Radware Ltd. (RDWR) Q3 2017 Earnings Report, Transcript and Summary

Good morning. My name is Sharon, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Radware Q3 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Anat Heilborn, VP Investor Relations, you may begin your conference.

Thank you, Sharon. Good morning, everyone, and welcome to Radware’s third quarter 2017 earnings conference call. Joining me today are Roy Zisapel, President and Chief Executive Officer; and Doron Abramovitch, Chief Financial Officer. A copy of today’s press release and financial statements as well as the investor kit for the third quarter are available in the Investor Relations section of our website. During today’s call, we may make projections or other forward-looking statements regarding future events or the future financial performance of the Company. We wish to caution you that these statements are just predictions and we undertake no obligation to update these predictions. Actual events or results may differ materially, including but not limited to general business conditions and our ability to address changes in our industry, changes in demand for products, the timing and the amount of orders and other risks detailed from time-to-time in Radware’s filings. We refer you to the documents the Company files from time-to-time with the SEC, specifically the Company’s last Form 20-F as amendment on May 16, 2017. Please note that in November, Radware will participate in the UBS Technology Conference in San Francisco and in the IDEAS Investor Conference in Dallas. In December, management will participate in the Imperial Security Conference in New York, and in January in the Needham Growth Conference also in New York. Please also note, the tentative earnings release date for 2018 are available in the Investor Relations website. With that, I will turn the call to Doron Abramovitch.

Thank you, Anat. Good morning, everyone, and thank you for joining us on the call today. We reported strong results for the third quarter with revenues and earnings at the high end of our expectations and with continued growth in our total deferred revenue balance that provides us with visibility and confidence about our future financial performance. Q3 revenues were $53 million up 13% from Q3 last year. Revenues from the Americas were up 33% from last year and accounted for 50% of total revenues. Revenues from EMEA increased 13% from Q3 last year and represented 26% of total revenues, and revenues from Asia Pacific were down 14% from last year and represented 24% of the total. Our business model transition creates quarterly fluctuations in revenue recognition. We believe that the nine-month revenue growth gives a better indication of the original trends. For the nine-month period, revenues from the Americas increased 11% from the first nine months of 2016, revenues from EMEA increased 7%, and revenue from Asia Pacific decreased 4%. Next, I will discuss expenses and profit in non-GAAP terms. A detailed GAAP to non-GAAP reconciliation is presented in the financial table accompanying our press release as well as in the Investor Kit posted on our website. Non-GAAP gross margin was 82.1% in Q3 2017 compared to 82.4% in Q3 last year. Our operating expenses were $42.4 million compared with $38.6 million in Q3 2016 in line with our guidance. As we discussed last quarter, the main factors behind the increase in operating expenses compared to last year are the stronger Israeli Shekel which had an impact of approximately $1.1 million. The consolidation of Seculert which had an impact of approximately $650,000 and higher sales commissions and sales and marketing expenses related to stronger performance. Compared to Q2 2017, the main driver for OpEx increase is higher sales commissions on increased business activity. Tax expenses in the quarter was $725,000 or 28% for our non-GAAP pretax income. This deviation from our normal effective tax rate is mainly a result of a one-time adjustments related to the Seculert acquisition. We expected going forward tax rate will remain at approximately 16%. Non-GAAP net income in Q3 2017 was $1.8 million or $0.04 per share diluted compared with net income of $1.6 million or $0.04 per share diluted in Q3 2016. Headcount at the end of September 2017 was 992 employees essentially at the same level of previous quarters. As of September 30, 2017 we had approximately $331 million in cash and financial investments. Cash generated from operations was $5.8 million in Q3 compared with cash outflow of $1.3 million in Q3 last year. Our operating cash flow for the last 12 months was therefore $46.7 million. Our collection in Q3 was exceptionally strong as reflected in the DSO ratio which was 21 days. We are pleased with our collection performance. At the same time DSO ratio it also affected by the transition in our business model because in our subscription business, we often collect payments ahead of revenue recognition. We believe that in time as our business condition mature further we will see a gradual increase in DSO ratio and expected to be at around 35 days to 40 days. Our total deferred revenue balance continues to grow. As of the end of September, we had total deferred revenues balance of approximately $139 million, up 27% from $110 million as of the end of September 2016. The proportion of revenues due for recognition within one-year remains stable at approximately 62%. Therefore, in the coming 12 months, we will recognize as revenues approximately $86 million out of the total deferred revenues, compared with $68 million that we recognized out of the total deferred revenues a year-ago. I will conclude with our outlook for the fourth quarter of 2017. We expect Q4 revenues to be between $55 million and $57 million. Non-GAAP gross margin is expected to be approximately 82%. Non-GAAP operating expenses are expected to be between $43 million and $44 million in Q4. We expect non-GAAP effective tax rate to be 16%. Non-GAAP EPS for Q4 is expected to be between $0.06 and $0.07. I will now turn the call over to Roy.

Thank you, Doron. We are very pleased with the performance and results for the third quarter. Revenues grew double-digit compared to Q3 last year and our book-to-bill ratio was significantly larger than one. Strong booking occurred across product lines in all geographies, with particularly strong growth in our product subscription and cloud business, which enjoys new logos, cloud service expansions from existing customers and high renewal rates. The solid performance reflects the fact that our strategy and evolution of our solution portfolio is well aligned with our customers evolving needs. Demand for our cyber security solutions remains strong. Attackers have become more sophisticated. The availability of attack tools has grown. In the variety of possible attack platforms including cloud and IoT is greater than ever. This results in an ongoing increase in attack frequency, complexity and size, and requires continuing investments in protection solutions. Cyber expertise is cost and companies find it increasingly difficult to satisfy all their security needs in house. This leads to an increased demand for security automation and fully managed services. Against this backdrop, we are very well positioned. First, the core of our solutions offered unique and cyber war proven, mathematical algorithms for behavioral-based detection, real-time automatic signature creation, and auto policy generation. Such capabilities are critical these days, because of the frequency and speed of attacks. There is simply not enough time, nor enough skilled resources to try and block each and every attack manually. Second, Radware's stands out with its comprehensive solution for datacenter attack mitigation, which includes all necessary protections such as DDoS, IPS, WAF, anti-scanning and behavioral analysis fully integrated and available, both on-premises and in the cloud. Third, we provide a full spectrum of solution management options, including a fully managed option by our emergency response team. Fourth, we perfected our ADC solutions to provide encrypted attack protection with the lowest latency, higher scalability and the widest coverage for encrypted attack mitigation. All of these differentiated mean we are able to solve our customers most pressing security issues. There are many examples from the last quarter that validate our strategy and the transformation of our solution offering, we undertook approximately two years ago. For instance in the third quarter, we’re selected to provide Cloud DDoS Protection to the globally distributed data centers of top 10 technology company. This will demonstrate that even large and highly sophisticated customers, lack all of the internal resources to handle today's cyber threats and prefer to purchase Managed Security Services from experts. We continue to maintain and grow our technological advantages with the innovation of new solutions and services. In September, we launched our new attack mitigation line, which provides automated protection from fast moving, high volume attacks, encrypted attacks and very short duration threats. The new lines enhanced capabilities are designed to overcome the complexity and scale of sophisticated IoT Botnets. The growth in the number of connected devices that are potentially vulnerable, increases the threat surface. IoT Botnets have been involved in nearly every major DDoS attack since the Mirai attack a year-ago. We believe the DefensePro is the only effective solution today against this new generation of IoT Botnets. We also see positive attraction for our Cloud Malware Protection solution, which is relatively recent expansion of our cloud solution portfolio. It monitors and analysis all web communication and appliance advanced machine learning on this data to provide real-time alerts and life feed of newly deducted malwares. Last quarter we won three years cloud subscription extension deal from one of the world largest food and beverage conglomerates. This customer is 10s of 1000s of employees throughout the web at the scale that mix malware activity, a key cyber security risk. Despite the customer existing firewalls, web gateways, and threat intelligence solution, during the past year we successfully deducted more than 1600 malware incidents with zero plus positive. This is clear evidence as to the importance of cloud-based big data analytics and machine learning in the fight against even cyber attacks. We continue to expand our market reach. In Q3, we’re pleased to see multiple wins with global Tier 1 carriers. These wins reflect a healthy mix of existing a new customer, which engaged with us an expansion projects or competitive displacement. We've also see continued business with carriers through our Nokia partnership and are excited with the way this relationship broaden, our access to network mutualization projects. Our relationship with Cisco made initial contribution to Q3 revenues as expected and the pipeline continues to grow nicely. We’re encouraged by the growing movement in the Cisco relationship. In summary, we are very pleased with the consistent execution against our expectations throughout the year, which is clearly reflected in our third quarter performance. We are confident we are heading towards a strong into 2017 as our Q4 guidance reflects. We've taken our strong position in data center application security and delivery and transforming so that directly address the most prominent industry trends. From a business model perspective we also made a strategic transition to our subscription sales. Not only the – this meet our customer needs, but it also creates a consistent and profitable revenue stream for Radware. Today we have better visibility that ever before and we are confident that our vision, technology, comprehensive offering, alignment with our customer business goals and strong go-to-market channels and OEM relationships all position us to delivery long-term growth. I will now open the decision for Q&A.

[Operator Instructions] Your first question comes from Alex Henderson from Needham Company. Your line is open.

Good morning. This is Dan Park on for Alex. Thanks for taking my question. So I was hoping maybe you could touch a little bit on what's happening in Europe. It’s seems like the business there continues to trend downward sequentially. Is it just a function of the transition to subscription based model or is it some macro factors that you are seeing there?

The Europe results we have been in EMEA are up I think on a revenue basis. It’s a double-digit up 13%. So we are actually very satisfied with the business in EMEA and as I have mentioned also in my comments regarding booking all of geographies went up also in booking quarter-over-quarter.

Okay, all right. Thanks for that. One more question if I could, so it seems like your service provider businesses really accelerating and I was hoping if you could just touch a little bit more on the business there and to see – any trends that you are seeing there that you expect moving forward?

Yes, so as we mentioned, we are seeing large opportunities in the carrier and service provider market which also includes for us the cloud, the cloud and hosting providers. As I’ve mentioned this past quarter specifically with a lot of activity there some delivers by our own sales people and some acceleration through the Nokia reach. We are seeing many carriers reevaluating, following Mirai, the IoT attacks, the scale, the need to deliver managed security services to enterprise. All of that brings many of the carriers around the world to rethink there is security strategies. For us it’s a major opportunity. We are definitely coming very strong in all technology evaluation and we are replacing the incumbent vendors across the world. So we see growth in existing Radware accounts. We see a lot of activity by the carriers to reevaluate their strategy and given our strength on the technology side and now with both Cisco and Nokia also stronger presence from the go-to-market side, we think we are very well-positioned.

Got it. Roy, thank you very much.

Your next question comes from Ittai Kidron from Oppenheimer. Your line is open.

Thanks and congrats guys on a good quarter. I guess I had a few questions. First, can you talk about Asia-Pacific that's a region that despite the fact you made some management changes and still isn't really nothing no real big changed here, so what's going on over there, should we not expect really any improvement to this area for a long time?

Yes, so you're right. Out of our region, Asia Pacific is the least growing one. I think if you look at the nine-month is a better trend because we have some fluctuations with the cloud and subscription, so it's up 4% year-over-year and definitely we are looking for more. Recently, as I’ve mentioned especially in Q3, I would say the booking trend is much stronger. However, we definitely are focused on increasing the growth there. No question about it. We don't think we should look for a long-term position at the current level. We do see some improvement already in the booking and we are focused to accelerate our overall business there but definitely an opportunity.

Okay. And then with regards to your enterprise business that's another area that I guess for nine quarters in a row now it's been declining. I mean clearly some of that probably relates to change in your business model and you're going through a lot of carriers and managed services type of companies, but what is it that's fundamentally flawed within your enterprise business or what – is that just not a focus area for you guys?

It's actually a focus area and we had a great quarter in enterprise. However, the heat of the cloud subscription and product subscription is predominantly in this segment. So the majority, I would say the vast majority of growth in total deferred you're seeing is coming from enterprise.

Got it.

So when we look in our actual business performance, we are very satisfied with enterprise. However, in revenue recognition, you don't see it because a lot of it is going to the deferred. You see growth in total deferred of almost $30 million that’s predominantly enterprise.

Got it. Okay. That makes sense. I guess then to tie is up Doron on just looking at your total deferred that $139 million number you gave. I don't know how to interpret this, I know if there's anything good or bad in this maybe just nothing to read into it, but your uncollected deferred has been flat for five quarters after growing quite nicely for some time. How should I interpret that? What does that mean?

In a way it's not the key issue in this $139 million. I mentioned in the last few call it’s the matter of timing. So overall, I analyze – if we analyze it on this or the total deferred revenues. And I mentioned during the prepared remarks that it also impact our collection, if you take this growth. So I suggest you will take only the $139 million and the growth in the 27% year-over-year. This is the key factor. If we are not collecting it or something like that it's just a matter of timing.

Very good. All right. Good luck guys.

Thank you.

Your next question comes from Michael Kim from Imperial Capital. Your line is open.

Hi guys. Could you just talk about the Alteon D-line it’s relatively new and just kind of curious what the early adoption has been and whether the value proposition on SSL inspection has been a strong driver behind that?

Yes. So I think the D-line is a dual purpose for us. On one end, it’s a reflection of our ADC line and we know for many years in the ADC market, customers tend to refresh and go to the latest and greatest. So that I would say on the – what I would call the legacy or traditional ADC line. But most importantly, the D-line is focused on security and specifically on encrypted traffic. It allows us to scale and provide the best encrypted traffic protection in conjunction with our attack mitigation line, that’s number one. Number two, we are targeting with that additional project in SSL inspection that before and with the previous line, we could not effectively run on. So we are seeing more growth in ADC security applications. We are seeing very strong advantage in the attack mitigation encrypted and we enjoy ADC refresh as we’ve done in recent years and so all of that is good. The last point I want to highlight that D-line comes also with new subscriptions, specifically the performance subscription and the secured subscription and we’re seeing higher uptick on these subscriptions than we’ve seen in the previous generation. So also that is a very good indication for us, not only the refresh of the appliances, it’s the higher subscription attach rate that we’re getting.

And has this also been a source for competitive displacement and are you primarily seeing demand from hosting companies or also enterprise or where are you seeing the demand opportunity?

So I think it split, in SSL inspection we're seeing mainly new customers. In ADC refresh, it’s predominantly ours, and in attack mitigation, it’s a very strong complement or attack mitigation solution. Aside from that as you know F5 is now in a refresh cycle and that creates many opportunities to compete on these customers and we are seeing competitive displacements as well.

Got it. Great. Thank you very much.

[Operator Instructions] Your next question comes from George Notter from Jefferies. Your line is open.

Hi. This is Kyle, here for George. Thanks for taking the question. So you mentioned Cisco OEM sales contributed the quarter. I was wondering if you could add anything to that in terms of total customers or install base opportunities out there, anything you can add on the attach rate and maybe what’s your expected trajectory to look like going forward?

Yes. So it’s still early days for this cycle with Cisco. What I can share is that definitely bringing us to completely new customers to Radware, the mix of new customers versus customers we were targeting or existing Radware customers is very, very strong on new customers. Also the sale process is different than what we use to and there is much less proof of concept or security discussions that are really selling it as an add-on to the firewall. Having said that, it’s still early on, for example this week, the Cisco Global Channel Conference where they're exposing the vDP option on firepower to the worldwide channels. They gave us a slot 105 vendors across Cisco, not only Cisco security, across all Cisco that got to present. So we are gaining momentum with the Cisco organization on end customers on the channels and so on, and we do expect to ramp in Q4 and onwards.

And any color on attach rate or any thing you can add there?

Cisco does not share with us yet these numbers.

Okay. And more if I may, the total deferred revenue balance, strong year-over-year growth, but somewhat smaller than the last few quarters. I am wondering if there is any seasonality to that that we can expect going forward in terms of the year-over-year growth. Are there certain quarters that are stronger for you for total deferred revenues, is there anything that you just call out there?

Yes. Usually the deferred revenues comes and end with the business itself. We have some seasonality, but in the last few quarters, we see the momentum that it created in each of the quarters, so we got used to even sequential growth. It’s not the trend that we see. So overall, our view is to review also this one – the sequential growth is something nice, but I would recommend with compared to year-over-year.

And another comment, there is a balance between the revenue growth and the deferred revenue growth. So for example in this quarter we’ve grown revenue 13%, year-over-year it was 27% on the total deferred. So you should expect a more balance I would say growth between revenues and total deferred that again we are seeing strengthening demand in subscription in cloud, we are seeing the growth in deferred, we are very optimistic about this figure.

Okay. Great. Thanks a lot. Congrats on the quarter. End of Q&A

[Operator Instructions] We do not have any questions over the phone at this time. I will turn the call over to the presenters.

Okay. Thank you very much everyone for attending and have a great day.