Tufin Software Technologies Ltd.
Q3 2020 Earnings Call Transcript

Published: 12 Nov 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Tufin Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to your Speaker today, Ryan Burkart, Director of Investor Relations. Please go ahead.

[Ryan Burkart:]

Thanks, operator. Good morning, everyone, and thank you for joining Tufin's third quarter 2020 financial results conference call. With me on the call today is Jack Wakileh, our Chief Financial Officer; and Ruvi Kitov, our Chief Executive Officer.

[Ruvi Kitov:]

Thanks, Ryan, and good morning, everyone. Thank you for joining us today. I hope that all of you and your families are safe and healthy. I'm happy to share that our business continued to improve in Q3 sequentially. Q3 revenues were $25.6 million, flat compared to revenues in Q3 of 2019, but up from Q2 of 2020 by 11%. Product revenues in Q3 were $10 million, up 27% sequentially and down 13% year-over-year. Product revenues have improved significantly from the COVID impacted results that we had earlier in the year. We are particularly encouraged to see moderate growth in product revenues from new logos, which had been under some pressure in the first half. We continued to see strong renewals, and total revenues are now back at the pre-COVID levels from Q3 of 2019, which is an important milestone on our path to sustainable long-term growth. Operating expenses were lower year-over-year in Q3 due to actions that we took earlier this year and an overall lower cost environment related to the pandemic. Our balance sheet remains strong, and we ended Q3 with $104 million in cash and marketable securities. Throughout the quarter, we continued to refine and improve our sales processes, as we discussed in recent quarters, to enable the business to scale up over the next few years. Overall, I'm pleased with our Q3 results in light of the challenging environment.

[Jack Wakileh:]

Thanks, Ruvi. Good afternoon, everyone, and thanks for joining us today. We had a good third quarter. Our business continues to recover from the depressed levels we saw in the first half of this year and realize the benefit of lower cost due to both environment and actions we took to reduce costs earlier in the year. At the same time, we're maintaining a prudent level of investments to prepare the Company to scale up over the next few years and capture the large greenfield opportunities in our markets. With that, let's discuss the quarter. Total revenue was $25.6 million in Q3 of 2020, flat compared to Q3 of 2019, but up 11% sequentially. Product revenue decreased 13% year-over-year to $10 million, while our maintenance and professional services revenue grew 11% to $15.6 million. Looking at the geographic mix of Q3 revenue, the Americas represented 56% of our revenue, Europe represented 40% and the remaining 4% came from Asia-Pacific. Moving to margins and expenses, I will discuss our results based on non-GAAP financial measures. Non-GAAP numbers exclude stock-based compensation expense of $4 million for Q3 2020 and $2.6 million for Q3 of last year. Please note that the GAAP to non-GAAP reconciliation can be found in the tables of our earnings press release located in the Investor Relations section of our website. Gross profit for the third quarter was $21.6 million or 84% of revenue, compared to $21 million or 82% of revenue in Q3 of last year. Total operating expenses for Q3 were $22.6 million, down from $26.1 million in Q3 of last year. Overall, operating costs were lower as we benefited from certain COVID-related savings, like no travel and more virtual events. In addition, we saw the impact of the cost reduction actions we took earlier in this year.

[Ruvi Kitov:]

Thanks, Jack. I'd like to wrap up by saying that I'm pleased with the progress we've made in the third quarter, especially on the new product front. Our business has now stabilized, and we continued to make improvements in our sales processes. Due to the actions taken earlier in the year, our costs are lower and our balance sheet remains strong, and as we benefit from the acceleration and the underlying trends of automation in Zero-Trust that I mentioned, I'm confident that Tufin is well positioned to achieve its long-term growth objectives addressing a large and expanding market. I'd like to thank our customers, our partners and our investors for their support and all the Tufin employees for their hard work.

[Operator:]

Our first question comes from the line of Sterling Auty with J.P. Morgan.

[Matt Parron:]

Hi guys, this is Matt on for Sterling. Thanks for taking the question. The first question I had was you guys launched a free offering on -- just wondering what -- have you seen any conversion from those users that are using it? And what -- theoretically, what's the update, I guess, on that front from users that are using the free tool? Thanks.

[Ruvi Kitov:]

Hey, thanks for the question. This is Ruvi. Can you clarify which app you're talking about?

[Matt Parron:]

I think you guys launched a free policy changing tool in the middle of the -- I think it was in the middle of the pandemic, but I was just -- just wondering if you guys could give us an update on that?

[Ruvi Kitov:]

Alright. Yeah. I understand that. I think you're talking about the Firewall Change Tracker. So that's going well, right. Is that what you mean?

[Matt Parron:]

Yeah. Exactly.

[Ruvi Kitov:]

Right. So we've had -- we have quite a few people that downloaded it. Using it we've had -- some of those turned into opportunities. So, people like it. It's -- it provides some of the functionality that people use on the low end in SecureTrack and for people that can't afford actually buying SecureTrack. It's a great initial tool. So for us, it's a great CD product. We're seeing customers get exposed to Tufin for the first time. So it's part of our CD strategy from this point, moving forward.

[Matt Parron:]

Great. That's very helpful. And then, just a quick follow-up. So using some of those breakouts from the geographical revenue, it looks like EMEA growth rebounded this quarter. Just wondering if you could give any more color on that and how you're thinking about the different geographies going forward? Thanks.

[Ruvi Kitov:]

Jack, do you want to take that?

[Jack Wakileh:]

Okay. Yeah, I'm going to take that. So, Sterling, geographical distribution has not changed probably for the past eight or nine quarters. We look at this cumulative as you already know. We can have fluctuations between the quarters, but so far we haven't been seeing significant fluctuations that would change the general split that we've been showing.

[Matt Parron:]

Yeah. My question was more in terms of the growth. So it looks like EMEA growth was actually positive this quarter. So I was just wondering what are you guys seeing there relative to other geographies? And how that kind of informs you going forward?

[Jack Wakileh:]

Okay. So, yeah, there is a slight growth in EMEA as you observe. It goes back with a large deals and the average size deals. So specifically, for this quarter, we talked about large deals, and we mentioned earlier that this is one of the main slowdown that we've seen in the business around last year. But those that we did close -- it happened in Q3 .

[Operator:]

Your next question comes from the line of Shaul Eyal with Oppenheimer. Your line is open. If your line is on mute, please unmute. Okay, no response from that question. We'll go to Saket Kalia with Barclays.

[Saket Kalia:]

Awesome. Hey, good morning guys. Thanks for taking my questions here. Ruvi, maybe first for you. Can you just talk about the competitive environment a little bit? I think your competitors here are largely private equity backed. So I'm curious if you're seeing this as a chance meeting the tough environment created by the pandemic. If you're seeing this as a chance to grab more market share or if anything has changed from a competitive perspective?

[Ruvi Kitov:]

Alright. So the market has always been competitive for us. So that hasn't really changed. We continued to see the usual suspects in competitive deals. Our win rates continued to be very good. That hasn't really changed now relative to 2019. And from a overall environment, I think the COVID factors are impacting us and I think they are impacting some of our competitors as well. One of our competitors raised debt recently. If you look at an opportunity to grab market share, I think the opportunity is there, and we're doing well.

[Saket Kalia:]

Okay. Got it. That's helpful. Maybe it's my follow-up for you, Jack. The cost actions earlier this year, I think have been very helpful in narrowing the operating loss. Can you just talk about whether there is any more expense reductions that we should see related to those actions, just as we modeled out? And maybe as part of that can you just touch on high level, how you're thinking about OpEx in the fourth quarter?

[Jack Wakileh:]

Okay. So maybe I'll start with the latter, Saket. OpEx for Q4 generally for Tufin, it is typically higher and this would be the case for this year as well. When we're looking at the cost reductions that we did, part of it was related to the fact that we reduced costs, proactively. Some of it was coming from the environment right, no travel, no T&E, some of it was proactively as we said before. One factor is reductions in compensation that we absorbed earlier in this year, and as we've seen Q3 improving, this actually was reversed. Initially, this was intended to be reversed to begin with. We just waited to see and get more confidence in the couple of our business. So, once this is reversed, Q4 is going to absorb higher expenses from that aspect. And then typically, Q4 is higher. As I said before, there are other expenses, commissions and end-of-year stuff that go in there. So when you're looking at Q4 in general for OpEx, you should be expecting it to be higher than Q3 and Q2, but still meaningfully smaller than Q1. Q1 probably was the -- our peak level of OpEx in our history. So that's not going to be there, but a bit higher than the last two quarters.

[Saket Kalia:]

Got it. That's really helpful. Thanks guys.

[Operator:]

Your next question comes from the line of Andrew King with Colliers Securities.

[Andrew King:]

Hey, guys. Can you hear me?

[Ruvi Kitov:]

Yeah.

[Jack Wakileh:]

Hi, Andrew.

[Andrew King:]

Hi. Thanks for taking my question. So just around this quarter, we've been taking up a lot of spending in the federal vertical. Can you give us an update to just the federal opportunity and any timeline update the aggregated FedRAMP certified?

[Ruvi Kitov:]

Alright. So we did some federal business in the quarter. I think there is a -- still large opportunity in the federal market, and it's -- that hasn't really changed. In terms of FedRAMP, we're evaluating whether that's actually something that we need. Currently FedRAMP is not really hampering our growth. We don't have major opportunities that are waiting for it, but it's something that we're considering.

[Andrew King:]

Great. And then can you just give us an update to the SDN opportunity with the VMware and Cisco ACI, and just any trends you're seeing around there?

[Ruvi Kitov:]

Sure. So we're seeing a lot more customers moving to SDN, and that's part of what I mentioned on Zero-Trust, right. I mean Zero-Trust is essentially -- if you think of it, it's the least privilege security principle. So in Zero-Trust, you can't trust anything. And therefore, you really need to segment and even micro segment both the on-premise and the cloud network. So this much more granular segmentation can actually be achieved with SDN solutions, right, I think what you mentioned, VMware and Cisco ACI in combination with firewall vendors and cloud-native security controls. The challenge when you do that is you add more segmentation technologies. You actually have a negative immediate impact on security management because you're adding complexity and management overhead. So the move to Zero-Trust architectures and moving to SDN technologies like NSX and ACI actually increases the need for visibility in automation. So we're seeing more and more customers deploy NSX and ACI. I think NSX is a little bit more mature than ACI. So NSX is kind of standardized data center SDN with a firewall built into it. And Cisco ACI, I think people are deploying it now more than before and figuring out how to manage it and how to use it with other firewalls. For us we're seeing more and more business coming from NSX and ACI.

[Andrew King:]

Great. Thank you.

[Operator:]

Your next question comes from the line of Brent Thill with Jefferies.

[Joe Gallo:]

Hey, guys. This is Joe on for Brent. Appreciate the question and really appreciate the return to guidance, and it makes sense, the wider range than typical such as the back-end loaded fourth quarter. I guess, what's your level of visibility and confidence in that guidance? We're about halfway through. So just any sense of how the quarter is tracking so far? Thanks.

[Ruvi Kitov:]

So far the quarter is tracking well, and we guided based on our forecast process. So, I don't have any other comments on that. We have a healthy pipeline compared to last year, and we are comfortable with the guidance that we gave.

[Joe Gallo:]

Okay. Great to hear. And then I believe you had Tufinnovate Americas in September. Ruvi, any top takeaways or surprises or requests from customers?

[Ruvi Kitov:]

So first, we were positively surprised with hundreds of people show up. It was about double the attendance that we have normally in the physical events. So in a weird sort of way, we reached more people. People were very excited about some of the things that we're doing with SecureCloud with the Vulnerability Mitigation App. So a lot of interest in the new things that we're doing and also generally in automation. If you think about it, most of our customers are still not automating, right. If you look at over 1,600 customers, more than half don't have automation yet. So from our perspective, it's not just the new-new stuff, it's also educating customers that are still doing just basic security management on moving into the world of automation and enabling a change process that takes -- some of that takes five days, enabling people to do things in an hour with much better security and accuracy.

[Operator:]

Your next question comes from the line of Jonathan Ho with William Blair.

[Jonathan Ho:]

Hi. Good morning. Just wanted to maybe start with your perspective on the pipeline. I think you've talked about some improvement here around the large deal activity. But I'm just trying to understand where we are in terms of the large deals returning? Is this just starting to fire? Is this sort of -- everything is back, but now it's a little bit backlogged? Any color there would definitely be helpful.

[Ruvi Kitov:]

Sure. So if you look at -- right now, pipeline is strong. We have increasing demands of automation, have good interest in SecureCloud. We saw this trend solidify in Q3, and that's sustained so far in Q4. So the continued stability is giving us more confidence, and also the traction with SecureCloud. If you look at our pipeline in general and also some of the sales process improvements that we've done, we feel comfortable with where we're tracking, because I think the deals are going through a lot more inspection and things that are forecasted today are good quality, and we feel comfortable with them. I'm not sure if that answers your question.

[Jonathan Ho:]

It does. But I think the second part of the question around large deal activity, I think you were saying that this was starting to come back, but I just want to get a sense of maybe what inning we are in terms of that return? Is it still in the early stage of it? Are we in the middle stages? Or -- I think, it's pretty much back to normal. Just trying to get a sense of that.

[Ruvi Kitov:]

Yeah. So from that sense, I think that what we've seen in COVID is continuing. We are seeing some large deals, but the COVID still has an impact from everything that has to do with purchasing. So larger deals, especially seven-figure deals, will get more scrutiny. There is more signature, sometimes it goes all the way through the CFO. That has two impacts. One is, sales cycles are a little bit elongated for large deals. And a lot of times those deals actually come in a little bit lower than what we expected them originally in order to fit a reduced budget or just because our champion in the account doesn't want to go through yet another signature that might cancel the project. So in terms of seven-figure deals, we're seeing less than before, that still hasn't rebounded. But we're seeing more smaller deals. And so I think it's a healthy mix. Once we see an overall business improvement, let's say once COVID starts subsiding, I think we will see a return of more larger deals.

[Jonathan Ho:]

Great. And I know this is relatively early, and that you just started to guide for the fourth quarter. But as we look at 2021, I mean, I'm just trying to maybe get a sense of what you're thinking in terms of potential growth rates, or whether we should be modeling much of a return back to prior growth during that timeframe? Or whether we should be taking a bit more of a conservative view? Thank you.

[Jack Wakileh:]

Yes. This is Jack, Jonathan. So we provided our guidance. Q3 was the first quarter for us to be at the level revenue that we were last year. Providing guidance due to the improvement of business and the more confidence we're having in our business, but we are looking only at one quarter now. At the end of -- when we report Q4, we will be in a better position to look at full-year 2021 goals.

[Operator:]

Your next question comes from the line of Rob Owens with Piper Sandler.

[Rob Owens:]

Yeah, thank you for taking my questions. I guess, first of all just unpacking the guidance a little bit, and given that the caveats that you gave around the pandemic, what could drive a result that would be down sequentially in the fourth quarter? I know you gave a wider range, and I appreciate that. But given the lower end of the range, is this all big deal related? Or is there something else that could actually kind of aide a quarter that's down sequentially from a revenue perspective?

[Ruvi Kitov:]

Yeah. So, hi, Rob. This is Ruvi. I will answer your question this way. When we're forecasting now, we're being prudent. We look at large binary deals, and if we're not confident in them, then we don't forecast them. And there is a wider range, because the first quarter that we're guiding, we are in a pandemic, and naturally, also if you look at our historical guidance we've always had wide ranges because we had multiple very large deals that could swing either way. So in terms of the width of the guidance, that's primarily what's driving it.

[Rob Owens:]

Fair enough. And you touched on the large deals and sales cycles and size and everything else. Could you address your run rate business? And kind of how that's returned in the level you're at there, relative to sequentially and also on a year-over-year basis? Thanks.

[Ruvi Kitov:]

Sure. So if you do the math, this quarter, Q3, similar to same quarter last year, but without some of the bigger deals, what that means is that we've actually closed more mid-sized deals. And one of the comments that we made is that we have actually growth in new logos in third quarter. We don't know if it's going to be a trend that will continue, but we're pretty happy with that especially in the pandemic. So we're seeing more growth, in general, new logos and mid-sized deals. Overall, I think it's a good thing for us, less reliance on seven-figure deals as we're building the momentum back.

[Rob Owens:]

Thank you for the color.

[Ruvi Kitov:]

Thank you.

[Operator:]

Your next question comes from the line of Andrew Nowinski with D.A. Davidson.

[Hannah Rudoff:]

Hi, guys. Congrats on the quarter. This is Hannah on for Andy. Clearly the pipe in the quarter improved enough for you to guide, but could you have some detail about how you've been refining the sales process to perform in the quarter and build that pipeline? And maybe if you could comment longer term on your comments about looking to scale up? Thank you.

[Ruvi Kitov:]

Sure. Thanks. So we've made significant progress on the sales execution initiatives, despite the pandemic. We're executing much better than we were nine months ago. So I'm pleased with that. But it's an ongoing process, where it's going to take time as with any significant change. So there is more work to be done. From my perspective, we're building the sales infrastructure and organization that will allow us to scale up to a much bigger company over time.

[Hannah Rudoff:]

Great. And just one follow up. I remember last quarter you didn't expect SecureCloud to be gaining top order revenue this year. But really excellent year. We're able to call it out and fix a large deal. Could you maybe give a roadmap for when you would expect that to begin to drive revenues? Is this is a 2021 event, maybe 2022? Thank you.

[Ruvi Kitov:]

Sure. So SecureCloud is a relatively new product. We launched it in Q1. It's still emerging space. It's taking time for customers to understand what it does and evaluate it before they move forward. But I think enterprises moving to the cloud is a big trend. We're all aware of it and of the need for a product like SecureCloud. So that's been true from day one. It's just taking time for customers to test it, to get comfortable with it, see how it addresses their needs, but it's still early in the product lifecycle. So we don't expect it to be a meaningful contributor in 2020. I think it's a bit too early to talk about 2021, but we want to close 2020 and then see how it goes.

[Operator:]

Your next question comes from the line of Shaul Eyal with Oppenheimer.

[Shaul Eyal:]

Thank you. Hey, Ruvi, Jack, Ryan. Good to see the stabilizing trends as well as the new product introductions. As we think about it from an ongoing product growth perspective, should we be expecting product -- the product line to continue and remain at double-digit territory? We've just had $10 million, maybe even accelerate given that we are heading into the seasonally strongest quarter of the year.

[Jack Wakileh:]

Hey, Shaul. This is Jack. I think the best way to look at products -- just trying to look at your models and then see what products going to land is to look at the split between product and services. So if you remember before we went into this environment in 2020, we were around 45/55 product to services through the year, and Q4 was a stronger one. It would be the other way round to 55/45 for products, and we closed the year at typically 50/50. This year if you followed our P&L and made it throughout the year, you'd see that these ratios have been less favorable toward products. We will be in around 35% to 40%, and each quarter on average throughout the year with 35%, 40% products and maybe 60% or 65% services. And now going into Q4, we will expect improvement in product given the mid-point and the guidance, and doing these numbers are going to reflect a higher product mix, but we're still not going to see it in the levels that we had previous years to get to where we were -- previous years, I think that there is a little bit more growth to do.

[Shaul Eyal:]

Understood. And Ruvi, what are some of the internal actions you've taken or implemented that are assisting in stabilizing the business? Or is the weakness that we have seen earlier in the year is strictly external? Is it just headcount addition or some additional best practices, processes that you've implemented over the course of the past few months?

[Ruvi Kitov:]

Hi, Shaul. So it's two things. I think the weakness is first COVID related, right. We spoke about that in Q1. The second half of the quarter, especially the last two weeks, were very difficult for us, because of the people that we sell to were nowhere to be found. And also with us in terms of large deals that really impacted us. So I think it's the combination of COVID and also sales execution challenges in our side. The COVID overhang, I think some of that -- people are back to work. There are some affected industries, some budgets have been shrunk, but mostly customers are back. Maybe not at the level where they were before, right. It's not in Q4 2019. And in terms of our execution issues, we feel we have fixed most of them. There is still some work to do. And we're working on it. So it's a combination of many things, organizational structure, it's processes, it's adherence to the processes, and we've done a lot of work and we're continuing to do more work.

[Operator:]

Your next question comes from the line of Jonathan Ruykhaver with Baird.

[Jonathan Ruykhaver:]

Yeah. Hello? Hey, Ruvi. I've got just one follow-up question on SecureCloud. There does seem to be an increasing number of vendors that are offering the so-called Cloud Security Posture Management capability, but a lot of that does include -- it seems automated policy configuration, identifying misconfigurations and remediating. So I'm curious how do you see the SecureCloud differentiating? And I know it's early here, but who do you see -- and who do you see most often in competitive deals?

[Ruvi Kitov:]

Hi, Jonathan. So there is -- it's an exciting space. Customers are investing a lot on the cloud. So there's a lot of different vendors. From a competitive market perspective, it's still developing. Our emphasis is on network segmentation and policy management, right. We're not a cloud firewall vendor, which is an important distinction. So some of the differences -- when you look at Tufin, we have a very small footprint, right. And that actually drive the much lower total cost of ownership. Almost all the other vendors in the space sell security management in order to them to sell their cloud firewalls, which -- that consumes a significant amount to compute and ramps up the total cost of ownership. So SecureCloud enables customers to manage policy through cloud native controls that are built into the platform, which are much cheaper from a compute and total cost of ownership perspective. Another differences that were, an open platform, and we are vendor agnostic. So you don't really have vendor lock in, which customers like a lot, and we're the only vendor that enables customers to view network changes both in the on-prem and in the cloud, which straddled essentially all parts of the enterprise network.

[Operator:]

Your next question comes from the line of Sterling Auty with J.P. Morgan.

[Matt Parron:]

Hi, guys. It's Matt for -- on for Sterling again. I just had one quick question as a follow-up to the guidance. Does the current guidance take into effect some of the recent lockdowns we've seen in EMEA? Thanks.

[Ruvi Kitov:]

I'll take this question. So the guidance reflects our forecast, right. We have a set number of deals. We're working on them. They have a certain probability. We provide our input on it, and then we decide what makes sense. So we also mentioned on the guidance, if you look at the 6-K we're assuming that there won't be significant business deterioration. And most businesses, I've now been working this way, right. When we have a customer that buys Tufin -- usually people don't even need to walk into the data center. They're doing everything remote, anyway. So unless a very significant change takes place that should not really change the guidance, but it really depends on how the world will look. Jack, do you want to add to that?

[Jack Wakileh:]

Yeah, sure. Maybe just give more specific color to that. You've seen the range. So one way to look at it, if you wish, is the fact that the range is large and this is due to this type of uncertainty, right. So the range is large, like Ruvi said earlier, mainly as a result of the binary deals either come in or not, I mean in terms of coming in on time or not. So to the extent, you'd like to look at it if we accounted for that -- I would say, we accounted for that through the wider range.

[Matt Parron:]

Great. Thank you, guys.

[Operator:]

At this time there are no further questions. I will turn it back to management for closing remarks.

[Ruvi Kitov:]

Alright. Thank you everyone for joining the call today. We really appreciate your time and your interest in Tufin. And we look forward to speaking with you again soon. Stay healthy and stay safe everyone.

[Operator:]

Thank you, ladies and gentlemen. That concludes the conference call. You may now disconnect.