Cognyte Software Ltd.
Q1 2022 Earnings Call Transcript

Published: 22 Jun 2021

[Matthew Frankel:]

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 expectation, and are not guarantees of future performance.

[Elad Sharon:]

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.

[David Abadi:]

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.

[Operator:]

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

[Daniel Ives:]

Yeah, thanks. So first off, like 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 bps more range? Could you maybe just give some color on that?

[Elad Sharon:]

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. And now that the transition to software is behind us, will shift the attention to increasing our subscription business. This is going to be a gradual process, giving the purchasing behavior of government customers in our domain, which is mainly perpetual license today. So we do not expect changes in the short term but in the mid-longer term.

[Daniel Ives:]

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 there’s large and more strategic deals, they’re going to accelerate given the climate?

[David Abadi:]

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

[Daniel Ives:]

Thanks.

[Operator:]

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

[Mike Cikos:]

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:]

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 kind of processes are taking time, especially giving the purchasing behavior of the government customers in our domain. And, as you know, mainly today perpetual license. And we think that position, it's something that will take some time. In the short term, we still have existed RPO that we need to execute. And we still have some recurring revenue. And we believe that the impact on the short term will be relatively minor. So from a growth perspective, taking the -- our assumption regarding the transition that are faced, we think that it will going to be a modest transition phase. We think that the short term impact on the top-line will be a relatively taking position in our -- in the way that we provided outlook. Obviously, if we see a faster adoption will be very pleased with it.

[Mike Cikos:]

Understood. And could you actually help us think about, what is 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 port to change the market’s thinking about this buying pattern?

[Elad Sharon:]

Yeah. So I think there's a few activities we should take into consideration. The first one, we obviously have to change our go-to-market and of course, offer more and more of our solution in subscription. And this is something we are going to do gradually. We also understand that also government customers, although they are used to certain business model. They are willing to shift. They understand that the world is shifting towards a subscription. And while it will be more difficult to do it in expansions of existing solution, or as David mentioned in existing orders that within our RPO. We believe that for new offerings and new use case says that we are going to launch, it will be easier for us to offer it in different way. And also, I believe that we'll have more of their 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 force certain level measures that will not fly. We are going to discuss it with them, to of course they're convinced them that there is a lot of value of shifting to subscription. While you shift to subscription, obviously you get quicker refresh to your technology. You benefit from innovation constantly. And this is something that I believe they will appreciate, but again, it will be a gradual process. Also the transition to software model took us about three years. I believe that also this transition takes 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:]

Thank you for that. And one more if I could just on the 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:]

Yes. So let me give you some color relative to currencies and why it's important for customers. And I'll also address your question about the maturity of the solution. So 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 third-party mediator, and which is the welfare of the identity of the parties involved. And 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. And obviously, this address a new challenge for our customers. They need to take it into account and to evolve. And 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 that's so important to have an open platform that can be easily 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 be growing. As you know, it's very convenient for illicit activities to be conducted in this ecosystem of cryptocurrency. Again, it's easier to hide, it's easier to transfer money domestically or internationally. And you cannot -- usually you don't know who is behind the transaction. And if you're able to address this challenge by strong analytics and help customers to identify the illicit transactions and also who is behind it, I think it's a lot of value. So we are in early stages, but believe that this will become create a lot of benefit to our customers over time.

[Mike Cikos:]

Thank you very helpful.

[Operator:]

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

[Peter Levine:]

Great, thanks for taking my questions. Peter Levine in for Kirk. So just to piggyback off of the comments you made on the call and the prior question. So can you talk specifically about the changes you're making to your go-to-market to accelerate software adoption? Are these -- are you adding new reps? Are you adding new partners? Just curious to know what these changes are?

[David Abadi:]

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

[Peter Levine:]

So, yeah, you talked about the changes to your go-to-market?

[Elad Sharon:]

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. So, customer used to have tailor made solutions. So the go-to-market was actually tailor made the solutions and offering a system integrator like solutions with professional services, a lot of customization, et cetera. And we shifted our model into software model. And now we are software companies. So actually, we were able to take the professional services and customizations down and productize our solutions in a way that it's very easy to deploy to upgrade and to update and the benefits for our customers was increasing accordingly. And also, we are able to shift a lot of our professionals to develop innovation, like the cryptocurrency I just mentioned instead of one-time customization. Looking ahead for subscription will help also to go there to some changes in the go-to-market. We will have to change the way we offer and sell our solutions in a way that the benefits and the offering will encourage our customers to shift from perpetual license into subscription. So, the offering will be a little bit different. And the way we are going to pitch our solutions and offering to the customer is going to be different. And this is something that we are working on these days towards the shift to subscription overtime.

[Peter Levine:]

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

[David Abadi:]

So, the guidance sticking its position, the level of our visibility. So we have strong visibility. We have current revenue around 50% of our revenue, our business is more than 90% of our revenue and we have strong RPO. So when we look our annual guidance, obviously, with the very strong start of the year with the strong Q1, the level of confidence that we have for the year is higher. The deals that we announced are aligned with our strategy. We believe that this strategy, we execute our strategy quarter-over-quarter with a very long-term view. And we are able to deliver what we are committed to. And giving that, I think that I'm very pleased with where we are. And I'm confident that we will be able to deliver our outlook for the year.

[Peter Levine:]

Great. Thank you very much for taking my questions.

[Operator:]

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

[Brad Rebeck:]

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

[David Abadi:]

So actually, the RPO overall is more than $0.5 billion. Again -- 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 -- for longer period. And the level of their 12 months, we are consistently around two thirds of the total RPO and more than $0.5 billion of RPO.

[Brad Rebeck:]

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

[David Abadi:]

So again, like we don't share the exact number on the quarterly basis. But as I mentioned, we have the capacity fulfil our RPO in the way that we actually outlook for the full year. So it's in line with our expectation to deliver our short and long-term expectations.

[Brad Rebeck:]

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 606. Would it be right to assume that you'd still get the vast majority of that contract value on a subscription basis recognized up front?

[Elad Sharon:]

That's correct. There will be some impact. I cannot say that it will be the vast feat. Because the way that we are changing the offering and the way that we deliver our software services will be impacted also from the shift. On certain cases, we love the situation because of the time they slice and that we will need to recognize the part of it upfront. But overall, we believe that there will be an impact between the revenue composition, and we will see more and more recurring revenue.

[Brad Rebeck:]

That's great. Thanks very much.

[Operator:]

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

[Brian Ruttenbur:]

Great. Thank you very much. Good quarter. Couple quick questions. This is housekeeping, but right now, where are you as a percentage of revenue on subscription? Is it zero percent, that subscription? 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 50% at subscription in year three? Give us some kind of parameters as you see things moving forward.

[Elad Sharon:]

So today, our recurring revenue stands at on about 50% of our revenues is recurring. One third of it is a subscription and two third of it support. We do not expect any major shift in first year. The reason for that is that it will take time for us and for customers to shift to subscription. And also, given the strong RPO, which is actually in the same mimics that we used to have. So the RPO is stronger. As David mentioned before, it's more than $0.5 billion. And it's not -- it's more perpetual license rather than a subscription. So for the short term, we do not expect any changes in the ratio. Going forward, we do not -- it's too early to say what are exactly the target, this is something we'll have to figure out in the next few months. We are going through the planning of the shift and transitioning to subscription. Again, including what I mentioned before, which means the go-to-market we discussing with customers and understanding the reading to shift to subscription and convinced them and providing them with -- encourage them and providing them with more benefits, to encourage them to shift. So it will take some time for us to set the targets. But generally speaking, we believe that this is something that we will be able to execute, like we did in the software transition. For the targets we'll have to do it at a later stage. David, you want to add there?

[David Abadi:]

So let's make a little bit more color again, about like where we are from subscriptions. So from the overall recurring revenue of the 50% of our revenue, one third is approximately currently subscriptions. So it’s around the a little bit more than the 10% of our total revenue that is today's subscription. And we do think that over time, we will see the shift in the transition. Obviously, it will impact also support and all the composition of the revenue in the long-term. But I do think that it will allow us to get better scale and the drive more growth over time.

[Brian Ruttenbur:]

Great. Thank you very much for that color. Shifting over to a different kind of question. In terms of the recent attacks, and the impact in the quarter, and maybe the impact going forward. Can you talk about -- we had a conversation recently, but you talked about having to shut down for a day because of the attacks? What is your game plan kind of going forward, if there's additional attacks? Do you have a new contingency plan post these recent attacks to normalize business? And was there any impact to you guys in terms of sales in the quarter because the recent attacks?

[Elad Sharon:]

Not sure what attack are you referring to?

[Brian Ruttenbur:]

I was just referring to your operations in Israel? I think that you had to, as I recall, having a conversation with you a couple weeks ago that you had to possibly shut down some of your operations for a day because the some of the missile attacks from Gaza, is that correct?

[Elad Sharon:]

No, actually -- okay. So, okay, so the attack in Gaza. Got it. First of all, we have business continuity management plan available, and it was executed well in the times of the COVID-19 and also in times of other constraints that we had. In our territory, again, geography, we didn't suffer any disruptions. Anyhow, most of our employees due to the COVID are working from home. We have the setup, we have the facilities. We shifted everything to a virtual work. By the way and till today, many employees around the globe including in Israel are working from home still working from home due to the COVID. So there was no disruption to the operations. It's only a matter of people either working from the office or working from home. The business is running as usual, and no disruptions related to this incident in Israel.

[Brian Ruttenbur:]

Okay, did it impact sales at all -- your sales? Was there a delay in any sales or an acceleration in the sales because of the Gaza attacks? Maybe the answer is obvious, no, but I just wanted to hear that from you.

[Elad Sharon:]

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

[Brian Ruttenbur:]

Okay. Thank you.

[Elad Sharon:]

Business is running as usual. Thank you.

[Brian Ruttenbur:]

Thank you.

[Operator:]

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

[Elad Sharon:]

Shaul, we can’t hear you.

[Shaul Eyal:]

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:]

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 a subscription. And also, we have a strong RPO that we have to deliver which is currently with a mix of more professional license as of today. So it will take a few weeks' time to complete this transition. So for the short term, we do not expect any material impact on our business. For the mid and longer term, we do believe that we will see more recurring revenue and more subscription, which is very good for us as we plan to see more visibility on our business and going forward being able to accelerate growth over time.

[Shaul Eyal:]

Got it. Thank you so much.

[Elad Sharon:]

Thank you.

[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.

[Matthew Frankel:]

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