.
Diluted weighted shares used for computing non-GAAP EPS for the third quarter were approximately 77.7 million shares compared to 79.9 million shares in the year ago quarter. On a GAAP basis, net income for the quarter was $12.1 million or $0.16 per share compared with net income of $74.9 million or $0.94 per share in the third quarter last year. As a reminder in the year ago quarter, we recognized a nonrecurring income tax benefit of $65.4 million, which represented approximately $0.82 per share. When adjusted for this income tax benefit, our EPS increased from $0.12 per share to $0.16 per share this quarter.
Turning to the balance sheet. As of September 30, 2022, we had $127.8 million in total cash and cash equivalents, compared to $166.8 million at the end of the previous quarter. During the quarter, we repurchased $47.5 million in shares at an average price of $12.77 and paid $3.8 million in cash dividends issued in the third quarter. We continue to carry no debt.
As Dhrupad mentioned, the Board has approved a 20% increase in our quarterly cash dividend to $0.06 per share to be paid on December 1, 2022 to shareholders of record on November 15, 2022. The Board also approved a new $50 million share repurchase plan. As Dhrupad mentioned, we are still well-positioned to achieve our full year revenue target of 10% to 12% growth and full year adjusted EBITDA margin of 26% to 28%.
I’ll now turn the call back over to Dhrupad for closing comments.
Dhrupad Trivedi
Thank you Brian. First, I want to thank all the global employees of A10 for continued performance in challenging and sometimes difficult situation. I’m proud of A10’s ability to continue to perform better than the overall industry. This performance is due in large part to a highly differentiated technical platform combined with our ability to achieve diversification in all aspects of our business. Our security-led solutions are in demand across all customer segments and each of our target geography.
We also maintained discipline in our execution, managing costs while investing to bolster our differentiation and successfully navigating ongoing supply chain challenges. Our solutions are well-aligned with durable secular catalysts, which results in sustainable performance.
Operator, you can now open the call for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question is from Christian Schwab from Craig-Hallum. Christian, your line is open.
Christian Schwab
Thank you. Congrats on another solid quarter. As we look to next calendar year, would you guys anticipate the security-led solutions to drive a strong double-digit growth in the enterprise like we’ve been experiencing?
Dhrupad Trivedi
Thank you Christian. And I think I would say, we don’t necessarily view it that way, although we do see the large enterprise segment continuing to be more balanced with our service provider outlook. I think the goal for us is, obviously, to deliver consistent performance regardless of the vertical. I think in the large enterprise segment, we definitely see traction and momentum led by security. And we expect to see that not just in North America, but also globally. So we’re certainly optimistic about it and we feel good that on a combined basis we are well-positioned to get to the 10% to 12% range in addition to overcoming FX headwinds.
Christian Schwab
Great. Is there any particular spending patterns or customer spending patterns in the service provider area that could be positive for the company as we look into the next calendar year?
Dhrupad Trivedi
Yeah. No, it’s a good question. So when you look at service provider spending patterns predominantly there is an infrastructure build-out that is CapEx-driven. However, because of the nature of our product, we continue to be relevant to them even as they add more subscribers and handle more data and so forth, right? So we see that as a balance of when interest rate might drive fear of CapEx right now, but it’s not as challenging to maybe do an expansion or enhancement of the network.
Beyond that, I think, we certainly see service providers in general be more-and-more concerned about cybersecurity, as it directly impacts their network performance and therefore their ability right to monetize it and generate revenue.
So that’s something we see as a more secular pattern. The CapEx obviously follows a little bit cyclical trends, but to the degree, we are relevant to them not just in the first build-out is important to us. And we continue to try to expand more things we can do with them.
Christian Schwab
Great. Thank you. And then, congratulations on the strong capital allocation continually buying back your stock, reupping another buyback, raising the dividend, are you guys beginning to look at or explore potential M&A as a way to complement the product portfolio or expand growth potential for the company, or are we still just focused on continuing to do a great job blocking and tackling running our own business?
Dhrupad Trivedi
Yeah. So I think good question. And I think as certainly you saw, we were not programmatic but kind of opportunistic as well as watching the market in such a volatile environment on the buyback, right? And therefore, having the buyback gives us that ability to respond when the timing is right.
As we look at our priorities, I think, if you look at our non-GAAP spending patterns, our R&D and sales and marketing is up about 7% 8% year-over-year, while we generate productivity in G&A and other functions to do that, because our goal is — our first priority is to invest in organic growth because that is the most efficient.
When we look at our customer base around the world of about 7,000 customers in many different verticals, we think there is a fair amount of room for us to continue expanding our product portfolio and customer penetration.
As we deliver more-and-more software, I think, what is not apparent is a lot of the new wins that are fueling our growth, came from innovations and releases that we’ve made in the last 12 to 18 months, right? So we continue to invent and add to what we do.
At the same time, of course, we are, interested and open to looking at ways to accelerate our growth through inorganic means, but the filters there would have to be it has to be aligned with strategy.
And second, right, it has to have the right profile on what we can deliver from a financial perspective as well. So, we of course continue to look at deals. And I have done those kind of roles before, so a high-degree of comfort in looking at them. But if we conclude organic growth is a good idea we’ll keep going, till we find something better.
Christian Schwab
Great. Congrats again on the good solid results. No other questions. Thank you.
Dhrupad Trivedi
Thanks.
Operator
Our next question is with Hamed Khorsand from BWS Financial. Hamed, your line is open.
Hamed Khorsand
Hi. So first question was, just given the gravity of how cybersecurity is really the primary spending spot are you seeing more competition? Are you seeing a pricing compression or customers taking a long time, because there’s, more new entrants in the same bid that weren’t there before?
Dhrupad Trivedi
Thank you, Hamed. Good question. So I think for us the phenomenon is, if you look at cybersecurity as a general category, there are several different segments of it, right? So you have endpoint security, identity management. And we participate in networking security.
I think endpoint security is the one where you hear about hundreds of companies competing all the time with new buzzwords. That is not the sweet spot for us. Our focus is where we can take our understanding of networking traffic, implied performance impact and bring intelligence into what affects performance, what can be detected and re-mediated quickly.
So in that segment I would say, certainly, we are not seeing any change in the competitive landscape. I think we see more maybe slightly positive for us as we continue to add more capabilities into that platform for our customers.
There’s not – I think the price compression is always there in any competitive dynamic but our goal is to manage it in a way where we are able to offset it with productivity and other measures that allow us to maintain the gross margin, right? So you can see gross margins still remain stable. So we don’t see a risk where that’s a concern.
And lastly, I think as you talked about the deal cycle, we certainly saw some slowdown earlier in the year. But I would say those cycles are generally normalizing. It’s impossible for me to predict what will happen after any announcement tomorrow from the Fed. But in advance of that I would say we certainly see our competitive positioning improving and we don’t try to participate right in every focus area or vertical. We are very targeted on where we generate value where we are highly differentiated. So we don’t see anything negative so far. If anything we see our position getting stronger.
Hamed Khorsand
Okay. It sounds like you don’t have a 10% customer anymore. Did they reduce their spending, or have they just been squeezed out with more of your other customers growing their spending with you?
Dhrupad Trivedi
Yes. So I think we have had a 10% customer, but typically they are like 10-point-something usually and it’s not always the same one, right? And I think Brian this quarter we had one in that category. But it’s not the same one every quarter.
Hamed Khorsand
And given that you’re saying there’s no concentration of the customers, do your top five customers make up 50% of your sales or is there more diversification on that?
Dhrupad Trivedi
Yes. I think roughly top 10 customers make up like 35%.
Brian Becker
Yes. It varies between quarters sometimes a larger number of customers make up a large portion of revenue depending on the cycles.
Dhrupad Trivedi
But if you average over eight quarters that’s probably kind of where it is there.
Hamed Khorsand
Okay. That’s helpful. Thank you.
Dhrupad Trivedi
Thank you.
Operator
The next question is from Anja Soderstrom from Sidoti. Anja, your line is open.
Unidentified Analyst
All right. This is Stefan Gill [ph] on for Anja. How are you?
Dhrupad Trivedi
Hi. Welcome. Thank you.
Unidentified Analyst
I guess my first question is are you seeing any inflationary pressures?
Dhrupad Trivedi
Yes of course, you are right. So we are not immune to the normal environment. So we see inflationary pressure in shipping and logistics, warehousing, supply chain, labor, engineering, right? Of course, we are not immune to the same inflationary pressures as everyone else. I think our goal is we continue to try to offset that with productivity. And we have generally always generating new measures and ideas for how to offset that. So yes we definitely have the same pressures on materials and people cost.
Unidentified Analyst
Thank you. My next question is how do you think you will fare if we basically head into a recession?
Dhrupad Trivedi
Yes. So I think, I would say, if you look at our product portfolio, typically the way our products are positioned is one, today where we are successful is because we are helping customers add capacity or security in the most efficient way without ripping everything and building a new network. I think that’s a pretty prudent approach that a lot of CIOs and CFOs will take if they are concerned about outlook and downturn because this is still critical to their ability to operate, right? So we are not based on a value proposition of wouldn’t it be nice to do X. We are in the value proposition of we need to do X, right? And I do think that when you look at the kind of growth in volume and sophistication of cyber-attacks and a lot of the kind of mandates of prescriptions around what people need to do to protect infrastructure, as well as operations, we believe that that will be one of the categories that will still be above the red line, in case of a recession.
So we are very focused on, how do we create value for our customers, as they face that and that’s how we plan to do it. And then of course, our global footprint helps further diversification where we don’t expect all regions in the world to have the same GDP, tread line all the time.
Unidentified Analyst
All right. Thank you so much for taking my questions.
Dhrupad Trivedi
Thank you.
Operator
Our next question is from Hendi Susanto from Gabelli Funds. Hendi, your line is open.
Hendi Susanto
Good evening, Dhrupad, Brian and Rob. My first question Dhrupad, you mentioned A10, a major investment in growth opportunity. What are the areas of your major investments? In the past A10 has mentioned security subscription offerings. So would you be able to elaborate more on where you invest for organic growth opportunity?
Dhrupad Trivedi
Sure yes. So I think for us obviously as it relates to cybersecurity where we are investing is in new capabilities, whether it relates to managing encryption algorithms like SSLi products, our DNS products offering East-West protection in addition to North-South, it’s a wide range of things right that we continue to add capabilities, which by the way would typically be done by a stand-alone start-up otherwise. So these are the reasons, why our customers look at us. They continue to expand, what they do and align on the roadmap.
As it relates to combining security with network infrastructure, our investments are in ways to combine the best way software with the hardware to drive, lowest latency and cutting-edge performance. An example of that is, it’s a long investment and program to deliver very high performance products for high frequency trading for example, right? That’s — that needs a lot of engineering. It needs a lot of innovation and research. And so our technical teams continue to drive that. So those are some examples, of where our investments are aligned with our differentiation. Our differentiation is better ability to detect and remediate cyber-attacks, and to provide the highest throughput lowest latency infrastructure.
Hendi Susanto
Got it. And then Brian, one question is about currency. How did A10 manage the strong USD appreciation in Japan? Like do you split the currency appreciation, between A10 and customers, or like how – essentially, how do you mitigate the strong USD appreciation?
Brian Becker
Yes. No, great question. It’s been very difficult for us to navigate. Most of our customers in Japan, we do deal in Japanese yen. Given the nature of our service provider clientele in Japan, it’s not surprising. I think I mentioned, that we lost revenue and deferred revenue accordingly to the magnitude of 2% in total, on both deferred and overall top line. So it was not an easy navigation that we’ve accomplished. But I think to Dhrupad’s point, about diversification across geographies and customer verticals that allowed us to overcome some of those headwinds. But, yes, it wasn’t something that we were able to escape.
Dhrupad Trivedi
Well, I mean it’s 100% absorbed by A10 Hendi. And we still delivered the growth by growing faster in other regions.
Hendi Susanto
Yes. I see. And then Brian, you may have mentioned this and I may have missed this. What is the recurring revenue by the end of the third quarter?
Brian Becker
Yeah. No, recurring revenue is both a combination of support contracts and subscription contracts. The subscription part is a small portion of it, but it’s right on our income statement about a little less than half our revenue is recurring revenue and it continues to be a pretty stable portion of our business.
Hendi Susanto
Got it. Yeah. And then Dhrupad, will it be reasonable to assume that you are winning market shares considering the top line growth execution that you have been delivering? And then if yes, could you point out like where you believe A10 is gaining market shares?
Dhrupad Trivedi
Sure. Yeah. So I think the way internally we measure our performance and drive it is we look at market indices that tell us what the market is growing at or lead indicators of the type. Second, of course we look at our peer group and I think you guys all know those peers that we were always being asked about. So when we look at relative to the peer group revenue growth this year, year-over-year as well as if you look at market indices like Gartner IT Spending or CapEx and telcos and things like that we believe that growing at 10% to 12% represents us driving, improving commercial execution and product portfolio that helps us grow faster.
So just mathematically, right, if our average peer group is growing low single-digits, we feel pretty good about it. And most importantly, when we are at customers, as we continue to replace competitors or win new business with a customer that didn’t even exist before, we think that’s another way for us to gain market share as well. So I think obviously you guys know well on the typical players in the space. So we feel generally pretty well that in both Enterprise and SP segment, we continue to execute well and we are making good progress.
Hendi Susanto
Thank you, Drupad, thank you, Brian.
Dhrupad Trivedi
Thank you, Hendi.
Brian Becker
Thank you.
End of Q&A
Operator
That concludes our Q&A. So I would like to hand the conference back to Dhrupad for any closing remarks.
Dhrupad Trivedi
Thank you, and thank you to all of our shareholders for joining us today and for your continued support. Thank you.
Operator
That concludes today’s call. Thank you for your participation. You may now disconnect your lines.
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