Check Point Software Technologies Ltd. (CHKP) Earnings Call Transcript & Summary

I think [ Jeff ] went away.

Kip, do you want to kick it off with the safe harbor. I think we're live.

Okay. Thanks, Patrick. During the course of this presentation, Check Point's representatives may make certain forward-looking statements. These forward-looking statements are within the meaning of Securities Exchange Act of the early 1900s. Because these statements pertain to future events that are subject to risks and uncertainties, actual results could differ materially from Check Point's current expectations and beliefs. Factors that could cause or contribute to such differences are contained in Check Point's latest earnings release issued on July 26, 2021, which is available on our website, and other risk factors that are discussed in Check Point's latest annual report on Form 20-F, which is on file with the SEC. And I'll throw it back to you, Patrick. Thank you.

Thank you so much. So hello, everyone. Appreciate you guys joining us today. I'm Patrick Colville, a senior analyst at DB covering cybersecurity software. The format of this session is going to be a fireside chat with listener Q&A. There's a chat box you guys will have where you can ask questions. Any questions are going to be anonymous. So we're not going to mention your name or company affiliation. So let's kick things off with introductions. We've got Dr. Gil Shwed, the CEO and Founder of Check Point Software. We've got Tal Payne, the Check Point CFO; and Kip Meintzer, the Head of Investor Relations at Check Point. Thank you so much for joining us today, guys. As everyone knows, Check Point is a cybersecurity pioneer and a leader in network security. So really glad to have you guys here. So given, I guess, time constraints, can we just jump straight to questions?

And a question we get a lot is cybersecurity risks are increasing. There's no doubt about that. How do you see the cyber landscape today? And I guess how does kind of Check Point play into that evolving threat landscape?

So first, you're absolutely right that cyber landscape is emerging, and I think the risks are becoming more -- there is more risks and they become more and more sophisticated. We framed it a few years ago with generations. And we are now in what we call the fifth generation of cyberattacks. These attacks are much harder to detect, what we call polymorphic. So the attack cannot be detected by some pattern that identified or what we call multi-vector. So the attack gets from one place -- from a few places. For example, you can get an app on your iPhone. That set up won't do anything to your iPhone. It will use the iPhone as a launchpad to get something into the data center and into the cloud. And then only in the third, fourth or fifth stage of the attack, it will download what we call the malicious payload, which will start causing the damage to you or steal data or anything like that. We've said it a few years ago, and back then, Gen V attack existed, but they weren't the common theme. In -- since the beginning of this year, since the end of 2020, it seems that Gen V attack are the norm. We are seeing more and more attacks like that. They are very, very damaging, very hard to detect, very hard to defend against. And that calls for a different type of architecture to defend against cyberattack. But if you look at the landscape today, there is plenty of very good vendors, a lot of cool technologies to defend ourselves against the cyberattacks. The main challenge today is actually that it's too distributed. I mean the market is -- the market needs to go through a consolidation. A company cannot build a cybersecurity solution by patching together 55 different technologies. And by the way, it doesn't always work because what we need is that all the components will work together. And I think that's the premise that we are trying to promote, consolidating and creating a platform that can give a very broad and deep coverage against the next generation of cyberattacks.

Got it. That's helpful. And I guess -- I mean, as we exit the pandemic, hopefully, how are corporates and federal budgets shaping up? Is -- are there noticeable trends that are different now versus, say, 6 months ago or 12 months ago? And I guess probably the second part of that question is also are there particular products that are seeing more demand now than 6 or 12 months ago? Is it firewall, hardware refresh activity? Is it cloud products? Just help us understand, I guess, their kind of budgets and then how kind of product demand has evolved?

So firstly, we are seeing good levels of demand for almost everything in cyberspace. I think that the challenge today is not the level of budget. The challenge is, again, that there's way too many solutions. And the customers don't know what to choose, and that's why there is no clear strategy to win. Again, I would say at Check Point, we do believe that we have the right strategy to win. But it's our job to convince the market that amongst all the few hundreds, if not more than that solutions in the marketplace, our solution is the right architecture. But budgets are generally okay. In the beginning of the pandemic, people said that maybe there is more shift into the cloud and people will not buy more physical firewalls to defend their networks. What we've seen in the last few quarters is that, that's actually reemergence of demand for the more traditional appliances that protect our data centers. And I think, by the way, we need both. We need to protect the cloud. We need to protect the users, and we need to protect our data centers. That's actually the first line. And maybe the best line of defense is to understand that we can defend our network against the attacks that are coming or maybe sometimes attacks that already got in, to stop them from proliferating inside the network.

I mean that point there about seeing a resurgence in demand for traditional appliances to protect data centers, I guess, that's super interesting. Just to kind of double-click on that, is that -- why might that be? Is that -- yes, actually, I don't want to put words in your mouth. Why might that be that there's a resurgence of demand for appliances?

It's a good question. I don't have a good -- I mean, that can be a few factors. I would say, I mean, for me, the easiest to say is that you simply need them. And again, I think what we've seen through the last almost 2 years, even in the half, with the corona is that the demand for networking has gone up drastically everywhere. Think about the enterprise networks that now needs to serve thousands of users connecting remotely. Services that existed on the corporate network still exist on the corporate network. We're building maybe cloud services to augment them, but they rarely -- but you rarely take things out. So I mean -- and actually, even if you rebuild the cloud service to be upfront and service to our services, it needs a connection into the data center. So the level of bandwidth is going up, the level of sophistication of attacks is going up. And maybe, by the way, the biggest revolution is the fact that most customers are using today Gen II, Gen III type of protection on their network. So they can protect, again, relatively simple network attacks. Protecting against fifth generation or Gen V attacks on the network is rarely -- is not rarely seen amongst Check Point customers. It's quite common. It's not the common in the industry today. And that requires much more power on the protection side, on the network side.

And I guess, I mean, the obvious kind of question from there is we've been hearing a lot in the press about supply chain issues. And clearly, no one is immune from that. That's affecting the whole kind of tech industry. How does that impact Check Point is probably -- would be one part of the question. I think the second part of the question would be, is there a risk for the remainder of the year around those appliance sales and appliance shipments?

I can't speak for the industry. I can speak about us. We are seeing the shortage of materials and some of that. I think so far, we are doing a very good job. Our logistical team is doing a very good job in securing the right inventories. It's good to see that overall, compared to the rest of the world, we are shipping many thousands, even tens of thousands of devices every quarter. It's a small amount in the big world and compared to the big things. So, so far, we've spent more. We've secured the inventories that we believe we need. So I hope that we won't see any surprises between now and the year-end. Again, Tal can speak more about it. I don't think it's worth spending too much time, but we've done everything we can to buy the supply that we need for the remainder of the year and maybe even through the beginning of 2022.

Got it. Tal, would you like to jump in and add any additional color and commentary?

I would say that -- sorry, you can't see me, I'm not taking the risk here with the Internet bandwidth, but I would say Gil is right. We secured the inventory. The team did a great job buying in advance raw materials that had more sensitivity than the other. It's evolving over time because things that were missing yesterday are suddenly missing, but so far, we're closing the gaps great, and we're dealing very well with this. So I don't anticipate at this point of time any issue.

And I mean is that consistent -- is this supply chain issues, have they been worsening or getting less bad, I guess, versus kind of recent trends in over the last like 3 to 6 months?

I would say it was worse than people thought, meaning in the beginning, everybody said they don't think there's an issue. Our anticipation was they will get worse. That's why we prepared in advance, and that's why we were not caught with a surprise. And -- but I'm seeing others that are being caught by surprise, not expecting it to expand to other parts of the raw material. That's why I'm saying so far, we're dealing very well because we were ahead of the curve. But hopefully, it's not going to get worse, but we prepared with inventory for a quarter in advance. So I don't anticipate at this point of time any issue.

Got it. And I guess as of today, kind of mid-September, not seeing it getting worse.

I think every day, you hear of another few items that nobody thought they will be missing and they're missing. So -- but if you plan in advance -- and things that maybe were supposed to take 2 weeks to deliver, now it's 2 months. But if you are ahead of the curve 3, 4 months, then it's not an issue. If you didn't thought -- well, it's only 2 weeks. It's not an issue, you're going to have a problem. So it depends how well in advance you prepare. And that's why I said I cannot predict the future in the sense that if things that -- instead of 2 weeks, now it's 2 months. And then when the 2 months will come, suddenly, they will say, sorry, 6 months, then you're going to have an issue. So that's very hard to predict. But so far, we're doing very, very well.

Okay. That's helpful. Got a listener question, and we'll jump to that in a second. I mean if any other listeners want to ask questions, there is a chat box. Any questions you ask will be fully anonymous. We're not going to mention any names or company affiliations. The question we have in a moment, Tal, probably for you is Check Point's got $4 billion of cash on the balance sheet. What's the thinking there? Why not do an accelerated share repurchase, increase the kind of quarterly repurchase? Like help us understand, I guess, that kind of cash balance and potentially using that cash balance.

It's a great question because we just had a conversation last week with someone who asked exactly the opposite. Why are you doing a buyback? Why don't you use all the cash for M&A? So I guess the answer is exactly that. It's -- the answer I gave him, I said it's a balance. It's a balance. We have money for buyback, and we have enough cash for M&A. We think $4 billion for M&A is good. If we need more, we can always get more. And we use about $1.3 billion a year for buyback where the philosophy around it was around the operating cash flow. It's slightly higher. Operating cash flow is $1 billion, $1.1 billion. So we thought $1.3 billion, it's a good amount for buyback. But there's always different types of investors requesting different things. Majority, by far, of our investors like the buyback. They want us to continue the buyback. But we don't see internal or external demand for increase of the buyback because everyone, including us, thinks that we would like to use it for operational investment and for M&A. So that's where we are right now. We have enough buyback. We have the opportunity -- when and if we need, we have the cash for M&A. And if we want to invest more in our headcount and internal resources, we have this capability as well. So everything is open.

And I guess, I mean, that kind of leads us quite nicely on to the acquisition that Check Point made last week or 2 weeks ago, Avanan, and if I'm not mistaken, a cloud e-mail security vendor. Just help us understand, Gil, the thinking there and why Check Point acquired Avanan, just the rationale would be great.

So I mean, historically, we've been a little bit present in that market, and we actually even used Avanan technology on an OEM basis in our product. But the big change that I think we made is realizing that there is a big opportunity here. 95% of cyberattack starts with an e-mail. And that means that, that's a very, very important vector to protect against. So you can say, can you compete on that because there is few pretty large vendors in e-mail security. And that's the real change now because the world is going through a shift from on-premise e-mail servers to cloud-based e-mail servers, mainly Office 365, but a few others. And that's a very interesting opportunity for us to bring it into the Infinity platform. So the Check Point platform makes native protection of cloud e-mail, something that we are the strongest in. And we found Avanan, which is the fastest-growing e-mail security platform. I think it provides very high level of security, much better than native security solutions for e-mail. And I think that's a very, very good extension to what we do, and that's the rationale behind this acquisition. I think it's been growing fast. We've been a little bit in that market for a Check Point product, and I think the combination should be very strong.

And I guess, I mean, where are you expecting to see best product market fit within Check Point's installed base? Is it going to be kind of smaller and midsized companies? Is it going to be, I guess, not headquarters country, kind of like remote countries? Like is it -- or are you expecting this to be enterprise scale replacement of a Proofpoint or Mimecast or Defender ATP?

So I think first, the opportunity is all over. In terms of where we are right now, the starting point is quite good. It's mainly in the U.S., which is excellent because I think that's the primary market for technology. Usually, my principle is if you win the U.S., you can win the rest of the world in technology. We are now in kind of very few large customers, a few even very large customers. But the majority is what I would call midsized customers. For me, it's excellent because I believe that if you're in the mid-market, you can scale up and down, and you can have something that's very repeatable. Many companies and many startup makes the mistake of focusing just on the giant deals, on like very, very large deals, and these deals are simply not repeatable. So the startup is successful serving 1 to 5 or 10 customers but can't translate it to more. So we are actually in a very good position. We have more than 5,000 customers now for the e-mail security, which is a very big number for something in the beginning. And yes, we will compete with all the vendors that you mentioned. And I think the main competition point will be when customers switch from the -- switch to the cloud. It's happening to every customer, almost every customer now. Some are completely shifting, and some are just moving, starting by moving hundreds and thousands of mailboxes from the on-premise e-mail solution to a cloud solution and testing it out. And again, I think the nice thing about the solution that we have, it's 5 minutes to set up. It gives you the highest level of security, much higher than any of the other solution. So it should be a very, very simple way to procure that and use it.

And I guess, I mean, in terms of company size, I mean, Avanan had roughly about 100 employees, and Globe's reported the acquisition price was about $280 million, which is larger than where Check Point usually makes acquisitions. And is there a slight change of strategy in terms of M&A to go after kind of bigger companies? Just help us understand that dynamic.

I think the strategy has always been to find the best fit. I mean that's why we say that the $4 billion that we have in cash is not in theory. We may find good companies to buy. Now tell me, if we would have been able to acquire Avanan at a lower price, it would have been better. But that's the price. I think it's a fair price, definitely compared to valuations that are running now in the marketplace. And I think we'll be happy to find more like that, companies that are in the main markets that's very scalable, but you can take it different directions and customers of all sizes, that has hundreds and thousands of customers, in this case, 5,000 customers and scale it and leverage the Check Point installed base, leverage the Check Point's sales force. So I think it's a very good fit to what we do, and I would love to find more companies like that.

Got it. [ There's an investor e-mail ] that say that the modern art behind you looks very similar to the modern art behind me.

Yes.

Back to the numbers. The question we get frequently on Check Point is that billings, I guess, on a -- currently on a trailing 12-month basis has been growing in the kind of mid to high single digits for the last couple of quarters, which is quite a bit faster than revenue growth on a trailing 12-month basis for the last couple of quarters. Is billings a good leading indicator of revenue growth?

In the long run, I'd say I hope it does. It is a good indicator. In the short term, let's remember that we are shifting more and more revenues from product sales to subscription sales. So again, in the long run, it shouldn't be a -- it should predict the revenue growth rate. In the meantime, we are shifting more and more revenues, which is a good thing because we are taking onetime revenue and shifting it to recurring revenues. But it does hurt the short-term growth rate. I don't know, Tal, if you want to add more to that.

No. I think it's correct. When you take a few quarters and average them, it should reflect the future revenue recognition, of course, with some adjustment, but in general, yes.

And I guess, I mean, when will they kind of equal each other? What's like -- is -- are you expecting this kind of delta between high single-digit billings growth versus kind of mid-single-digit revenue growth to persist for a while? Or do you think there should be convergence?

I think when you think about it, deferred revenues almost -- doesn't have product -- well, historically didn't have product at all. [ Now it had Infinity, ] right? So historically, there was none. Now we also -- Infinity defers some of the product revenue, and it's been recognized only when the customer actually pull the product. So there's also some slowdown in the product revenue recognition. That's just one example. So when the customers pulls it, it's in the revenues. When it's still just as a credit, it's not recognized as revenues. So that's one difference. Subscription is a straight line. So the more it's built into the deferred revenues in the billing over time, over 4 quarters, you'll start seeing it hitting the P&L revenues as well. And the same is support. Support is something that is you bill 1 year, it goes to the deferred revenues, and that is being recognized over the relevant period, typically 1 year. Again, if it's billed, it's typically for 1 year. The thing that is very hard to predict is the Infinity. So the Infinity, the subscription and the support portion is recognized and still do the billing. You will start seeing it over the next 4 quarters running into the P&L. And if you even look at our beginning effect of that Infinity and the cloud, which is subscription, and Harmony, which is majority of it is subscription, you can already see that the subscription revenue moved from 9% growth year-over-year to 10%, to 11%. So it's accelerating. You start to see that effect into the subscription line. And support, if you recall, when you asked in the beginning of the year, I said it's probably going to be around 0, it's actually, what, 2%. So it's staying very strong there. So I would say you already start seeing it going there. The only part that lay heavy, but we understand it because it's part of the conversion process from product into subscription, is that product get less and less dollars out of these big large deals, and most of the revenues are being allocated into the subscription. So the product having a harder time to grow naturally, although the deal grows, and it would flow into the P&L with higher dollar value over the next year.

Yes. That's helpful. Okay. So look, just to paraphrase that back and to make sure I got it right. So currently, billings is growing faster than revenue growth. And in the long run, billings should be a predictive revenue growth. But it's uncertain kind of when they will equalize. The delta -- the reason for this delta is as a result of Infinity. And Infinity, there's a deferral of product revenue. So more revenue is going to deferred revenue, which is a tailwind for billings growth and a headwind for product. So that's the kind of big change, right?

Yes. And again, I always take 4 quarters and not look at the billing of one specific quarter because billing can fluctuate between quarters, right? It depends on the timing of the issuance of the invoice. If you take 4 quarters, it should give you a pretty good picture.

Okay. That's helpful. I mean kind of sticking, I guess, on the numbers, I mean, you called out that CloudGuard and Harmony now totaled 20% of subscription sales in second quarter, which was almost doubling year-on-year. I guess fast forward 2 years, what do you expect CloudGuard and Harmony to -- do you expect this to continue to grow as a percent of subscription sales? Can you quantify or give us a kind of like a ballpark of where you think these 2 new product areas might grow to?

I definitely expect it to grow. I don't have specific numbers in mind, but expect it to grow significantly. I think that we want this product family, the CloudGuard and the Harmony, to deal with the cloud and with the user and remote connection, to be important growth areas, faster than others. And they are all subscription. So it should -- so again, I don't know if it should grow to 30% or 40% and when, if it should be 1 year or 3 years, but it should definitely grow quite fast. Tal, any thoughts on that?

I agree. I think it's about 20% now. Then if it will continue to grow in strong double digit, it should get to 30% and, hopefully, over time to 40% and even more. Because when you think about it, what do you have in the subscription? You have the -- think of the 3 pillars. You have Quantum, you have Harmony and you have cloud. The Quantum pillar is the network security subscription, which is -- think about it as the SandBlast, as a zero-day protection, as all the added services there. And they are not fully penetrated, but they're well penetrated into the installed base, right? So the growth there is slowing down by definition. The cloud is growing at double digit. The Harmony in double digit. Infinity grows in a strong double digit as well. So that 20% should continue to grow in a faster rate. So I think definitely, it's going to get bigger and bigger over time out of the subscription pie.

Yes. That's helpful. For any listeners, if you have any questions, please drop them in the chat box. They are completely anonymous, and I'll read them out to Gil and Tal. In terms of the rest of this year, in your guidance, you're forecasting a pretty big decline in margins in fiscal third and implicit in fiscal fourth quarter. I guess where is that investment going? And how is that kind of -- how is that trending?

Tal, that's for you. [indiscernible]. Carry on.

I would say, first, let's [ think ] in the beginning of the year. In the beginning of the year, the thought was that over time, corona, like you started the call, the corona would leave us. And we'll all be flying all over the world in the jets and closing business. But as you can see, that was not as fast as all of us thought. So on that side, there's less expenses when it relates to travel and entertainment. That's one. On the other hand, we are recruiting, and we have a target to recruit significantly. We would like to get almost to 6,000 employees. On the other hand, it's a period that is challenging when it come to recruiting, but we're doing a pretty good job. So if you ask me where the majority of the increase in the expenses, it's probably headcount and the related to headcount. So it's R&D, sales, marketing. We have a big opportunity here. We have big potential. We are in a good and strong market, and we would like to get our share with it. So that's the focus. And that's why we guided, again, in line with our expectation, investor expectation, analyst expectation. Everybody agree with us that we need to invest more and -- in order to get our share of the market, in order to get the revenue growth. Because if the revenue will grow and accelerate, it's going to the bottom line. We're not concerned about it. Everybody know we know how to manage our profitability. That's not an issue. So it doesn't really matter in the long run if the margin is 52% or 47%. If we succeed to take these resources, invest them and over time, to see the growth in the revenues, it will pay dividends. So that's pretty good investment.

And did you say the target is to get to 6,000? Was that -- did I hear that correctly?

Yes. We would like to continue to grow our headcount significantly.

Okay. And again, in terms of -- we hear from other vendors that hiring is difficult. The labor market for cybersecurity is extremely tight. How is execution versus that target? Is it -- are you guys being able to get these people on board? Or is it quite a tight market?

I think it's actually a good market for hiring for us. We are becoming a very, very attractive employer. I mean we get -- I mean, the number of CVs that we get on our website is doubling and sometimes tripling. In the past, we've hired a record number of people since the beginning of the year. We've actually seen a turnaround. The beginning of the year, we started slow. The last 3 months, we've hired record number of people, and we started growing the headcount in a nice way. There are still challenges. There are still places when it's tougher, like hiring some type of better experts and so on when the competition is very tough. But I must say that I'm very encouraged to see the results from the last 2 or 3 months. We've never seen in the Check Point history so many people that we were able to hire.

Yes. That's really interesting. And I guess, I mean, a question we get from probably generalist investors is that over time, cloud adoption, be it public cloud or SaaS, surely will have a negative effect on appliance sales. Why would you need an appliance if you're going to be -- if you're in SaaS and public cloud? Just help us understand why that might not be correct.

First, I think the world is evolving in different directions, and that's why we are betting on the cloud. The cloud is important. We invest in the cloud. We are one of the biggest cloud security vendors. It's a business that's in the order of magnitude of $100 million for us. And so cloud security is definitely important. I think on the same time, customers will continue to have their physical networks. Customers will continue to have data centers. And they will need -- so I mean, we'll see 2 things happening. There will be more bandwidth on the data center on one hand. On the other hand, the amount of security that you'll need there or security power that you'll need will be also big. So if we say that in 3 years, we'll have double the bandwidth and double the need of power, which is 2 pretty actually not very significant assumptions on what we need, that means 4x growth in the security power that you need. Again, if that would be the prediction, then I think we should be very, very optimistic about the network security appliance. Not all customers get it, not all customers are using the security level that they need, but the potential is definitely there.

And I guess, competitively, I mean, when do you win versus the likes of a Palo Alto Networks, a Fortinet, a Cisco? And on occasions when it goes their way, what are the reasons why sometimes it goes their way? Just kind of help us out those -- understand those kind of competitive dynamics.

So first there is the very broad set of customers and markets and geos and customer sizes, and they're not all the same. But I think in general, we have a pretty high win rate when we are in the account, when we are participating. That might sound it's positive from a product standpoint and technology standpoint because it means that we have good salespeople, good technologies, good product, and that's the encouraging part. The less encouraging part about it and that's the potential is that we should participate in more deals. The number one reason that we don't win is that we either weren't in the account at all or that we came very, very late into the game when the customers already formed their RFP and opinion and so on. So I think we need to -- I mean, definitely the place that we can improve and do much, much better is at improving our sales execution, reaching more new customers, reaching more even to existing customers, and there is plenty of potential there.

Got it. I think we're almost out of time. So I guess, for me, the kind of key takes from the call are that seeing good demand for traditional appliances to protect data centers. Supply chain issues -- haven't seen an impact on Check Point from supply chain issues. The company bought raw materials in advance. And so it's pretty well placed. In terms of cash and on the balance sheet, unlikely to increase the buyback, want to keep a balance between the buyback, M&A and operational spend. The acquisition of Avanan is to compete against the likes of Proofpoint, Microsoft ATP and Mimecast in e-mail protection. Billings growth is a predictive revenue growth. The delta at the moment refers to more product revenue being deferred as a result of the Infinity product bundle. But over time, billings and revenue should normalize. And hiring going pretty well in the last 3 months, Check Point's being able to hire a record number of headcounts. So to me, like a number of really interesting points. Gil, Tal, Kip, thank you so much for taking the time to join us today. It's been a real really fascinating conversation.

Thank you, Patrick.

Thank you very much, Patrick.

Have a great day.

You too. Have a great day. All the best. Bye-bye.

Bye-bye.

Thank you.