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A10 Networks, Inc. (NYSE: ATEN) Q1 2022 Earnings Conference Call May 3, 2022 4: 30 PM ET
Rob Fink - FNK IR
Dhrupad Trivedi - President, CEO & Board Chair
Brian Becker - CFO
Conference Call Participants
Christian Schwab - Craig-Hallum
Anja Soderstrom - Sidoti & Company
Hamed Khorsand - BWS Financial
Hendi Susanto - GAMCO Investors
Good afternoon, and thank you for attending today's A10 Networks Q1 2022 Earnings Call. My name is Sam, and I will be the moderator for today's call. [Operator Instructions].
At this time, I'd now like to turn the call over to our host, Rob Fink, of FNK IR. Rob, please proceed.
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 website at a10networks.com. Hosting the call today are Dhrupad Trivedi, 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 2022 financial results. Additionally, A10 published a presentation and supplemental trended financial statements. You may access the press release, presentation and the 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 its projections for future operating results, including potential revenue growth, industry and customer trends, and its focus and investment in go-to-market strategy and infrastructure, our capital allocation strategy, M&A opportunities, supply chain constraints and expectations and positioning, and repurchases and dividend programs and its market share. These statements are based on current expectations and beliefs as of today, May 3, 2022. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond the company's control, such as the potential impact of the COVID-19 pandemic on its business and operations that could cause actual results to differ materially, and you should not rely on them as predictions of future results.
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. Please note that with the exception of revenue, financial measures 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 that may be different from non-GAAP financial measures presented by other companies. A reconciliation from GAAP and non-GAAP measures can be found in the press release that was issued today and on the trended quarterly financial statements posted on the company's website.
With all that said, I'd like to turn the call over to Dhrupad. Dhrupad, the call is yours.
Thank you, Rob, and thank you all for joining us today. Driven by continued adoption of our security-led solutions, revenue increased more than 14% year-over-year, positioning us to deliver revenue growth at the high end of our full year guidance range. As expected, we continue to see leverage in our business model with improvement in gross margin, operating income and earnings per share. We generated $15.5 million -- $15.9 million in cash from operations, ending the quarter with $164.7 million in cash and cash equivalents after repurchasing $28.3 million in stock and returning $3.9 million in cash to shareholders in the form of a dividend during the quarter.
As discussed at our recent Analyst Day, we have developed a sustainable business model, and our goal is to achieve the Rule of 40, meaning a combined revenue growth and EBITDA margin of 40% or greater, in line with highly valued cybersecurity companies. The first quarter results continue to build the Hyundai Foundation and demonstrate that our model is working in spite of multiple macro headwinds. Security-led solutions continue to serve as a durable secular catalyst for our growth. We have built security into every facet of our business, helping differentiate our technology solutions with focus on customer-centric innovation that delivers business value for our clients.
We all continue to see high-profile cybersecurity incidents, including recent ransomware situations impacting large technology organization here in the States, as well as the several state-sponsored cyber attacks taking place around the world, including Ukraine. Headlines about cybersecurity intrusion seem to be a weekly, if not a daily occurrence with attacks moving beyond isolated incident involving small groups or individuals through state sponsored sophisticated and large scale, targeting key infrastructure, government agencies and utility companies alike.
As a result, CIOs and IT leaders are increasingly focused on security first. Our ability to integrate security and encryption capability into all of our networking solutions sets us apart. A10 has differentiated itself as a leader in security-led infrastructure solution, including the Zero Trust architecture with superior networking performance and best-in-class cybersecurity protection. As a result, we are winning in our target markets and applications.
Our global customers also continue to expand their global IT networks in an effort to handle more traffic and data. A10s product suite allows our customers to increase traffic capacity and throughput without sacrificing security. In fact, we build DDoS recognition and mitigation capabilities as well as malware protection and privacy safeguards into nearly all our networking offerings, enabling our customers to improve their resiliency, while expanding their networks.
Let me highlight some key areas of progress within our business. Security-led product revenue increased 20.1% year-over-year in the quarter with North America being the leading driver of this growth. From a geographical perspective, revenue from the Americas grew 25.5% year-over-year to $33 million, reflecting our investment on commercial initiatives in the Americas. EMEA revenue increased year-over-year from $8.6 million to $11.9 million. Asia, including Japan, declined from $20 million to $17.8 million. This is a consequence of continued depressed economic outlook in those countries and the lingering impact of COVID-19.
Within APJ [ph] Japan went from $13.6 million to $11.5 million in Q1 2022, inclusive of a significant foreign exchange headwind and in line with our expectations. Our diversification continues to provide a resilient foundation. We continue to focus our investment in growth opportunities with balanced profitability and a focus on achieving our stated Rule of 40. A key part of this strategy is improving our ability to cross-sell solutions to our customers, while continuing to reduce that overall capex and opex. Over the past year, our product revenue growth rate with existing customers has consistently exceeded our target growth rate, demonstrating our ability to successfully leverage our strong installed base and bolster our confidence in delivering 10% to 12% consolidated growth.
We have proven our ability to grow, invest for future growth, return capital to shareholders, and bolster our fortress balance sheet. We will maintain a disciplined, flexible and opportunistic capital allocation strategy, exploring all options, while demonstrating rigor in evaluating potential uses of shareholder capital. As I'm sure you are all aware, supply chain issues continue throughout our industry. A10 has been able to successfully navigate these issues to date. Our customers are looking for supply assurance, and we have been able to meet those requirements so far.
A10 is well positioned in a growing market, and this is proven by our strong financial performance. Cybersecurity remains the primary catalyst for our growth. We are now well positioned to achieve the high-end of our full year target around top line growth of 10% to 12% and expanding EBITDA in the range of 26% to 28%.
With that, I'd like to turn the call over to Brian for a detailed review of the quarter. Brian?
Thank you, Dhrupad. As Dhrupad mentioned, revenue in the first quarter was $62.7 million, up 14.3% year-over-year. Product revenue, which is a lead indicator for future revenues was $37 million, representing 59.1% of total revenue, up 21.3% year-over-year. Services revenue, which includes maintenance and support revenue was $25.6 million or 40.9% of total revenue.
Moving to our revenue from a geographic standpoint. Revenue from the Americas, including Latin America, was $33 million, which was up 25.5%. Revenue from EMEA was $11.9 million compared to $8.6 million last year. Revenue from Asia, including Japan, was $17.8 million, down 10.8% compared to $20 million in the first quarter last year. This is inclusive of the strong headwind from foreign currency exchange rates mentioned by Dhrupad earlier.
As you can see on our balance sheet, our deferred revenue was $121.3 million as of March 31, 2022. That's up 7.2% year-over-year. Please note that this is in line with typical seasonality. Recurring revenue, defined as support and subscription revenue grew 8.9% year-over-year to $27.9 million in the first quarter, which is within our target range of between 45% and 50% of revenue. 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 80.2%. As Dhrupad mentioned, thus far, we have been able to successfully mitigate the impact of industry-wide global supply chain constraints and input cost increases. Non-GAAP operating expenses in Q1 were $38.6 million compared to $32.5 million in the first quarter last year, reflecting increasing investment in our growth priorities, including cybersecurity and commercial execution. We reported $11.7 million in non-GAAP operating income compared to $10.8 million in the year ago quarter. Adjusted EBITDA was $13.5 million for the quarter or 21.4% of revenue.
Non-GAAP income for the quarter was $10 million or $0.13 on a per share basis. Diluted weighted shares used for computing non-GAAP EPS for the first quarter were approximately 79.3 million shares. On a GAAP basis, net income for the quarter was $6.3 million or $0.08 per share compared with net income of $2.7 million or $0.03 per share in the first quarter last year. For the quarter, we generated $15.9 million of cash from operating activities. We generated $12.8 million of free cash flow for Q1. As a reminder, we define free cash flow as net cash provided by operations, less capital expenditures. Capital expenditures is the purchase of property and equipment.
As of March 31, 2022, we had $164.7 million in total cash and cash equivalents, which compares to $161 million in the year ago quarter. Growth of which includes $32.2 million of share repurchases and quarterly dividend during the quarter. We continue to carry no debt. During the quarter, we repurchased 2.1 million shares at an average price of $13.35 per share, totaling $28.3 million. We have $64.6 million remaining in our $100 million share repurchase program. Since January of 2020, we have repurchased 8.7 million shares at an average price of $9.06, totaling $79.1 million. In addition, the Board has approved a quarterly cash dividend of $0.05 per share to be paid on June 1st to shareholders of record on May 16th. In total, we have returned more than $30 million to shareholders in the quarter between share repurchases and the dividend. As Dhrupad mentioned, we are now well positioned to achieve the high end of our full year revenue target of 10% to 12% growth and full year adjusted EBITDA of 26% to 28%.
I'll turn the call back over to Dhrupad for closing remarks.
Thank you, Brian. The first quarter represented a strong start to the year for A10. Our position as a trusted partner with security-led solutions is helping us to deliver consistent results and outpace the market. We are well diversified in terms of product mix, regional sales and customer mix, enabling a more durable business model in spite of macro headwinds. I would also like to thank all employees, customers and shareholders of A10 for their continued support.
Operator, you can now open the call up for questions.
[Operator Instructions]. Our first question comes from the line of Christian Schwab of Craig-Hallum Capital. Christian, your line is open.
Great. Thank you. Congratulations once again for another solid report and consistent results here. Can you help -- we -- almost every company I follow is facing some challenges in the supply chain in one way or the other, and you guys have just done a wonderful job of handling the supply chain issues. Can you help us better understand what you saw or what you've done to be able to perform at such a consistent level and then continue to raise expectations?
Yes, thank you, Christian. Yes, no, let me talk to that a little bit. So of course, if you look at the broader picture, our suppliers, especially on things like silicon, the same suppliers you hear about, right? So some of the things that I think have helped us mitigate this, I'll walk through some of those examples that hopefully help. So about 2, 2.5 years ago, while we started really putting in much more stringent, longer-term planning processes around supply demand, commercial initiatives and operational capabilities, etc., so that we are driving a mix in line with customer needs, but one that we can deliver. And so that was a good foundation for us to start from.
Second thing, we had to do as things got harder from an input cost and delivery perspective was we took initiatives around our footprint and simplifying it as well as regionalizing it where it makes sense with our footprint, right, obviously in Japan, U.K., Taiwan and U.S. Third thing for us is, as we saw very early signs, beginning of 2020, anticipating what could be worst case scenario on sort of non-silicon components, right, we started developing at least more second sources for some of those components around the world. And last, I would say we have been much more deliberate on focusing on what portfolio is most relevant to our customers, simplifying some of our skis if we have to, but then putting ourselves in the best position to deliver, right? And so far, it has not obviously impacted our ability to deliver and we'll continue to monitor it closely and try to find new levers as we need to.
Yes. Congratulations on that. Thanks for that clarity. I guess my last question is, in the current security environment where you guys are outperforming, can you just give us an update on, in general, who you're competing against most often? And is it different in different geographies in the Americas, say versus Japan, for example.
Yes. No, good question. So I think -- so I'll answer your question directly and then give you the certainty [ph] as well. So first, typically, we are competing with people who have installed footprint in the DDoS marketplace. So oftentimes, it will be someone like Arbor Networks, which is part of Netscout now. Other times, we would be competing with a broader solution, which includes many different things as well. So our service provider customers, it could be working on a solution where we are competing with some like Juniper Networks, for example, as well.
It does not weigh tremendously by geography. It varies a little bit in the sense that in some of the developing nations you will see local competitors who are purely price driven. But on a -- when we look at the customer set that we target, those customers are generally looking right for high reliability and high resilience and high level of expertise versus the lowest cost, which may be true for kind of small, mid-enterprise segment, right? So by virtue of our product positioning and performance, like we are typically competing with high-end performers. And those are most often the companies that we would run into. Now it does change the landscape when we also say we are selling products for SSL encryption. We are also integrating all those products with our other product platforms, right? So when you compare it to that, there's not an apples-to-apples, but I hope that gives you a flavor for the mix we compete with.
Yes, that's great. Congratulations on a solid quarter in this environment and raise guidance. That's it. Thank you.
Thank you, Christian.
Thank you, Christian. The next question is from Anja Soderstrom of Sidoti. Anja, your line is open.
Hey, thank you for taking my question. Congratulations on the continued great results. So I'm just curious for the product gross margin, it's sort of contracted at least sequentially. What drove that? And what can we expect from that going forward?
Yes. No, and I think I'll let Brian comment to it more. So nothing unusual, Anja, to note on that. I think, of course, right, there is a little bit of variation with product mix and it's not a lot, it's very low that we see, slightly quarter-to-quarter. And as we look at obviously year-over-year trend, right, you will see some impact of volume if you look at sequential Q4 to Q1, obviously, right? So -- but if you move Q1 to Q1, right, you can see that trend line. And within that margin, obviously, we are also absorbing or accommodating all the input cost inflation in the market right now, like whether it's from FedEx or chip suppliers, right? So we think net inclusive of those impacts as well as product mix is kind of where we end up. And Brian, anything add.
Yes, that's exactly. Our product gross margins are relatively consistent while fluctuating very slightly, it's really just a matter of the mix of products and services that we're selling.
Okay, and then in terms of input cost inflation and I would also assume to some extent, labor, including labor cost, how are you able to mitigate that?
Sure, yes. So, I think that there are several things we have been doing right. So those obviously are -- continue to be relevant to us. So in the last several quarters we have continued to simplify the business, continue to address things that were structural things we could do to get better cost structure in place. And we obviously had initiatives in place around PPV and logistics and things like that, that ultimately have ended up being required just to offset the input cost, right? So those have been -- things we put into place several quarters ago as a goal towards continuing to improve our portfolio and margin. And a lot of those have helped us offset kind of cost inflation.
On labor and operations cost inflation, obviously we face the same phenomenon. But as I think we noted a little bit on the Analyst Day, as a company I also focus a lot on delivering productivity that helps us offset some of those inflationary costs, right? So not 100%, but that has helped us offset those, whether it's on materials, operations or people side.
Okay, that was helpful. And then in terms of, I mean, it looks like the Americas was very strong for you. What are you seeing in Europe given the geopolitical environment here and the increased sort of cyber work that's gone on there?
Yes, so I think we talked about it, right. So far as EMEA, grew year-over-year. I think we are seeing 2 things, right? So one is, we don't have any direct impact from the conflict there. So that's not relevant to us either plus or minus. But what we are seeing is 2 things. One, as people become more conscious of cybersecurity, whether it's a budgeted topic or not, there is increased importance in doing more to protect themselves. And we are beginning to see that activity and typical sales cycle is 6 to 9 months, right? So we do expect that to result in more people prioritizing cybersecurity in their budget. We see a little bit of hesitation because customers are uncertain, right, of the outlook and economy and what can happen. But I think what we see as more interest and importance of cybersecurity is higher than the uncertainty that is causing them to be worried right now.
And how sensitive do you think you are to sort of a flat economy and inflation. I mean, it seems like you have a pretty critical solution, right?
Yes. No, that's right, that's right. So I think that's exactly well, Anja. So for us, cybersecurity we see it as leading with that. And by the way also all our products around network build-out and throughput and data management are very strong secular trends, right? So whether inflation is slightly up or slightly down, people are still going to use the Internet and want to be more secure. And as they see more public incidents, right, it raises the awareness as well. I think more on the mid-enterprise side you would see cautioned with interest rates and economy slowdown about initiatives that were more about the things like digital transformation or doing all of those ambitious IT projects, right, where cybersecurity is a more urgent and critical need. So we certainly see that as a more secular phenomenon right now.
Okay, thank you. That was all for me.
Thank you. The next question is from Hamed Khorsand of BWS. Hamed, your line is open.
So first question was, given that security is about a 6 to 9-month lead time, what is the conversation that starts now? I mean, how are you doing the promotions? Is it all security-related even for service providers?
It's -- yes, so I think typically -- I mean, obviously, one of the things in cybersecurity, right, for every incident that is public, there's a lot more things the company see that are not public, right? So they are themselves obviously also seeing different ways, they are trying to be attacked and compromised on data. So the [indiscernible] for us is more about having more secure integrated infrastructure that is more, so for a mobile carrier it would be, you have so many subscribers, you want to now have so many more and you want to offer these new revenue services. Here is how we can help you do that with your infrastructure and make you more secure.
Or it could be as they are seeing more and more cyber attacks, right, we work with them to develop and deploy something like the Zero Trust framework, which is not only our product, right? That includes things outside of what we do. But as a trusted adviser, work with them to say, here's what you should monitor and we publish a lot of threat intelligence, which talks about the kinds of threats we see and how people can mitigate remediate. So a lot of it is around being seen first as a trusted expert in security, but at the same time being able to deliver that with the network infrastructure build-out that also gives them lower capex and opex, right, as it relates to data management.
So it's -- without getting very specific, Hamed, obviously, we have specific commercial initiatives that focus on if there is a new infrastructure build, how can those customers benefit from it. If there are new types of cyberattacks we are seeing, how do we advise our customers and when they choose to spend money, they might spend it with us, right? So there's -- we typically, at any point in time would have 3 most and occasionally I would prefer 2 very clear commercial initiatives around what is happening, what is most relevant to our customers, and how do we solve that problem versus product we got right.
Okay, and then given that there's no COVID restrictions in markets, is this a proper sales and marketing expense for you going forward? Are you looking to attend more conferences and so forth where you could spend more on sales and marketing?
Yes, I think if you look at it on a trended basis, Hamed, I think the way to look at it is compared to last year we certainly see a resumption of sales and marketing, travel and activities. I think it's not going to go back to 100% of what it was a few years ago, but maybe 70%, 75%. And so you can see that reflected right in our sales and marketing now reflects some amount per quarter that relates to that discretionary spending that had stopped, but hopefully its towards lead generation, right? So then it's okay.
The only other way I think sales and marketing to think about is on incremental revenue, obviously, right, we will incur the variable sales expense as we grow that. So while we get some obviously productivity as well, we also expect with increasing revenue variable sales compensation goes up and on a year-over-year basis, travel and entertainment and event spending goes up on a year-over-year basis, roughly $2 million a year.
Okay, D&A, 10% [ph] customers this quarter?
We had one.
And then my last question was, are you winning large deals or are they pretty much in the smaller range in the sales side?
It's both, right? I mean,so I think if you look at our average deal size, it may be 100,000 maybe, but there are deals that are 20,000, and there are deals that are several million, right? So a lot of these deals progress, right? So typically, we will get a first deal that's a one location, one site and then they deploy it, they try it out and then they add so many more. So it's a progression and even within an existing customer. So our first deal will not be the biggest deal, but they will typically continue delivering revenue every year, right?
Okay. Thank you.
Yes, thank you.
Thank you, Hamed. Next question is from Hendi Susanto of Gabelli. Hendi, your line is open.
Good afternoon, Dhrupad and Brian. Congrats on strong Q1.
Thank you, Hendi. Dhrupad, some companies talk about longer lead times and then a stronger order visibility that gives higher convictions on the pipeline and the continued strength throughout 2022. Can you talk about order visibility and your conviction on the pipeline? Yes, no, sure. So I think for us, as I think we have continued to refine our processes. We typically look at our sales forecast, our outlook on revenue from several different points of view, one of which would be our own 12-month funnel, 3 months, 9-month funnel, etc., and understanding of the rates at which those translate? Second is we obviously look at market lead indicators, not necessarily what happened last quarter and how those lead indicators, whether it's got net IT spending on cybersecurity, capex, delta, etc., etc.
So that's a second thing we look at. And there's a couple of other factors, right? So we look at multiple factors when we think of outlook and what we commit. And you can see right, hopefully we have demonstrated some consistency on that front. I would say lead times are extending from our suppliers. I think our customers are generally, of course, concerned about that. But our outlook when you think of Q2 or full year is not based on any specific customer orders or things like that. It's based on our engagement, the deal visibility we have, and we talk about, obviously cycle time is roughly 6 to 9 months, right? So we should have a pretty good perspective on that versus be surprised with 1 month to go.
And so we look at multitude of those factors. And so for us, I would say visibility is -- I think we talked about the headwinds and tailwinds, right? So things that are giving us a little bit better visibility is increased relevance and importance of cybersecurity. Second is we continue to see people wanting to use and extend their assets more towards data and connectivity versus maybe 3 years ago they were looking at radical transformation. Headwinds for us, obviously are, we talked about, right, there could be some customer uncertainty around economy and interest rates and things like that which may cause them to defer spending by quarter or something. But generally, we are tracking them on a project-by-project basis, not on a large macro one number basis, right?
So we would try to keep visibility on where the project is and budget is and approvals are and all of that. So far as I would say, compared to -- compared to 1 year ago, visibility is not worse, I would say its slightly better. And compared to 2 years ago, it's definitely better. Thank you, Dhrupad, that's very insightful. And Dhrupad, you stated that the main growth drivers this year is security. Can you help break down, let's say the growth in security in service providers versus enterprise? And then I'm also wondering what the state of application delivery controller outlook? I assume that you're still gaining market shares in application delivery controllers. And then if I look at the your top line growth, I'm wondering what is reasonable to think that, lets say growth in security is somewhat close to 20% plus and minus and then the remainder comes from application delivery controller.
Yes, I think, so that -- so in our Analyst Day, we talked about 3 categories, right, stand-alone ADC, CGN, CFW or firewall and then DDoS, SSLi. And I think, Hendi, your observation is correct. So for us, stand-alone ADC is not declining, but it is less than the fleet average. And by the way, the reason it is not declining is because we are continuing to invest and innovate in it with more security embedded features, right? And then if you look at DDoS, SSLi, CFW, all the security-oriented products, those are certainly growing north of the average. And I would say we saw growth this quarter in both service provider and enterprise and in security and non-security. So it's not big difference or a drag for us. But remember that for us, our enterprise focus is large enterprise, which tends to be like customers who are worried about critical data availability, uptime and security. So they are closer to other companies that are delivering services as well.
Thank you, Dhrupad. Thank you, Brian.
Thank you, Hendi. There are no further questions waiting at this time. So I'd like to turn the call back over to Dhrupad for any closing remarks.
Thank you, and thanks to all of our shareholders for joining us today and for your continued ongoing support of A10. Thank you.
That concludes the A10 Networks Q1 2022 Earnings Call. Thank you all for your participation. You may now disconnect your lines.
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