Check Point Software Technologies Ltd Q2 FY2021 Earnings Call

Greetings. My name is Kip Meintzer, Global Head of Investor Relations for Check Point Software. I’d like to welcome everyone to our Second Quarter 2021 Financial Results Video Conference. At this time, all participants are in a listen-only mode during the formal presentation, which will be followed by a question-and-answer session. Joining me remotely today on the call are Gil Shwed, Founder and CEO; along with our CFO and COO, Tal Payne.

Right, thank you, Kip. Good morning and good afternoon to everyone joining us on the call today. I'm pleased to begin the review of the second quarter. Revenues for the quarter increased by 4% to $526 million, a million above the midpoint of our guidance. Our non-GAAP EPS increased by 2% to $1.61 per share, surpassing the top end of the guidance.

Hi, everyone, very happy to see you on our earnings call. Actually, we're celebrating today; I think it's my 101st earnings call, 25 years as a public company. We went public in Q2 1996, which was our first quarter as a public company. So I'm very pleased to see you. I will go quickly, I'll try to go through this presentation. I'll skip the first few slides, which are all the forward-looking statements, but I'll speak about the business highlights. This quarter, I chose to focus on case studies that will demonstrate our three pillars of security. So before I jump into that, a quick introduction. And you've seen the data, you've seen the numbers, the increase in revenues, the full data again, so I won't stop on that. But let's go to the state of the business. First, I think we've completed a pretty good, actually a very good first half, especially in Europe and Asia. If you remember a couple of years ago, we put some new leadership in Asia; two quarters ago, we had a new leader for Europe. And I must say that in these two quarters, we had a very good second quarter in Europe, and a nice momentum, new customers and all the pillars. So I'm very, very pleased to see that in Europe. And I'm very pleased to see the first half in Asia, which continues with a positive trend, even with the few challenges that we faced in Asia due to COVID in the second quarter, especially in India. And by the way, within the U.S., we have a new leader who was in for like five or six weeks during the quarter. I hope that within a few quarters we'll be able to see similar trends in the Americas as well. In terms of technologies and products, the CloudGuard and Harmony product line have doubled in the past two years since 2019 and now account for 20% of our subscription revenues, almost doubling the amount that they were before. So which is again pretty good, the same strategic trends that we're speaking about with our Infinity architecture.

It was the energy company deal.

Okay. So I was—let's see how quickly I can shift slides here? Great. So I was speaking about Maestro, which is our scalable solution. It became a real game changer in the last year, year and a half in our solution. Basically, Maestro allows the customer to get a cloud-like environment in terms of scalability, redundancy, and reliability for their data centers, simply by stacking up many solutions and getting one high-performance network security solution with a high level of redundancy. In this case, we're talking about a government agency in one of the largest European countries that needed to protect their very public services and like everybody else, they see more services provided through the internet in the last year and a half. And they were looking for a solution that would not just meet the current requirement but would be future-proof. And Quantum Maestro was the winner here. The reason they quoted is the ability to scale up our security environments on demand, the flexibility of that solution, the fast-changing environment, and also, very importantly, the EAL4+ certification, which is one of the highest certifications a product in our industry can get. Not many vendors have that certification. So they like to always factor that in when replacing their previous solution with our solution, which is a brand new customer to Check Point, a seven-digit deal. This is a very nice win for our European team. And actually, by the way, we completed a winning streak in the same region, where every quarter we win a similar deal like that; a major new customer with a large deal, which is something we're very proud of. Last, let's move to CloudGuard. I think we all know the importance of the cloud these days, and the ability of companies to move workloads to the cloud to support private cloud, public cloud. I think we have two examples that demonstrate different aspects of our solutions in the cloud. First one is a technology company in North America, like many others, they acquired several cloud startups and realized that they now need to get more visibility and control over their multi-cloud environment, which involves different companies and different cloud providers. They purchased CloudGuard for posture management and threat intelligence to get a better grip on their entire cloud environment. The reason they quoted is having the best visibility across multiple cloud environments and the superior flexibility or the ability to do automation scripting, so whenever a new asset is added to the cloud, it automatically joins the control panel. Whenever automatic actions are needed to be taken, our scripting ability allows them to do it automatically. And again, a seven-digit deal, a new customer to us, competitive win over Palo Alto Networks, which is a good example in the heart of Silicon Valley. Switching to the last example, we have a very large, long-time Check Point customer on the network side. It's a Fortune 500 media company, and it was a complicated project. On one hand, they had the new data center, a new private cloud or physical data center. On the other hand, we were moving more and more applications to the public cloud and they needed to connect the private cloud and the public cloud. What they purchased here is both CloudGuard and the Quantum Maestro connected together. The reason they quoted for choosing Check Point was first unmatched scalability with Maestro, which I think is great. And we talked about it earlier. They increased efficiency with the unified management. It sounds simple; I’ve spoken about our management before, but here it’s another angle. We are the only vendor that has the same architecture, the same management for most of the private cloud and public cloud solutions. It’s the same management, the same solution, which can secure the data on both ends and connect the data from the data center to the public cloud. That was a very important factor for them: the ability to control it from within the same panel. Lastly, they conducted very sophisticated tests, real-life testing of us versus several other vendors. And Check Point got the best results on the security and performance side, and you see, we won here over Palo Alto Networks and Cisco. I mean, we're very proud of the seven-digit deal that expands our footprint in this large media company. Overall, I gave you some color about why the Check Point pillars win. And I think you can see some of these reasons. This sounds like our marketing material, but this echoes what customers are saying. They like us first and foremost for the real-time prevention. This is a result of many cases we collect and interview customers, asking why they chose us. These are the reasons: our prevention-first architecture, the real-time prevention, which sounds trivial but it’s not, as most of our competitors rely on detection and remediation, which leads to attacks and is not very favorable. They appreciated our security management, something that I think we’ve been winning for 27 years now. They also like the complete solution; the Infinity architecture, and you saw here many examples that were part of the Infinity solution and many of them involved multiple solutions from our three pillars that start to show the consolidation and the importance of consolidation in the marketplace. Overall, we believe that we can prevent the next cyber pandemic, and we can really protect against the Generation 5 attacks, which are becoming the new norm for internet and cyber attacks. Just to quickly mention the state of the market based on our research organization: for those of you who follow our Check Point Research CPR blog, you will see dozens of different researches and vulnerabilities we've found. But I'm not going to go through them today because they deserve a full presentation of their own. Just some of the trends we're seeing at a high level: we’ve noted a 93% increase in Generation 5 attacks, particularly ransomware, with over 1200 organizations impacted by ransomware weekly based on our sensors, which represents a 93% increase from June 2020. This is huge, as you can see in the graph. The leading regions with the largest increases are Latin America and Europe. However, for those in North America, after seeing incidents like the Colonial Pipeline, it's clear that this issue doesn't just occur elsewhere; it impacts critical infrastructure everywhere. Remember, we coined the term Generation 5, a few years ago, for attacks which are multi-vector and can start from one place and travel through different environments before hitting the target. These types of attacks are very hard to detect and understand the origin of. Recently, we’ve seen the supply chain as a vector for attacks which we haven't observed before, and I believe this is becoming the new norm in internet attacks. The good news is that customers who deployed the Check Point Infinity remain protected, even though these are zero-day attacks, and many of these attacks are previously unknown. We are very proud of what we’ve delivered to our customers over many years, particularly with our Infinity architecture. Summary: After discussing the strong Q2 financial results in terms of projections and internal metrics, especially in Europe and Asia, we see that the Infinity architecture as a solution is gaining momentum, with double-digit growth in CloudGuard and Harmony and triple-digit growth for the Infinity deals. While we’ve had good progress, there is still plenty to ramp up and achieve. I believe we are fulfilling on the strategy of providing the industry's most secure and comprehensive architecture. Let me summarize my presentation. Before opening the floor to your questions, I want to share our projection for the third quarter: our projection for revenues is expected to be between $515 million to $540 million. As always, projecting the future is challenging, especially these days with the global climate changing rapidly and introducing high levels of uncertainty, which can cause our results to be better or worse than projected. Still, the revenue range of $515 to $540 million suffices. Our EPS estimate should be between $1.54 to $1.64, while GAAP EPS is expected to be approximately $0.24 less. Thank you very much for listening. I hope I’ve provided good insights into our business, and we’re happy to hear your questions now. Thank you.

Congratulations on the 25th anniversary for the company. I just wanted to maybe get started with a little bit more color in terms of your recent sales leadership changes and new channel incentives. Could you help us understand what’s making the most difference in terms of driving either improved productivity or channel engagement? Thank you.

Firstly, in terms of changes in Asia, we have new leadership for quite a few years. So I don’t know if it’s new anymore. In Europe, we had Thorsten, who became the new leader during Q4, so this marks his second full quarter. We are very pleased with results so far, especially the good momentum in the U.S., where we have a new leader, Jeff. Jeff joined us halfway through the quarter, and I believe that during the second quarter, he had only been with us for about six weeks. There’s still a need for him to deliver the first quarter leading the field. I hope that we will see the changes we implemented and the new hires he brings, along with new energy in the Americas over the next few quarters. We have a significant sales force doing many things, and in the last few months, we have focused on accommodating and improving channel support, even though I must mention that I don’t see our work as solely channel or incentive-based as much as it’s about our people collaborating with channel personnel to drive results together. We’ve done well in some areas and can do better in others. Overall, we had a strong first half in Europe and Asia, and we’re stable in the Americas. I hope to see the Americas follow suit with Europe in the coming quarters.

Jonathan, maybe I would just add that, some we can discuss and some we can’t but we made significant changes in the partner program. We introduced new MDF (Market Development Funds) at the fall of last year, and we increased the amount this year, allocating a lot of dollars into collaborative marketing efforts with partners. Additionally, we have different rebate programs in various areas, so we’ve made substantial adjustments in our marketing efforts with partners and more direct marketing as well.

Tal, I want to focus on the P&L. You’ve seen strong billings over the last year and revenue has consistently been around the 4% mark. I understand there’s still this ongoing transition from hardware to software. Is there a point where we should expect the revenue growth to accelerate from 4% and align more closely with the short-term billings that have been in the high single digits?

Remember, there should be an acceleration at a certain point. The product revenues account for about 30%, while the rest is subscription and support. The deferred revenue mostly pertains to subscriptions and support, and the product portion is quite small. Over time, that should reflect positively as subscription and support continue to grow. Subscription is at 12% while support is at 2%, so it is not fully reflected in the deferred revenues. The product revenue is separate, and what you see in the P&L aligns at a high level with what you've sold, as it’s not going into deferred revenues typically. In cases of Infinity deals, while products are part of the deal, we have to wait until the customer pulls the product before recognizing that revenue. We may encounter some delays in product recognition with more Infinity deals, but once it’s pulled, you will see it on the P&L.

Tal, you mentioned double-digit growth in the lower end of the appliances product portfolio. Is that a new trend? Or have you seen it picking up a little bit in prior periods? What’s driving that change?

It is fair to say that I see improvements in the last two or three quarters in terms of unit numbers. That’s why I told you previously, we’re losing some of the dollars in the subscription deferred revenues. But the overall number of units is experiencing double-digit growth, particularly in the lower end. The top 10 appliances have also exhibited double-digit growth, which is a healthy sign; it has grown even higher in the low-end segment. This trend began when we launched a new product line that is catching on nicely. It may not represent huge dollar amounts, which is why I haven’t discussed it extensively, but the growth is indeed notable because we have successfully penetrated several markets with MSPs. These connections allow sales of smaller products to scale as needed over time, leading to substantial growth in the total appliance market.

Congrats on impressive results; this seems like one of the best quarters we've seen in years. Can I ask if there were any large deals this quarter, or were the deal sizes typical for a given quarter?

I think we had an increase in large deals, which is very good, particularly regarding the size of the deal. I’m not sure whether we financially benefited from them this quarter, as many of these Infinity deals have product portions that may be deferred over time. So if it's okay, I would turn it over to Tal.

Firstly, this quarter was great in terms of large deals, and we’ve seen an upward trend there for a few quarters now, which is a good sign. The large deals provide us an opportunity to sell more to customers and have deals that include two or three pillars, which is a nice phenomenon we expect as we succeed in establishing large Infinity clients. In terms of revenues, most of those large deals have not reached the P&L yet. For example, take a typical Infinity deal, the product portion typically starts being recognized only the quarter after we initiate the deal, as we are very back-end loaded. Usually, the deal comes in the last one or two weeks, which makes timing difficult. Product revenues are likewise contingent on customer pull, so you’ll only see that reflected once we complete the delivery of the product. There is less correlation between the timing of bookings and billing versus when we see it in the P&L.

I wanted to inquire about investments; Gil, you entered this year with expectations for investments in R&D, sales, and marketing. In Q1, OpEx was flat year-over-year, and from Q1 to Q2, revenue grew faster than OpEx. What do you see moving forward with these investments? Is this trend expected to extend over the next few quarters with margins trending below 50%?

Yes, we do want to invest heavily, especially in sales and marketing as well as R&D. We have hired a lot of new people since the beginning of the year, and the hiring has gone very well. We’ve received lots of feedback regarding our employment profile, indicating it is working well. We observe notable increases in our hiring, though I don’t assume the high attrition rate is positive. Conversely, I’m pleased to note that the attrition among high performers is still relatively low. To answer your question, we’ve added about 100 new hires in recent months. I believe we could realistically add another 300 positions between now and year-end. However, that’s a cautious estimate.

To add to that, Adam, you’re correct in your observations. We have a proper plan and are ramping up; I mention this as I do not want you to expect cuts to our full-year plan. We did recruit, but we didn’t fulfill all the hiring because we are also increasing our goals. The market has had ups and downs with talent coming and going. We are ramping up significantly; we hope to see some reductions in our margins in Q3 and Q4 as we continue to recruit the talent we need to drive our growth going forward.

I have a quick follow-up. Gil, you discussed concerns surrounding the macro environment. I’m curious about the funnel and pipeline for the back half of the year. Can you provide some context around it, irrespective of your macro concerns?

First, I believe that the need for cybersecurity will remain with us for a long time. My long-term projections, especially with AI in the cyber landscape, are very positive. I think right now, our competition is tougher; there are many strong companies in the field. However, I believe that our value proposition in terms of security level and consolidation will win over the long run. The pipeline started positively, especially in areas where we’re seeing beneficial management changes. Our Q1 pipeline looked particularly strong in Europe and Asia. The U.S. pipeline is improving, although it may take several more quarters to see the full effect of our changes.

It was good to see the additional disclosures on CloudGuard and Harmony, both doubling since 2019. How should we think about growth in those products going forward? What can we anticipate over the next two to three years?

Before Tal provides further numbers, I must clarify that there’s considerable discussion in the marketplace regarding the potential of the cloud. To some extent, it’s still a relatively small market today. We see significant vendors participating, and although growth in cloud security could be substantial, we still need to navigate its evolution. My expectation is that we will see consistent high double-digit growth from both CloudGuard and Harmony, and they will become significant portions of revenue while gaining share from network security and Quantum. The Quantum family may also grow, though I believe that its growth would remain in the single or low double-digit percentages if everything goes perfectly.

You’re correct; our strategy is about building diverse growth engines. If one succeeds, we’ll ensure that we’re in a good position overall. Both Harmony and Cloud platforms offer great potential together with the Infinity connection; Quantum can fit in conjunction with Cloud and Harmony as well. Our goal is to upsell the customer, transforming that value into consolidated security at an affordable price. Most of the growth will likely come into the subscription line, potentially moving from 9% growth to 10%, 11%, or 12%, and we aim for both Cloud and Harmony to sustain double-digit growth as well. Subscription growth should steadily improve, and that will pull even more to the product side, as support is linked to that segment. Which would allow us to envision larger footprints with our customers in the Quantum space while ensuring that Cloud and Harmony predominantly maintain their subscription nature. So we hope for uplifts in subscription as we see continued success in either or both products.

Gil, you outlined some case studies involving new customers and existing accounts expanding with Check Point. How are you tracking on your goals for new business growth this year as we reach the halfway point?

In Europe and Asia, we are on track for growth, though perhaps not the full 20%. We have observed very good performance in the first half, particularly in Europe. Meanwhile, we are seeing stability in the U.S. with signs of improvement, though we can’t yet make early predictions about the overall year-end results.

I want to get some clarity on guidance: we didn’t see updates on your annual expectations. With Q3 guidance released and the first half of the year behind us, what is your outlook on Q4 and your previous annual guidance?

Currently, we don’t anticipate many changes to our annual guidance, as we remain on track. Although I wish I could report that things are tracking significantly better, it’s still optimistic. I’ve seen unexpected surges in large deals come in late in the year and enhance results. Past years have often resulted in meeting annual plans, but I can’t make concrete predictions just yet. I will have a clearer picture towards the end of December.

To your inquiry, I understand the interest due to our numbers surpassing the midpoint of our guidance. However, the critical determining factor for annual guidance revolves around product groupings for Q4. Given the current lack of visibility, there’s little benefit in adjusting our guidance before we finish the year.

Gil, congrats on the results; it looks like solid billing growth for sure. I'd like to ask about the channel and what your observations are there. We are hearing greater competition among channel providers, especially Wescon, on margin. How is that impacting your business? Regarding the deals you've highlighted, how many of these were initiated by new Check Point relationships versus channel-driven?

Salespeople tend to drive every deal when they strive for increased margins. I believe this emphasis has less effect on overall channel performance. While it's essential to provide good margins to partners, a successful approach depends highly on collaboration. We have been increasingly focused on ownership of deals and working directly with customers. Channels play integral roles, and while they contribute to all our deals, their role has shrunk somewhat in certain transactions. One of our tasks is to broaden that role. We aim to motivate them to extend their efforts on our behalf, ultimately thriving together.

I’m curious, Gil, there’s a perception among investors of a surge in security spending due to the increase in ransomware attacks and incidents like the SolarWinds breach. How would you characterize what you’re seeing? Is there a surge, similar to what we observed in 2013 or 2014, or would you view it as a modest increase? How sustainable is this growth?

Based on what I've observed, I would describe the current trend as a modest multi-surge rather than a significant increase. The main issue is confusion, as customers often feel overwhelmed by the numerous vendor options available. The market is not constrained by budget but rather by the uncertainty regarding solutions. However, we have some clients using our full Infinity architecture, such as various small businesses in construction, transportation, finance, and law firms. When speaking with these customers, they often express how overwhelmed they feel managing numerous vendors. Our capabilities allow them to simplify their approach to security, leading them from small transactions to larger contracts. This presents a potent opportunity for us in the future.

Thank you all for joining us today. We appreciate your attendance, and we look forward to speaking to you throughout the quarter. We’ll see you at the next earnings call. Thank you, and have a great evening or day.

Thank you very much.

Bye, guys.