Earnings Call Transcript - CGNT Q1 2022

Operator, Operator

Hello, everyone and thank you for joining us today. I'm here with Elad Sharon, Cognyte's CEO; and David Abadi, Cognyte's CFO. Before getting started, I'd like to mention that accompanying our call today is a WebEx with slides. If you'd like to view these slides in real-time during the call, please visit the IR section of our website at cognyte.com, click on the investors tab, click on the webcast link, and select today's conference call. I would also like to draw your attention to the fact that certain matters discussed in this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other provisions of the Federal Securities Laws. These forward-looking statements are based on management's current expectations and are not guarantees of future performance. Actual results could differ materially from those expressed in or implied by these forward-looking statements. The forward-looking statements are made as of the date of this call, and except as required by law, Cognyte assumes no obligation to update or revise them. Investors are cautioned not to place undue reliance on these forward-looking statements. For more detailed discussion of how these and other risks and uncertainties could cause Cognyte's actual results to differ materially from those indicated in these forward-looking statements, please see our annual report on Form 20-F for the fiscal year ended Jan 31, ‘21 filed with the SEC on April 29, 2021, and other filings we make with the SEC. The financial measures discussed today include non-GAAP measures. We believe investors focus on non-GAAP financial measures in comparing results between periods and among our peer companies that publish similar non-GAAP measures. Please see today's presentation slides, our earnings release, in the investors section of our website at cognyte.com for a reconciliation of non-GAAP financial measures to GAAP measures. Non-GAAP financial information should not be considered in isolation from, and as a substitute for, or superior to GAAP financial information, but is included because management believes it provides meaningful information about the financial performance of our business and is used by investors for informational or comparative purposes. The non-GAAP financial measures the company uses have limitations and may differ from those used by other companies. Now I would like to turn the call over to Elad. Elad?

Elad Sharon, CEO

Thank you, Matt, and welcome everyone to our first quarter of FY22 conference call. I'm pleased to report a strong quarter with both revenue and diluted EPS coming in ahead of our expectations. During our last conference call, we discussed the completion of our transition to a software model. And I'm pleased to report that in Q1, we continue to see the benefits of our strategy and our results. Non-GAAP revenue increased 12.3% year-over-year, while gross profit increased at an even faster pace of 18.8%, reflecting an improved software mix. We are particularly pleased with our gross margin, which came in at 72.6%, up 400 basis points. Adjusted EBITDA increased a strong 66%. Our strategy is to empower security organizations with an open analytics platform to help them address many different security use cases. To help bring this strategy to life, today I will review our market opportunity, discuss several large first quarter orders, and discuss recent innovations in our analytics platform. Our customers are facing many security challenges. Well-organized, well-funded entities are becoming harder to detect, as they take advantage of the latest technologies to hide in the shadows. At the same time, there is a growing volume and diversity of structured and unstructured data. Data is fragmented and spread across organizational silos, making investigations more difficult. Many customers recognize that homegrown solutions cannot keep pace with these evolving security challenges, and they have increasingly sought open security platforms with cutting-edge analytics, solutions that can fuse data at scale from different sources and generate high-quality insights faster to mitigate a wide range of security threats before they unfold. Our open platform provides many benefits to our customers, including faster innovation and more frequent updates with the latest analytics and artificial intelligence technology. We believe the security analytics market is in its early stage, and we are committed to staying ahead of the demand curve with our open analytics platform. With nearly 1,000 people in R&D, primarily based in Israel, we are focused on developing highly sophisticated security analytics software. Our total addressable market is $130 billion, growing 10% per year. We believe we are well positioned to address this opportunity with our open analytics platform. Let me take you through several large Q1 wins that reflect the successful execution of our strategy. The first is a $40 million order that came from a national law enforcement organization that started with one use case, as it is expanding into a second use case. This customer initially deployed our platform Rhythm Analytics for fighting drug trafficking in one agency, and over time, it has deployed it across multiple agencies to facilitate collaboration across its different operational units. This customer is now expanding our platform to add an additional use case for anti-terrorism. This is a good example of how our platform supports multiple use cases and enables us to go wider and deeper and grow with our customers' needs. The second example is a $9 million order from a national security organization that is replacing the homegrown solution. This organization needed the most scalable, open, and advanced platform and faster innovation to address its changing security needs. Our platform allows them to easily add new data sources and accelerate criminal data investigations using advanced analytics capabilities. This is a good example of how our platform addresses the limitations of homegrown solutions. The third example is a $6 million order from an existing national intelligence customer that is expanding the deployment of our latest security analytic software. This is a good example of how customers look to Cognyte to help them address their growing security challenges with real-time analytics. As a reminder, about 90% of our revenue is repeat business from existing customers, reflecting our ability to help them address their evolving security challenges with our cutting-edge technology. We continue to innovate our platform by adding analytics to address new use cases. A recent example of our innovation is addressing cryptocurrency investigations. Cryptocurrencies are increasingly used for illegal activities, such as money laundering, extortion, drug transactions, terror funding, and cybercrime. Cryptocurrencies can be anonymous and borderless, making it a challenge to find who is behind those illicit transactions. Investigations with existing technologies often reach a dead end when trying to determine who is responsible. We are about to launch a new solution to help security organizations conduct investigations involving cryptocurrencies. Our solution will be offered on a subscription basis and is designed to identify illicit transactions and suspects and generate actionable intelligence to successfully complete investigations. Blockchain analytics and the challenges it poses to security organizations are good examples of why the rapid pace of innovation is required for customers to stay ahead of the curve. This is also a good example of how customers can easily deploy new solutions from our open analytics platform. In summary, we are pleased with our strong first quarter as a pure-play security analytics company. For the current year, we expect around 10% revenue growth, and we target revenue growth rates and margins to further improve in FY23 and FY24. I'm also pleased to share with you that after a successful transition to software, we are now turning our attention to shifting to a subscription model. We expect this initiative to have a positive impact on our revenue composition with more recurring revenue over time. Now, let me turn the call over to David to discuss our Q1 results and outlook in more detail. David?

David Abadi, CFO

Thank you, Elad and hello everyone. Our discussion today will include non-GAAP financial measures. Reconciliation between our GAAP and non-GAAP financial measures is available, as Matt mentioned, in our earnings release and in the investors section of our website. As Elad mentioned, we had a strong start to the year, with revenue and EPS coming ahead of our expectations. During Q1, we won multiple seven and eight-digit orders from existing and new customers driven by ongoing demand for our analytics software and our strong differentiation. Non-GAAP revenue came in at about $150 million, up 12.3% year-over-year, and non-GAAP diluted EPS came in at $0.20. Non-GAAP operating income increased more than 100% and adjusted EBITDA increased 66% year-over-year to $21.1 million. The end of our strong result was the demand for our solution and the successful execution of our software model strategy, which I would like to discuss in greater detail. In Q1, nearly 50% of our revenue was recurring and 89% of our revenue came from software, up 400 basis points year-over-year, reflecting the adoption of our analytics platform and the reduction of hardware selling and professional services. Our non-GAAP gross margin increased 400 basis points to 73%, and our non-GAAP gross profit increased approximately 19% year-over-year as a result of this improved mix. Over the last few years, we've made investment transitions from a system integrator model to a software model. These investments are behind us, and we're seeing the benefits of this investment in our software mix and gross margin. As Elad mentioned earlier, after the successful completion of our transition to software, we are now shifting our attention to a subscription model and are in the process of reviewing our go-to-market strategy with the goal to drive more subscription revenue over time. Turning to FY22, we are pleased with our strong start to the year and expect a strong Q2 and the full year. Our confidence in the outlook has improved due to strong Q1 results, faster delivery cycles as a result of our transition to the software model, and the gradual increase in recurring revenue. Our outlook for the full year is $490 million of non-GAAP revenue, with a range of plus or minus 2%, reflecting approximately 10% year-over-year growth. We expect our non-GAAP diluted EPS to come in at $0.80 at the midpoint of the revenue range. Our diluted EPS guidance reflects $85 million of adjusted EBITDA, or 14% year-over-year growth in adjusted EBITDA, normalized for the spin-off dis-synergies. Let me provide you with a little more color on how we see the year progressing. For revenue, we expect a sequential increase throughout FY’22. In Q2, we expect approximately 9% revenue growth year-over-year and approximately $0.14 of diluted EPS, reflecting the timing of certain expenses. In summary, with cutting-edge analytics and AI technology and the strong track record, we are well positioned to go into a large addressable market driven by favorable trends. We're pleased with our first quarter results. And for the current year, we expect 10% revenue growth and 14% normalized adjusted EBITDA growth. Looking beyond the current year, we expect revenue growth to accelerate and our margin to continue to expand as we execute on our growth strategy. With that, I would like to hand over to the operator to open the line for questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. We have a question from Daniel Ives from Wedbush.

Daniel Ives, Analyst

Yeah, thanks. So first off, in terms of the subscription shift. If there was no subscription shift, can you maybe just talk about from a growth perspective? What that would look like? I mean, is it 200 basis points more range? Could you maybe just give some color on that?

Elad Sharon, CEO

Yeah, thank you, Dan. So in the last two years, the transition to software was our major focus. And it was very successful. Actually, we were able to improve the gross margin by 1,000 basis points in the last few years, and also grow the recurring business to reach about 50% of our revenue. Now that the transition to software is behind us, we will shift our attention to increasing our subscription business. This is going to be a gradual process, given the purchasing behavior of government customers in our domain, which is mainly perpetual licenses today. So we do not expect changes in the short term but in the mid-longer term.

Daniel Ives, Analyst

Got it. And can you just maybe talk from a pipeline perspective, just given the climate that we're seeing, are you seeing larger deals within the - especially within European government and other geographies, Middle East and others in terms of larger and more strategic deals that are going to accelerate given the climate?

David Abadi, CFO

Thanks, Dan. So, in the last few years as part of the transition, we actually relied less and less on large deals. We do see demand for our solution, and we do see customers willing to put large deals like we shared. And it's, again, evidence of the stronger solution that we have. Currently, we are not relying on certain specific large deals, but the demand is there. And there is a variety between the different governmental agencies in the way that they're purchasing. And we see all types of ranges of deals.

Daniel Ives, Analyst

Thanks.

Operator, Operator

Thank you. Our next question comes from Mike Cikos from Needham.

Mike Cikos, Analyst

Hey, guys. Thanks for taking the question. I also had a question on the subscription model shift that you guys are talking about. I'm curious with these subscription contracts. Do you expect that you can, I guess, improve or increase sales velocity based on the different contract structure? And then the follow up would be, if that's the case, should we expect growth to accelerate based on that?

David Abadi, CFO

So over time, we believe that revenue will be shifted to subscription. We do think it's going to be gradual. And then as Elad mentioned, these kinds of processes are taking time, especially given the purchasing behavior of the government customers in our domain. As you know, today, it is mainly perpetual licenses. We believe that these processes will take some time. In the short term, we still have existing RPO that we need to execute. We still have some recurring revenue. We believe that the impact on the short term will be relatively minor. So from a growth perspective, taking our assumptions regarding the transitions we are faced with, we think that it will be a modest transition phase. We think that the short-term impact on the top line will be relatively limited in the way that we provided our outlook. Obviously, if we see a faster adoption, we will be very pleased with it.

Mike Cikos, Analyst

Understood. And could you actually help us think about what Cognyte is doing to help change? Because obviously, if your government customers have typically been purchasing these perpetual licenses, are you changing anything in your selling motion, or what additional investments are required on Cognyte’s part to change the market’s thinking about this buying pattern?

Elad Sharon, CEO

Yeah. So I think there's a few activities we should take into consideration. First, we obviously have to change our go-to-market and of course, offer more and more of our solutions on subscription. This is something we are going to do gradually. We also understand that government customers, although they are used to certain business models, are willing to shift. They understand that the world is shifting towards a subscription. While it may be more difficult to do it in expansions of existing solutions, or as David mentioned, in existing orders that are within our RPO, we believe that for new offerings and use cases that we are going to launch, it will be easier for us to offer it in a different way. Also, I believe that we'll have more cooperation in that respect. We have a close relationship with our customers. So we are going to do it while talking to them. We are not going to enforce certain measures that will not work. We are going to discuss it with them to convince them that there is a lot of value in shifting to subscription. When you shift to subscription, obviously you get quicker refresh of your technology. You benefit from constant innovation, and this is something that I believe they will appreciate. But again, it will be a gradual process. The transition to the software model took us about three years, so I believe that this transition will also take some time. I also believe that if you want to be successful, we are committed to it and I believe the market will appreciate and accept it.

Mike Cikos, Analyst

Thank you for that. And one more if I could just on the cryptocurrency that you guys were talking about earlier. I'm curious, is that a new solution that you guys don't currently have on the market? Is that something that you plan on selling soon? Or is that already out in the market at this time?

Elad Sharon, CEO

Yes. So let me give you some color relative to cryptocurrencies and why it's important for customers. Cryptocurrencies are stored in digital wallets. It’s an alternative to a standard banking system of cash. If we compare it to traditional banking, unlike the traditional banking system, cryptocurrency can be traded between people anonymously, without the need for a third-party mediator, which keeps the identities of the parties involved hidden. Unlike cash, cryptocurrencies are digital, so there is no physical component, which makes them easier to hide from law enforcement and also easier to transfer domestically or internationally. This presents a new challenge for our customers, and they need to take it into account and evolve. That's the reason it's so important to have an open platform that is able to keep pace with technology changes. We discussed it a lot previously about homegrown solutions that are rigid, and it's crucial to have an open platform that can be quickly refreshed with new use cases and new analytics. We believe that the demand will grow over time. For now, it's an early opportunity for us. We are conducting pilots with some of our customers, and I believe that over time, this need will grow. As you know, it's very convenient for illicit activities to be conducted within the cryptocurrency ecosystem. Again, it's easier to hide, easier to transfer money domestically or internationally, and usually, you may not know who is behind a transaction. If you're able to address this challenge with strong analytics and help customers to identify illicit transactions and those responsible, I think it offers tremendous value. We are in the early stages, but we believe that this will bring considerable benefits to our customers over time.

Mike Cikos, Analyst

Thank you, very helpful.

Operator, Operator

Thank you. Our next question comes from Kirk Materne from Evercore ISI.

Peter Levine, Analyst

Great, thank you for taking my questions. Peter Levine is here for Kirk. I'd like to follow up on your earlier comments and the previous question. Can you discuss the specific changes you're implementing in your go-to-market strategy to boost software adoption? Are you adding new sales representatives or new partners? I'm interested to learn more about these changes.

David Abadi, CFO

Are you referring to the transition to software or the transition to subscriptions that you're planning ahead?

Elad Sharon, CEO

Yeah. So in terms of go to market, in terms of transitioning to software, what we did before and later on, I'll address what we are going to do going forward for subscription. Customers used to have tailor-made solutions. So the go-to-market was actually tailored to those solutions, offering a system integrator-like approach with professional services, a lot of customization, etc. We shifted our model into a software model. Now we are a software company, so we were able to reduce professional services and customizations, productizing our solutions in a way that makes them very easy to deploy, upgrade, and update. The benefits for our customers have been increasing accordingly. We have also been able to shift a lot of our professionals to develop innovations, like the cryptocurrency initiative I just mentioned, instead of focusing on one-time customization. Looking ahead for the subscription model, we will implement some changes in our go-to-market approach. We will need to change the way we offer and sell our solutions in a way that emphasizes the benefits and encourages our customers to shift from perpetual licenses to subscriptions. So, our offering will be a bit different, and the way we pitch our solutions will also change. This is something we are working on now as we prepare for the shift to subscriptions over time.

Peter Levine, Analyst

Great, thanks. And maybe one for you, David. Sticking to your full-year guide, it looks like you're maintaining your guide at roughly 9% at the midpoint. You've highlighted a number of large deal wins, and pipelines seem to be active. So love to understand what's behind the guide number, kind of what tailwinds are you building in and what are you not building in that could potentially be upside? Thanks.

David Abadi, CFO

The guidance is sticking to the level of our visibility. We have strong visibility with current revenue around 50% of our earnings coming from our business, more than 90% of our revenue, and we have strong remaining performance obligations (RPO). When we look at our annual guidance, with the very strong start of the year and strong Q1 results, our confidence in the outlook has improved. The deals that we announced align with our strategy. We believe that we are executing our strategy quarter-over-quarter with a long-term view and will deliver on our commitments. Based on that, I am very pleased with where we are and confident that we will be able to deliver our outlook for the year.

Peter Levine, Analyst

Great. Thank you very much for taking my questions.

Operator, Operator

Thank you. Our next question comes from Brad Rebeck from Stifel.

Brad Rebeck, Analyst

Great, thanks very much. Quick follow-up on that last answer. You mentioned strong RPO. Can you give us a sense of what it grew in the quarter?

David Abadi, CFO

So actually, the RPO overall is more than $0.5 billion. And you need to look at the RPO in two elements: the one that we will have for the next 12 months and the one that is for longer periods. The level of our 12-month RPO is consistently around two-thirds of the total RPO and more than $0.5 billion.

Brad Rebeck, Analyst

But how about the growth rate year-over-year?

David Abadi, CFO

We don't share the exact number on a quarterly basis. However, as I mentioned, we have the capacity to fulfill our RPO in the way that we actually look to deliver our short and long-term expectations.

Brad Rebeck, Analyst

Okay, that's great. And maybe getting into the accounting weeds a little bit on this shift to subscription. Given that most of your customers deploy on-prem and using ASC 606, would it be right to assume that you'd still get the vast majority of that contract value on a subscription basis recognized upfront?

Elad Sharon, CEO

That's correct. There will be some impact. I cannot say that it will be vast because the way that we are changing the offering and delivering our software services will also be impacted. In certain cases, we may love the situation because of the time slices, meaning we would need to recognize part of it upfront. Overall, we believe that there will be an impact on revenue composition, and we will see more and more recurring revenue.

Brad Rebeck, Analyst

That's great. Thanks very much.

Operator, Operator

Thank you. The next question comes from Brian Ruttenbur from Imperial Capital.

Brian Ruttenbur, Analyst

Great. Thank you very much. Good quarter. A couple of quick questions. This is housekeeping, but right now, where are you as a percentage of revenue on subscription? Is it zero percent? And then, where do you expect to be in year one, year two? What is the plan that you're going to switch over and be at 50% on subscription in year three? Give us some kind of parameters as you see things moving forward.

Elad Sharon, CEO

So today, our recurring revenue stands at about 50% of our revenues, with one-third of it being subscription and two-thirds being support. We do not expect any major shift in the first year. The reason for that is that it will take time for us and for customers to shift to subscriptions. Given the strong remaining performance obligations, which are mimicking what we used to have. The RPO is stronger, as David mentioned before, it's more than $0.5 billion. It's more of a perpetual license rather than a subscription. So in the short term, we do not expect any changes in the ratio. Moving forward, it's too early to say exactly what the targets will be; this is something we'll need to determine in the next few months. We are undergoing planning to shift to subscription, including what I mentioned before about go-to-market, and understanding customer readiness to shift to subscriptions. We will encourage them to see the value in that shift. It will take some time for us to set the targets, but generally speaking, we believe that it is executable, as was our software transition. For targets, we will finalize those at a later stage. David, do you want to add anything to that?

David Abadi, CFO

Let me give a bit more context regarding where we are with subscriptions. In total, our recurring revenue at 50% of revenues, around one-third is currently subscriptions, which is a little over 10% of our total revenue. We do think that over time, we will see a shift in the transition. It will also impact support and the entire revenue composition in the long-term. However, it should allow us to gain better scale and drive more growth over time.

Brian Ruttenbur, Analyst

Thank you for that insight. I have a different question regarding the recent attacks and their effects this quarter and possibly in the future. Could you elaborate on the situation where you had to shut down for a day due to these attacks? What is your strategy moving forward in case of further attacks? Do you have a new contingency plan to stabilize business operations after these recent incidents? Additionally, was there any impact on sales this quarter as a result of the attacks?

Elad Sharon, CEO

Not sure what attack you are referring to?

Brian Ruttenbur, Analyst

I was just referring to your operations in Israel? I think that you had to, as I recall, have a potential shut down for a day due to the missile attacks from Gaza, is that correct?

Elad Sharon, CEO

No, actually. So, regarding the attack in Gaza, we have a business continuity management plan in place that was successfully implemented during COVID-19 and previous incidents. In our region, we did not face any disruptions. Most of our employees are working from home due to COVID. We have the setup and resources to operate remotely. Additionally, many employees globally, including those in Israel, are still working from home because of COVID, so there was no impact on our operations. It’s simply a matter of employees either being in the office or working remotely. Business is functioning normally, and there have been no disruptions related to this incident in Israel.

Brian Ruttenbur, Analyst

Did the Gaza attacks have any impact on your sales? Were there any delays or accelerations in sales due to the situation? I understand if the answer is straightforward, but I wanted to hear your perspective on it.

Elad Sharon, CEO

Yeah. There was no impact at all on our business, including deployment, sales, and deliveries. Nothing was impacted from this incident related to Gaza and Israel.

Brian Ruttenbur, Analyst

Okay. Thank you.

Elad Sharon, CEO

Business is running as usual. Thank you.

Operator, Operator

Thank you. We have a question from Shaul Eyal from Cowen.

Elad Sharon, CEO

Shaul, we can’t hear you.

Shaul Eyal, Analyst

Apologies. I was muted. I'm sorry. Yeah, I apologize in advance if the question was already answered; I was a little late to the call start. In terms of the subscription transition, what's the timeframe you have in mind for it?

Elad Sharon, CEO

I believe it will be similar to the transition to software models, so it will be about three to four years to execute that. The reason for that is that it involves changes in the go-to-market strategy and the pace of the adoption of customers, mainly governmental customers, to shift to subscriptions. We have a strong remaining performance obligation that we need to deliver, which currently comprises a larger portion of professional licenses. It will take a few weeks to finalize this transition. In the short term, we do not expect any material impact on our business. In the mid and longer term, we believe that we will see more recurring revenue and more subscriptions, which is very beneficial as we plan to improve our visibility on business and accelerate growth over time.

Shaul Eyal, Analyst

Got it. Thank you so much.

Elad Sharon, CEO

Thank you.

Operator, Operator

Thank you. At this moment, we have no further questions. I would like to turn the call back to Mr. Frankel for final remarks.

Operator, Operator

Thanks, operator. And thank you everyone for joining us today. I look forward to speaking to you again soon. Have a good day.