CyberArk Software Ltd. (CYBR) Earnings Call Transcript & Summary

Okay. Hey, good morning, everyone, and welcome to the Barclays TMT Conference. My name is Saket Kalia. I cover software here at Barclays. Very happy to have with us the team from CyberArk. We've got Josh Siegel, Chief Financial Officer; and we've got Erica Smith, Head of Investor Relations. We've got about 25 minutes together. So maybe I'll lead 15 or 20 minutes of some fireside chat here with Josh and Erica. And then we'll open it up for some Q&A from the audience. We're not going to do live Q&A. So if you've got any questions on the webcast, just shoot me an e-mail at [email protected], and I'll do my best to weave them in at the end. So maybe with that as a framework, Josh, Erica, thanks so much for being with us here today.

Thank you for hosting the call.

Great. Thank you, Saket. It's always great to be at your conference even if it's around the world virtual.

Absolutely. I look forward to when we could do this in person again, Josh. Josh, maybe just to start off, there's a lot to get through from the last quarter just in terms of the bigger move to a recurring revenue model. But maybe just to level set us a little bit. Can you remind us of some of the highlights from the last quarter that you really want to make sure we know about to help frame the discussion?

Yes, absolutely. And first, we had 59% of our total $107 million revenue was recurring, either coming from SaaS, subscription or maintenance, we saw more than 45% in the fourth quarter. Our new license bookings were from SaaS and subscription-type licenses. And that really -- that -- those are 2 important numbers because there's things that we're going to be focused on going forward. Although as we had just kind of coming out of 2020, it did create about a $14 million headwind when we think about revenue of the $107 million, $107 million of revenue that we did report. And so that's -- when we think about those concepts of the mix shift moving in towards SaaS and subscription, and we think about the percentage of total revenue, and then on the headwind, that's why we really start to introduce AAR in the fourth quarter, annual recurring revenue, which was already $250 million at September 30. That's a 40% year -- growth year-on-year. And where we saw the big growth in that AAR was 400% growth in the SaaS deferred revenue. That was a contributor to that AAR. We also -- on the new customer front, we also signed just over 190 new logos. And from a product perspective, we continue to have shown a really strong growth in our Endpoint Privilege Manager and PAM solutions across for Core PAS. And on the SaaS side, really seeing nice growth in the Privilege Cloud.

Got it. Got it. There's a lot to dig in there, which I'm looking forward to digging into. But maybe before we get into some of those mechanics, Josh, I'd love to just talk a little bit about what you saw in terms of underlying demand of Core PAS in particular. What are you seeing from existing customers and new customers? And you touched on this a little bit in your prepared remarks, but just talk to us about it from an overall demand perspective and what you're seeing out there competitively as well.

Yes. So when we look at the demand, I mean, obviously, we look at what we actually did, which I just talked about, the 40% growth in AAR, $107 million. And then actually, you could also add a $14 million headwind to that. But then we look deep down into really where is the market going, which is basically a reflection of our pipeline. And the pipeline growth for Q3, but also for even the whole first 9 months of the year has really been growing at a record pace all year. And that new pipeline generation, I think, really puts a stamp in the ground for us about where we see Core PAS going, not just in from quarter-to-quarter, but when we think about over the next 6 to 12 months. And so we see that as a tailwind to our PAM business, for our Core PAS, for our Privilege Cloud. And it doesn't surprise us all that much. So we all know that the attack surface is larger, and there's certainly a high-end sense of urgency around securing environments and not just securing on-prem environments, but securing cloud environments. And for most companies, it's actually securing hybrid environments who are working with environments, both on the cloud, in the cloud and on-prem. I think when we think about competition, it's a lot of -- more the same for Core PAS. We're seeing Thycotic where they're coming more from some new enterprises, but they also have an offering that competes with our Privilege Cloud. And so we see them. And then, of course, we see as well sometimes BeyondTrust.

Got it. Got it. That's really helpful. I want to move into sort of the mechanics of the business model change. And actually start with what you've seen so far. I think so far, nearly 30% of your license revenue and a higher percentage of license bookings, I think you said was 45%, are coming in as SaaS or term. And that, too, historically, has been happening without the change in sales commission or sales compensation, right, the structure that you announced most recently. Maybe the question, Josh, is, what do you feel like is happening in the underlying market that's driving some of that increased demand for SaaS and term in your view before, I mean, arguably before CyberArk even really start to drive this change internally. Does that make sense?

Yes, it does. And some of this was even a bit of a surprise to us in 2020 and -- but some of it wasn't. And I think if we look at the drivers for where that transition has been happening is, first of all, when you see the enterprise demand for SaaS in general, enterprises are moving for SaaS applications across a lot of the software enterprise, across a lot of the software space. We clearly know that for PAM, it's one of the last, I think, one of the later adopters because of the sensitivity of putting the keys, the kingdom and a third-party host in a cloud environment. But even now we're seeing it in PAM, particularly around medium enterprises and small enterprises and starting -- and larger enterprises, at least talking about it and wanting to know where it's going to be in their migration. And I think a lot of that also has to do with just the digital transformation and automation and things like that. So that was what we expected would happen. And I think COVID was an accelerator for that. When we look at COVID, I think enterprises have become more conscious, more cost conscious. They've also been more budget conscious in the context of wanting to control their budget from year-to-year, certainly from period-to-period and be more precise on what they're spending and not necessarily or less interested in maybe plunking down large dollars for large perpetual deployments. And this way, they're able to control their budget, their operating budget from year-to-year. So I think those 2 things combined really kind of generated some acceleration for CyberArk in its transition -- in transitioning us. I think the other component we said early on in this year, is this is the first year where we actually were comp neutral for our account executives. So they actually didn't mind or didn't have a problem going selling SaaS or subscription products versus a perpetual quote. So with the natural transition by the industry, with the natural accelerator by COVID, we didn't get caught up with a conflict of interest in our selling motion. So I think all that combined, really kind of gave us a tailwind for that transition.

That's interesting. That's interesting. Josh, maybe that's a good segue into maybe the sales compensation changes that you've talked about going forward. And of course, without getting too specific, I guess, what are the changes that are happening here in 2021? And how do they change -- and if this is too far ahead, you let me know, but how do they change kind of beyond 2022 such that you sort of continue to incentivize recurring but are also able to see operating leverage? Sorry, there's a lot there. Does that make sense?

Yes. Yes. So first of all, with regard to the compensation, that obviously is a clear priority for getting through the transition in the right time frame and in an efficient way and in the right way, there are several aspects of being successful in transition, but getting the compensation program [ proactive ] is clearly one of those [indiscernible]. So I'm sure, we're really going to be focused our go-to-market teams on being compensated for building our annual recurring revenue. And for sale they'll be receiving metrics and targets that in the end will be generators for growth in our -- in annual recurring revenue. As opposed to where we've been historically, which is more around licenses and total contract value. When you think about the leverage over longer term, obviously, through a transition, there's a transition laws of physics that occur, right? And you have a ratable revenue, so you have a slowdown in the revenue number. But at the same time, you're continuing as long as your pipeline is growing, you're continuing to invest, maybe even at the same rates, maybe in some cases, higher rates. So the 2 against each other are certainly going to have an impact on bringing margins down during the transition period. However, when we think about -- without giving guidance for a long-term model yet, we do see coming out of the transition being able to be, again, a company with 20% operating margins and 20% growth rates.

Got it. Got it. That's great. Maybe staying with the transition, but moving outside of sales comp. I think one of the interesting things that you and Udi sort of touched on a little bit last quarter, was the prospect for potentially some new SaaS packages/bundles that might be attractive for those that are perhaps new to CyberArk. Of course, without preannouncing any new products, what could some of these new packages sort of look like? And what do you think are going to make them sort of more attractive to customers, if that makes sense?

Yes. Saket, absolutely. This is Erica.

Erica, do you want jump in?

Absolutely. So I think the way to think about it, Saket, is as opposed to new products, is more around bundling, right? So we have a very broad portfolio, particularly around the SaaS. And so when you look at the new subscription offer that we'll be rolling out to customers beginning in January, it's really going to be taking some of the functionality from the broader portfolio and including that in the subscription offer to make it more attractive for the customers. So that we'll actually be creating a push and a pull from a demand perspective. So we'll have the sales compensation changes. And then we're going to incentivize the customer with more attractive functionality around the subscription offer. If you think about something like an MFA or third-party access and obviously, analytics are all features and solutions that we offer, and when you put those together as a package, that can help the customer really move in the interaction of subscription. And so that's the way to kind of think broadly without getting into too many specifics around how we're going to be looking at the subscription bundles.

Sure. Sure. That's really helpful. Maybe shifting back to some of the mechanics here, Josh. You talked about a few new metrics that we should be looking at because again, as you said, clearly, the headwind to the income statement is only going to be growing, right? And actually, the first one that I want to talk about is that mix of license bookings, right, that is subscription. I think you said it was 45% in the last quarter. Can you just remind us, because I don't think we historically talked about license bookings. Can you just talk to us about sort of what that represents, and what you said about where that mix can sort of go over time?

Yes. So basically, when we're thinking about the mix of new license bookings from SaaS and subscription or term-based license, it's grown from over around -- it was around over 20%, close to 25% in the first quarter. And when we came out of Q3, we were talking about a mix of 45%. So over the first 9 months, it's about a 35% mix going to licenses, mix of bookings that are going to either set -- recurring license bookings. And if you think -- if you recall, I mean, you've been with us from the beginning Saket. So if you recall, even 2 years ago or 3 years ago, those numbers were in single digits in terms of how much was going to SaaS and how much was going to term-based license. And I think when we think about the transition, where we really want to get to is we're less concerned about 100%, although we -- at some point, we'll get there because there's always going to be laggards of existing customers who will persist on perpetual. There may be some verticals, federal or other verticals, that may have a problem switching. But we see a goal of one [ group are we ] out of that transition period is when we're above 85% of our new -- of our bookings mix is for license will be from subscription and SaaS, and that will basically already give us -- when we look at the revenue forecasting, it's going to be mostly coming from, I mean, a very large percentage coming from recurring revenue streams. So we don't -- we're focused on getting to the high 80s and breaking -- at some point, then breaking through 90%, a mix -- of the mix coming from SaaS and term-based licenses.

That's great. That's great. And if I missed that, apologies, but when did -- what's sort of the time frame for when you can get to that, call it, 85%-plus?

So we're actively switching to the -- we're actively transitioning in Q1. So while this year, we've already started along the curve, but it's been through a natural acceptance of it because when we talked it about earlier today, the industry is moving that way. COVID provided a bit of a tailwind accelerator to it. And by the way, CyberArk on its own has now -- when you think about us a year ago, where the only real SaaS product we were selling was Endpoint Privilege Manager. Today, we're selling 6 SaaS products, right? We have Privileged Cloud, we have Endpoint Privilege Manager. We have Alero. Now we have Idaptive that we've acquired and we just introduced Cloud Entitlement Manager. So all of that together has also helped us kind of move into -- move us along that transition curve. But we kind of view this transition. We look at a lot of other stories, a lot of other companies that have done it. It's really an 8 to 10-plus month transition. And so we kind of see getting to that 85% level at the -- probably closer to the 8 month, 8 quarter -- sorry, not a month, 8-quarter transition, starting with Q1 of 2021. And the reason why I really emphasize that it's beginning in Q1 is because of some of the things we talked about. We're only starting a pro comp plan for selling subscription and SaaS to our go-to-markets team in January. We're only really releasing the new subscription packages that Erica had talked about only in Q1. And those are 2 really critical components to really get -- to kick off a transition program.

Got it. Got it. Clearly, as part of any transition, right, to recurring, especially for what was largely a perpetual license model, right? We've got -- the counterbalance there is perpetual license, right? And so as the mix of subscription will increase, clearly, the mix of perpetual will do the opposite. I guess the question is, Josh, how do you think about that pace of perpetual decline in the next couple of years and -- yes, let's maybe just start there on perpetual.

So it's going to be really the inverse of what we just talked about, right? If I think during -- it's going to start off slow, a slow decline in the first half of 2021, and that's just because of our sales cycles. We have a 6- to 9-month sales cycle. Much of what we're selling in Q1 has already been quoted that we expect to sell in Q1. A lot of it has already started to be quoted. And a lot of the pipeline for Q2 is already opened opportunities and so forth. So we anticipate a gradual decline in H1, a steeper decline in H2 of next year. And then in '20 -- by the end of 2022, we're already talking about less than 15% of our bookings coming from perpetual in terms of the new bookings mix because we're talking about 85%. By the end -- by the time we kind of move into 2023, we're hopefully past that 8-quarter segment in the beginning of 2023, and we're -- and by then, already, we're in 10% to 15% perpetual.

Got it. Got it. And for folks on the line, we've got about 5 minutes left. So anyone that's got any questions again, feel free to e-mail me at [email protected]. Maybe last question on the top line. Recurring here, right? Let's take maintenance out of it, right? Like the recurring piece is going to be SaaS or term. And of course, as you know, in a post-606 world, those are very different rev rec models. So I guess -- and it's probably early to kind of put numbers to this. But as you think about the model going forward, how much of this is going to be a SaaS transition versus term? How do you sort of see that playing out between the 2?

Yes. Well, what we saw in this year so far naturally before we've kind of actively pulled the trigger, is it -- we've seen it be a SaaS-heavy transition. So if we look at the first 9 months, the growth has really been $2 of SaaS to $1 of term-based license. And right now, where we -- because of the SaaS products that I also talked about that we really are going into 2021 now with a real group of 6 SaaS products, we still think that -- and with the overall industry moving towards digital transformation still and cloud applications, we still feel like at this point, we expect it to be SaaS heavy. I don't know if it's going to be 2:1, but we do anticipate the transition to be heavier to the SaaS side.

Okay. Got it. Got it. Maybe a first question in from an investor. I'll just paraphrase a little bit. Josh, you've talked about maybe even increasing investment, right? So maybe moving beyond the top line, but kind of moving to the margin to the operating margin. You've talked about just kind of high level potentially increasing investment through this transition. Other transitions have maybe taken different approaches, whether that's -- I cover Adidas, they've kept OpEx flat. Others have grown as well. How should we sort of think about the trend in OpEx over those 8 to 10 quarters, let's say?

So I think if you -- first of all, increasing. We anticipate to increase on a nominal dollar investments across all the areas. And the reason is because what we talked about in the beginning of this 25 minutes is where we see the market, right, and where we see the growth and the potential of Core PAS and where our record pipeline has taken us. So we do see the reason to invest and I think if you kind of -- if you add it in, so to speak, the headwind of the apples-to-apples of the cost of the transition from a revenue perspective, I think sales and marketing and G&A will be roughly in line and R&D will be heavier. Probably a bigger investment in R&D comparison, and that's really natural because of the fact that we're really doing also a migration on the technology path, and we still have 6,000 or so customers that are coming in with on-premise solutions that we want to keep them very happy with. So -- and now we have all these bonafide SaaS solutions. I think the other piece of the pie will be the more SaaS we sell, then we will have some movement on gross margin downward. So typically, we've been in the high 80s. This year, we're in the mid-80s, it came down a couple of points, mostly because of the cloud impact, and we can see it going down to the low 80s as we move more and more into the SaaS-heavy transition.

Got it. Got it. That was going to be my next question, Josh. So thanks for addressing that. We've got a couple of minutes left, and I don't see any other questions in my inbox. So maybe I'll wrap up with sort of a big question. Josh, you've always been one of the CFOs and my coverage, that's really involved with the technology and sort of the operations. And so one of the questions that we're trying to ask all our management teams here at the conference is for the handful of customers that you've spoken to here, right, or have spoken to through your sales team, what are your customers saying about the willingness to spend in 2021? Obviously, 2020 sort of an unprecedented year. What's the feeling around the willingness to spend next year, open-ended?

Yes. So I can talk about it from the context of what we're hearing from customers and a little bit from the context of kind of how we're looking at the world as well as CyberArk. But I think there's willingness to spend with caution. And what I mean by that is that they're going to be very thoughtful about what they spend. Because even with the vaccine, presumably, on its way tomorrow, and things like that. They do know that there's going to be still a bit of a topsy-turvy economic recovery over 2021. So when I kind of think about what CFOs are doing, they're saying, yes, we need to build a budget for growth because the world is generally an economically healthy place. There is positive light around the corner from COVID. But we're going to do it in a way where we can preserve the ability to manage that growth downward if we feel like there's some new bumps in the road.

Got it. Got it. Well, I think we're at the end of our time, have plenty more questions that I could ask here, but I want to be respectful of your time. Josh, Erica, as always, thank you so much for taking the time here. I really enjoyed it, and look forward to seeing you here in person at the next Barclays tech conference.

Great. Thank you very much, Saket.

Thanks, Josh. Thank you, Erica. Have a good one.

Thanks, Saket.