Earnings Call Transcript - RDWR Q2 2022

Operator, Operator

Welcome to the Radware Conference Call discussing Second Quarter 2022 Results, and thank you all for holding. As a reminder, this conference is being recorded, August 8, 2022. I would now like to turn this call over to Yisca Erez, Director, Investor Relations at Radware. Please go ahead.

Yisca Erez, Director, Investor Relations

Thank you, Angela. Good morning, everyone, and welcome to Radware's second quarter 2022 earnings conference call. Joining me today are Roy Zisapel, President and Chief Executive Officer; and Guy Avidan, Chief Financial Officer. A copy of today's press release and financial statements as well as the investor kit for the second 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 forecasts and estimates. Factors that could cause or contribute to such differences include, but are not limited to, the impact from the COVID-19 pandemic, general business conditions and our ability to address changes in our market and 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 and furnishes from time to time with the SEC, specifically the company's last annual report on Form 20-F as filed on April 11, 2022. We undertake no commitment to revise or update any forward-looking statements in order to reflect events or circumstances after the date on which such statements are made. I will now turn the call to Roy Zisapel.

Roy Zisapel, President and CEO

Thank you, Yisca, and thank you all for joining us today. In the second quarter, we drove solid results. Our total revenues grew 8% year-over-year, EPS was $0.18, and cash flow from operations was very strong at $31.5 million. Cybersecurity plays a pivotal role in today's business environment. Radware is a provider of real-time protection and serves as a fundamental force in defending our customers' most critical applications and data centers from cyber attacks. As the threat landscape continues to evolve, with a continuous increase in the number and size of attacks, our customers must ensure their business continuity, strengthen resilience, and improve the customer experience. Therefore, we have every reason to believe that the demand for our solutions will continue to grow in the long term. At the same time, we also believe that uncertainties present in the current macro environment might impact the spending behavior of our customers in the short term. Recently, we've seen more delays than usual and lengthening sales cycles in large deals in the Americas enterprise, with some customers opting for staged deployments. Looking at the bigger picture, Radware is a healthy company, and we are well-positioned for times of recession. We operate in a large and critical market with a growing addressable market. We continue to deliver and forecast sustained growth, high gross margin, and healthy cash from operations. We have best-of-breed technology which provides better protection for our customers. We have a large customer base that is diversified across industries and geographies, and we have a strong balance sheet with more than $440 million in cash. Backed by these assets, we remain optimistic about the long term. Therefore, we will continue to make investments in our business and specifically in our strategic cloud security initiatives. The demand for cybersecurity solutions is highly correlated to the level of threats and attacks. The international conflict in Eastern Europe is a clear example of the use of cyber attacks by nation states as an extension of armed conflict. A couple of months ago, we announced that the Ukraine State Service of Special Communication and Information Protection is using Radware cloud DDoS protection and cloud application security to protect infrastructure and applications in the face of daily attacks. Our success in blocking these attacks is a great testament to the capabilities we have. In the second quarter of 2022, DDoS attacks were relentless. The number of DDoS attacks that we blocked more than tripled compared to the second quarter of 2021. Not only are DDoS attacks mounting, but so are web application attacks, which during the second quarter increased by 24%, and bad bot attacks rose by 148%. This very active threat landscape creates a huge challenge for enterprises around the world. The midsize customers have the same cyber threats and security requirements as their large enterprise peers, yet they cannot afford the required capital investment and personnel needed to deploy and manage high-end solutions by themselves. Our cloud security as a service allows them to enjoy a high-end level of protection with fully managed services and enables us to increase our customer base and growth rates. In the second quarter, we continued to expand our cloud service footprint and capacity. We recently opened new points of presence in Taiwan and Chile. We plan to continue our global footprint expansion to penetrate new customers and geographies. We also continue to innovate on the product front; we just released a new set of crypto mitigation algorithms that block sophisticated bots that evade additional solutions. At the same time, these algorithms enable genuine website visitors to enjoy a frictionless CAPTCHA-free user experience. Our cloud application security continues to receive market recognition. Last quarter, Radware was named a Leader and an Outperformer in the Innovation Hemisphere of GigaOm's Application and API Protection Radar report. GigaOm awarded Radware the highest possible scores in key criteria categories, such as rule bundles, AI enhancement, API discovery, data leak protection, and bot management. Additionally, Quadrant Knowledge Solutions named Radware the leader in its SPARK Matrix for DDoS Mitigation report. With comprehensive technology and customer experience management, Radware received the highest combined ratings for technology excellence and customer impact, making it the leading vendor overall. I would like to share some of the key wins we had in the quarter. For instance, we signed a large DDoS deal with an IT services and web hosting company. They experienced multiple high volumetric attacks that were not blocked by their incumbent solution, alerting them that they needed more comprehensive and robust protection. Our solution is blocking massive attacks at this customer's site daily, automatically and without any intervention from their staff. During the quarter, we also expanded our business with one of the world's leading software and SaaS companies. This customer is building a new Internet Gateway Infrastructure and chose our hybrid cloud DDoS protection to protect it. We saw another large deal this time for our bot management solution with one of the largest financial services companies in South America. This customer has been suffering for a long time with outages caused by sophisticated and massive bot attacks. This deal was done with our partner Azion, a leading edge CDN provider in the region. To recap, we've been building a leading comprehensive portfolio of data center and application security solutions. We are investing in our strategic cloud initiatives to bring our solutions to a broader set of enterprise customers around the world. We are a strong and healthy company in terms of financials and well-diversified in terms of customers and geographies, enabling us to overcome macro challenges and deliver sustained revenue growth with profitability. With that, I would like to thank our customers, shareholders, and employees for their confidence and trust they place in Radware. I will now turn the call over to Guy.

Guy Avidan, Chief Financial Officer

Thank you, Roy, and good day, everyone. I'm pleased to provide the analysis of our financial results and business performance for the second quarter of 2022 as well as our outlook for the third quarter of 2022. Before beginning the financial overview, I'd like to remind you that unless otherwise indicated, all financial results are non-GAAP. A full reconciliation of our results on GAAP and non-GAAP basis is available in the earnings press release issued earlier today and on the Investor section of our website. Second quarter 2022 revenue grew 8% year-over-year to $75.1 million, compared to $69.7 million in the same period of last year. On a regional breakdown, revenue from the Americas in the second quarter increased to $29.5 million, representing 6% growth in Q2 2022 compared to Q2 2021. The growth rate remains the same at 6% when we compare the revenue of the Americas over the trailing 12 months. In the last week of the quarter, we saw lengthening sales cycles in some of our large enterprise customers, which affected our growth in the region. EMEA had another strong double-digit revenue growth in the second quarter, reaching $29.7 million, representing 24% growth year-over-year, consistent with the longer-term trend represented by the 27% growth in trailing 12 months. APAC revenue was $15.7 million, a decrease of 10% compared to Q2 2021. The long-term trend in APAC represents a modest 1% increase on a trailing 12 months basis. The Americas and EMEA account for nearly 40% of total revenue, and APAC accounts for the remaining 21% of total revenue. I will now discuss expenses and profits. Gross margin in Q2 2022 was 83.3% compared to 82.3% in the same period in 2021, an expansion of 100 basis points. Our gross margin improvement is mainly the result of the complete integration of Security-Dam, partially offset by higher costs related to cloud infrastructure and supply chain. Operating expenses in the second quarter of 2022 were $54.1 million, representing an increase of 11% compared to the same period in 2021. The increase is predominantly due to additional R&D headcount focused on our cloud and Hawks initiatives. The full impact of the Security-Dam integration and increased travel costs due to COVID affected operating income, which was $8.5 million compared to $8.8 million in Q2 2021. Last quarter, we shared with you the new structure of Radware, which consists of the core business of application delivery, application and data center security, and cloud security as a service, and the Hawks business which comprises of SkyHawk and EdgeHawk. Radware's adjusted EBITDA for the second quarter was $10.5 million, which includes the negative $2.1 million impact on adjusted EBITDA of the Hawks group. Earnings per diluted share for the second quarter of 2022 was $0.18 compared to $0.19 last year. Turning to the balance sheet and cash flow items, deferred revenue this quarter increased by 18% over Q2 2021 to $187 million, and ARR grew by 10% over the second quarter of 2022 to $195 million. We generated strong cash flow from operations in Q2 2022, which totaled $31.5 million compared to $8.8 million in the same period of last year. Cash flow from operations was favorably impacted primarily by strong collections, as reflected in a decrease in accounts receivable and an increase in deferred revenues. During the second quarter, we repurchased shares in the amount of approximately $18.1 million and ended Q2 2022 with approximately $442 million in cash, bank deposits, and marketable securities. I'll conclude my remarks with guidance. As Roy mentioned earlier, while the current global macroeconomic environment poses some uncertainties, we expect cybersecurity spending in our domain to remain resilient in the long term. However, we're witnessing longer sales cycles among large enterprise customers. Therefore, we choose to take a more prudent approach in the short term. We expect revenue for the third quarter to be in the range of $73.5 million to $75 million. Given our long-term positive view on the market and our opportunities, we continue to invest in infrastructure and R&D in order to capitalize on these future opportunities. We expect our operating expenses to be between $54.5 million and $56.5 million. Given all these trends and developments reviewed earlier, we anticipate Q3 2022 diluted earnings per share to be between $0.15 and $0.18. As a result of the expected revenue for the third quarter, we are forecasting 6% annual revenue growth for 2022.

Operator, Operator

We will now take our first question from Alex Henderson with Needham.

Alexander Henderson, Analyst

Great. Thank you very much. Hey, guys. I was hoping you could talk about a couple of issues. So first one was in the quarter, it looks to me like you would have had earnings about $0.04 higher had it not been for the currency translation hit in the quarter. First off, is that right? And then second, as we look forward, can you remind us how you’re hedged and what your approach to the shekel is at this point? Obviously, you’ve seen a very significant move in the exchange rates over the last pretty much since the war started in Ukraine.

Guy Avidan, Chief Financial Officer

So, hi, Alex. So I will start actually with the second part of the question. So we already hedged from the first half, let's say the middle of the first half of the year. So the FX news really regarding the shekel versus the U.S. dollar didn't impact us a lot when you look at the non-GAAP reporting. However, you can compare financial income from GAAP and non-GAAP and then you can see the impact of the new Israeli shekel. We already hedge for the beginning of 2023. So what was the first part of the question?

Alexander Henderson, Analyst

So your hedge... yes, just going before you get off of that, your hedge…

Guy Avidan, Chief Financial Officer

Partially mid-2022.

Alexander Henderson, Analyst

So mid '22 to when? Mid '23?

Guy Avidan, Chief Financial Officer

Mid '23, but it is partially. It's not 100% hedge.

Alexander Henderson, Analyst

Partially. Okay. If the exchange rate stays where it is, how would that impact your OpEx costs? How much would you save on a full year '23, if the exchange rate stays at the current levels?

Guy Avidan, Chief Financial Officer

It's supposed to go down. More than 100 basis points. I'm saying …

Alexander Henderson, Analyst

So you would save a 100 basis points on OpEx?

Guy Avidan, Chief Financial Officer

Again, if the FX stays as it is today, we expect to reduce, let's say, OpEx based on the same headcount as of today, more than 100 basis points in 2023.

Alexander Henderson, Analyst

That's what I was looking for. Thanks. Going back to the operational aspect of your business, where you guys have been making a pretty, pretty aggressive play to sign up a lot of partnerships. A lot of those partnerships are in the early phases of ramp. Generally speaking, it takes a long time for them to go from concept signing a contract to impacting your revenues. In this environment, does that process get stretched out? Because those companies are looking at the macro and thinking, do I really need to drive this business forward? Or can I slow that down a little bit? How do we think about all of these programs? Because it's been a big piece of the investment thesis that all of these partnerships would ramp into a meaningful contribution over time?

Roy Zisapel, President and CEO

Yes, I think it varies. Partnerships that are more focused on natural reselling might be more inclined to minimize future investments and adopt a conservative approach. On the other hand, partnerships leaning towards the MSSP side or even CDN are seeing an opportunity to expand their presence and market share with customers. For instance, some partners involved in bot management and many others in the MSSP space are demonstrating considerable activity. As they increase their share of wallet with customers, they can emphasize that security is now a fully managed service at a high level, rather than requiring dedicated operational and capital expenditures. So, it really depends on the partnership, but some are performing very well, and we intend to keep investing in them. They have helped us acquire some valuable new clients in Q2. It's growing, it's still early, but we see potential there.

Alexander Henderson, Analyst

Similar … obviously, the Cisco relationship is an important piece of the puzzle. And you've had Cisco unable to get the parts necessary to ship systems, but sitting on essentially 40% of four-quarter revenues, product revenues and backlog, does that impede the timing of when they ship your product? So with those products, how do we think about their backlog and your realization of revenues into that account because it's a non-material PC business at this point?

Roy Zisapel, President and CEO

The Radware software that operates with Cisco hardware, such as the Firepower Firewall, depends on the firewall being shipped for us to achieve our results. However, there is a silver lining to the supply chain challenges we are facing with the appliances. This situation is prompting Cisco and our other partners to deepen our collaboration in the cloud sector. Consequently, I anticipate that Cisco will become more engaged with our cloud DDoS and cloud WAF offerings due to their current shipping limitations with firewalls. It's still early to draw definitive conclusions, but we will keep you updated in future calls. Additionally, we have initiated new programs with both Cisco and Check Point focused on cloud solutions.

Alexander Henderson, Analyst

Great. I will cede the floor. Thank you.

Operator, Operator

Your next question comes from Tavy Rosner with Barclays.

Chris Reimer, Analyst

Hi, this is Chris Reimer on for Tavy. Thank you for taking my questions. I was wondering if you could give any further color on gross margins and what's contributing to the expansion we're seeing there?

Roy Zisapel, President and CEO

We mentioned that we grew around 100 basis points to a point of 83.3%. Some or most of the growth is attributed to the acquisition of Security-Dam. Having more scrubbing centers and WAF spread across the globe allows us to achieve higher gross margin.

Chris Reimer, Analyst

And how confident are you in the pipeline through next year, especially considering the macro headwinds, if they persist and considering if the customer behavior changes longer than you expect?

Roy Zisapel, President and CEO

I think in my comments, I've mentioned that we took that into account in our forecast as much as we can at this point. I would like to draw attention to the growth in our ARR. The annual recurring revenue is now getting close to $200 million. And with that, the increase in deferred revenue obviously gives us confidence as an early sign of future growth. At this point, we were quite consistent in previous quarters around 8%, 9%; this quarter even 10%. But let’s call it the 7% to 9% CAGR that we were alluding to as the growth rate of the company, I think it's well backed by the ARR and by the deferred revenues that are future looking. Together with that, our pipelines today are at record levels, some of it because of the delays in closing but some of it because we continue to enhance the pipeline. So looking at everything together, I think the focus we gave is well backed, and we have the ARR and deferred revenue giving us some tailwind for that. So we feel confident about it.

Chris Reimer, Analyst

Understood. Okay, thank you. That's it for me.

Operator, Operator

Your next question comes from George Notter with Jefferies.

George Notter, Analyst

Hi, guys. Thanks very much. I guess I was looking at the Americas revenue generation. It seems like it's sort of topped out a bit the last handful of quarters. I guess I'm just wondering how you guys are doing there. I know hiring has been an issue in general. Any thoughts on sort of North American contribution growth hiring, that would be great. Thanks.

Roy Zisapel, President and CEO

Hi, George. We are definitely aiming for North America to experience faster growth, and we have successfully completed our hiring goals. However, most of the new hires are relatively recent, having joined within the last three to six months, so they are still in the ramp-up phase. With the combination of this personnel ramp-up and a sharper focus on cloud security solutions, we believe we can achieve higher growth rates in North America. This remains a key priority for us.

George Notter, Analyst

And then, is there a headcount number for the company? And can you remind me how many of those new hires came from Security-Dam?

Guy Avidan, Chief Financial Officer

So, for June 30, we ended with 1,282 employees, close to 70. Actually, 69 employees came from the Security-Dam side.

George Notter, Analyst

Got it. Okay. Thank you.

Operator, Operator

Your next question comes from Tim Horan with Oppenheimer.

Timothy Horan, Analyst

Thanks, guys. Maybe just a little more color on the slowdown. Do you think it's more macro-driven, or customers are maybe just trying to figure out how to re-engineer their whole IT as they move to the cloud? Or is it supply chain driven? I guess those are the three buckets unless there's something else going on.

Roy Zisapel, President and CEO

I want to say macro because our exposure to all of that is not that high. But if I look at specifically three large deals that we had in North America, each one of them in the millions of dollar range that I can think of as prime examples of those delays. So we saw budget freezes towards the end of the quarter that I think is more macro than anything because we're talking about a very large, successful, profitable growing company. By now, that was actually released and went on. In financial services, we saw a delay in pushing investments towards Q4. In the last case of infrastructure, it's more scrutiny, more look at architecture, budgets, etc. By now, I think we have a variable for forecasting this quarter. But that’s what we’ve seen in June, beginning of July. So, definitely, some of it is heavily impacted by the macro. But those companies that we work with are the larger enterprise, the carriers, it's not a risk for their business. It's those delays, recession, budgets, scrutiny of the budget that comes into play in those times.

Timothy Horan, Analyst

And do you think the supply chain is having any impact on their decisions or your decisions or your revenue? And are you seeing any other real supply chain?

Roy Zisapel, President and CEO

I think the supply chain is not only from last quarter, we've seen it. On our end, I think we were able to navigate it really well. We increased inventory; Guy mentioned also in his remarks, we were paying more for components, we were suffering in gross margin, but we were able to supply. However, in some cases, we do see that they're building a new data center, and the switching equipment is not ready to ship in the next 6 months. They're not taking our deliverables because they have nothing to do without the underlying infrastructure. So there is some, I would say, overall delay because of the global supply chain. But that's already built into our guidance, forecast, etc., we're seeing that. I would say that’s another good reason to focus on hardware and on cloud security services. It frees us from all those delays and supply chain issues.

Timothy Horan, Analyst

Got it. And just lastly, I know you're kind of talking about the revenue growth, 7% to 9%. Will you kind of be willing to sacrifice margin expansion for a few years to make sure that you're well-positioned longer term? If we're in a weaker environment in the next 18 months, do we expect margins to be down?

Roy Zisapel, President and CEO

We might do that; at least in the short-term that's our decision to continue to invest. Over the long run, I must tell you that with the resumption of sales growth towards the 7% to 9%, I believe you would see delivery in the model. So I'm not worried about that. We want to bring back the growth towards our 7% to 9% CAGR; I think the delivery will be seen.

Operator, Operator

There are no further questions at this time. Mr. Roy Zisapel, I will turn the call back to you.

Roy Zisapel, President and CEO

Thank you everyone for attending and have a great day.

Operator, Operator

This concludes today's conference. You may now disconnect.