Check Point Software Technologies Ltd Q1 FY2023 Earnings Call

During the formal presentation, all participants are in listen-only mode and this will be followed by a question-and-answer session. During this presentation, Check Point's representatives may make certain forward-looking statements. Forward-looking statements generally relate to future events or our future financial or operating performance. Forward-looking statements include, but are not limited to, statements related to our expectations regarding our product solutions, expectations related to cybersecurity and other threats. Our expectations and beliefs regarding these matters may not materialize and actual results or events in the future are subject to risks and uncertainties that could cause actual results or events to differ materially from those projected. These risks include our ability to continue developing platform capabilities and solutions, customer acceptance, purchase of our existing solutions and new solutions, the market for IT security continuing to develop competition from other products and services, general market, political economic and business conditions, including as a result of the impact of the COVID-19 pandemic. These forward-looking statements are also subject to risks and uncertainties, including those more fully described in our filings with the Securities and Exchange Commission, including our annual report on Form 20-F. The forward-looking statement in this management presentation is based on information available to Check Point as of the date hereof and Check Point disclaims any obligation to update any forward-looking statements except as required by law. In our press release, which has been posted on our website, we present GAAP and non-GAAP results along with a reconciliation of such results and the reasons for our presentation of non-GAAP information. If you have any questions after the call, please contact Investor Relations at kip@checkpoint.com. Now I'd like to turn the call over to Roei Golan for a review of our financial statements.

Thank you, Kip, and thank you to everyone for joining the call. Let me just share the presentation. So I'm excited to present our results for the first quarter of 2023. Our revenues this quarter reached $566 million, which is $1 million above the midpoint of our projections. Our earnings per share were $1.80, surpassing our endpoint of our projection and $0.07 above the midpoint of our projections. Despite the market uncertainty and tough macro environment, we delivered 4% growth based on our projections and reached our projection, delivering 15% growth in our earnings to $1.80. Now let's dive into a detailed review of the quarter. The revenue increased by 4% to $566 million. Our deferred revenues were up by 8% to $1,797 million. Our short-term deferred revenues were also up by 8%. Our calculated billings reached $485 million, a decline of 3% year-over-year. Our billing is affected by duration, payment terms, and in this uncertain market environment, we saw fewer customers willing to pay upfront for multiyear deals, resulting in shorter billing duration. If we look at our current calculated billing, it was actually up 2% year-over-year. Our product revenues declined by 7% year-over-year, resulting from extended sales cycles and deferral of projects, mainly refresh projects in the Quantum Appliances. If we analyze our security subscription, we had a very strong quarter with 13% growth year-over-year, reaching $228 million. This double-digit growth was driven by our CloudGuard and Harmony E-mail businesses, both experiencing strong double-digit growth in revenues and new business bookings. Additionally, our Infinity product continues to flow into our revenues, reaching a growth of over 140% year-over-year. We've achieved a key milestone of 81% recurring revenues from our total revenue. Out of the 81% recurring revenue, 50% of it is subscription-based. We're seeing consistent growth in our subscription and recurring revenues over the last few years. Now let's look at revenue by deals: 45% of our revenues came from EMEA, 43% from Americas, and 12% from Asia Pacific. Our gross profit increased by 5% to $502 million, representing a gross margin of 89%, which is higher than the 88% from last year. These total margins are impressive given the pricing increases by many vendors. We're observing improvements in the supply chain environment, which was very challenging last year, and we hope to see this trend continue in the remainder of 2023. Our operating expenses increased by 11% due to ongoing investments in our workforce, cloud infrastructures, and in-person marketing activities, including our CPX event that took place this quarter. We achieved a solid operating income of $238 million, representing a 42% operating margin this quarter. Our financial income this quarter reached $19 million as we invest in higher interest rates over time, and we expect this income to increase in the next few quarters. Our non-GAAP tax rates for this quarter were around 15% due to indexation and updates in tax provisions because of several tax assessments worldwide. Our non-GAAP net income increased to $218 million, reflecting a 7% growth year-over-year, with an EPS of $1.80, signifying 50% growth year-over-year, very strong results. Our GAAP net income was $184 million or $1.52 per diluted share. In terms of cash flow and cash position, our cash balances as of the end of the quarter were $3.6 billion. Our operating cash flow was strong at $386 million this quarter. During the quarter, we continued our buyback program, purchasing 2.6 million shares for $325 million at an average price of $127 per share. Over the past 12 months, we have purchased a total of $1.3 billion in shares. In summary, we experienced double-digit growth in subscription revenues driven by our Harmony E-mail and CloudGuard products, achieving over 80% of our total revenues in recurring revenues. The macro environment has resulted in extended sales cycles, leading to a decline in our product revenues, but we finished with strong profitability, showing a 15% growth in EPS. Now I'll turn the call over to Gil.

Thank you, Kip. Thank you, Roei. That was a very good update on the financial side. On the business side, I'd like to reiterate some of the messages and provide additional insights into the technology trends we observe. The need for cybersecurity remains high, with growing numbers and sophistication of attacks. I'm very proud of our financial results. Our revenues were above the midpoint and 15% EPS growth is exceptional. We also had a healthy business in renewals, indicating that our customers are loyal. However, we continue to operate in a challenging economy. We've seen the impact of this economy on our business with extended sales cycles and postponed projects. Roei mentioned the decline in new product sales, but we still have double-digit growth in CloudGuard and Harmony E-mail, with 140% growth in Infinity revenues, and 13% growth in all security subscriptions. I am proud that we have reached over 80% recurring revenues. This progression is driven by significant initiatives and technologies we are delivering each quarter. Now let me highlight some of the things we launched in the first quarter. First, Infinity Global Services. We all understand that customers want better security. There is a huge skills shortage in the cybersecurity market. Our partners and customers have expertise but often lack full capabilities. With Infinity Global Services, we aim to augment the needs of customers at any stage, whether it's security assessment, optimizing the security environment, training, or managed security services. The security services market is $75 billion. We're not aiming to be a giant player, but we will participate and help our customers realize value from security technology. Similarly, we've launched a new family for Horizon, focusing on the rapidly growing sub-$1 billion market of Security Operations Centers with XDR/XPR. Our approach incorporates prevention and response to all types of security events. By leveraging AI, we turn incidents into automatic prevention quickly. I want to emphasize our unique integrated approach, enabling access to a CISO and Security Operations Center for tremendous customer value. Lastly, the CloudGuard family has expanded with CNAPP, combining six technologies into one solution for cloud security. This multi-billion dollar market is fragmented, and our solution allows customers to consolidate various devices for improved security. Our 3C strategy focuses on making security comprehensive, consolidated, and collaborative, emphasizing how the entire architecture works together. The excellent quarterly results demonstrate the strength of our products, even in slowdowns, and I look forward to sharing our projections. Revenues for the year are expected to be between $2.34 billion to $2.510 billion, and non-GAAP EPS ranges between $7.70 to $8.30. We've also provided the projected range for the second quarter: revenues expected to be between $570 million to $605 million, with non-GAAP EPS expected to be between $1.85 to $1.95. Now I'll open the call for your questions.

Thank you, Gil. As a reminder, please ask one question and one question only, and hopefully we can come back around and go through everybody. Starting today is Shaul Eyal, as our first up with a question, followed by Keith Bachman from BMO. All right, Shaul.

Good afternoon, everybody. Good to see, Gil, that you're keeping fiscal '23 guidance intact. I had a question about the product decline. How much of that was attributed to Infinity actually showing solid performance?

The product decline obviously doesn't come from Infinity, which showed good performance as customers are purchasing more of our architecture and comprehensive solutions. The decline mainly stems from refresh projects that are being delayed. Since last November, we've seen significant changes in the industries, reflected in many companies' results, including declines in PC shipments in the first quarter. This tightening spending is evident across the marketplace, yet I'm proud of our results due to our robust renewal rates and recurring business.

Next up will be Keith Bachman from BMO followed by Patrick Colville of Scotiabank.

Hi, Gil. It's Keith Bachman from BMO. I wanted to ask about why things might get better. What’s the driver of improvement? You mentioned billings growth net of duration changes was around 2%. What would be the catalyst for mid-single digits or even higher? Additionally, will billings be positive or negative during calendar year '23?

While I’ll let Roei comment on the technicalities of the billings, the high-level business trends have several elements that could lead to accelerated growth. First, the new products we've launched, including Horizon, Harmony, CloudGuard, and the Infinity architecture can drive this growth. Second, there’s significant potential within our existing installed base and expanding engagement with customers. Many Chief Information Security Officers are unaware of the full extent of our capabilities. We recognize there’s plenty more to achieve, but it requires time and effort given the ongoing economic headwinds.

Next up is Patrick Colville followed by Tomer Zilberman, Tal Liani of BofA.

Thank you so much, Kip. Last week at the RSA conference, CNAPP was the talk of the town. I was excited to see the launch this morning of CloudGuard CNAPP, which you called a combination of six technologies into one solution. Of those six technologies, what's new? Is it just rebranding and bundling, or is there a new product launch alongside this announcement? Additionally, do you expect CloudGuard CNAPP to bring in new customers or mainly cross-sell into the existing base?

There are several new elements in the CloudGuard CNAPP. The pipeline source security and entitlement management are new features. Our technology, combined with improved AI capabilities, provides targeted security results. Monitoring the cloud infrastructure reveals many issues, and the aim is to prioritize and address the most significant ones. We’ve integrated multiple technologies into this offering to provide customers with a comprehensive security solution that meets various cloud needs.

Next up is Tal Liani, followed by Gray Powell from BTIG.

Hi, Guys. I had a question regarding the correlation between historical orders, supply constraints, and the current product dynamics. Can you explain whether this year's product revenues might be affected by diminishing backlog of historical orders or if we are currently seeing reflections of the marketplace environment?

We've successfully shipped products each quarter without significant backlog affecting our capabilities. Last Q1 was strong in obtaining new business, making comparisons challenging. The current issues stem from real changes in the marketplace. It’s vital to note that we maintained strong shipment capabilities throughout. Unlike other vendors, we secured components well and managed to effectively fulfill customer orders.

Next up is Gray Powell from BTIG, followed by Joshua Tilton from Wolfe Research.

Is it possible to quantify how much of the weakness in Q1 billings was linked to uncertainty in the banking sector versus general slowdown in refresh activity? Any insights on April trends would be appreciated.

Unfortunately, we cannot quantify the specifics. We've seen broad impacts on refresh projects delayed across the board, rather than in specific industries. While our sales team generally remains optimistic for Q2, Roei and I exercise caution due to market observations. We always gather comprehensive data to inform our projections but remain aware of the unpredictable nature of current conditions.

Next up is Joshua Tilton followed by Brad Zelnick from Deutsche Bank.

Did the macro impacts seen in Q4 worsen in Q1? Could you clarify the assumptions in your full-year guidance and how you are preparing for the rest of the year?

In comparing Q4 to Q1, we did notice slight deterioration in our internal trends, and it's compounded by last year's exceptional first quarter performance. For the full year, we have maintained our previous guidance expectation as we still see potential for improvement in the second half, although aware of inherent risks that need to be considered.

Next up is Brad Zelnick followed by Ray McDonough.

What are your thoughts on the impact of generative AI on cybersecurity, both for good and bad actors?

Generative AI is a double-edged sword. On one hand, it can enable malicious actors to create sophisticated attacks quickly and effectively. On the other hand, it offers transformative opportunities for us in cybersecurity, which we have been investing in for years. Our AI-driven technologies are integral to our defensive strategies, and we are continuously exploring innovative solutions within our platform.

Next up is Ray followed by Max Gambrell from Goldman Sachs.

What can you tell us regarding discounting levels industry-wide and the potential impact of rising financing costs on deal activity?

The discount levels have not changed materially, with higher discounts resulting from consistent demand. While we experienced some discounts this quarter, renewals remained healthy, reflecting customer satisfaction with our technologies. It is a competitive environment, but we do not observe a significant trend toward increased discounting overall.

Next up is Max, followed by Saket Kalia of Barclays.

Looking at the sales force productivity, how are the changes made to your go-to-market organization playing out this year? Do you still plan to grow your sales headcount by double-digits in 2023?

Sales productivity remains healthy, but we are not planning significant growth in the sales force this year given current economic conditions. We aim for the salespeople we have to be productive, and I believe we can drive more engagement and customer coverage. We're open to adding resources as we see fit in specific segments, but we want to maximize what we already have before hiring further.

Next up is Saket Kalia, followed by Jonathan Ho.

Could you touch on the impact of ITP on billings and how you view billings throughout the rest of the year with the changing industry dynamics?

Most Infinity deals are not billed upfront due to specific payment terms. The billing for Infinity generally covers one year. We've observed fewer customers willing to pay up front for multiyear commitments due to the current economic climate. Despite this, we're still seeing healthy annual billings and renewals, particularly in our cloud and Harmony E-mail businesses. It's challenging to forecast far into the year given recent trends.

Next up is Jonathan Ho followed by Joel P. Fishbein, Jr. from Truist.

Could you detail the impacts from the deal postponements this quarter and what assumptions factored into your annual guidance?

Some impacts are evident in product revenues. We are maintaining our projection for the year based on robust sales forecasts, despite being aware and responsible regarding risks involved. I aim to be realistic rather than conservative in my guidance, as I believe steady growth potentials exist, particularly in the second half of the year.

Next up is Joel P. Fishbein followed by Gregg Moskowitz.

With $3.6 billion in cash and the continued buyback program, what is your view on potential M&A opportunities and the current environment?

We are looking at additional M&A opportunities, and I am cautiously optimistic regarding valuations. The market is beginning to consolidate, and while I see many companies adjusting their expectations, we remain keen to explore viable partnerships. As we assess potential deals, I hope to secure positive opportunities within our sector.

Next up is Gregg Moskowitz followed by Shebly Seyrafi.

Given the macro pressures, do you attribute the current product revenue weakness solely to these factors or were there any internal execution issues that contributed?

While I can identify areas for improvement within Check Point, the current struggles arise primarily from economic factors. Our sales force is demonstrating improved performance, and while more productivity is possible, I attribute the present challenges to external conditions, not internal execution.

Next up is Shebly Seyrafi followed by Dan Ives from Wedbush.

Have you observed any significant trends in specific verticals, particularly in financial services and technology?

The trends we observe are fairly universal across sectors, including financial services and technology. We’ve seen successes and challenges in both areas, indicating overall market behavior rather than sector-specific dynamics.

Next up is Irvin Liu, followed by Michael Turits.

Can you explain the reasoning behind customers delaying project refreshes? Is it due to lower-than-expected IT budgets or targeted slowdown in cybersecurity budgets?

Overall, cybersecurity remains a strong area for investment. Customers still recognize the need for robust defenses against the evolving threat landscape. However, in comparing broader IT spending, some sectors are facing tighter constraints which can affect project timelines and budgets.

Next up is Michael Turits followed by Ittai Kidron, who will be our last call for the day.

Have you adjusted expectations regarding sales force growth for this year?

Our focus remains on enhancing productivity within our existing workforce rather than significant growth in sales staff this year. Additionally, while we observe significant opportunities to engage with more customers, we want to ensure our new hires are effectively integrated before expanding the team further.

Thank you, everyone, for joining us today. That concludes our call. We look forward to seeing you throughout the quarter.

Thank you very much. Bye-bye.