Radware Ltd. (RDWR) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Radware Ltd. First Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host for today, Mr. Roy Zisapel. Sir, you may begin.

Thank you. Good morning, everyone, and welcome to Radware's First Quarter 2012 Earnings Conference Call. Joining me today is Meir Moshe, our Chief Financial Officer. Meir will start the call by reviewing the financial results, and afterwards, I'll discuss the business highlights of the first quarter. After my comments, we'll open the discussion for Q&A. Meir?

Okay, thank you, Roy, and welcome, everyone, to our first quarter conference call. First, I would like to review the Safe Harbor language. During the course of this conference call, we'll make projections or other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are just predictions and that actual events or results may differ materially, including, but are not limited to, general business conditions and our ability to address changes in our industry, changes in demand for products, the timing and amount of orders and other risks detailed from time to time in Radware's filings. We refer you to documents the company files from time to time with the Securities and Exchange Commission, specifically the company's last Form 20-F filed in March 2012. And now, ladies and gentlemen, for the financials. Revenues for the first quarter totaled $45 million, representing 17% year-over-year growth. Non-GAAP EPS amounted to $0.39, $0.03 to $0.05 better than guidance. Non-GAAP operating expenses amounted to $28.4 million. The non-GAAP net income for the first quarter of 2012 amounted to $9 million or $0.39 per share compared to a net income of $6.1 million or $0.27 per share in the first quarter of 2011. Stock-based compensation expenses in the amount of $1.6 million, amortization of intangible assets in the amount of $800,000 offset -- and offset of exchange rate income in the amount of $300,000, bringing the GAAP net profit this quarter to $6.9 million or $0.30 per share compared to a net gain of $4.4 million or $0.19 per share in the first quarter of 2011. The non-GAAP gross margin remains at 82%, as in the previous quarter. The headcount for the end of the quarter was 759 employees. During the first quarter, we generated cash in the amount of $20 million, including $13 million from operations. Thus, our cash position, including short-term and long-term bank deposits and marketable securities, increased this quarter to $239 million and we have no debt. Shareholders' equity amounted to $236 million. Guidance for the second quarter. We expect revenues to range between $46 million to $47.5 million, 82% gross margin; operating expenses will range between $28.6 million to $29.2 million; financial income at $1.2 million and non-GAAP EPS to range between $0.41 to $0.44. As you can see, ladies and gentlemen, first quarter results exceeded guidance, and we expect better results in the next quarter. And now I would like to turn the call over to Roy.

Thank you, Meir. Our first quarter results reflect continued traction and strong leverage from our business model. In fact, in the last several quarters, we have seen strong sales results, and as with the guidance we provided, we are targeting and expecting a record quarter in the second quarter across all financial metrics. We are pleased with the progress we are making on the key points of our strategy, focusing on data center application delivery and application security, benefiting from virtualization and cloud computing growth drivers in the enterprise market and mobile data growth driver in the carrier market, growing our business with our existing customers and increasing our channel network and market systems. This quarter, we enjoyed significant growth in the U.S. across all market segments, including enterprise, online and carriers. Also, our attack mitigation solution and our application delivery solution, with its leading virtualization architecture, are gaining traction, and we are securing wins with major new customers. In Q1, we recorded significant sales from our chassis-based Alteon 10000 product line. The key strength of the product is its market-leading application delivery performance, the ATCA standard-based architecture and our VADI capabilities that allow our customers to consolidate up to 256 application delivery instances into one platform, 16x higher than the competition. We landed several Tier 1 carriers, online companies and financial institutions with the sale of this product, and we are encouraged by additional wins in the product line last month, as well as the pipeline for the coming quarters. We continue to innovate and lead the market in application delivery virtualization, and we provide today the strongest solution for virtual and cloud data centers. This past quarter, we continued to release additional components of our VADI, virtual application delivery infrastructure strategy. On the product front, we made a very important announcement last quarter with the new Alteon 5224 application switch. The Alteon 5224 application delivery controller delivers the highest performance, on-demand scope and scalability and highest pod density than any other platform in its class while offering the only 10-gigabit connectivity and application delivery virtualization capabilities in this market. What are the key points? One, being the first application delivery platform to bring 10-gig connectivity to the midsized enterprise, supporting them with the migration to 10-gig networks and servers; and two, being the only platform that provides midsized customers with the ability to consolidate and virtualize their application across their own data center. These 2 key points are very powerful differentiators for us. We received strong market reception for this new platform with several new customer wins across all new geographies. With the Alteon 5224, we have the only product line in the market that is scalable on-demand from 1 gig all the way to 80 gig and the only product line that supports application delivery instances across all form factors with seamless integration to data center orchestration systems. Our solution leadership in the cloud data center has translated into multiple wins in the industry. In Q1, we announced that KPN, the Netherlands' largest carrier, has standardized on the Radware VADI solution to power their data center hosting and cloud services. One of KPN's key requirements when they designed their cloud data center for the enterprise customers was that each customer would have an isolated environment and service level per customer and security, so each customer's information could be guaranteed. Radware VADI was the only solution that allowed KPN to provide full application delivery isolation with the required customer density per platform. KPN purchased several Alteon 5412 that can grow up to 28 instances and are purchasing more platforms and more instances as their business is growing. The superiority of our VADI solution allowed us to earn more product awards. This time, our ADC-VX Virtualization platform was the winner of the 2011 Cloud Computing Excellence Award by the Cloud Computing magazine. On the vendor alliance side, Red Hat shows that our Alteon virtual appliance is the sole partner for the Red Hat Enterprise Virtualization platform. Alteon VA for Red Hat Enterprise is a fully functional application delivery solution packaged with a virtual appliance running on the Red Hat Hypervisor. It is the only application delivery solution certified for Red Hat Enterprise Virtualization environment. Through this partnership, every Red Hat customer can purchase Alteon VA through the Red Hat marketplace whenever they need load balancing and acceleration for their application. Moving now to security, in the first quarter, there were several cyber attacks around the world that we were able to stop and thus, secure our customers' mission-critical systems. We have seen a lot of traction for our attack mitigation solution as more and more enterprises and carriers recognize that traditional security devices, such as firewalls, intrusion detection systems and antivirus, cannot block the current attack vectors. In addition, we published the 2011 Global Application & Network Security Report, which contained the most detailed industry view on cyber attacks, given our key role in researching, fighting and stopping them. Contrary to conventional thinking that large-bandwidth cyber attacks wreak the most damage in enterprises, our security experts found that bigger problems usually arise from lower-scale attacks targeting application and business layers. To summarize, today we have a leadership position in the market as it relates to our products and solution offerings. We are introducing key innovations into the market both with our VADI strategy for application delivery virtualization and our attack mitigation solution. We have consistently grown revenues over the past several years, and we are also optimistic for this year's growth opportunities. We continue to demonstrate increased efficiency in our business, and we continue to forecast additional improvements in our operational results. Before concluding, I would like to thank our customers and partners for their continued support and trust, and I would like to thank the Radware team for all their efforts, commitment and success in growing our business. With that, I would like to open the discussion for Q&A.

[Operator Instructions] And our first question comes from the line of Mark Sue from RBC Capital Markets.

If I look at the business, it's been kind of running around 15% to 16% year-over-year growth. Do you feel that's sort of the normalized run rate for the business? And what might drive that higher this year? Maybe if you could give us your thoughts on any acceleration by vertical, telcos or data centers which can add to that base.

I think now if we look at the drivers for growth, mobile data and the enterprise virtualization and cloud data centers, those are definitely areas that allow us to grow faster, as well as the cyber security area. Assuming the attacks will continue in the pace that they are, I think this business is also forecasted to accelerate over time. Beyond that, as we've outlined in other calls, the more OEM revenues we will have within the year and the next year, we think, also can start to contribute to the growth rate of the company.

Okay. So when we look at the new partners, Juniper, IBM and any others that you might be working on, collectively, can they add up to possibly 10% of revenues as you exit the year? What are some of the things that you can do to kind of accelerate the development there and incentivize these partners now that the deal has been signed?

From a potential point of view, definitely, those partners can grow considerably, to 10% or more. That would require obviously also a lot of work on our side in training their salespeople, in accompanying them for the initial deals and growing the confidence and success with these parties. That's what we're doing in the field. And I believe that will translate to more and more revenues through the partners. I believe this partnering strategy that we have can be extremely successful. And every quarter, we are reporting on more partners that are joining, whether it's Red Hat or IBM that you referenced to, Juniper, et cetera.

Okay. And just maybe on Juniper, how you might be seeing the order flow. I recognize that revenues are still very early with this partnership. Just a pipeline of activity, orders, trends, anything you can provide that will be helpful.

I think so far, we are -- based on the plans, so we've recognized a small deal that Juniper brought us in Q1, and we expect more significant business to come in Q2. And we also -- we believe the pipeline is growing. The combined deal flow is growing, and now we are targeting more revenues from them.

[Operator Instructions] Our next question comes from the line of Rohit Chopra from Wedbush Securities.

I wanted to ask a couple of questions. One, on the security business. Roy, you touched upon that. I just wanted to see what the growth was like in the security business. Is it growing as fast as the core ADC business? And then the second question is -- maybe this is for Meir, but I just want to get a sense of -- 2012, as you exit the year, where do you guys see gross margins and operating margin?

Okay. So on security, we don't break out the growth rates by product line, but definitely, we are seeing a lot of traction, especially in the U.S., for that solution. So where the biggest online customers or largest enterprise with online presence, that's where we see the most traction. We believe that in the coming years, that traction will also grow internationally as those risks are becoming wider across the world.

Okay, right. As for the margins, as we said in the call, in the last call, we plan to exit the year with 23% of operating margin. And for the gross margins, it has been taken 1 point up last quarter to 10%. We expect -- [indiscernible], I agree that there is a room for improvement, but this would depend not only on the revenues that we can get from OEM but also on mix of the total products and the pricing in the market, so it's more complicated. So far, we take into the model that no change from 82%. For the rest of the year, we'll leave it as a cushion for the -- on the business model.

Okay. And can I just ask a quick follow-up on geographies? Can you just break out the U.S., EMEA and APAC, as well as enterprise and service provider?

Okay. Enterprise was 72% this quarter; service provider, 28%; geographic, the U.S., 32%; EMEA, 32%; and Asia Pac, 36%.

[Operator Instructions] Our next question comes from the line of Ted Moreau from the Knight Capital Group.

A quick question, kind of a follow-up on that gross margin question. Can you correct me if I'm wrong here, but I thought that the margin profile on the OEM partner business was higher than corporate average. So as that grows, wouldn't that contribute positively to the gross margins as the year progresses?

It depends on the nature of the OEM. Some OEMs, such as where we supply only software, you're absolutely right. The gross margin is higher, and then that's an upside. In other OEMs, where we supply complete products, including the hardware, generally, the margins will be lower than the corporate average. So it depends which OEMs are more successful and to what extent we take them into the mix of the overall gross margin.

Okay, okay. Sounds good. And then are there any -- continuing on the OEM channel partners business, are there any revenue recognition differences between the OEM channel partners and your traditional organic business?

No, it is the same.

Okay. And do any of these channel partners cannibalize any current revenue-generating programs or opportunities?

In theory, it might be, but we believe, since the market is very big, it's about -- it's almost 100% net additions to our business, both in security and application delivery.

Okay, great. And then uses of cash, I mean, you guys generate tremendous cash flow, which is great. Are there any technologies you need to develop to remain competitive, or do you have any pending product intros that will cause R&D to fluctuate? So, I mean, could we see R&D jump up, or could you comment on any other uses of cash?

So in general, we continue to invest in our business back both in R&D and in sales and marketing. And I think this continued investment will mean an increase in operational expenses you should expect, and as we've done in the last several years. In terms of use of cash, we are looking for acquisitions as the key target for accelerating growth and strengthening the company. And when we have something to report, we will show it.

Okay. So if you're looking for technologies, what sorts of technologies might add incremental value then?

So definitely, we are focused on the data centers, so we are looking OEMs that are complementary to our data center technology. It can be a core application delivery and security.

Okay, great. And then, I mean, I'm assuming there's nothing that's kind of imminent here or anything like that, but do you have a time frame that you would like to add to the technology?

We don't want to think of a specific time frame. We are constantly looking, and when there's something that we feel is going to be accretive to our business model and strengthen the company, then we act on it.

Our next question comes from the line of Robert Katz from Senvest.

I have a question about your OEM strategy. In the last month, IBM has been highlighted as, I guess, an OEM for your products now. Can you comment on how you see that relationship evolving and others like that evolving; a little more detail?

Okay, first, on IBM, we -- our announcement, we're on alliance with IBM, on partnership models. So I don't want to comment on OEM relationships with IBM. And concerning OEM strategy in general, we are seeing many opportunities for companies in adjacent spaces, in carrier market, in the security market, in the data center market to use our technology as part of their overall solution, especially today, when we are seeing a strong rise in carrier needs to have an end-to-end solution for LTE or 4G or in the data center that [Audio Gap] fax also for data centers by the likes of IBM and Cisco. And we definitely see a very big potential for application delivery and application security being a strategic part of this overall solution, and that's where we are targeting our OEM strategy.

How do you see the receptiveness of some of these potential targets to your OEM strategy versus -- I guess some of them already have relationship with some of your peer group companies, either resale or joint sale. Can you comment on how you see that evolving?

I think overall, when you integrate products, it's much more strategic than just reselling them. But I don't want to -- this comment is not on a specific vendor or specific competitor. It's just on the overall solution in the market. Product integration gives the most value to the customers, and I think all vendors do that in the same manner, and therefore, I think the OEM strategy has a lot of merit.

Thank you. And with no further questions in queue, I'd like to turn the conference back over to management for any closing remarks.

Thanks. I would like to thank everybody for joining us today, and have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the program, and you may all disconnect. Have a great rest of the day.