Trend Micro Inc

TSE:4704

Earnings Call Transcript 2018-Q2

[Mahendra Negi, executive]

This is Negi speaking. I would like to use a PowerPoint slides to talk about the second quarter highlights and this is a summary. Sales up 12%. Operating income 13% up. And excluding amortization of goodwill 12% growth in terms of profit. And pre-GAAP showed a 9% growth. We don't provide a quarter forecast, but in the first quarter the number was a little bit weaker than the annual plan. There were several major projects that we could not close at the time, which was one of the factors. But in the second quarter, we managed to close them.

So for the half of the year, the landing is in line with the plan. I will talk about the details later on, but corporate business is doing well and the consumer business is not doing as well. And here you can see the progress against the plan, and currently the progress is in line with the budget. And this is the list of numbers on U.S. dollar basis. By region, this is indicated in Japanese Yen at the constant exchange rate.

North America growth looks a little bit weaker as we explained in the previous quarter. Up until last year TippingPoint product sales was all accounted for but now we have distributed that to various regions. And Europe is the biggest part of that. So 17% for Europe is a little bit high because of that. If we were to adjust that both North America and Europe would show double-digit growth. And in Asia, we have high growth rate.

Nothing to comment on this slide, and this is on the constant currency basis how the revenue growth has transitioned over time. After the peak of TippingPoint acquisition, we have seen some decline, but it's growing once again.

This is sales by segment. The situation is as we expected. Consumer in North America is continuing in the negative territory. But for enterprise business, we are seeing double-digit growth. TippingPoint sales adjusted basis, we are seeing double-digit growth in all of the regions.

Hybrid infrastructure protection, this is our strategic product, network security and cloud security combination. 21% growth was seen in sales. 11% growth was seen in the first quarter, and the full year forecast was 20% level of growth. So again, we are coming back to our forecasted level. For User Protection, 7% year-on-year growth has been observed. This is already a matured market. And considering that, we believe that this growth rate is quite high.

In terms of growth rate, Cloud Edge is the biggest contributor. This is for SMEs, cloud appliance sold in Japan, and Mr. Omikawa will explain about this business in greater detail. So appliance sales is doing very well in this quarter.

And this is the sales by region, pre-GAAP sales. Again, at constant currency the situation is the same. North America growth seems to be weak because of a weaker consumer business and also because of a fact that the TippingPoint sales has been distributed to other regions. But once that is adjusted, we're actually seeing a double-digit growth in North America as well.

And this is a summary slide. Enterprise business 15% growth, and the pre-GAAP 13% growth. For enterprise, in the first quarter, this was only 5%. But in the second quarter, we are seeing a very healthy recovery. And this is the deferred revenue balance, which is showing an increase. And I would like to skip the slide and go to the expenses. In this third quarter, what I should highlight is the second one from the top, selling and marketing. Compared to the previous quarter, we have seen a big increase in this expense.

Large events in relation to customers and partners, we had some global events and that accounts for a big proportion of the sales and marketing cost. Yellow is solid benefits. This has increased according to the headcount growth. There was no factor of increased share price, but the salaries and benefits have increased because of the increase in headcount. This is a pre-GAAP versus total costs. Moving onto cash flow. JPY 14 billion and this is 1% increase, but this is actually the best number on a quarter-to-quarter basis for Trend Micro. We have a very healthy cash flow situation.

Headcount, increase of 156 for the second quarter. Sales, research, technical support, in all of these divisions, we are seeing a growth. We also plan to continue that increase of headcount in sales and marketing. In order to sell more products throughout the world, we will be opening new offices and also strengthen our sales activities in North America. And the technical support will have to increase as our customer base increases. For admin, we are seeing an increase because when we have new hires until they're allocated to certain divisions, they have to stay within the admin. So the admin itself, headcount has not really increased. In the next quarter or in the following quarter, these additional headcounts will be shifted to other divisions. There's nothing to comment on this slide.

Moving onto highlights and lowlights. I have already covered this. Growth in enterprise business has improved and appliance business. Until -- up to several years ago, we didn't have many hardware products. But looking at this quarter's results, the sales is up and profit margin has also improved. It is a profitable business now and operating cash flow, as I mentioned, has achieved record high. Lowlights, of course, exist, decrease in consumer business. Appliance business growth is a good thing, but -- because this is a hardware-based business, cost of goods sold has increased. So in this second quarter compared to the previous year, about 30% growth in cost has been seen. And this is the half year result. As I mentioned before, compared to the annual plan, progress is in line with the expectations. This is the total of the first and second quarters. So I don't think I have to explain any of these slides.

And in terms of expenses, again, nothing of note. Forecast has not been changed so far. Second half forecast remains the same as what we had planned in the month of February.

That's all from me. And I will be happy to take questions later on. Thank you very much.

[Eva Chen, executive]

Good noon, everybody. I'd like to explain about our strategy of securing a connective world. Actually this year is Trend Micro's 30th anniversary. I know for Japanese company, 30 years old property is like still young. But actually in technology company, especially in security, cybersecurity business, for a company that stay in the business without changing the company name or structurally changing the management team, 30 years is long live company already. So 30 years, actually when I review within these 30 years, every 10 years we have a big change and it's caused by the industry, the threat landscape or the user profile change. In 1988, when we first started, we provide peace of mind computing, mainly for desktop computer. 10 years later, Internet come out. Then Trend Micro move up, and we say we secure, we are your Internet virus world, and we come out with the world's first Internet gateway antivirus protection software. Then 2008, 10 years ago is cloud. Cloud just emerged. Trend Micro, again, become the first company in security business field to utilize the cloud to provide security from the cloud, but also we say we want to secure our customers journey to the cloud and we become world's #1 cloud security leader. Until now, our market share for cloud security for server data center security is more than 30% and is the world's largest market share in this field.

And now when we look forward from 2018, what will be the big trend and what is Trend Micro going to do. I will say, it's securing a connected world. But what is the difference between the Internet cloud in connected world? I think if we look from the big picture, then we can realize what is the ecosystem and what is the value-creation in the connected world, it's quite different. Before the first wave of Internet business come out, it's usually big company, one big company collect a lot of similar data from a lot of people. And then they use that data to create the value in artificial intelligent or AI field, we call that A2B value creation.

For instance, Google. Google collect a lot of data about your click and your keyword, and then they generate the value from themselves by collecting those data and generate the ads word, advertisement, keyword advertisement or Facebook, they collect your social network, who is your friends and all of this similar data, then they create, again, this value is advertisement. And/or Amazon, Amazon creates a shopping experience that is very easy, very cheap for everybody. Then they collect lots of buyers, the customers who buy, and then they create, you buy this and therefore, you probably would like to buy this also, they create value. But this all data to value creation is the data collector themself create the value for themself. So it's only A2B.

In the next wave, I believe in the connected world it's different. The creation, the value creation come from different angle. You will see that a lot of the different devices, especially in the IoT world, a lot of device, a lot of different vendor, they collect different type of data. But these data are sitting in a silo. For instance, if we say the car manufacturer collect a lot of car information. They use those information to make their maintenance better, make their car a little bit better, but not a huge value creation, right. Or the traffic light or the weather bureau or the SCADA system, utility company, they all create, they all collect the data, their own data, but this data itself did not create gigantic value. But who will create the new value, gigantic big value? I call them that will be whoever that can connect all this data silo and create new value, which we call in AI, transfer learning. That is A+B+C equal to D. And D is a new problem that could be solved, worth of solving. That is the D, that's the new value that will be created. So take a IOC -- IoT, as an example. All those data created by each of the manufacturer doesn't create a huge new value. What if there is a company come out and say, "I can integrate all this data and create a smart city." That is a big value creator. That is connect data before we called this big project people. They are system integrator, right. But now, I think it's not just hardware, software system integration. The most important thing, the best value creation come from data integrator, whoever can break this data silo, integrate them together, that can create the biggest value.

But breaking all this silo is very difficult. I recently was reading Microsoft CEO, Satya, his book and also his reading list, his book about Hit Refresh or talking about how he try to break the silo within Microsoft. And his reading list, his -- the book he like to read, one of the book called Silo Effect is a book very interesting, talking about a data scientist person to become a Chicago policeman, because he want to solve a problem of how to reduce the crime rate in Chicago. And he find out that, by collecting data is not enough. The only way he can reduce the crime rate in Chicago is to integrate the different data silo for Fire Fighter Department to Police Department for Population, Calculation Department, Education Department, all those data, very interesting book to read. And that is what we say the new value created come from the integration, but the power to break the data silo is a worthy solvable problem, a problem that everybody feel passionate and needed to solve. Only when you have that problem, then everyone will break their data silo and willing to contribute those silo. And what I want to say is, most likely what we see that worthy solving problem is cybersecurity. When IT meets OT, we talk about that. IT department, information technology department and operation technology department before, they never talk to each other, they never want to talk to each other, always separated. But recently, we're starting to see like WannaCry, that event caused a lot of company need to relook how to integrate their IT department and the OT department. You probably also hear about the news yesterday TSMC, the world's largest IC manufacturer, that his production line was all full of iPhone's production and they were forced to shut down for a day. That caused them 3% of their yearly revenue. Think about how big that is. And that is something that cybersecurity that will force all of this data silo to break and need to come together that is a big problem need to be solved. And therefore, we will say for cybersecurity company and we look at the trend. On this trend, when they want to break the data silo to solve the cybersecurity problem, what they -- we see in the customer side is that they start to set up or they update something called SOC, security operations center. They need to integrate all the security, all the security posture, no matter its network, endpoint operation, everywhere they established something called security operation center. And from that operation center, they were able to see the whole security structure and that is the new value that were created from all the different products. That's why Trend Micro starting beginning of the year, we say our strategy is to focus on SOC, security operation center.

But when we say security operation center, 2 important thing, very important. First, we are not just talking about the very big enterprise. Enterprise customer, they will set up their own security operation center. But meanwhile, small business because of GDPR, because of all these compliance, they also worry about cybersecurity, but they don't have the security experts and therefore, they outsource. There will be a new type of managed security provider that emerge that not just firewall monitoring, they will need to provide actionable instant response containing the outbreak of this service that will be what we call shared service, shared SOC, or even for the consumer, customers we already seeing that telecom company like we -- maybe later Omikawa-san will mention about our collaboration with NTT. A lot of this telecom company, they are establishing their customer SOC. They need to establish security operation for their customer, no matter they are small business or even consumer homes. So that's the first thing.

Trend Micro's strategy about SOC is not just about the very large enterprise. It's actually covered all of the segments, our security operation center. Second, it's important that Trend Micro is not trying to build a SOC. We'll not say, "Oh! We will take over your SOC, we'll build your SOC." What we will see is that SOC's biggest problem right now is they got too much alert. They just cannot handle it. They don't know how to handle it. When they receive alert, they say, "Oh! This PC is down." But it's not just that PC is down, it's they need to investigate where does it come from, who else got impacted, what data has lost, all of this. And that need something we call it smart sensor. Currently most of the security product they only provide their own alert. I'm a networking product, I'm a firewall, I'm endpoint, they just provide their own alert. And you cannot link them together. And therefore, the security operation center just kept individuals alerts from silos. They cannot see the whole picture.

So Trend Micro's strategy is, we will make Trend Micro's security product more open and connected, enable the security operation center to have smarter alert. When they receive the alert on Trend Micro, it's not just, "Oh! This PC is infected." It's telling you all the contractual information, say, this PC is infected from this process coming from that protocol and it has been connected with the other account that, therefore, you must also investigate the other account and the other host. And that is what we say Trend Micro's product, our XGeneration Trend Micro product is building a connected data lake that we can utilize our AI to enable our product to make them each of the product becomes smarter and generates smart alert for the SOC. And therefore, they will or this company that either operate the SOC, establishing the SOC, they will want to use Trend Micro's product because we give them better view into what's happening in the overall picture.

So this is our whole picture, but don't worry I'm not going to bore you with all the technology that we try to do. But I'm just showing that this is how we revamp all of our product to become smarter technology, link them altogether so that we can have better connection with the SOC operation center.

But if you look at this, you will know how many data, how many technology, how many product that need to be linked, right. So when you try to link them together, even though Trend Micro, as we very proud, we had built it from 30 years ago, we are a company that is very collaborative. We almost or we all know each other so well. But still a 6,000-people organization, there is silos. When you have function, you have silos. So when I look at our very simple strategy, we say, "We solved the customer problem by observing the infrastructure change, the user behavior change and the threat landscape change." But when I analyze, within each one of them, there is all these different functions. They serve their own purpose, each of the function they have their own purpose. And therefore, they have their own database, when they apply their AI, they only use their own data. That's not enough.

So if I may, I will say, Trend Micro next 10-year strategy, the real strategy is how to break the people silo. These are smart people. They're passionate about customers' problem, but we need to link their passion and link their organization so that they can work together to come out with solving the worthy solving problem, the SOC operations, the SOC customers problem. That is why all 3 of us just come back from 2 weeks camp in Prague in Czechoslovakia. In there, we organized we call it summer camp. We have all of those, almost 400 engineers or PM, sales customers, some of our customers joining us in the camp, 2 weeks in a very hot summer day and we all back to -- we intentionally held this in school in the Prague Chemical and Technology University. We say every one of us, we all back to school, we need to restudy everything. And in that whole camp, none of us, none of the executive speak, all the professor is from different department. And at the end, we have a project, they do overnight, they study and come up a solution they think that is best fit for the SOC customer. And frankly, we were all blown away from the solution they come up together. I asked them like, how come, you worked together for years and within 12 hours, their assignment, they only have 12 hours to come out with the project they want to do. But 12 hours, the project they come out is so good that it's not just an assignment in the summer camp. We actually even Mahendra say, "Okay, let's invest in that project, that you go ahead and do it, starting to do it." And what they told us is, "Well, we actually all know that, but it's just that this project need to have different function, different region, different product line to work together." And back then, we would say, it's impossible. So nobody proposed it. But when the silo break, then they come out with the excellent product that they can feel all of this. So I will say the strategy for any company, I will argue, to survive or really become the great company in the connected world, the biggest thing is build a connected organization so that we can secure the connected world.

And that will be Trend Micro's next 10-year strategy. Thank you.

[Akihiko Omikawa, executive]

Please allow me to talk about the business situation of our second quarter. First of all, in regard to the business strategy, the Japanese market, we will continue to expand on this. In the enterprise area, we have the XGen IPS, which is TippingPoint, and we have the efforts towards SOCs. And in the consumer area, we have the home network mobile security and also we have talked about the aspects of what we're doing in IoT. In regard to the enterprise market as already mentioned, there is the TippingPoint and the SOC initiative, and we have also conveyed to you what we are planning for the consumer market. And in regard to IoT, we have security solutions. We have collaborations in place. And now, I would like to talk about what progress we've been able to achieve.

In regard to the enterprise and consumer business of the second quarter, first, we have the hybrid infrastructure protection, HIP. On a global basis, Trend Micro Japan has continue to win in this market, including the Asian market. And there was an event, VMware Partner Leadership Summit 2018. And for 2 years consecutively, in the technology ISV category, we won the Global Partner Innovation Award for 2 years in a row. And the collaboration with VMware has been especially strong in Japan, which indicates how successful our deep security business has been here.

Second, in regard to the SOC area, we have target this and in regard to the detection of ATPs to prevent the expansion of attacks, we have the MDR, manage detection and response, and a trial project with InfoSec has been announced and they have been using Deep Discovery. And when some incident occurs, there are endpoint efforts, including forensics that will be carried out. An announcement was made about this and already this project is underway. Things are quite successful in Deep Security. And we have 25% growth on a year-over-year basis. And in terms of sales, we have achieved, plus 13% over the previous year in terms of new sales. And there have been cases where we have been providing things free of charge. And we may have been -- said to have lost business opportunities, but AWS wanted to have their environment used, targeting startup companies. And so, therefore, in that area for the startup company security purposes, we have deployed Deep Security. And they were initially not users of Deep Security users. But once they grow, then, well, they get to free server coverage. But after that, they would be on a -- once it expands, then it would be on a paid basis. And so, therefore, it would be possible for us to grow the business here. And so we have announced our effort to support startup companies.

Next, TippingPoint. We have a large growth here, especially these are all new users. So what is notable is the fact that, in a single order, it could well be JPY 200 million or more. And this is in the OT systems in factories. And TippingPoint would be offering integrated functions with Deep Security to look at internal threats in factories. And in Q3, there has been a major deal in TippingPoint that we have been able to get it in the third quarter. So within Japan, we have started up the TippingPoint business quite successfully.

Next, User Protection. On a year-over-year basis, we have 19% increase in sales and 37% year-over-year increase in new sales, and we have the gateway security appliance, which is doing quite well. Cloud Edge is growing on a monthly basis. We're seeing more and more companies handling this so that there are close to 3,000 units per month going out. And the year-over-year growth in sales is 201%, and we have been increasing the number of customers as well. And there's the partnership with NTT DOCOMO until now. But since we have our cloud functions available, it would be possible to monitor the situation of customers through the cloud. And so it will be possible to carry out service business. And if monitoring of service business is carried out, then the situation of PCs can be detected and additional service business can be generated. So this could act as a core to generate new service business and to establish an ecosystem. So it's not just a matter of providing a UTM , but a cloud-based security business that we can offer as well matched to what we are -- what they are trying to do. And in terms of the handling and sales of Cloud Edge, we have seen an increase in a number of partners. And for security, for cloud applications, including Office 365, we were able to get very big deals in the second quarter. So the cloud application services have been moving forward, including box and so on is growing steadily.

And for the DOCOMO consumer market. In Japan, we are doing quite well in the large discount houses, we have been going forward. The other vendors are dropping share. So we have continued to grow. And when it comes to the sales agents of mobile phones, including DOCOMO shops, when people purchase smartphones, clerks talk about the importance of security and they can do security settings at the stores. So the business model is showing growth in the consumer area. On a year-over-year basis, it's increasing by 2.4x. We're also getting involved in Home Network Security. If you go to the stores then you'll see there are smart TV corners or connected appliances. And you can see our smartphone network security products are displayed. And in those discount stores, there are explanations made about the necessity of these kind of products, so that our sales is growing. And if you look at the router corner, you can see that the trend -- micro is used in many of the routers for security purposes. And there's about 0.5 million units being shipped in this area. And in the utility applications for the Macintosh, it's quite difficult to get Japanese Mac users to buy this. But if we include Europe and The United States, the Macintosh utility software that can be used free of charge as well as on a paid basis. And this is now being -- growing into a level of several hundred million yen

Next, IoT. In regard to IoT, in the area of network security, in new network environments for new network virtualization efforts, in this area, we had the security functions that are being provided. We have the network function virtualization suite that has been announced. And starting from the second half of this month, we're able to offer this and there have been verification trials carried over the past 2 years. So we've made confirmation of this technology and we have been looking at the timing to see when the carriers will deliver this. And it will not just to be in Japan, we have been negotiating about this outside of Japan as well. And about 1 month ago, NTT DOCOMO has made an announcement in this area, and they have talked about our company as well in the 5G open cloud. There are various application vendors that are involved, altogether about 1,000. But there are 6 that we're especially focused upon for a collaboration. And as a security vendor, Trend Micro was the only company that remained among the top 6, and there our name was announced as well, and in the area of 5G validation, we are a candidate vendor.

Virtual Network Function Suite, VNFS functionality will be used here. Security for IoT device router-ready business, we have already shipped more than 0.5 million in Japan. And IoT security supporting devices are now being verified. It includes gateways for factories. We have completed the verification process. And we are ready to announce some of them. Safe Lock for point of sales in Japan. If something happens, you can lock it down. This is a very important solution for factories. And this was developed in Japan and has been available for several years. Now it's available in North America as well. So Safe Lock for factories and also portable security, which makes it even easier to deploy. So now this is available just in Japan, but globally. That's all from me. Thank you very much.

[Hideaki Tanaka, analyst]

I am from Mitsubishi UFJ Morgan Stanley and I'd like to ask 3 questions. I believe that the pre-GAAP enterprise numbers were very good. But besides what was the blue, is there a -- the large type that is getting in for? What is the dependence on the large deals? Is there a solid increase in the number of deals or are you dependent on the large deals? Is there going to be further fluctuations in the future? Or do you think that this trend will continue in regard to the big deals?

[Mahendra Negi, executive]

Of course. For the first quarter, there were deals that could not be closed that were closed in the second quarter, but then there were also other deals so that overall we had solid business in the second quarter. Meanwhile, in regard to the impact of big deals to increase sales, I believe that this scenario will continue. Mr. Omikawa explained about this, but it was quite rare for us to get very big deal but we've seen an increase of deals amounting to JPY 100 million or more. And we're now working with value-added resellers who have large budgets. But then this means that there won't be larger quarterly impacts depending on whether those deals are closed or not.

What about the third quarter of last year? Was there large concentration of big deals?

I don't remember that far back. I've grown old. And so the third quarter of last year is quite a long time ago for me. Last year in the third quarter, there wasn't that many big deals. But in terms of costs, because the cost were not that high, we were able to generate more profits in the third quarter of last year.

[Hideaki Tanaka, analyst]

Now the second question I have, in regard to the SOC matter that you talked about, for related businesses, what is the impact in regard to the numbers? How many customers do you have? Or do you have some idea about this?

[Mahendra Negi, executive]

When we talk about strategic aspects, it's not something that we immediately switch on. And for our customers, who have SOCs, we're moving forward. But the problem that they face as users of SOC is because information is siloed. And they want to respond more quickly, and they want to analyze more quickly. And so to break down the silos, we believe that we can offer better products and solutions. And so we are strategically focusing more in this area by holding the camp sessions and so on and, of course, in regard to SOC-related sales. Well, we haven't established a separate category for SOC sales, but in the IT infrastructure, in the enterprise market, we are thinking of generating more profits through the SOC business.

[Eva Chen, executive]

You will not see our revenue item that there is a revenue from SOC. Actually it's all from the different product. You can say it's actually extension of what we call connected threat defense strategy. For instance, right now, we're starting to see our customer using TippingPoint. Originally our only product that was used by security operation centers are TippingPoint product. But now the TippingPoint product, customer are coming to us and ask about our Deep Security or even our OfficeScan end user protection, because they're seeing the need for integrate all those data. And we are trying to make our user protection product, Deep Security products or even sometimes consumer product, IoT products, to be more integrated, so that the SOC buyer who originally only use TippingPoint would now also think our other product is better for them.

[Akihiko Omikawa, executive]

[ Foreign Language ] And also with maybe IoT or in regard to the SOC strategy, we made announcements and since then among the corporation that we've been talking to as well as the departments we have seen more departments talk with us and more upper management people have been talking with us as well. And in regard to IoT as well, we talked about Panasonic, and we're going to build a SOC with them. So overall in these talks, we're being asked to join in the conversation more and more. We talked about InfoSec and the tie up that we have with them. And there were cases where customers had specified us to be involved. So we are seeing specific progress in this area.

[Hideaki Tanaka, analyst]

The third question that I'd like to ask is something that came up. In regard to Panasonic or Mentor Graphics, I understand there are various collaborations underway. And what has been the recent follow-up to those activities?

[Akihiko Omikawa, executive]

Well, this is going to cover a long period of time. In the case of the connected car, we are periodically and steadily carrying out meetings. And we've finished Phase 1 and are moving to Phase 2, and preparations are underway. I think that discussions are covering a span of 3 years. And we are moving forward in these efforts.

[Hideaki Tanaka, analyst]

I think that's the case for Panasonic. But what about with a company like Mentor Graphics, is this starting to generate sales?

[Akihiko Omikawa, executive]

In case of Mentor Graphics there in Tier 1 and they have efforts on their ICs and also our products are involved and when the vendors are going to release this, it's going to take time So we have to look at of cycles of at least 3 years or 4 years.

Any other questions?

[Unknown Analyst]

I'm [ Sata from Mizuho Securities ] and I have just one question. For the third quarter, last year you posted JPY 11 billion operating income, which was record high, and I think it's going to be difficult to beat that. Is there a risk factor your operating income will be lower than the previous year? In which case you have to try really hard in the fourth quarter otherwise you will not be able to meet the guidance. That's my first question. And also appliance hardware, I think it's increasing in terms of overall weight, and you were talking about increased cost for the hardware. When you provided your forecast, you mentioned that more numbers will be generated during the second half. Should we feel convinced, comforted? Or do you think the third quarter profit operating income will be the last hurdle that you have to overcome?

[Mahendra Negi, executive]

We don't provide forecast for quarters. So we don't really talk about the third quarter. Is it high hurdle? Yes, it is. But the biggest thing for us is fourth quarter in terms of sales size. So rather than the third quarter, the question is what happens in the fourth quarter. So right now, looking at the numbers we believe that we will meet the expectations, but we cannot really guarantee that yet, because we will have risks until the end. But we think it's going to be in line with the plan.

[Unknown Analyst]

So you know how much of the pipeline can be cut over in the fourth quarter?

[Mahendra Negi, executive]

Yes, some of that.

[Eva Chen, executive]

Well, appliances products, our costs were increased. But actually our appliances product is also sold with subscription revenue. And we take very conservative measure for revenue recognition, subscription only recognized per quarter. But the cost part, we recognize once we sell. So when we sell a lot of appliances, the first quarter you see is higher cost. But later on, it becomes subscription revenue.

[Unknown Analyst]

Are you expecting out of hardware installs recognized in the fourth quarter?

[Eva Chen, executive]

I don't know. But our Omikawa-san kept on selling a lot of Cloud Edge and TippingPoint. So it might be.

[Satoru Kikuchi, analyst]

My name is Kikuchi of SMBC Nikko Securities. And I'd like to ask about Page 10 in terms of costs. It was already mentioned about the fact that the costs were low in the third quarter and the costs were higher in the fourth quarter. I think there were fluctuations. If you try to level that out, then gradually you're seeing the increase in the headcount and the costs are going up in parallel to that. But in the second quarter, it seems like the cost were rather high. It seems like the costs have accelerated and increased. So for this fiscal year's company plans, it seems like the progress that you're achieving in profits is not as fast as previous years. In terms of increased cost, I'm sure that you're making efforts, but you're also increasing the headcount. And there are unavoidable strategic elements that have to be covered. And I'm sure that you're cognizant about this. But when it comes to cost to expand the business, it's unavoidable. Do you feel that it's unavoidable to increase cost? Or are you going to be looking into way of reducing cost?

[Mahendra Negi, executive]

In our case, we have previously explained about this. But the priority is for customers, employees and then shareholders. So we're not -- the important thing is to continue to look at opportunities for investments. There are a lot of opportunities and in regard to where we need to focus. We have to look at the competitiveness of our company. We have to look at what can benefit the customer and look at the opportunities for investments. If there is the opportunity and if we have more investments that need to be made beforehand and that the profits may be undermined, as long as we are able to explain to the shareholders, we'll move forward with such efforts. And we are also told that we shouldn't hold onto that much cash that we should invest more. And if we do make the investments then profit ratios may go down. That's understandable. But it didn't, right? We want to look at how we can generate value for the customer. That is our highest priority.

[Satoru Kikuchi, analyst]

Well, even if cost increase, if the top line increases, that's fine. But currently, I think that your pre-GAAP numbers are growing. So on a historical basis, it's on a high level. But the pre-GAAP growth is lower than average? So there's a possibility that the top line may increase very rapidly. But are you still going to continue to give priority to investments?

[Mahendra Negi, executive]

In a particular quarter, if the investments are made, then it's not going to linked to the profit levels. For 3 years ahead, we may have to make investment now. But we have to also look at whether we were able to achieve profitability levels for that particular quarter. I think even we give priority to the profitability in the future. And also we have to look at the annual numbers. So we believe that we can achieve the numbers that we've been talking about, but if there are positive opportunities to make investments for the future, then we will give that the highest priority. And so there may be cases where we'll not be able to generate the profits at that particular time when the investments have to be made.

[Eva Chen, executive]

I think I need to take a responsibility for some of the cost. But I believe the cost, there's good cost and there's bad cost. If the cost was used to, for instance, we all get a big salary increase, that's a very bad cost. But we do hire some new people, but that is because we believe some of the region for instant, Mahendra mentioned, some of the new region that we want to invest in, so we establish the support center and everything in there. So some of the new cost were spent on the new office establishment in the new region. But the other cost is probably something like I just mentioned about the Prague summer camp, that's quite some cost, but it's very important. So we have, I would say, 3 major costs. First cost increase is our cloud expense like AWS, Azure, as we move our computing and also our AI engine running in there and building up of the data lake, that part of the cost increase. The second part of the cost increase is a lot of this training that we need to provide. And we believe upgrading our people's capability. So that's the second part. And the third part is, it's true that by selling more appliances, of course, we need to increase all these appliances cost, inventory costs, and -- but that is paving for -- that means we are acquiring new customers, and later on that would turn into subscription model. So those are the cost we believe is good cost that we are increasing.

[Akihiko Omikawa, executive]

[Foreign Language] That means that we'll be able to get our bonuses just like the investors.

Any other questions?

[Keisuke Nakayama, analyst]

Nakayama, Amundi Japan. Question about SOC and silos. So silos is the current situation. And you have explained the strategy about the silos. Competitive security companies, what are they doing in this area? And how would you position your strategy? What kind of advantage does your strategy have?

[Eva Chen, executive]

Thank you very much for your question. If you think, well, I say, Trend Micro has silo, at least we recognize that, we make an effort to break it. I will say most of our other competitor, if you see they acquire a lot of company and they kept on changing their organization, they were just creating more silos. And that's why I believe our strategy for creating a connected organization that's a sustainable strategy, competitive advantage, especially in the age of AI. If you want to utilize the best technology like data lake, artificial intelligence, analyzing data, then creating organization without silo is the only sustainable strategy for any company. I cannot comment on my competitors. But if you would just see from outside, they change their product name, they change their company name, they change their CEO, they change their organization, they announce all this acquisition and I don't think they are aware and making an effort of breaking the silos in their organization. And that's why I think our strategy is more sustainable and going to be a long-term competitive edge, especially in the cybersecurity world because the only way that you can secure a connected world is when your organization is connected.

[Audio Gap]