A10 Networks Inc

NYSE:ATEN

Good afternoon, and thank you all for joining. I would like to welcome you all to the A10 Networks Fourth Quarter and Full Year 2023 Financial Results. My name is Brika, and I will be your moderator coordinating today's call. [Operator Instructions]. I would now like to pass the conference over to your host, Tom Baumann at FNK IR to begin. So Tom, please go ahead.

Thank you all for joining us today. This call is being recorded and webcast live and may be accessed for at least 90 days via the A10 Networks website at a10networks.com. Hosting the call today are Dhrupad Trivedi, A10's President and CEO and CFO, Brian Becker. Before we begin, I would like to remind you that shortly after the market closed today, A10 Networks issued a press release announcing its fourth quarter 2023 financial results. Additionally, A10 published a presentation and supplemental TriNet 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.

Thank you, Tom, and thank you all for joining us today. The fourth quarter 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 third quarter call, orders slipped from our third quarter into our fourth 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 am encouraged by the sequential improvement in both revenue and profitability from the third quarter into the fourth quarter. 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 fourth quarter, 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 threat 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% to 82% gross margin and 26% to 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% to 82% adjusted EBITDA margins of 26% to 28% and single-digit growth in our full year non-GAAP EPS. We continue to buy back 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?

Thank you, Dhrupad. Fourth quarter revenue was $70.4 million, a decrease of 9.3% year-over-year, reflecting the headwinds that up described earlier. Sequentially, revenue increased 22% compared to $57.8 million in the third quarter. This reflects some orders that were delayed right at the end of the third quarter and recognized during the fourth quarter, though we continue to see longer than normal sales cycles during the fourth quarter 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 fourth quarter, 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 fourth quarter was 81.8%, in line with our stated goals of 80% to 82% and especially unchanged from the third quarter 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% to 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 at the A10. Diluted weighted shares used for computing non-GAAP EPS for the fourth quarter 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 10.2% 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% to 82% and adjusted EBITDA margins of 26% to 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.

Thank you, Brian. A10 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. And 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 Instructions]. The first question we have comes from Christian Schwab of Craig-Hallum. You may proceed with your question.

Guys, just a few quick questions. On the service provider level, I think in the prepared comments, I think you said future and then second half waited. 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 going to be driven by enterprise?

Yes. 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 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, 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.

And then as we look further out into '24 then, would you expect a snapback and service provider revenue after a difficult long period? Or would you anticipate that business to return to like flattish, plus or minus?

Yes. No, it's a good question. So I would say that it would normalize to the 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 the movements we see in terms of interest rate actions and particularly then affected by the fact that there's 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 in 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 the core of what they need to deliver new services and maintain customer experience, as opposed to a dramatic reinvention of the network. So we do expect that as it ramps up in 2024, we could see a more positive cycle in 2025 and beyond.

Your next question comes from Anja Soderstrom from Sidoti.

First of all, is there anything to call out geographically in terms of revenue?

Yes. Good question, Anja. So I think 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, 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 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.

And can you just remind me in this year to past year 2023, the product revenue was a little bit lumpy in second and fourth quarter was a lot stronger. I know some of it was pulled in from the third quarter to the fourth quarter. If we had the same happening in the second quarter? And how should we think about the quarterly cadence for next year or this year?

Yes. I would say that, certainly, we saw some movement from third quarter to fourth quarter, and you can see it really in our sequential product revenue growth from that, particularly in service provider segment information that we publish. First quarter, I think, for us was a little bit unusual because in addition to the macro environment, we also were focusing on strengthening our own cybersecurity posture and our own position on that. Going into '24 and beyond, I would say we expect to return to our normal seasonality of 47%, 53% first half, second half. We don't expect, obviously, to the best of our ability, onetime events to affect that, that much.

And touch on the longer sales cycles that you've been citing, how that's standing now? Are they like becoming even longer? Or are they improving?

I do not think they are becoming longer. I think what we have seen is even in Enterprise segment, generally something that needed 5 steps, 6-step process in sales and signature and approval. In 2023, we saw typically customers adding 1 or 2 more steps in that process, whether they were finance-related or company CapEx or cash management related. And we don't see it getting worse. And I would say, it probably takes a couple of quarters before we see it getting better, but we don't see 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.

[Operator Instructions]. We have the next question from Hamed Khorsand from BWS Financial.

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

Yes. So I would say, Hamed, that I would probably separate service provider and enterprise in that segment. As if you look at historical cycles for service provider spending that CapEx is cyclic and our enterprise revenue has grown every year. So that's not a factor here. And on the service provider side, what we saw was pullbacks from a handful of large SP customers who had projected plans to add capacity on new services and have subsequently recut those plants to be over longer periods of time or reduce them.

And 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, the 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. So it's more that the customer was planning to spend x million dollars and ended up ultimately spending half of that. 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 think I'll leave that to the economists and our analysts to figure that out. But 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.

Okay. And could you just talk about the sales timing within the quarter? Did it all happen towards the very end of the quarter?

What we saw in Q3 phenomenon. And 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 fourth quarter, I would say, definitely improved from second and third quarter in terms of what we were able to book and ship in month 1, month 2 and month 3.

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

It's fairly diversified, but I know, Brian, you can add to that.

Yes. No, we did have 2 large customers in AR, but it's a normal cycle. I think as Dhrupad mentioned in the past, it does change quarter-to-quarter. And the 2 that we had this quarter, I think, did not appear as the same customers in previous quarters.

[Operator Instructions]. We now have Hendi Susanto from Gabelli Funds.

My first questions are for 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 surface providers segment has seen its button? Or is there still any risk that it may continue to slide down sequentially?

So Hendi, if you remember in the third quarter, 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 materialize in Q4. In some cases, they were slightly smaller than what we originally thought in Q3. But in general, you can see a fairly significant step up, but it's related to that timing between the 2 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. And 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.

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

Yes. I believe it was around 50%, just below that. So in line with our goal of achieving 65%, which we announced in 2022. So it's steadily growing, and we're tracking to plan.

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

Good question, Hendi. There's a few factors obviously, variable comp is lower than expected, not only because of the changes or at least the misses that we saw in Q3. And then overall you know, we were projecting a little bit better result in Q4. But 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 '24, we'll be expecting to add back that variable comp, maybe like 1/3 of that cost back as a result.

[Operator Instructions]. We currently have no further questions registered. So I'd like to hand it back to Dhrupad Trivedi for any final remarks.

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.

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.