RDWR - A10 Networks Feels The Pinch Of Slowing Sales Cycles

2023-06-08 19:22:23 ET

Summary

• A10 Networks, Inc. reported its Q1 2023 financial results on May 4, 2023.
• The company provides a range of application delivery and security software for organizations worldwide.
• A10 Networks' security product demand is holding up, but other segments are seeing delayed purchasing decisions from clients and prospects.
• I'm on Hold for A10 Networks stock until we see evidence of a demand pickup across its offerings.

A Quick Take On A10 Networks

A10 Networks, Inc. ( ATEN ) reported its Q1 2023 financial results on May 4, 2023, beating revenue and matching EPS consensus estimates.

The firm provides an array of networking software products and related services worldwide.

While leadership is managing the company for a balance of growth and profitability and the firm’s security offerings will likely continue to be resilient, lengthening sales cycles will continue to pressure profitability and revenue growth in the near term.

Until the macroeconomic environment stabilizes and customer demand picks up, I’m on Hold for A10 Networks, Inc.

A10 Networks Overview

San Jose, California-based A10 Networks, Inc. was founded in 2004 to provide a growing list of networking software for a variety of use cases in application delivery, security and vertically optimized solutions.

The firm is headed by President and CEO Dhrupad Trivedi, who joined the firm in 2019 after serving as vice president at Belden and prior to that held management roles at JDS Uniphase.

The company’s primary offerings include the following:

• Data Center and Cloud

• Security

• Application Analytics

• Vertical solutions - Financial Services and Education.

A10 acquires customers through its direct sales and marketing efforts as well as through partner referrals.

A10’s Market & Competition

According to a 2022 market research report by Allied Market Research, the global market for application delivery controllers was estimated at $2.3 billion in 2020 and is forecast to reach $12.8 billion by 2030.

This represents a forecast CAGR (Compound Annual Growth Rate) of a very robust 19.1% from 2021 to 2030.

The main drivers for this expected growth are a growing need by organizations to maintain uninterrupted application services and improve end-user experience.

Also, coupled with security needs, the market is moving toward cloud delivery and hybrid cloud delivery models across all levels of the enterprise and in numerous verticals.

Below is a chart showing the application delivery controller market segment growth through 2030 by end-user type:

Major competitive or other industry participants include:

• Citrix Systems

• F5 Networks

• Array Networks

• Webscale

• Dell

• Barracuda Networks

• Fortinet

• Cisco Systems

• KEMP Technologies.

A10’s Recent Financial Trends

• Total revenue by quarter fell in the most recent quarter, YoY:

• Gross profit margin by quarter rose in Q1 2023:

• Selling, G&A expenses as a percentage of total revenue by quarter rose sharply in Q1 2023:

• Operating income by quarter dropped substantially in Q1 2023:

• Operating leverage by quarter has generally remained positive in the past ten quarters:

• Earnings per share (Diluted) fell materially in Q1 2023:

(All data in the above charts is GAAP.)

In the past 12 months, ATEN’s stock price has fallen 9.45% vs. that of Fortinet, Inc.’s ( FTNT ) rise of 14.78%, as the chart indicates below:

For the balance sheet , the firm ended the quarter with $144.5 million in cash, equivalents and short-term investments and no debt.

Over the trailing twelve months, free cash flow was $39.0 million, of which capital expenditures accounted for $10.3 million. The company paid $13.6 million in stock-based compensation in the last four quarters, similar in amount to previous quarters recently.

Valuation And Other Metrics For A10

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm’s projected growth and earnings:

Assuming generous DCF parameters, the firm’s shares would be valued at approximately $12.23 versus the current price of $14.27, indicating they are potentially currently overvalued, with the given earnings, growth, and discount rate assumptions of the DCF.

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

A10’s most recent Rule of 40 calculation was 28.2% as of Q1 2023’s results, so the firm is in need of some improvement in this regard, per the table below:

(Source - Seeking Alpha.)

Commentary On A10 Networks

In its last earnings call ( Source - Seeking Alpha ), covering Q1 2023’s results, management highlighted the drop in revenue growth but its expectation that it will match its full-year non-GAAP earnings per share targets.

While customers are increasing their spending scrutiny, the firm’s security products are showing resilience as customers prioritize security spend.

Also, leadership is seeking to diversify the firm’s revenue streams, so it recently inked a partnership with Fastly to combine A10’s ADC solution with Fastly’s web application firewall solution.

Total revenue for Q1 2023 fell by 8.0% year-over-year, while gross profit margin improved by 2.9 percentage points.

Selling, G&A expenses as a percentage of revenue increased 5.2 percentage points year-over-year, a negative development and operating income dropped by a substantial 22.5% year-over-year.

Looking ahead, management did not provide specific guidance for full-year 2023; rather it said it expects "double-digit growth in 2023 full-year non-GAAP EPS."

The company's financial position is strong, with plenty of cash, no debt and $39 million in free cash flow in the past four quarters.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below:

I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited "Uncertain" once, "Challeng[es][ing]" three times, and "Macro" three times.

The negative terms refer to the current challenging macro-driven market conditions forcing management to implement a series of cost-cutting measures.

Regarding valuation, compared to competitor Radware Ltd. (RDWR), the table below shows the two firm’s various valuation metrics:

(Source - Seeking Alpha.)

In the past twelve months, the firm's EV/EBITDA valuation multiple has varied materially and dropped a net percentage of 30.0%, as the chart from Seeking Alpha shows below:

The primary risk to the company’s outlook is the slowing pace of prospect and customer purchasing decisions due to macroeconomic concerns and waning demand.

While leadership is managing the company for a balance of growth and profitability and the firm’s security offerings will likely continue to be resilient, lengthening sales cycles will continue to pressure profitability and revenue growth in the near term.

Until the macroeconomic environment stabilizes and customer demand picks up, I’m on Hold for A10 Networks, Inc.

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