Tufin Software Technologies Ltd.
Q1 2021 Earnings Call Transcript

Published: 13 May 2021

[Operator:]

Greetings and welcome to Tufin’s First 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 first quarter of 2021 ended March 31, 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.

[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 well. Our first quarter of 2021 results were within our provided expectations and was typically our seasonally slowest quarter. During the first quarter, we announced our shift to a subscription model. The portion of our business that closed a subscription in the first quarter exceeded our expectation and had an impact on revenue for the first quarter. In this quarter product revenue grew 4% year-over-year and total revenue grew 1%. As we progressed on the transition to a recurring revenue model we expect the results to be more consistent and predictable on a quarterly basis. While we are still in the early stages, the transition is going well and early activity indicate a strong level of customer acceptance of the subscription model. For example, in Q1 we had subscriptions representing approximately 24% of new business bookings compared to 9% of new business bookings in Q1 of 2020. As a reminder, we define an annual target for 2021 of having one third of our total new business bookings coming from subscriptions and based on our transition plans and Q1 results we feel confident that we will meet or exceed this target.

[Jack Wakileh:]

Thank you, Ruvi. To echo Ruvi’s sentiment we are making good progress. We have a plan that we are executing on and early indications give us confidence in our strategic direction, and the effectiveness of our actions thus far in 2021. As I outlined during the last earnings call in February, we started our shift to a subscription based revenue model beginning in the first quarter of 2021. This shift will allow us to have greater predictability and visibility into our business. We are pleased with the initial response from our customers in our move to subscription.

[Ruvi Kitov:]

Thank you, Jack. As many of you know we are the security policy company, helping large enterprises manage their network policies to improve business agility, while mitigating security risk. As these enterprises embrace digital transformation, and adopt new technologies, such as Cloud, SDN, and micro services, the IT and cloud environments become increasingly complex. To counter these challenges, enterprises continue to implement additional security controls at the perimeter, in the data center and at endpoints. However, most enterprises still lack a comprehensive security policy around access. And we're seeing examples of successful attacks carried out on a daily basis. Keep in mind those are only the breaches that reach the headlines. As I mentioned earlier, the need for automation is paramount for customers. With IT departments being tasked to do more with fewer resources, Tufin’s proven track record of automating security policy, risk management and compliance across complex environments is what sets us apart from the competition. We recently saw this with a multibillion dollar IT services company that sought our help to help solve their limited visibility and lack of compliance, which was largely a result of their inefficient manual processes, and the lack of a centralized security policy. They needed to become PCI compliant and wanted to automate their network change process. But first, they had to gain visibility and establish basic reporting to stabilize their security posture. Their lack of visibility and manual approach caused many delays and errors in Tufin’s unified security policies, and out of the box PCI compliance reporting were critical for them, and ultimately help us beat the competition and win this new local. Another notable deal in the first quarter was a large global services company, which already spent close to $2 million with us in the past, and owns both SecureTrack and SecureChange, Visibility, Compliance and Network Change Automation. They were expanding into a new data center and given the return on investment with two front over the past six years, they decided to expand our two foot footprint as well and ensure that they maintain policy compliance and process automation throughout their state.

[Operator:]

The first question today is from Sterling Auty of JPMorgan. Please proceed with your question.

[Sterling Auty:]

Yes, thanks. Hi, guys. So a couple of questions from my side. First, when you look at the subscription deals that were done in the quarter, what was the overall mix of new versus existing customers that chose subscription?

[Jack Wakileh:]

Hi, Sterling, this is Jack. We had a fair mix between new logos and existing logos. I would say it's pretty much in line with the general split that we've been seeing in Tufin for the past two quarters. So no surprises I would say, bottom line, it's in line with our regular mix.

[Sterling Auty:]

Okay, great. And then how about you gave an example of a large customer, but that was going to kind of be the next question. What is the mix between large deal and small deal? So in other words, are people just kind of dipping their toe in the water? You know, on the most part are you seeing serious commitment to that subscription option?

[Ruvi Kitov:]

I certainly...Go ahead, Jack.

[Jack Wakileh:]

Yes, I'll start with and then you take it. Certainly Sterling, we have seen a wide range of deal sizes. Again, just like we normally expect in our perpetual business in the past, we certainly had six figure deals, large six figure deals being subscription. So there's no surprise there. We're seeing good reception in terms of what you call serious deals from serious customers, global 2000 customers, and we're happy with the mix of the real science.

[Ruvi Kitov:]

Hi, Sterling. I'll just add that, we're expecting large deals and a high speed like we normally do. Model transition, obviously, it's going to result in fewer mega deals, and a higher number of midsize deals. Overall, I think that's healthy because we want to have a more predictable business.

[Sterling Auty:]

That makes sense. And last question. But last question is, if you're an RC, besides just looking at the mix of bookings that chose subscription, what else should we be looking at in terms of your metrics to understand the success of the transition? And if the general spend from your customers is continuing to grow?

[Ruvi Kitov:]

So it's a good question, when you're looking at the at some of the numbers that we shared. When we look at the transition progress, we're very happy with where we are. In some ways we're ahead of the plan, we shared that 24% of new business bookings were subscription. And on the year, we're expecting that to be a third. So we're on target to meet or exceed that. And also in general, this subscription revenues when you look at subscription plus SaaS, significant growth over last year, also when I'm looking at the pipeline, a good very good percentage of the pipeline right now is subscription. So I think we're making very good progress on the transition from that perspective.

[Sterling Auty:]

Understood, thank you.

[Operator:]

The next question is from Katherine Trebek of Collier. Please proceed with your question.

[Katherine Trebeck:]

Thanks for taking my question. Can we talk a little bit about the sales cycle and productivity or sales organization? Now you've discussed that you are seeing larger deals. Is there any change in the temple of these larger deals or midsized deals? Thanks.

[Ruvi Kitov:]

Hi, Katherine. Thanks for the question. So, Ray's on board now. We feel that we've made a lot of improvements. And we're continuing to make improvements. We're focused on executing the transition well. Overall, we've rolled out a lot of incentives to the sales force. So they're very excited, but subscription, especially to new logos. And I think that's going well, overall.

[Katherine Trebeck:]

Okay, so there's no change in camp or office that, say a large financial institution might take 9 to 12 months still will take 9 to 12 months.

[Ruvi Kitov:]

Yes, the only impact I would say is, if you're looking at how we, the timing of the announcement, we announced this internally, at the end of January. So, salespeople looked at a lot of deals they had in their pipeline that might have been perpetual, started shifting them to subscription, some of those deals, we closed the subscription. Now in Q1, some of those shifted to later quarters and they are working on getting them in subscription because they're heavily incentivized to do so. Customers that might have budgeted are now changing budgets or going through new signatures, new approval process, because they had perpetual, they might have been CapEx now they're moving to OpEx, which is natural. But other than that, there's no change to deal execution or how long deals take.

[Katherine Trebeck:]

Alright, thank you very much.

[Ruvi Kitov:]

Thanks.

[Operator:]

The next question is from Saket Kalia of Barclays. Please proceed with your question.

[Saket Kalia:]

Okay, great. Hey, guys, thanks for taking my questions here. Jack, maybe just to start with you, understanding it's still early in the transition? How much of that 24% mix in the quarter was term subscription versus SaaS? And what is sort of the average duration of those contracts, sort of look like?

[Jack Wakileh:]

Hi, Saket. Sure. So we did not break down SaaS and subscription yet, I think it's early in the process. But you should think of subscription being more so much more significant than SaaS, and they think that's something we communicate in the past, talking about SaaS, growing and not comprising a big part of our business. So you think of the majority being subscription. And then in terms of subscription deals, I think we answered the size question when Sterling asked. On the other parts, like we said in the past, we expect, expect a differed mix between multiyear and single year deals in terms of duration. And this actually, what we've seen, we've seen a fair balance between multi years and single years. And when I say multi years Saket, I mean 36 months, although we had a couple of deals that were either more or less than 36. And qualitatively as well, in the deals they met our expectations with in terms of compliance versus automation. They met our plans with regards to the spread in terms of geographies and in terms of industries.

[Saket Kalia:]

Got it. Got it. That's helpful, Ruvi maybe for you. Obviously, great hire with Raymond Brancato the last quarter, but can you just maybe talk about some of the foundational steps you're taking internally, in addition to that, to set up the or the sales organization to sell subscription more actively as the year progresses. And whether that means sales incentives or comp or just any changes in the organization, just very broad base, any other changes that you're making to sort of pave the path for higher subscription next, in quarters and years to come?

[Ruvi Kitov:]

Hi, Saket. It’s a good question. So if you look at some of the investments we've made, maybe 6 months or 12 months ago, we've already started investing, we knew that we wanted to move to subscription eventually. So we started investing more and more in sales operations. We're investing in terms of infrastructure, and things like the ability to run licenses concurrently, somebody that might have perpetual license today, existing customer and they buy subscription, you want their entire system to work with something's timing out in terms of subscription, and the perpetual licensing on board. So all of that work is on-going. In terms of incentives, we're incentivizing subscription deals significantly over perpetual deals. So we've created a plan where salespeople make the most money selling subscription deals to new logos based on TCB. They follow that with selling subscription to existing logos. And the fewest, I'd say, that's the lowest comp from their perspective is selling perpetual deals. So they still make money in perpetual but they make a lot more money on subscription and especially to new logos.

[Saket Kalia:]

Got it? Very helpful. Thanks, guys.

[Ruvi Kitov:]

Thank you.

[Operator:]

The next question is from Brent Thill of Jeffries. Please proceed with your question.

[Joe Gallo:]

Hey guys, this is Joe on from Brent, really appreciate the question. I'd actually love a little color from both of you on this. But it's great that you guys are at or ahead of your plans for 1/3 bookings to be subscription for the full year. But given that, the lowest percentage was in 1Q of percentage of subscription. The second half implies sharp acceleration in revenue growth rate. So I'm just kind of curious, given that headwind from subscription, what, what gives you the confidence to kind of maintain that full year guide? What kind of visibility pipeline, any color, you can kind of get into that visibility would be helpful.

[Jack Wakileh:]

Yes, hi, Joe. So when we forecast and we guide, this is based on our plans, roll ups and pipe, like it's not only our gut feeling, but based on our roll ups and pipeline, looking into the pipeline, both elements that you raise exist. And this gives us a lot of confidence, both elements, I mean, one, the fact that we have a higher subscription mix going forward, plus, drilling given zooming in more, we're seeing more large deals coming in later in the year as subscription. So that's one component. And obviously, the second component is the fact that we have a supporting pipeline for the numbers who guide. In terms of headwinds, we said in the past that for the full year, we're looking at several million dollars, impact on total 2021. We may end up, Q1 was a good start. We may end up a little bit more, but that's a good problem to have.

[Joe Gallo:]

Okay, so but if the headwind could be more than hypothetically that revenue range might have to be lowered, which isn't a bad thing in the long term. But I'm just kind of curious why maintain that revenue range now.

[Jack Wakileh:]

We just started the transition, Joe, it's too early, we may later in the year, see that things are moving a different pace. And then just the numbers. Having started announcing in February, the move, and we're just a few months from there. I think we felt most confident than just look at it the way we evaluated the full year. And as I said, if things change we’ll update within the year.

[Joe Gallo:]

Okay.

[Ruvi Kitov:]

And hi Joe. I'll just add to that. So in general, we're comfortable with the current pipeline, we're confident in our ability to execute better than last year. We have Ray on board. We fixed a lot of the sales execution issues that we had. And also, in general, we're expecting customer spending patterns to improve in the back half of the year, as the pandemic impact is reduced in our industry.

[Joe Gallo:]

Okay, that's great to hear. And that you guys are confident, that's great. And then on the flip side, the bottom line is actually a little bit better for the full year guide, so kind of can you parse that out, you're investing for growth, you're making some changes, but then you also have a higher mix of subscription, which I would assume would be lower margins. So maybe just kind of walk us through the improvements to your guidance on the bottom line. Thanks.

[Jack Wakileh:]

Yes, sure Joe. So let's start with the impact on the gross margin. We should not expect a lot of impact, we modeled the impact in our in our guidance. And remember subscription, not SaaS, but subscription is dealt with just like perpetual deals, accounting wise on the P&L. So margins are a result of the scope of our business. But that's the only, like, accounting for subscription will not change our margins. That’s one. On the bottom line we did some cuts in 2020. I assume you're looking at 2020 as a comparison, and I think we said this in the past, we shouldn't be careful to compare to 2020. We did some cost cutting measures in May, the second quarter last year. So if you're looking, if you're comparing Q1 of this year to Q1 of last year, you can see that actually expenses are down. So what happened through 2021, towards the end of the year, we started bringing back some of those expenses. We give back salary cuts that we did earlier. So expenses have been ramping up through this year. We said and we keep saying that we believe in the opportunity. So we're doing more investments, and we're focusing on the long term. And we're focusing mainly on growth. So we're doing investments, we're growing our R&D team, growing the sales and marketing team, and we are moving ahead full speed, while being prudent with spending. So this is why we adjusted our guidance and I think if you're comparing the full year to the full year of last year, and accounting for the changes we had in 2020, you can see that we're pretty much prudent in how much we're going to cost.

[Joe Gallo:]

Okay, thanks, guys really appreciate all the color.

[Operator:]

The next question is from Andrew Nowinski of D.A. Davidson. Please proceed with your question.

[Andrew Nowinski:]

Great. Thanks, guys. So I want to ask a follow up question on the back half of your pipeline. It sounds like a lot of the pipeline, and the large deals that you have in the pipeline are coming back online, somewhat related to the opening of the economy. And as the world emerges from COVID, but I'm wondering if any of the breach activity that we've seen in the news, has actually had an impact on those deals? Or if you're seeing, more customers prioritizing policy automation, because of the breaches.

[Ruvi Kitov:]

Hey, Andrew, thanks for the question. Yes, so we're we are seeing demand for automation. And what we do that demand is strong across the board, hasn't really changed. I think, when you look at Colonial pipeline and other breaches, this is going to be hopefully tailwind for us. It's not an immediate impact in terms of in terms of demand. So we're not factoring anything like that in our pipeline. Maybe it'll have some effect. And we're hoping it will, from our perspective, but we're not banking on that. When we look at pipeline and how things have moved, I mentioned that earlier, sales people, in Q1 saw their plans, they saw the move to subscription, obviously, trying to move some deals to subscription quickly, and they're still in the process of doing that now. And that is shifting some of the pipeline that we had in Q1 and Q2 to the back half. And now when we're looking at it, we feel comfortable with the guidance that we gave, and we're reiterating it.

[Andrew Nowinski:]

Okay, thanks, Ruvi. And then my second question just on the services line, it doesn't look like you've ever really had a year-over-year decline in services, is that attributable to the shift away from perpetual? Or is there when you sell a term subscription and a SaaS solution, is there any revenue that goes into that services line? And how should we think about services going forward?

[Jack Wakileh:]

This is Jack. The flat level with services in 16 are attributable to the PS, the professional services and not to the maintenance. So the subscription does not impact the maintenance just answering this piece of your question. It's treated like I said earlier, to other questions, it's treated just like perpetual subscription resides in the books in a split between license and maintenance, just like perpetual would think of, 7030 if you like for a single year deal, think of, half half for a multiyear deal. So specifically for Q1, being flat is attributable to professional services and professional services. This is not indicative of what's happening. It's not a trend. BS is around timing of project, timing of delivering projects. Sometimes it sits on a single paperwork approval that either comes in or does not come in within the quarter. So I wouldn't say this is indicative.

[Andrew Nowinski:]

Okay, thanks.

[Operator:]

The next question is from Jonathan Ho of William Blair. Please proceed with your question.

[Jonathan Ho:]

Hi, guys. Good morning. I just wanted to maybe start with, a couple of financial questions. Is there a way for you to maybe quantify for us what the impact on revenue was for the quarter from the higher subscription mix that you saw versus your expectations and original guide?

[Jack Wakileh:]

Yes, hi, Joe. When we came out in February, we said that we're not going to guide for headwind or sheer headwind. We said that headwind for the full year is going to be in the order of several million dollars. I don't think at this point of time, we want to start going out headwind, several million dollars for the full year. This is the scope that you should be looking at. And as I said before, if this surprises us and the number is higher, it's you know, we're happy to have this problem.

[Jonathan Ho:]

Got it. And then…Oh, go ahead.

[Jack Wakileh:]

Yes, I mean, does this answer your question?

[Jonathan Ho:]

Yes, it does, it does. And in terms of your free cash flow that was very strong this quarter. Can you talk a little bit about what your free cash flow expectations are for the year?

[Jack Wakileh:]

Yes, sure. So I wouldn't be looking at quarterly cash flow at Tufin because of the seasonality or the of our business. Q1 is typically a stronger cashflow quarter for us, because of having a stronger Q4. Q4 is normally our strongest quarter. In the year, I would look at it, like you say on an annual basis, we're not capital intensive. So we should think about cash burn or cash flow in line with, give or take in line with the bottom line results, the operating results.

[Jonathan Ho:]

Great. And then just maybe one last one for me, are you seeing any pent up demand start to materialize from COVID-19 versus sort of getting back to more of a normalized cadence? Thank you.

[Ruvi Kitov:]

Hi, Jonathan, I think there's some pent up demand. But mostly, I would say just people are getting back to business getting back into normal. So, cycles are starting to normalize. I think there's more optimism. Buyers are more active. So we're seeing some effects. I'm not seeing like huge, sort of pent up demand of people that were waiting to spend a ton of money and are coming out all sudden, but people are, are now starting to prioritize things that they couldn't prioritize earlier.

[Jonathan Ho:]

Great, thank you.

[Ruvi Kitov:]

Thanks.

[Operator:]

Our next question is from Rob Owens of Piper Sandler. Please proceed with your question.

[Unidentified Analyst:]

Hey, guys, this is Justin on for Rob, maybe just digging back into the transition. I know, last quarter, you had mentioned you expect, about half of new logo business to be from subscriptions. And maybe just digging into that further, if that's still the expectation for 2021? And maybe how that's trended in the quarter? And then also, does this possibly imply an acceleration of new logo business baked into the guidance?

[Jack Wakileh:]

Yes, this is Jack. So we did say that we expect half of our subscription to come from new logo business, and we're certainly on track with this. Going forward looking at the pipeline, we think that this we're going to continue, I can say overall for the year. We're still reiterating this comment that half of our subscription income will come from new logos.

[Unidentified Analyst:]

And we're talking dollar wise.

[Jack Wakileh:]

And just to be clear, we're talking about dollars.

[Unidentified Analyst:]

Got it? Thank you.

[Operator:]

There appears to be no further questions at this time. I would like to turn the call back to Ruvi Kitov for closing remarks.

[Ruvi Kitov:]

Thank you, operator. As you heard today, while we have a lot of work to do, I'm confident that we had the right plan. And we're building the right team to deliver value to our shareholders over the course of 2021 and beyond. We look forward to updating you on our progress on our next earnings call. Thank you all for joining today. Bye bye.

[Operator:]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.