Radware Ltd. (RDWR) Q1 2019 Earnings Report, Transcript and Summary

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Radware Q1 2019 Earnings Call. [Operator Instructions] I would now like to turn the call over to Anat Earon-Heilborn, VP-IR, please go ahead.

Thank you, Michelle. Good morning, everyone, and welcome to Radware's first quarter 2019 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 first 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. These forward-looking statements are subject to various risks and uncertainties and actual results could differ materially from Radware's current forecast and estimates. Factors that could cause or contribute to such differences include, but are not limited to: general business conditions and our ability to address changes in our industry, changes in demand for product, the timing in 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 are furnished from time to time with the SEC, specifically the company's last annual report on Form 20-F as filed on April 15, 2019. We undertake no commitment to revise or update any forward-looking statements in order to reflect events or circumstances after the date any such statement is made. Please note that in May management will participate in the Oppenheimer Israel Conference in Tel-Aviv and in June, management will participate in the Jefferies Tech Trek in Tel-Aviv, the Baird's Global Consumer, Technology & Services Conference in New York and the IDEAS conference and the Piper Jaffray Symposium both in Boston. With that, I will turn the call to Doron Abramovitch.

Thank you, Anat, and thank you all for joining us. We are pleased to open 2019 with revenues growth and increased profitability. Revenues for the first quarter was $61.4 million, up 13% year-over-year. In Q1, we recognized revenues from several deals including some which we had expected to recognize in Q2. Revenues from the America were 40% of total Q1 2019 revenue, and increased 2% from Q1 2018. Both EMEA and Asia Pacific delivered revenue growth of 21% from last year and each represented approximately 30% of the total. I will discuss now expenses and profit all in non-GAAP terms. Non-GAAP gross margin for the first quarter grew to 82.8% from 82.3% in Q1 last year. Non-GAAP operating expenses were $43.2 million compared with $43.4 million in Q1 last year and below our expectations. Our headcount at the end of the quarter was 1025 employees, including 62 from the ShieldSquare acquisition, which closed in mid March. As such the stable headcount was in fact below our plan and we are in the process of increasing our sales force and support staff. We are committed to ramp our investment in our business to facilitate our growth, while delivering operating leverage. Our non-GAAP operating profit in Q1 2019 was approximately $7.6 million, representing a 12.4% margin up significantly from 2.8% in Q1 2018. We are clearly on track to meet our 15% operating margin target for 2020. non-GAAP tax rate was 11.5% compared with 12.7% in Q1 2018. Q1 non-GAAP net income was $8.9 million or $0.18 per share diluted up from $2.6 million and $0.06 per share diluted in Q1 last year. Turning to balance sheet and cash flow. We ended the quarter with total deferred revenues balance of approximately $160 million, up 8% from March 2018. In the coming 12 months, we expect to recognize revenues approximately $103 million off of the March total deferred revenue balance or 64%, this is up 10.5% from $93 million in Q1 last year. Operating cash flow in the quarter was $23 million, driven by strong collections and also reflected by the low DSO ratio, which was 21 for the quarter. We expect DSO to return to the high 20's and Q2 operating cash flow to offset some of the out-performance of Q1. We ended the quarter with approximately $420 million in cash and financial investments up from $401 million as of the end of 2018. In line with our capital allocation policy which includes both acquisitions and share purchases, we announced today a new one-year $40 million share buyback plan. Our outlook for the second quarter of 2019 is as follow: We expect Q2 2019 revenues to be between $59 million and $61 million. 2019 first half revenues are therefore expected to grow approximately 7.5% to 9.5% over the first half of 2018. This is in line with our full year revenue guidance of 7% to 9% growth over 2018, which we reaffirm. Non-GAAP gross margin to be approximately 82.5%, and non-GAAP operating expenses to be between $43 million and $45 million, we expect tax rate to be approximately 12%. Non-GAAP EPS for Q2 is therefore expect expected to be between $0.12 and $0.15. Let me remind you that this guidance includes ShieldSquare that is not expected to have meaningful contribution in revenue in Q2 given the subscription nature of the business. The acquisition is therefore expected to have a dilutive effect of approximately $0.03. I will now return – turn the call over to Roy.

Thank you, Doron. As though we noted first quarter results together with our outlook for the second quarter position the first half of 2019 in line with our expectations for the full year. From a booking perspective, Q1 in EMEA was not as strong as we had expected. Although, we believe our execution in the region is solid. On the positive side, we continue to see globally strong growth for our subscription business and in particular, our cloud business. Overall, we are pleased with our results for the quarter, which were above our expectations in revenue, profitability and operating cash flow. We continued to focus on the market for private and public cloud application delivery and security solutions. In this context, our subscription business continued to grow strongly and is affected by two major and connected trends. The first trend is that the transition of applications to the cloud and environment that brings new security challenges. In the first quarter, we broadened our portfolio of cloud security solutions with the launch of Cloud Workload Protection, which is an agent less cloud native solution for comprehensive protection of cloud assets. Our first customer for this solution is Varian, an active company that there's a variety of services deployed in multiple AWS accounts. Varian was looking for visibility into account updates, ability to track usage of access permissions and protection from data breaches. During the proof-of-concept phase, our Cloud Workload Protection already detected eight attack scenarios. The CWP solution is particularly appealing to cloud native companies, who are not traditionally our customers and needs a broadening our addressable market. The second market trend is the demand for cloud security services. Well, obviously, part of the overall transition of applications to the cloud, we believe it's main driver is wider than just that and is derived from the increasing need for manage security services driven by attack complexity and skew shortage. This growth affects our business sneaks and drive operational and infrastructural requirements. With 11 scrubbing centers supporting our cloud DDoS service and 24 Points of Presence supporting our Cloud WAF Service, we have one of the world's largest global cloud footprint for data center and application protection. For example, during the first quarter, we won a new logo a multi-billion dollar revenue, IT consulting and system integration company replacing an existing solution provided by their carriers. This service was no longer capable of withstanding the increasing complexity of the attacks from this customer and in case selected to switch to our hybrid DDoS Protection solution for its two main data centers. Our hybrid DDoS customers rely on our operation and infrastructure at time of attack. And in today’s cyber threat environments, some customers experienced daily attacks. In addition, we are seeing strong traction for always on the cloud DDoS Protection, which means that the customer traffic always go through our service and they depend on us for their entire network connectivity. We are proud to be trusted by so many respected customers and be that strategic to their business. In mid-March, we closed the ShieldSquare acquisition and we are very excited to welcome the new employees to Radware. We're progressing very quickly with the integration plan and already earlier this month, we released the fully integrated ShieldSquare both management solution in our Cloud WAF. This launch provides our customers with a full cloud bot management solution that requires no software installation on-premise. We are also pleased with the progress made from a business perspective. We already won the first customer for this service, a new logo from the insurance sector selected Radware to provide a fully managed end-to-end solution that includes cloud DDoS, Cloud WAF and bot management. If these triple play deal illustrates the bot management solution is closely linked and highly complementary to our Cloud WAF. We're excited about the breadth and depth of our cloud security portfolio and the opportunity to broaden our customer base and address new market segments. In summary, we have an extended portfolio, which is aligned with customer needs, covering private, hybrid and public cloud data centers coupled with fully managed service offerings. We are committed to maintain our technology and innovation lead as well as we invest in bringing our technology to a wider customer base and delivering operational excellence for our managed services customers. We are on track to meet our full year 2019 goal and we will continue to execute on our strategy. With that, I will open the call for Q&A.

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

Thank you very much. Hi, Roy, Doron. I was hoping you could talk a little bit about the degree of what was pulled forward out of 2Q into 1Q. Looking at the guidance for the second quarter at the midpoint, it's around 4% growth, which is well below what we would normally expect. So could you give us some granularity? Was it a couple of million dollars pull forward? What are we looking at there?

Yes. It's roughly a couple of million predominantly from 1Q [Audio Dip] we will deal that – we will receive acceptance ahead of what we felt will be the schedule.

All right. Second question, if I could, the slowdown in Europe, obviously, accelerated over the course of the quarter post and when most people gave guidance, but it seems to me that's probably more on the ADC side and less on the security side. So can you talk a little bit about the delta between the growth between security-related transactions and ADC transactions? Did you see a decline in the ADC business? And was that particularly pronounced in Europe? How do we parse that?

Yes. We did see a decline in the ADC business. But in Europe, it was mainly focused on the country basis. I think we saw a weakness in the UK and in particular, in Germany, and that's our analyzes not necessarily ADC and security.

Just going back to the ADC piece, had you expected that to be up a little bit before and so there was a variance in your expectation within that?

As you know, we are looking for ADC business to be flat to 5% up, given our focus and we were able to – if I'm looking like 12 months period, we are able to achieve that in this quarter specifically, we do not.

I see. And then just going back to ShieldSquare, clearly, you've got some costs kicking here, but it sounds like you've been unbelievably executed that in terms of getting it in the marketplace that rapidly to get customers already. Can you talk about whether you expect any revenue contribution over the course of the year from that? Or do you – will it take a fair amount of time for that to build to any meaningful scale? It seems like certainly looking at the competitive position of ShieldSquare, it's an outstanding asset as that reasonably attractive price here.

Yes. So we'll definitely encouraged by the phase of the integration and the customer feedback. So we are seeing already booking, I mentioned, one customer in – the first customer in my comments, we already winning more customers. It was just another win, very nice win today displacing competition. So we are progressing though. We see good pipeline, good activity. And now that it's integrated with our Cloud WAF, I think it's extremely compelling offering to increase win ratio in both bot management and the Cloud WAF offerings.

In terms of their revenues, Alex, and I said in nature of the business is the subscription, so obviously, I mentioned it in Q2, it's close to zero. I hope that with the magnitude you will see something positive in terms of revenues in the third quarter. But therefore for Q2 we look almost nothing but just because of the nature of the business.

Thank you very much for the questions.

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

Thanks. Roy, I did want to go back to Europe again, because frankly, I'm a little bit surprised you are disappointed by it, I mean 21% growth is a number, then I'll take any day. I guess, my question is why are you not worried about the Americas over therefore four quarters in a row now year-over-year – well, there hasn't been any year-over-year growth really for four quarters in a row and a very low single-digit decline or very low single-digit increase. No movement at all. Why is that not the region, you're worried about? What's going on there does not conducive for growth?

Okay. So my statement was related to bookings not to revenue. Obviously, the 21% in the revenue in EMEA and in APAC we're happy about. But those are given the subscription business, the result of earlier bookings in 2018 to some extent 2017. As we go to Americas, we did have a nice booking result in growth in Q1. The region is grew double-digit figures and I think we given our model, you will see that in revenues in the coming quarters.

Okay, very good. And then as a follow-up, just on Cisco, Doron, can you talk about the contribution business activity there? How's that progressing?

Yes, I'll take it. The Cisco revenue will be below our plan and it's not in line with what we obviously expected. However, we still believe in the relationship. And we do see meaningful contribution down the road. We know, we said it and we repeated it in several quarters. By now, but that's our view.

Okay. Any color, Roy? You think it's not moving as fast as you'd hope.

In those multiple ones, in terms of our – I would say, affinity to a Firepower on one end. At the other end, we just now expanded the joint portfolio and the focus of the teams and so on. We've done some, we all seen larger pipeline, significantly larger pipeline without seen involvement in larger deals, but we do see our pipelines to Cisco to have longer sales cycles. In terms of times then what we use to build the general larger deals, more involving multiple products, not only specific opportunities and we just see that probably we'll need to get to used to the longer sales cycles.

All right. Good luck guys.

Your next question comes from George Notter from Jefferies. Your line is open.

Hi, thanks a lot. This is Kyle on for George. Curious to get your perspective, you launched some new cloud description services. And in the first quarter, you also had a number that you added to the menu in 2018. I'm just wondering, if there's anything you can get add to how those are doing in the market. Is there anything new in terms of attach rates or total deal size with your customers? And I have a follow-up. Thanks.

So the – as I have mentioned the subscription businesses are whole in cloud in particular continue to grow very strong. We've seen – I shared some information in the Analysts Day, for example, one of the cloud subscriptions, the ERT Active Attackers Feed. And we gave some – at that point, it was I think $600,000 quarter-to-date and we were looking for $3 million over the year. I think we're finishing above our expectation and with – at this point, this specific subscription probably go even further. And this was just an example. So we're seeing very nice contribution from subscription. We're seeing big adoption of multiple subscriptions from the company, it would cloud or product subscriptions. We came out with several brands of subscription that also look to be accepted well by the customer. So this whole area of our business, we're very, very bullish on.

Great. Thanks a lot. And then I know, you added the Global Elastic License and I mean, aside from the other subscriptions you added, is there any headwind to callout, like you've experienced in the past that would that we should think about in terms of the year-over-year growth rates, pretty impressive growth. But I'm wondering if there's any headwind associated with some of the new subscription services any transition of those?

As we discuss, the reasons we have given the model, but we took it into account in the guidance of the – yearly guidance of 7% to 9%. So obviously, when you take a cup, perpetual deal and move it to subscription, there is some headwind to revenues. But you seen the model, we don't see any reason to change. As we said, we were pretty confident on the yearly guidance we've given and we would be there just above 2018 H1 and I'm sure we will continue to execute accordingly.

Okay, great. Thanks a lot. And one last one, typically Q1 is your low point for profitability and given the strong results this quarter and your comments, appreciate those around OpEx, does your view change for the year? Are you still going to see margin – operating margin ramping through the year as you've seen in the past? Or will this year be different given your comment?

Things that we will continue to see the growth from 2018 as we expect it and then I saw some of your model, the change between the quarters in the way right now as bit meaningless, because if you take the revenues light flattish between the quarter. So overall, we'll improve 2018 and will we see the deliberate as we as we said in the investor meeting.

Okay, great. Thanks a lot.

The next question comes from Catherine Trebnick from Dougherty. Your line is open.

Thank you for taking my question gentlemen. One is, could you give us any more detail on how you're doing with Check Point? I know that relationship last year was struggling that you weren't really getting some on the performance through it. And how the Nokia relationship is involving? And then the second piece of the question is, how did you – you did a great job, and Asia-Pac up 21% year-over-year. I know that's been in the past years of frustration. Any changes in the sales team or new wins in that area you could discuss? Thank you.

So first one, Check Point and Nokia, those relationships continue at the same base. I've mentioned that we've now expanded also the portfolio with Check Point. And I think also with Nokia, we're starting to engage in more curious. So all in all, we feel good about these relationships they are developing, they're not growing significantly, but they are quite steady. Regarding Asia-Pacific, as we mentioned in several calls, the revenues at that time were not showing growth, but we told you that we're seeing the booking and it's progressing well. You're starting to see the evidence for that also on the revenue side. We constantly do adjustments in the region, we think in Asia-Pacific there's more potential for growth and we will update you as things progress.

Thank you. And one final question. What are your 5G plans, because you do have a strong carrier presence in multiple data scrubbing centers. What would be – any specific products you are coming out with or to go after 5G?

So we mentioned that in the Analyst Day, we obviously see that as a growth area. Those new requirements for traffic management, those new requirements for security and we are working with our partners there Cisco, Nokia to address this market. I don't think it's a 2019 opportunity, I think it starts in 2020 and probably we are working on specific solutions to address these potential. So we see that as a great opportunity but it's not like coming 12 months, longer cycle and obviously we are preparing ourselves to that.

All right, thank you.

The next question comes from Tavy Rosner from Barclays. Your line is open.

Hi. Thank you for taking my questions. Most of them have been asked, so I guess two quick ones. First one, can you talk a little bit about the acquisition pipeline you've given where your cash balance is, are you seeing anything out there that would be relevant for you guys? How do you think about these?

We continue to be active in the market. And we are meeting companies and possible targets. But we will continue to have the same policy of being very conservative on tech acquisitions, looking for business impact and the return on our investment. But definitely we are looking in the market, we think there might be some good opportunities for us. And as you've mentioned, we will be – the increase in cash flow where we have a lot of options how to execute it.

Thanks for that. Maybe just a final quick one. Last quarter you disclosed the recurring revenues were about 65% of sales. Is that – in Q1, was that something similar to what we saw in 2018?

So, Q1 obviously going to be down because some of the product recognition et cetera. But as said in other area, for the rest of the year, we will be back in the neighborhood of the 60's. But Q1 was a bit below.

Thank you. I appreciate it.

The next question comes from Josh Tilton from Berenberg. Your line is open.

All right. Thanks for taking my question. In regards to the carrier strength, I understand that much of the cloud business goes to the enterprise side. Was the cloud growth in the quarter in line with your expectations?

Yes, it's been even or above.

And then is it safe to say that the cloud mix is still 90% going toward the enterprise?

Yes.

So is it possible to comment on how much of this business is net new to Radware?

We don't break it, but it depends on the offering. Some of the offering there's a significant a portion, let's say even 50% net new. And it depends on some of the newer offerings, of course, CWP and the anti-bot, it's almost 90% net new. So it really depends on deal free.

Okay. And then maybe just ask a little differently. So last quarter you mentioned a multiyear cloud security deal, that was one of the largest in the company's history. Are we seeing the same continue momentum that we saw last quarter?

Yes. As I mentioned in my comments, it's a very, very strong business for us.

Okay. Thank you very much.

And your next question will come from Alex Henderson from Needham. Your line is open.

Thank you. I was hoping you could talk a little bit about strategy here for a second. You've guys have gone through a period of pretty tight cost controls because you've been transitioning from your traditional perpetual business to SaaS and to cloud and to security. Fairly flattish OpEx expending that you are mechanically delivering here seems inconsistent with a company of your size and the opportunity in security where most of these companies choose to accelerate their growth even at the cost of margins. And I wondering if you have rethought it all this approach to fairly tight cost management, pushing margins up to 15%, in lieu of the fact that virtually every company that I look at in the security space has a premium on growth and a much lesser premium around margin structure. So, wouldn't it be make sense to push these growth rates up and take further advantage of this market instead of being fairly cautious in the spending side?

We agree, as Doron mentioned in his comment, our OpEx was below our plan, meaning, we are not in line with our hiring plans and we took measures to accelerate that. But definitely we're seeing the opportunity for growth. We're definitely adding people in our plan across all departments of the company. So, we also guided for higher OpEx in the coming quarters. So we are definitely focused on that. The major hiring we're doing in all geographies and as we said also in the operating margin, we are ahead of plan though. We had these early big reorganization of the scare of deal. Obviously with our 80-plus gross margin it impacts margin considerably. But there's no retention in our mind, we are going after growth and we're going after adding people and leveraging the opportunity.

So if we were to look past 2019, which is obviously an investment period, based on your comments you just made, should we be thinking about the company as a 10% plus growth company in the headlights beyond 2019?

So in our model, we gave a 9% this year, we gave it a year ago. We still feel very comfortable with that as we showed one year was fast. We all know a way to achieve the second year and so far we feel confident in our ability to continue in that pace. And hopefully with the investments, we will make, we will be able to accelerate that. But it's early to discuss that, currently we're reaffirming the 7% to 9% and we are filming the two year 9% CAGR, we will be a bit above it. And going into the third year, hopefully with the investments already behind us, we might be able to accelerate it, push it forward.

If I could, one more. So your growth rates in the June quarter, obviously because some of the pull in, in the 1Q is a lot lower than most people were modeling. But it seems that that probably belies your pipeline. Can you talk about the deal pipeline to what extent are you seeing strengthening in the pipeline, which may not be consistent with the revenue growth given it's a SaaS model and bookings could be quite a bit stronger? Would we be looking at a book-to-bill in the – or that's probably above 10% or how do we think about the pipeline relative to the slow growth rate?

Yes. So for the full year, don't want to speak quarterly booking guidance, but for the full year – full year, obviously we're looking book-to-bill above 1% and that would support the next year 9% and that's the part of the model. That's how our model works. So definitely we there and reaffirming the guidance meaning that that's what we are seeing and believing in.

All right. Thank you very much.

I have no further questions. Thank you. I turn the call back over to presenters for closing remarks.

Thank you very much for joining us and have a great day.

Thank you, everyone. This will conclude today's conference call. You may now disconnect.