Tufin Software Technologies Ltd.
Q2 2021 Earnings Call Transcript

Published: 11 Aug 2021

[Operator:]

Greetings and welcome to Tufin’s Second Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Jackie Marcus with Investor Relations. Please go ahead.

[Jackie Marcus:]

Thank you operator, and good day everyone. Tufin released results for the second quarter of 2021 ended June 30, 2021 earlier this morning. If you did not receive a copy of our earnings press release, you may obtain it from the investor relations section of our website at investors.tufin.com. With me on today’s call are Ruvi Kitov, Tufin’s Co-founder and Chief Executive Officer and Jack Wakileh, Tufin’s Chief Financial Officer. This call is being webcasted and will be archieved on the investor relations section of our website. Before we begin, I would like to remind everyone that any statements made in today’s webcast that express a belief, expectation, projection, forecast, anticipation or intent regarding future events and the company’s future performance may be considered forward-looking statements as defined by the Private Securities Litigation Reform Act. These forward-looking statements are based on information available to Tufin’s management team as of today and involve risks and uncertainties, including those noted in this morning’s press release and Tufin’s filings with the SEC. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those projected in the forward-looking statements. Tufin specifically, disclaims any intent or obligation to update these forward-looking statements, except as required by law. Please note that a reconciliation of any non-GAAP number to the most directly comparable GAAP number can be found in the tables of our earnings press release located in the Investor Relations section of our website. With that, I’d like to turn the call over to Tufin’s CEO and Co-Founder, Ruvi Kitov. Ruvi?

[Ruvi Kitov:]

Thank you Jackie. Good morning everyone and thank you for joining us today. I hope that all of you and your families are safe and doing well. I am pleased to report that Tufin delivered a strong second quarter with 12% year-over-year revenue growth through model transition for also exceeding our guidance for the top and bottom line. Our revenue beat was largely driven by 23% year-over-year growth in product revenues. Our financial results in the quarter are indicative of the strength of our team, our product, and our ability to generate a significant return on both time and human capital for our customers through automation and improved security. We finished the second quarter with $25.7 million in revenue, with subscriptions representing approximately 40% of new business for the first six months, which puts us well ahead of our target at 1/3 of all new business bookings being sold subscriptions in 2021. 61% of the bookings from new logos in the first six months were subscription compared to our target of reaching 50% by the end of 2021. I'm encouraged by our progress thus far in 2021 and I believe that we're well positioned for the second half of the year. While we made significant progress in our business, I am also pleased with our efforts to improve our sales execution as we build on the great team that we have at Tufin. As I mentioned last quarter we have been hard at work on aligning sales and marketing teams to ensure that we're well-positioned to capture new opportunities. Our Chief Revenue Officer, Ray Brancato has made significant strides in driving these initiatives by creating a strong team with key regional hires in the Americas. Furthermore, our customers and users inspire us to drive innovation every day. And I'm pleased to report the success of our fifth annual Tufinnovate User Conferences held virtually again this year, in which we brought together nearly 1,000 Tufin customers and partners to hear about security policy automation, and our plans for the next 12 months. The second quarter was a marked improvement for us, and provides proof that our shift from a perpetual to subscription license is working both for us and for our customers. Before I discuss some of our recent customer wins I'd like to now turn the call over to Jack for a deeper discussion of our financials. Jack?

[Jack Wakileh:]

Thank you Ruvi. We're continuing to make good progress on our initiatives, and we remain on track to successfully execute on our transition. As many of you know, we started or shift to a subscription based revenue model beginning in the first quarter of this year. And as I mentioned before, this shift will allow us to have greater predictability and visibility into our business. To remind everyone on the call today, we will be providing ARR on an annual basis since it may have variability between quarters at our scale. As Ruvi mentioned earlier, the indications from our sales teams combined with our progress on the percentage of new business bookings coming from subscription gives us confidence in our ability to achieve our annual guidance and long term goals. Let's discuss the second quarter results. Total revenues of $25.7 million in Q2 of 2021, which is 12% of Q2 of last year. Product revenue increased 23% year-over-year to $9.7 million while maintenance and professional services revenue was up 6% to $16 million year-over-year. On a geographic basis, Americas represented 46% of all revenue. Europe represented 46% and 8% came from Asia-Pacific. On a sector basis financial services and insurance providers represented our strongest industries during reporter with secondary strength from business services and consulting customers. The complex nature of these businesses necessitates a complete solution that is driven by automation. Moving from our general expenses, I will discuss the results based on non-GAAP financial measures. Gross profit for the second quarter was $20.5 million or 80% of revenue compared to $18.7 million or 81% of revenue in Q2 of last year. Our operating costs for the quarter totaled $8.1 million, up 21% compared to $23.3 million in the year ago period. R&D expense for the second quarter was $9.2 million, or 36% of revenue compared to $6.9 million, and 30% of revenue in Q2 of last year. Sales and marketing expense for Q2 was $13.8 million, or 53% of revenue, compared to $12.6 million, or 55% of revenue in Q2 of last year. G&A expense for Q2 was $5.1 million or 20% of revenue, compared to $3.7 million, or 16% of revenue in Q2 of last year. I would like to remind you that in Q2 of 2020, we took some cost reduction actions, which impacted our operating expenses in Q2, and Q3 of last year. Following that, we saw a continuous improvement in the business in the third and fourth quarters of last year, and resumed hiring again and return to pre-COVID compensation levels. Operating loss for Q2 was $7.6 million, compared to an operating loss of 4.5 million in Q2 of last year. Net loss for this quarter was $8.2 million, compared to a net loss of $5.2 million in Q2 of last year, and net loss per share basic and diluted was $0.22 for Q2 this year, compared to $0.15 in Q2 of last year. Turning to the balance sheet and cash flows. During the quarter cash flow from operating activities was a net outflow of $11.2 million versus $11.7 million in the year ago quarter. We closed the quarter with total cash, cash equivalents, restricted cash, and marketable securities of $101.9 million, down $2.1 million from the beginning of the year. We believe we remain well positioned to continue to pursue the strategic transition to subscription while continuing to serve our existing customer base. We are managing our cash well and are actively investing in both our people and the areas in which we believe will help expand our suite of products and services in the coming quarters. Turning now to guidance for the third quarter and full year. For the third fiscal quarter of 2021 we expect total revenue to be between $23.5 million and $27.5 million and non-GAAP operating loss to be between $10.3 million and $6.9 million. For the full fiscal year of 2021, we expect total revenue to be between $105 million and $113 million and non-GAAP operating loss to be between $30.4 million and $23.6 million. We're continuing to improve our business operations and efficiencies. And I'm happy to see our continued progress in reducing our expected operating expenses for the year. With that, I'll turn the call back over to Ruvi. Ruvi?

[Ruvi Kitov:]

Thank you, Jack. As all of you have seen recently, hackers and bad actors have not wasted any time going after organizations of all sizes in various ways. The most visible being the recent ransomware attack and and its customers. The security challenges that large enterprises and organizations face are only getting worse, and malicious actors are well-positioned to attack any company. While this is the current state of security in parallel, many large companies are looking for ways to achieve digital transformation and accelerate their transition into the cloud. In the second quarter, we released Tufin Orchestration Suite R21-2 which contains significant new capabilities around automation in software defined networking and access decommissioning. With version R21-2 we now have deeper integration with VMware, enabling VMware to from customers to automate more types of changes in their environment, and to troubleshoot connectivity problems that they encounter. We've also added automated access decommissioning that streamlines the process of removing underlying rules and network objects once access is no longer deemed appropriate or necessary. Decommissioning access is typically a complicated task that requires visibility into the implications of potential changes, to avoid breaking valid connections and disrupting applications. Tufin customers now have a controlled and well documented method of removing access, ultimately minimizing the risk of outages while maintaining the highest security posture. We also released another app on the Tufin marketplace called the Rule Lifecycle Management app. This app simplifies and manages the rule review and recertification process by automatically identifying expiring or expired network rules and mapping them to their owners, enabling a simple recertification or decertification of access. I would now like to highlight some of the interesting deals that we saw on the quarter. The first one was a large financial institution, which is Tufin for several years now. Last year, they expanded from secure track into automation with secure change, including an integration with ServiceNow for their workflow. We've been able to successfully automate their network change process. And that resulted in their expansion to use secure track insecure change last quarter, to also monitor and automate changes in their cloud environment, as well as an initial purchase of secure app to manage access control between applications. Another significant deal this quarter was with a large bank that sought our help to solve their limited visibility, and lack of control. They had a firewall vendor that was failing, and caused a large outage across the entire organization. And they were in the process of migrating to another firewall vendor. They were also using to Tufin competitor that was not providing enough value. We were able to demonstrate our ability to manage policies across their entire infrastructure, and even help them safely migrate from one vendor to another. They're key needs where the ability to automate network policy changes across a complex and fragmented infrastructure, as well as in their cloud environment. This is both a new logo and a subscription win for Tufin. In addition during the quarter, we closed a unique opportunity with a large financial services technology company. Their team lacked visibility and could not manage their network infrastructure efficiently and needed a solution that was both cloud based and on-premise. The customer ended up purchasing secure track insecure change. And what's interesting about this customer is that they are a fast growing company with about $500 million in annual revenues and several 1,000 employees clearly below the global 2,000. Tufin was found enclosed by our inside sales team in four months for an annual subscription of over $200,000. It underscored the potential that we have beyond the global 2000 while we are very focused on the high end of the market in terms of functionality and scalability. More than 1/3 of our business today comes from accounts below the global 2000. So we believe there is a significant opportunity for Tufin in the mid market as well. Before we open the line to questions, I want to reiterate that I'm happy with our progress on our stated goals. The heightened state of awareness around cyber security has magnified the importance of using software from clear market leaders that have the resources and capabilities to protect our own IT operations. Our product stand up to the challenges of today, and the potential threats of tomorrow. We will accomplish our goals with the support of our dedicated employees, customers, investors, and other value stakeholders. And I'm excited about the next chapter of Tufin as a recurring revenue company. I now would like to turn the call over to the operator to open it for questions. Operator?

[Operator:]

Thank you. At this time, we will be conducting a question and answer session. Our first question comes from Katherine Trebek with Collier. Please proceed with your question.

[Katherine Trebek:]

Thanks for taking my question and nice quarter. Yes Could you elaborate more on the mid market? Sorry can you hear me?

[Ruvi Kitov:]

Sure.

[Katherine Trebek:]

Yes, elaborate more on the mid market and how your sales plans are to reach that market. And then a little bit on are these new regional managers hired in the last quarter have been hired over the last six months since Ray's been on board? Thank you.

[Ruvi Kitov:]

Hi, Katherine. Thanks for the question. So we've so far been focused primarily on the global 2000. We have sales managers with named accounts. And we have an inside sales team that's been handling the mid market, but frankly, it's quite small team. And we haven't invested a lot in. And so that's an area of growth for us moving forward. And on the new sale managers, we replace some of the sales leaders in the U.S., and we're happy with the people that we have on board right now. And its part of the changes that Ray's been instituting since he came on board.

[Operator:]

Thank you. Our next question comes from Adam Borg with Stifel, please proceed with your question.

[Adam Borg:]

Hey guys, thanks so much for taking the question. Maybe Ruvi just for you. And you talked a little bit about this in the prepared remarks. But I guess just given the threat landscape and just the overall increasing fragmentation of networks, I guess, in your conversations with customers and prospects, where does security policy management automation really fit in terms of other competing cyber security priorities? Thanks so much.

[Ruvi Kitov:]

Hi, Adam. Thanks for the question. So I think security policy management and security policy automation is high and its priorities and we're seeing a return to interest levels that we've had pre-COVID at this point. So there's a lot of need for what we do especially as people want to automate their change process. And to realize that it's very difficult to manage their network effectively without something like Tufin. Obviously, we don't solve every cyber security challenge, and people have various priorities, but we see the need for what we do coming back after obviously, a difficult year in 2020 the demand is now back to where it was pre-COVID levels.

[Adam Borg:]

That's really helpful. And maybe just a quick follow up. It's been great to see that like a handful of apps are so that you released on the marketplace. And I was just curious kind of which of these apps do you think we should focus on in terms of where you think you're seeing the most interest over the course of the next 6 to 12 months? And if you can just remind us what kind of uplift these apps provide from an ARR perspective, relative to call it a baseline search? Thanks again.

[Ruvi Kitov:]

Sure. So I think there's various apps that we released on the marketplace. The one that probably has the biggest near term potential is the VMA, the Vulnerability Mitigation App, which competes with some of the things that other vendors have done in the space. So it's an entry, our entry into looking at vulnerability management and prioritizing vulnerabilities. A lot of customers have asked us to add that capability and now we've ended up with this app. Now, overall, all these apps, the ones that are paid for, they're all on an annual subscription basis. So they're all additive from an ARR perspective. And we have a lot of interest from customers so far.

[Operator:]

Our next question comes from Shaul Eyal with Cowen. Please proceed with your questions.

[Shaul Eyal:]

Thank you. Hey, guys. Good morning. Good afternoon. My first question Ruvi or Jack is about hiring. How did your hiring numbers during the past six months stacked against your initial plans? Are you in line, ahead or behind? And I have a follow up.

[Ruvi Kitov:]

Hi Shaul, thanks for the question. So far it's been a mixed bag. We're hiring aggressively. It's hard to find talent. There is so many cyber security companies that are trying to hire people right now. So it's been challenging, but we've been meeting our numbers, but it's not easy.

[Shaul Eyal:]

Got it. And maybe on top of that, what is maybe the one or two points worthy of note that Ray is doing differently since joining Tufin that wasn't present prior to his coming on board?

[Ruvi Kitov:]

So there's a lot of things that Ray's focused on. I think what we're doing is more than anything else is the alignment between sales and marketing to drive better go to market processes, the programs, the campaigns or sales plays, we're simplifying and improving some of the processes. There's an executive sponsorship program to engage with key decision makers. So it's a variety of things. It's not one or two things that really make a huge difference, but it's many different initiatives that we're driving with Ray and some of the other executives at Tufin.

[Shaul Eyal:]

Got it. Good job. Thank you Ruvi.

[Operator:]

Thank you. Our next question comes from Jonathan Ruykhaver with Baird. Please proceed with your question.

[Jonathan Ruykhaver:]

Congrats on the improved execution. Ruvi I'm wondering if you can talk about some of the issues that you had last year just in terms of qualifying deals, obtaining financial commitment, and just some of the improvements you've seen along those lines? What has changed and how you see that played out as we go into the into the rest of the year?

[Ruvi Kitov:]

Jonathan, thanks for the question. So overall I think there's just an improvement of the attitude of buyers, people are opening up. They are opening new projects. They are coming back with projects that were frozen. The sales cycle is shorter. So we're seeing the processes get faster. The time that it takes for various stages in the sales process is shorter than it was before. So we've learned how to do this virtually. In some cases we're meeting people physically, but now customers are coming back in terms of demand to where they were before. And the processes are no longer taking as long as they did in 2020. I don't know if that answers the question fully or if you wanted to focus on other areas.

[Jonathan Ruykhaver:]

Yes. That's helpful. And maybe you can give us some color on what you're seeing in terms of how renewal rates are trending and then as I think important would be the maybe some color as a percentage of new business that you see coming from subscription term in the quarter how that's progressing?

[Jack Wakileh:]

This is Jack. So the first part of the question renewal trends, there are no changes, we've been saying we're above 90% renewals. And we're in line with what we've been saying. And that's going on at the same levels. For the second question, we will go back to the beginning of the year, we said that we're targeting 1/3 of our business to come from subscriptions. We gave the updates in the first quarter and now in the second quarter, we're hearing that we're around 40% of our new business coming from subscription on a comparative level and that's for six months. So looking at the first half, we're well ahead of this goal and we're very happy with this. We also share that earlier in the year we shared that we're expecting to have at least half of our new logo business coming from subscription. So I can share that will also on target on this metric as well.

[Jonathan Ruykhaver:]

That's helpful. And that just say the final quick question I have is just large deal activity, you guys often benefit from seven figure transactions and was quite healthy. Can you just touch on that dynamic whether that influenced that growth?

[Ruvi Kitov:]

Sure. So, we have seen a return on some large deals. It's still not at the level where was if you look at the first couple of quarters of 2019. But there is several factors that are influencing large deals from our perspective and part of it is the move to subscription. So when we're looking at deals that previously would have closed as a perpetual deal, some of those deals are now closing as one year deals. So obviously, there is, if you think about it, some headwind in terms of the large deals, but we've had seven figure deals this quarter. We had quite a few six figure deals. So we're seeing more large deal activity. And we expect moving forward, fewer large deals as we move to subscription because the SP is going to go down as we're looking at one year deals.

[Operator:]

Thank you. Our next question comes from Jonathan Ho with William Blair. Please proceed with your question.

[Jonathan Ho:]

Hi, good morning, I just wanted to understand a little bit better the guidance that you provided for Q3 and Q4 and sort of the linearity that's implied there. It seems like you raised guidance for the full year. But I think the Q3 guidance was maybe a bit below the consensus. And so it was this issue of timing. Just want understand sort of how the pattern maybe deviates this year relative to last year?

[Ruvi Kitov:]

Hi Jonathan. Sure. So Q3 we didn't guide to Q3. So analysts had all sorts of numbers in there. From our perspective, we have a very regimented process of how are we guiding. It's based on our forecast. And we're comfortable with the guidance for Q3 and for the year. And in general, when we're looking at Q4 and the entire year, the guidance is based on an annual outlook and pipeline. Q4 is always our biggest quarter. So at this point, there is all sorts of factors. When we look at Q4, there is large deal closes, the mix of multi year versus one year. So we're comfortable with the guidance that we gave for both Q3 and the year.

[Jonathan Ho:]

So there's no deliberate change or something that's, from an expectation standpoint shifting business more to the fourth quarter than the normal. I just want to verify that.

[Ruvi Kitov:]

Yes. That's right.

[Jonathan Ho:]

And then, in terms of it gets to the perpetual the subscription shift, it seems like you're executing well ahead of plan here. Can you give us a sense of if you originally were targeting sort of 50%? Like, how do you think about sort of the opportunity set now that you're tracking well ahead of that expectation? And are you sort of shortening the timeframe to reach the end goal at this point?

[Jack Wakileh:]

Hi Joe, this is Jack. So originally, we shared when we move to subscription we shared that we're looking at 11, 12 quarters of transition to be able to have the vast majority. We said that we don't expect 100% transition. Some of our customers will still want to consume perpetual basis, but no, the very vast majority will and going to be a this space, beating our internal KPIs on this transition. It can be shortened by couple of quarters and the impact is going to be felt in growth. So once we have a substantial part of our business being subscription, we can see thereafter accelerated growth driven by the new model. So this is one impact that can happen, and it can happen instead of like 12 or more quarters out. It can happen earlier. But it's difficult to see it's only two quarters. We are beating this number two quarters. It's a little bit early to say if there's going to be a trend, like we're like 20% ahead when measuring those KPIs, if this 20% is consistent and persists, then you should take quarters out of the plan and expect the transition of the vast majority in 9 to 10 quarters, but it's early to tell two quarters only, and hopefully this is going to be continued and even overachieved.

[Jonathan Ho:]

Fantastic. Congrats on the strong quarter. Thank you.

[Operator:]

Thank you. Our next question comes from Rob Owens with Piper Sandler. Please proceed with your question.

[Rob Owens:]

Thanks for taking my question. With the accelerated shifts in subscription can you maybe help us a little bit with what that revenue headwind looks like, on a year-over-year basis? if e were at the same levels of perpetual that you were in June of 20, what the growth might have been?

[Jack Wakileh:]

Yes. Rob, hi, this is Jack. We did not share the impact, or actually, the headwind at the beginning of the year, we said it's difficult for us to calculate it. And still now only two quarters into this transition actual quarter and happen to the transition, it's difficult for us to calculate the headwind for the full year. There are a few factors, that's going to impact the headwind. The pace of the transition to subscription obviously is being the main factor. But then we also have the mix of multiple deals versus single year deals. But we expect less to no headwind when we close multiyear deals, and we had substantial most of your deals for the first half of the year. We said, we have a balanced, fair share of multiyear deal we feel like out of those also these variables, makes it difficult for us, at least as we have started only this year to create the mechanism or the formula for calculating the headwinds, this is why we did not share it. Nevertheless, we did say that we're expecting an impact of several million dollars for the full year 2021 coming from the transition.

[Rob Owens:]

Great, I understand their term, their success, there's a lot of different moving components. But if you can unpack a little bit relative to the balance sheet and deferred revenue, why it declined more, I guess, Q2 versus Q1 this year, as compared to last year, especially in that short term category, we just assume that with the shift to subscription, we would see more carved out to the balance sheet. So maybe help me with some of those mechanics on the deferred revenue line? Thanks.

[Jack Wakileh:]

Yes. This is a good point. I think it's good to clarify that you should remember that subscriptions accounted for just like a perpetual view in terms of accounting. We apply 606, which requires full recognition of the product, the license part and only the support part of the subscription goes to deferred revenue and is recognized over time. So subscription versus perpetual, there is no change in accounting. It contributes to the deferred in the same mechanism that a perpetual contributes, obviously, subscription deals think of year deals are going to be smaller. So that's the headwind question. But in terms of accounting, it has the same mechanism of impacting license recognized revenue versus deferred revenue. So that's not a change, right. You're referring to SAS, where you should see a bigger impact on deferred revenue. And to the other question of why did decline so it ideally decline we did not share full numbers, but when you think of deferred revenue, if we have slowly had a slow year in 2020, so obviously, it has an impact on the deferred revenue coming from services that added to the deferred revenue. And the other moving factor is going to be the PS. PS can fluctuate between quarters, it depends on delivery of PS. And this can be a lumpy between quarters and have impact on before turning.

[Rob Owens:]

Alright, thank you for the color.

[Operator:]

Thank you. Our next question comes from Saket Kalia with Barclays. Please proceed with your question.

[Saket Kalia:]

Guys thanks for taking my questions here. Jack, maybe first for you. You mentioned sort of multi year versus annual deals. Can you just talk about maybe how different the multiyear mix was this quarter versus your expectation? And secondly, just remind us how the rev rec there works on a multiyear deal versus an annual deal? Sorry, there's a lot there. Does that make sense?

[Jack Wakileh:]

It does. It does make sense. I am happy to address both pieces. So on the mix itself, we're just giving you color we're in when you're raising it in dollars, money wise, around 60%, 40%, single versus multiyear, those are wise 60%, being single 40% being multi year. Obviously, for counting deals, because of the large deals a multiyear deal, then it's much more biased to single year deals when you're counting deals and that is right. So that's the first part I hope discovers because you're on what you're asking. And then you're asking about how this hits the book in terms of revenue, how is it recognized? So maybe I'll give you an example, if a single year deal is recognized just as a perpetual deal based on 606 think of the $100 deal subscriptions single year, you will see approximately 70% going to licensers, 30% going to services maintenance. And that's when we recognize over the term of the contract, if that's going to be a three year deal, a $300 deal versus 100, then the $300 deal is going to be recognized again, just like a multiyear perpetual deal, the multiyear maintenance in a perpetual deal, you're going to see out of the 300 around 45% going into the license into the product, and 55% going into the maintenance. And that's going to be recognized over the 36 months.

[Saket Kalia:]

And maybe just a clarification there is very helpful, by the way. But just to clarify, how did that 60/40 mix, sort of compare versus your expectation of the quarter, meaning how much because I mean, the revenue came in above the high end of the guide, which is great to see. I'm just curious if the multiyear mix here was maybe one of the factors to consider.

[Jack Wakileh:]

Against your plans. I think we showed this in the past Saket, we said that we're expecting a balance of 50/50. So it's a little bit ahead, but it's not. It's double what we expected.

[Operator:]

Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. I will now turn the call over to Ruvi Kitov for closing remarks.

[Ruvi Kitov:]

Thank you, operator. As I mentioned in my remarks we are achieving our targets and continue to execute on our strategic objectives. We believe our products and services stand up against today's and tomorrow's challenges and rise above the competition. We look forward to updating you on our progress on our next earnings call. Thank you all for joining today.

[Operator:]

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.