Tufin Software Technologies Ltd. Ordinary Shares

Greetings, and welcome to the Tufin third quarter fiscal 2021 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Jackie Marcus, Investor Relations. Thank you. You may begin.

Thank you, Operator. And good day, everyone. Tufin released results for the third quarter of fiscal 2021, ended September 30th, 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 Ruby Kitaf, Tufin's co-founder and chief executive officer, and Jack Wakile, Tufin's chief financial officer. This call is being webcasted and will be archived 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 Tufan's CEO and co-founder, Ruvie Kataf.

Ruvie? Thank you, Jackie. Good morning, everyone, and thank you for joining us today. I'm very pleased to report another good quarter that demonstrated our ability to serve our current customers while also adding several significant subscription deals during the quarter. Our third quarter revenues grew by 9% year over year, which was largely driven by the 17% year over year increase in product revenues. We also surpassed our guidance on both the top and bottom lines, which puts us in a strong position to close out the year. We finished the third quarter with $28 million in revenue, with subscriptions representing approximately 46% of new business bookings for the first nine months of the year, against our targeted one-third of all new business bookings being sold to subscription in 2021, with the majority of subscription deals being multi-year deals. 81% of the bookings from new logos, excluding hardware and professional services in the first nine months, were subscription, compared with our target of reaching 50% at the end of 2021. As I reflected on our third quarter, we made significant progress across our strategic initiatives. We completed the key hires to round out our sales management and we saw more organizations emerging from the challenges of the pandemic ready to invest in their network security solutions. Before I discuss our latest product announcements from this morning and 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?

Thank you, Ruby. As Ruby mentioned, we are pleased with our performance in the third quarter as we made continued progress towards our initiatives and subscription-based goals. We're happy with the positive momentum in new business bookings coming from subscription, paired with a strong sales pipeline as more companies look to invest in their network security. As a reminder, we plan to provide ARR on an annual basis since it may have variability between quarters, and we plan to share this metric on our next earnings call. Let's discuss the third quarter results. Total revenue was $28 million in Q3 of 2021, which is 9% over Q3 of 2020. Product revenue increased 17% year-over-year to $11.7 million, while maintenance and professional services revenue was up 4% to $16.3 million. On a geographic basis, the Americas represented 57% of our revenue, Europe represented 36%, and 7% came from Asia Pacific. On a sector basis, we saw our greatest percentage of revenue come from financial services and energy customers during the quarter, with secondary strengths coming from telcos and healthcare customers. Moving to margins and expenses, I will discuss our results based on non-GAAP financial measures. Cross-profit for the third quarter was $22.6 million, or 81% of revenue, compared to $21.6 million, or 84% of revenue, in Q3 of last year. Our operating expenses for the quarter totaled $28 million, up 24% compared to $22.6 million in Q3 of last year. R&D expense for the third quarter was $8.8 million or 32% of revenue compared to $6.8 million and 27% of revenue in Q3 of last year. Sales and marketing expense for Q3 was $14.4 million or 51% of revenue compared to $11.9 million or 46% of revenue in Q3 of last year. G&A expense for Q3 was $4.8 million or 17% of revenue compared to $3.9 million or 15% of revenue in Q3 of last year. The increase in our operating expenses is attributable to the return to pre-COVID compensation levels and higher commissions paid as a result of higher bookings. It is important to note that the increased expenses also reflect the investment in our strategic initiatives that further strengthen our technology platform and enhance our current and future product and services offerings. Operating loss for Q3 was $5.4 million compared to an operating loss of $1 million in Q3 of 2020. Net loss for this quarter was $6.3 million compared to a net loss of $1.2 million in Q3 of last year. And net loss per share, basic and diluted, was $0.17 for Q3 of this year compared to $0.03 in Q3 of last year. Turning to the balance sheet and cash flows. During the quarter, cash flow used for operating activities was $8.7 million versus $4.5 million in the year-ago quarter. We finished the quarter with total cash, cash equivalents, restricted cash, and marketable securities of $92.9 million, down $11.1 million from the beginning of the year. I will finish up with a discussion of guidance for the fourth quarter and full year. For the fourth fiscal quarter of 2021, we expect total revenue between 30.9 million and 36.9 million dollars, and non-GAAP operating result between 4.9 million dollars loss and 0.2 million dollars profit. For the full fiscal year of 2021, we expect total revenue between 106 million and 112 million dollars, and we expect non-GAAP operating loss to be between 27.4 million dollars and 22.3 million dollars. We are keenly focused on growing our business, particularly through subscriptions and new logos, and believe we are well positioned to execute on our plans. With that, I'll turn the call back over to Ruvie. Ruvie?

Thank you, Jack. With the expanding complexity of today's businesses, combined with the increasing sophistication of security breaches, the need for network security solutions like Tufin is more critical than ever before. And as we saw with a recent outage at Facebook, Simple network configuration changes can have serious implications if they're done without monitoring and without following a well-defined policy. We're hearing more and more from customers and prospects that IT budgets are increasing the allocations to network policy and to automation. Key considerations for our customers today are preventing outages, mitigating potential threats to IT infrastructure, and implementing US government best practices against ransomware. Earlier this morning, we announced our latest product offering, the Tufin Orchestration Suite R21-3. This represents an important milestone for both Tufin and our customers with several key pieces of new functionality. First, we've added support for Zscaler Cloud Firewall to centralize and simplify SASE policy management. We've seen a lot of requests for this from our customers, with Zscaler providing more features and competing directly with traditional firewall vendors. We've also added a new security policy dashboard to provide real-time insights into operational, security, and compliance data that's collected by Tufin. The dashboard highlights security policy violations, expired and uncertified access rules, and policy optimization recommendations. Finally, with R21-3, users can leverage Tufin SecureChange workflows to automate data center migration by cloning security policies from the old data center to the new one. and removing obsolete networks from the policy. These workflows also support data center migrations to the cloud, which are becoming more common. With Tufin Orchestration Suite R21-3, we're extending our technological leadership and answering more of the critical needs of large enterprises. Let's spend a few minutes discussing some of our recent deal activity from the third quarter. The first one is a large diversified utilities company that wanted to increase the efficiency of network operations reduce downtime during changes, and automate its compliance reporting and analytics. They are subject to the NERC regulation and have failed multiple critical infrastructure protection audits. As a result, they receive fines for every failed audit, and we're going to spend a substantial amount annually on manual policy cleanup. With SecureTrack, Tufin will help this customer ensure continuous policy compliance and reduce audit preparation time. ultimately resulting in significant cost savings. In addition, they were making changes manually to their network security infrastructure, which significantly delayed IT projects, including the implementation of the new multibillion-dollar electrical grid. By providing streamlined workflows and change automation in secure change with end-to-end provisioning, they increased their productivity by accelerating change design and delivery, allowing IT engineers to focus on more strategic operations. This was also a multi-year new logo subscription win for Tufin. We continue to expand our presence in Asia PAC this quarter with the addition of a large financial services customer. With many entities and offices across Asia, this customer needed a proper process and a solution that could dynamically manage and track its configuration changes against a consistent policy across the entire organization. They also wanted the ability to easily roll back a change in case they found an error. While policy management across multiple offices and geographies can create complications, Tufin was able to dramatically improve the efficiency of their operations. The flexibility of our architecture and our ability to integrate with Infoblox for zone management further strengthened the value that we were able to offer them. This new logo subscription purchase included SecureTrack, SecureChange, and the new IPAM Security Policy Marketplace app, which provides strong confirmation of the many opportunities that lie ahead of us in this region. The last deal I'll mention today is the expansion of an existing relationship with another large energy company that has spent over $3 million with Tufin over the past few years. They've been migrating from Check Point to Palo Alto, and their security and network teams have been short staffed with difficulties retaining and recruiting talent, so they couldn't keep up with the demand of the business. Following the Colonial Pipeline hack, they needed to prove compliance with regulations to the federal government, which only increased the pressure on the network security team. With SecureTrack, they could ensure a tight security posture and easily prove compliance with regulations to the authorities. They expanded full use of SecureTrack from two business units into three and are now looking actively at secure change for automation as their next step with 2FIN for all three business units. As you heard today, we're making significant progress in shifting our business to a subscription model. We are seeing positive momentum in a variety of industries and geographies while also launching critical capabilities that help keep organizations safe from outside threats. I wish to thank our team members for their hard work as we continue to deliver significant value for our customers. I would now like to turn the call over to the operator to open the line for questions. Operator,

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. In the interest of time, we ask that you each keep to one question and one follow-up. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of Sterling Audi with JP Morgan. Please proceed with your question.

Hi, this is for Sterling. Can you help me understand what's the mix of business from the subscription versus transition and both the customers renewal versus the new customers?

Hi, this is . So like we said, we said that we're 46% of our new business coming from subscription. This is coming from new customers and from existing customers. We've also said that for new customers, the vast majority is coming from subscription for our new logos. And in terms of how much of this is renewal versus new business, we kicked off our proactive subscription this year. So the majority of it is obviously going to be new subscription deals that were done this year. The renewal part, if you're looking, let's say, on the past three quarters, that's going to be around 20% to 30% of the total subscription, and then the 70% to 80% is going to be new subscription from this year.

Okay. And then maybe a small one. How are you seeing the hiring plans going? going on? Like you mentioned about the Palo Alto and Check Point, unable to like retain the talent, but how is that going on your front? And have you seen any improvement from the previous quarter?

Can you clarify the question? Are you asking about the acquisition of customers or acquisition of talent?

Acquisition of talents.

So for us, you know, we're investing heavily both on sales front and also on development. You know, the economy right now is booming, especially in Israel. The high-tech sector is very competitive. So it's difficult to find good engineers, but we are investing and hiring. So there's no changes to our plans from that perspective.

Thanks a lot, guys. Thank you.

Thank you. Our next question comes from the line of Saqib Khalia with Barclays. Please proceed with your question.

Okay. Hey, Ruby. Hey, Jack. Thanks for taking my questions here. How are you? Good. Ruby, maybe just to start with you, you know, some firewall vendors have been talking about more refresh coming, and generally it feels like firewall spending has been strong on the whole. I guess the question is, in your experience personally, How do policy management tools behave in those types of backdrops? Meaning, does demand typically lag performance in firewall, or is it something that we are seeing the strength come through now? I would just love some context on sort of what you've seen historically between policy management demand and firewall demand.

Sure. Thanks, Akit. The two are not directly correlated. First of all, we support not just firewalls, but in general segmentation technologies, including AWS, Azure, VMware, and a SEC, Cisco ACI. So it's broader than just firewalls. But if we think of firewall refresh cycles, we're selling into a broad install base of, let's say, the last, let's say, five years of purchases. So the fact that somebody is going through a refresh does not increase you know, the install base stat dramatically. What it does influence is if there's major purchases. So if somebody is, for example, moving into a new data center or they're moving between vendors and they're buying a lot of new infrastructure, that just happens to be a major ticket item. So if they're spending $20 million, let's say, on refresh, they have budget that they can use. So it's more of an opportunity to get some budget less than, Not necessarily, okay, we have a lot of new infrastructure that we need to support. So in the past, we haven't seen major upticks or downticks, whether it's right before refresh or right after. There's some budget that opens, but it's not a significant driver for us.

Okay, got it. That makes sense. Jack, maybe for my follow-up for you, and apologies if I missed it in your guidance commentary, but Can you just remind us what your goals are for subscription mix for next quarter? And I just wonder, could we actually see that mix maybe just be a little volatile, particularly for Q4, because that's when you typically see stronger demand for perpetual?

Yes, sure. So maybe I'll take you back to the beginning of the year when we announced the move to subscription. We said that at that early point, And you remember that we announced the transition, the proactive transition, as we announced it also internally, right? We did not come with a lot of mileage before that. So we estimated that we're going to transition around one-third of our business, for new business, to subscription in 2021. This was the initial expectation, with more coming from new logos, obviously. This was the case, we did even a little bit better in the first two quarters. In Q3, we saw much more subscription business from our new business. And as you saw, we reported 46% on average versus 33%, with Q3 weighing higher on that. For Q4, we think, looking at the pipeline, we think that this trend of majority, if you like, of our new business coming from subscriptions is going to continue. So, you know, 46% now, we may end up equal or a little bit higher for the full year.

Okay, and if I can actually just sneak one more in, maybe for you, Jack, just to make sure it's asked. You know, I think that the revenue guide here for Q4 is just a little bit wider than what we've typically seen. I think it's a 6 million spread. You know, I mean, I think we can guess why that is, but, you know, I'd just love to hear you kind of comment on on why the wider guidance reach here in Q4 for revenue, that is.

Yes, I mean, like I said before, we have a lot of multi-year deals in our subscription business, right? As with subscription, I think I mentioned this on the first question, that a lot of it is multi-year. So, again, we still have large deals, even though a lot of it is subscription, and the variability and the sway deals that we felt in the perpetual model still exist in the subscription model so far at this point. And since you're looking at the pipeline, we have a list of those deals. We were careful in providing guidance. While we believe in our guidance, we wanted to be safer in terms of being within the guidance if, God forbid, some of the deals would slip. This is where the wide guidance came from.

Very helpful. Thanks, guys. Thanks, Akit.

Thank you. Our next question comes from the line of Shaul Yao with Cowan & Company. Please proceed with your question.

Thank you. Good afternoon, Ruby and Jack. It would appear that customers are mostly receptive of the shift to a subscription model. Are you seeing some resistance from other customers that are slightly more reluctant? And if they are reluctant, why that would be the case?

Hi, Shaul. Thank you for the question. So, you know, we're not yet converting the existing customer base en masse, so we're not doing that proactively, although we're keeping that option for the future. The sales force is very incentivized to sell subscription, obviously, so we are seeing more and more existing customers buy subscription as well. We've been positively surprised with several accounts where the sales team was actually able to transition a perpetual renewal into subscription accounts as part of the new business expansion. So we're not proactively trying to move them at this point, but we're actually seeing positive, you know, positive movement there. And, you know, if we do decide to transition everybody, as in all of the existing perpetual accounts, then we'll reexamine it. But at this point, we're not seeing strong resistance yet.

Understood, understood. And, Ruby, I was a little late to the call, so apologies in advance if the point was addressed, but any supply chain constraints that you might have seen as of late?

Not really. I mean, we have our appliances that some customers decide to purchase. It's an option. Some people can deploy in appliances. So we've had longer shipment times, but we've taken that into account. We're ordering a lot more appliances a lot earlier. and we're able to manage that.

Got it. Understood. Thank you so much. Appreciate it. Thanks, Joel.

Thank you. Our next question comes from the line of Adam Boyer with Stifel. Please proceed with your question.

Hey, guys. Thanks so much for taking the question. My first one may be a two-parter for Ruby. So just remind us, when customers upgrade to, let's say, 21-3 from older versions of TOS, Is there any pricing uplifts? I guess that's part A. And then part B, you know, it's nice to see the Zscaler Cloud Firewall integration coming. I know that was in the roadmap for some time. Just curious about demand on this in your install base. I know you kind of alluded to that in the prepared remarks, but is that a driver for upgrades, you think, to the latest version? Thanks.

Thanks, Adam. So 21-3 is a standard release. It's not a special release, so we're not charging customers more for it. Now, specifically on Zscaler, we announced integration with Zscaler Cloud Firewall today. It's becoming more popular. We're adding support for visibility now, and we're going to add automation for Zscaler down the road. It's the first of SASE and SD-WAN players, and we're considering others on what's next. There's a lot of demand right now for Zscaler, but if you look at SASE and SD-WAN, it's pretty diverse. There's a lot of different vendors. and customers are asking for more and more of those. So Zscale is interesting because in some cases with their web firewall, they're competing directly with Palo Alto Checkpoint Fortinet, and more and more customers are starting to use them.

Very helpful. And maybe just as a quick follow-up, it's nice to hear the win in the APAC region, although it is still a small part of the business. Just curious how you're thinking about the opportunity in APAC going forward and, you know, the opportunity to expand presence since you signaled there's some other opportunities there. Thanks so much.

Sure. So, you know, the APAC business is fairly small for us at this point. It's below 10%. We believe that there is growth opportunity there, sure. There's a lot of countries that were just opening or the demand is, you know, in the early stages. So we believe there is significant opportunity there, and we are continuing to invest in Asia-Pacific.

Great, thanks again. Thank you.

Thank you. Ladies and gentlemen, as a reminder, if you'd like to join the question queue, please press star one on your telephone keypad. Our next question comes from the line of Jonathan Ho with William Blair. Please proceed with your question.

Hi, good morning. I just wanted to understand, given your comments around customer spending prioritization, how do we think quantitatively or qualitatively about the improvement in pipeline

Hi, Jonathan. So pipeline has been improving, and you're seeing some of that in the results of Q3. We have a healthy pipeline for Q4 and also for 2022. So we're feeling pretty good about the pipeline and the conversion rates, and we're hoping for that to continue.

Got it. And then just in terms of the key hires that you've recently completed, You know, what's made the most difference? And as we start to look towards 2022, you know, how do we think about maybe the trajectory of the business, you know, just given these new hires? Thanks.

Sure. So, you know, Ray Brancato came on board earlier this year at the beginning of the year, and he's made several changes to three of our area VPs in the U.S. Essentially, all the area VPs are new, so they've been hired in the last few months. We also have a new VP of sales operations, so those are some key hires that were made. It's tough to say which ones make the most impact. I think they're all making an impact, and it's all additive. So I'm seeing that in improved execution within the sales team. You're seeing that in some of the results, and I'm looking for that to continue from this point forward. Great. Thank you. Thanks, Jonathan.

Thank you. Our next question comes from the line of Andrew King with Collier Securities. Please proceed with your question.

Hey, thanks, Jake. My question, a really nice quarter. I just wanted to get an idea. As we're seeing more companies start to return to post-pandemic action, can you talk about how those customer conversations are changing and how you see the sales cycle changing versus how it was pre-COVID?

Sure. So... We're seeing demand coming back. I think demand now is at pre-COVID levels. There's a lot of interest. The need for what we do was always around, but I think during the pandemic, it took a backseat to more urgent items like work from home. Now that people are done with that and we're turning the corner on COVID, we're seeing a lot of projects, a lot of interest in security policy automation. The demand is back and The team is executing better, which is sort of visible in our results.

Great. Thank you.

Thanks.

Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Kitav for any final comments.

Thank you, Operator. As you heard today, we're very pleased with our business in the quarter and the progress that we've made so far in 2021 in our transition to subscriptions. We are executing against our goals and strategic initiatives and continue to bring industry-leading solutions to our customers. I look forward to sharing more of our progress and our plans for 2022 early next year. Thank you all for joining us today.

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