KnowBe4, Inc.
Q2 2021 Earnings Call Transcript

Published: 2 Aug 2021

Operator:

Ladies and gentlemen, thank you for standing by. And welcome to the KnowBe4 Second Quarter 2021 Results Conference Call. Please be advised that today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Now, it is my pleasure to turn the call over to Ken Talanian, KnowBe4 Vice President of Investor Reporting.
Ken Talanian:

As a reminder, our commentary today will include non-GAAP financial measures. Information regarding our non-GAAP financial results, the limitations and reconciliations of our GAAP and non-GAAP results can be found in our earnings release, which was furnished with our Form 8-K filed today with the SEC and may also be found on our supplementary financial information available on our Investor Relations website at investors.knowbe4.com. In addition, some of our comments today, including those related to our guidance, may contain forward-looking statements that are subject to risks, uncertainties, and assumptions. Should any of these materialize or should our assumptions prove to be incorrect, actual company results could differ materially from those projected or implied during this call. These risks are described in our Form 10-Q that will be filed following this call. These documents can be found on the SEC's website sec.gov and on our Investor Relations website. During today's call, you will hear prepared remarks from our CEO, Stu Sjouwerman, and CFO and Co-President, Krish Venkataraman. Lars Letonoff, our Chief Revenue Officer and Co-President will join our question-and-answer session. And with that, I will turn the call over to Stu.
Stu Sjouwerman:

Thank you, Ken. And thank you all for joining us today. We are excited to share our results with you this morning. Building on last quarter's strong performance, we exceeded our guidance. We had a record quarter with over 40% year-over-year annual recurring revenue growth. As many of you know, I started KnowBe4 to help organizations manage the ongoing problem of social engineering. We are the only public company dedicated to securing the human layer. The emphasis in cybersecurity has traditionally been on legacy controls. However, the exponential growth in cyberattacks and their relative success proves we cannot solely rely on security software infrastructure. According to the newest Verizon 2021 data breach investigations report, 85% of breaches involved a human element. Ignoring the human element of this equation leaves organizations of all sizes vulnerable, which is why we are dedicated to helping our customers transform their employees into a successful last line of defense against cyberattacks. Over the last quarter, you have seen countless examples of the increased threat of social engineering attacks. This has security professionals around the world on edge. In fact, a recent survey from the IASCA found that two-thirds of companies surveyed plan to improve their cybersecurity defenses in the wake of recent attacks, such as the one on the Colonial Pipeline. We expect many of these organizations to look at securing their human layer with KnowBe4.
Krish Venkataraman:

Thanks, Stu. And good morning, everyone. As a quick reminder, unless otherwise noted, all numbers except revenue mentioned during my remarks are non-GAAP. As you heard from Stu, we definitely see strong performance across the business with AR for Q2 accelerating versus the first quarter to 42% year-over-year. This was actually driven by another strong quarter for new logo addition in enterprise and SMB, and continued cross sell to existing logos and global expansion. Our platform continues to perform well across all geographies, to customers of all sizes and industry. I want to remind everyone that a key pillar of our model is the ability to efficiently scale to customers of all sizes from organizations with less than 100 seats addressed by our channel partners to customers with several hundreds of thousands of employees served by a hybrid inside sales model. Since day one, we are focused on four pillars of growth – new logo expansion, cross selling to existing customers, international expansion, and finally, channel expansion. We saw success in each of these areas throughout the quarter. Our first pillar of growth is new logo expansion. Today, about 87% of our logos are in the SMB space, which we define as less than 1,000 employees and about 13% are in enterprise space which we define as greater than 1,000 employees. Both these segments saw significant growth over the past few years.
Operator:

. Our first question comes from line of Rob Owens with Piper Sandler.
Rob Owens:

Stu, I want to unpack a little bit the new logo acquisition you talk about more specifically, but what you're seeing in the enterprise market? Just channels into those customers, some of the strength you're seeing overall. And my sense is those are most likely competitive displacements rather than greenfield, but if you can expand on that, that'd be great.
Stu Sjouwerman:

Rob, actually, that is a very good question for sales. I'll throw it over to Lars in a second. Let me just comment that there is still a significant amount of greenfield and enterprise as well, especially international. But Lars is in the trenches. He has a better view on those enterprise sales. Lars, could you hop in?
Lars Letonoff:

Question, are you talking specifically Compliance Plus and adjacent products? Or was it just in general?
Rob Owens:

I think it was in general relative to the whole product set. But the more you want to expand on Compliance Plus, that'd be great.
Lars Letonoff:

SMB for us is still pretty much greenfield opportunity, occasional competition with enterprise. There's really two areas that we go after. Our marketing team provides a ton of very strong A leads for our sales teams to go after. And then, part of that go-to-market is we're actively going after business from our competitors. With Compliance Plus, that's going to be probably more a competitive displacement than a greenfield in the enterprise space. I think in SMB, again, it will probably follow the same trends as being greenfield opportunity.
Rob Owens:

Maybe, Lars, since I've got you, could you touch a little bit on your SLED activity. It truly feels like there was a lot of momentum related to education and state, local governments this quarter. Thanks.
Lars Letonoff:

Obviously, in the news, there's been a lot of attacks against the SLED market, and that always helps us with our products. But our product is 100% horizontal. It's relevant to any size organization and then any vertical market. So, we really don't have any concentration in any specific vertical.
Operator:

Your next question comes from the line of Joel Fishbein with Truist.
Joel Fishbein:

I just have one, Stu, on the – just talk a little bit about the new product, the Compliance Plus. If you can give us a little bit of color about the differences between KCM GRC and Compliance Plus? And also, what the go-to-market and cross sell opportunity looks like there?
Stu Sjouwerman:

KCM GRC really is a tool that you use to keep track of all the controls for a specific regulation. Let's take easy example, PCI, the payment card industry, they have 200 controls. It's check your firewalls once a month and you need to do that and a test is done, upload evidence, and so auditors can look at – yes, that was correctly done. That's what KCM manages. Compliance Plus, on the contrary, is essentially gives all employees in the organization the compliance training modules that they have to step through. And those are things like privacy, data protection, sexual harassment, there's a raft of different compliance training that these people literally by law need step through. So, Compliance Plus is super easy to sell and also deploy. You can literally within a minute, in the existing platform, turn it on and roll it out.
Joel Fishbein:

And then, in terms of the cross sell opportunities and go-to-market, that would be really helpful.
Stu Sjouwerman:

If you look at the existing customer base, which is now, as you just heard, 41,000 plus, it was relatively easy for us to go back to these people and say, hey, what are you currently doing for compliance training. And very often, that is an existing vendor who is quite expensive. Then it's not that hard for us to come up with a competitive bid. Compliance Plus pricing was based on a lot of market research and was positioned to be disruptive. So, it's very easy for an existing customer to look at that and say, wow, we're moving.
Operator:

Your next question comes from the line of Brian Essex with Goldman Sachs.
Brian Essex:

Krish, I was wondering maybe if you can just touch on ARR for a bit. Given your comments on catch and cross sell, upsell, is there seasonality, I guess, embedded in that? And I was wondering if we could dig in maybe a little bit to some of the moving parts underneath it, whether it was revenue mix or linearity that might have – maybe not linearity, but customer size, large deals that might have affected that compared to last quarter.
Krish Venkataraman:

Let me answer the latter part question first. So, if you look at our ARR growth, as I said, in excess of 42%. And if you look at the trend, especially in the last year, especially since Q2 COVID shutdown last year, you're seeing a real acceleration in our ARR. Now to unpack the ARR growth, I go back to our four key pillars of growth because each of them has been contributing significantly to that ARR growth. First, let's talk about enterprise. And within the enterprise itself, there are two real distinct stories that are emerging. One is, if you look at enterprise, in the last couple of years, as you can see, almost half of our AR now comes in the enterprise side. But especially in the last year-and-a-half to two years, the mega side of the enterprise world has significantly accelerated. And a couple of reasons for that, Brian. One is the international story, the power of the platform, the capabilities of the platform, the multi-language capabilities embedded now on the platform, of course, drive a lot more mega enterprise attraction towards the platform. And that has been a driver of our ARR. On the enterprise holistically, that itself is also a combination of our international growth, as we are now expanding significantly into EMEA as well as APAC. The second key part, I would say, of the ARR unpacking is really what you're seeing in this cross sell story. And just to remind everybody, just couple of years back, we were largely a single product tenant on the platform. And with the launch of KCM G RC, PhishER, and now Compliance Plus, we are really providing significant platform capabilities to our global clients, which of course, drives a lot more interest in the platform and the cross sell capability. And the other thing, we have done a great job, Brian, is really cross selling at scale. Right? Now, we've got 7000 plus customers now have multi product capabilities on the platform, which is an incredible testimony to not only the platform's strength, but our cross sell motion. And finally, I think the channel expansion, as well as international expansion has really contributed to that uprising of ARR growth that you're seeing in the last quarter. Now, the last part of your question is seasonality. Now, the way I think about seasonality is early on in KnowBe4's history, we were largely an SMB shop. So, there was very little seasonality in the business, given we were largely going after a greenfield opportunity, SMB. Lately, especially last year-and-a-half, two years, given they're evenly balanced now between SMB and enterprise, you will see some level of seasonality in ARR, but that's less got to do with KnowBe4, but more got to do with the overall software sales motion that companies face, which have a large enterprise mix in them. But right now, sitting today, at the seat right now, we don't see or don't expect any atypical seasonality and we believe that we have really strong robust growth ahead of us.
Brian Essex:

Maybe if I could just touch on net retention rates, as you increase the percentage or your mix of large enterprise and improve cross sell/upsell, can you maybe give us an understanding of what the rate of improvement is there? I understand that you don't regularly disclose it, but just trying to get an understanding of how the churn and cross sell and upsell might be impacting your net retention rates and you're foreseeing consistent improvement there.
Krish Venkataraman:

I think there's two key components of net dollar attention. And as you mentioned, we don't comment on the dollar retention every quarter. But the two most important ingredients of any net dollar component is – one is, your growth/logo retention. Right? The second part, of course, is the ability to cross sell. Now, let's talk to the first part. Now, growth/logo retention, which in our case is a world class number given the mix of SMB and enterprise that we have, reached the highest levels we have seen in KnowBe4. So excellent progress on that side. The second part of it is the cross sell motion because, just to remind everybody, our KMSAT motion from a sales perspective is always to land large. So, we get 100% of the employees at any client upfront. So, cross sell is one of the key drivers of growing your net dollar attention. And in that case, as you see the trend, quarter after quarter, it has nothing but been an amazing sales execution. Right now, 17% of our 41,000 global customers have got cross sell capabilities. So you are seeing that momentum. And given that, as I said, net dollar attention is a component of these two ingredients, both of them are trending in a positive direction.
Operator:

Your next question comes from the line of David Hynes with Canaccord.
David Hynes:

Congrats on the strong result. I want to ask about PhishER and what you're seeing in terms of attach at land? And maybe as part of that, you could touch on trends in initial ASPs.
Stu Sjouwerman:

That is a question for sales. I'm going to give this one straight to Lars.
Lars Letonoff:

I can't speak on specific attachment rates, but our attachment rate has been ever increasing each month since we initially put the product out. And we drive a lot of gains and drive a lot of incentive for our sales team to increase those attachment rates. And we've had a lot of success with that. Maybe Krish can talk about a little more specific on the numbers.
Krish Venkataraman:

I think just to add some more color in terms of the attachment rates. Now, I think of attachment rates across both the cross sell motion as well as on the ARR upliftment motion. Now, if you look at PhishER and you compare what we are seeing, we are seeing very, very strong ARR attachment rates when customers actually buy both KMSAT and PhishER together. And that ranges anywhere between, say, 35% plus, depending on whether you're SMB or enterprise, and of course, SMB is actually much larger than the enterprise size, given the size of the accounts and the seats we're talking about. So, overall, I think the attachment rates have been strong and growing, given the cross sell motion, and the ARR attachment rate also has been very, very encouraging and trending up.
David Hynes:

As you think about compliance vis-à-vis the go-to-market model, is the playbook always going to be to lead with security and then work to cross sell compliance? Or is there an effort of – or will there be an effort to kind of sell compliance standalone as well?
Stu Sjouwerman:

Let me grab that one. For the moment, since we have this huge customer base that we can mine, it's most efficient to simply go back to existing customers and say, check this out and save some money because your existing vendor is twice as expensive. Ultimately, we would probably also start and we are doing the initial testing in marketing to just go this as a separate campaign, if you will, and drag A leads specifically through the compliance management/HR and drive that as a separate go-to-market strategy. For the moment, we have enough work in the existing customer base to keep us busy.
Operator:

Your next question comes from the line of Hamza Fodderwala with Morgan Stanley.
Hamza Fodderwala:

First question maybe for Stu. I'm just curious, I know it's hard to kind of break down exactly, but to what extent would you say that this more recent acceleration, particularly in the ARR growth, is coming from perhaps a stronger spending environment that we're seeing from these recent cyberattacks or more of a natural acceleration coming off of some of the – maybe some of the modest weakness you might have seen in the middle of last year due to the COVID shutdown?
Stu Sjouwerman:

Generally speaking, what we're looking at is the market is becoming aware of the fact that bad actors essentially grab humans as their first attack vector and simply send phishing emails, highly scaled these days and very sophisticated, to try to get in. That's one of the successful – really more than 50% of them are caused by phishing. So, it's time is money for the bad guys, too. And what we're looking at here is – and organizations start to understand it, they absolutely need a strong last line of defense, which is employees being on their toes with security top of mind, and then the media that currently have been giving enormous airplay for things like Colonial Pipeline and ransomware, that is significant tailwind for us just there.
Hamza Fodderwala:

My follow-up for Krish. Krish, you mentioned 13% of your customer base is now enterprise. And then that accounts for a little over 50% of your ARR. If you do the math, that's about a little over $20,000 in terms of ARR per customer among that large enterprise cohorts, about four to five times the overall. How has that over $20,000 ARR per customer grown in the past couple of years? And where do you think this can go? You think this can go to $30,000 or $50,000? Kind of what's really the potential there?
Krish Venkataraman:

I think there's two parts to the question. One, it would be helpful to understand that, if you look at our enterprise story, our enterprise story is not a Q2 2021 story only. We started initially moving from, of course, SMB to, I would say, the small to mid-size enterprise customers. And over the last year-and-a-half, two years, we are really trying to migrate up towards the mega size. So, given that we already have, as you said, in excess of 5000 plus enterprise customers, the average is a mix between the smaller enterprise customers and now the mega-sized enterprise customers. From a trend perspective, of course, the trend has been growing and the trend has been positive. And the trend has been positive because of two reasons. One, as I said, not only the motion moving towards the upper end of the enterprise side, but also – it's also the addition of the international logos where we are more enterprise first than SMB first than we were in the US. The second part of the question is, you're seeing a lot more cross sell motion, Hamza, in the enterprise space. And that, of course, adds to your overall average ARR for enterprise. But we're still early in that motion, but that motion has been growing every quarter for the last year, year-and-a-half. And we do see definitely an upside ability to the average ARR on enterprise as we get not only additional mega-size or midsize enterprise customers domestically and internationally, but also cross sell now three additional products to that base.
Operator:

Your next question comes from Shaul Eyal from Cowen.
Shaul Eyal:

Congrats for those strong set of results. Two quick questions. Maybe start with Stu first. In light of the recent large GDPR related fine on Amazon in Europe, I was wondering if there's any flow through benefits you are seeing or hearing from the channel, Stu, really related to regulatory or compliance front.
Stu Sjouwerman:

Not necessarily directly from the channel. However, you do need to remember that, internationally, we are 100% channel. And the focus on data privacy, especially in Europe with the GDPR, instead of viewing compliance as a simple check the box requirement, at this point in time, organizations will literally be forced to view it as a component of their day to day operations. And that is where we come in with the training for employees to begin with and then, with the KCM GRC product, to actually track compliance and report on it, if that gives you a bit more visibility.
Shaul Eyal:

My follow-up question is maybe Krish or Lars or even yourself, jump-off question is the Proofpoint, they reported last week, was wondering if you are seeing any change of controls noise that, I guess, KnowBe4 has taken opportunity of lately?
Stu Sjouwerman:

This was a question for Krish, correct?
Shaul Eyal:

Yeah. It could be Krish or Lars or even yourself, Stu.
Stu Sjouwerman:

It's Proofpoint related. I can start with just a general comment. We are as KnowBe4 still heavily investing in the platform, the international, multi=lingual. We're on the opposite spectrum of where Proofpoint's are currently moving to. PE is generally focused on cost cutting. So, we see them now and then, but I think Lars can expand a little more on exactly where and how we see Proofpoint today.
Lars Letonoff:

I really can't speak on any specific competitor, but I'll answer this way. First, we rarely see competition in SMB. It's mostly greenfield. On the enterprise side, when we're involved in new business in a bake off type scenario, in that case, we rarely lose to competitors. We win those hands down. The other part of our go-to-market in enterprise, as I mentioned before, is that we're actively going after our competitors' existing customers. So, sometimes, in those cases, when we're going after that business, we'll see them bundling the product, kind of a scramble just to keep the business in house. And that's where we'll occasionally lose a sale. But we're winning a lot more of those than we're losing. And not only do we view the competition as competition, but with our go-to-market, we also view the competition as opportunity.
Operator:

Next question comes from the line of Jonathan Ruykhaver with Baird.
Jonathan Ruykhaver:

Congrats on the strong performance. I have a product question. When you look at product development, I'm wondering if you could just talk about the emphasis you're placing on improving existing products versus building out new SKUs? Obviously, something like PhishFlip is a nice improvement to PhishER, but maybe not as directly monetizable. So, just kind of curious how you look at that dynamic and that trade off?
Stu Sjouwerman:

Absolutely. We have a really strong feedback loop with our existing customer base on it. That data stream, if you will, gives us great insight into the features that they would like to see. And PhishFlip is a great example of customers coming up with, hey, it would be great if. We also have our own product team that is super focused on giving our customers a fantastic platform at a very competitive price. So, for people who don't exactly know what PhishFlip is, an administrator sees a malicious email come in and with a few clicks, they can turn that particular malicious email into a phishing template for everyone else. So, you can immediately see who would have fallen for this particular attack. It's very handy and super popular feature.
Jonathan Ruykhaver:

I have a follow-up. It is somewhat along the same lines. But you introduced some artificial intelligence capabilities into the core KMSAT product recently. I'm curious how you see that differentiating. And then, maybe any color you could provide on product roadmap that leverages AI in the future. It'd be interesting to hear an update there.
Stu Sjouwerman:

Absolutely. For the last five years, we've been very focused on making the platform AI enabled. And you will see more and more AI-driven, machine learning driven features, things like suggested training modules for employees, similar to what you see on Netflix, we think you'll like, also suggested training modules that we present to the administrator, so they can roll it out to their users. Apart from that, we have now 60 patents and a lot of them are focused on the AI related to security awareness. So, we are very heavily investing in that particular direction, and will provide more and more AI-enabled functionality in the core platform itself.
Operator:

Next question comes from the line of Tyler Radke with Citi.
Jonathan Ruykhaver:

I was curious, just given the strength that you've seen in the business the last couple quarters as well as the strength you've seen in kind of cross sell and upsell, where are we at in terms of your headcount growth plans this year, particularly in quota carrying reps? Have you kind of accelerated those based on the strength that you've seen? Are you leaning more into the channel? Just help us understand kind of the increased investments that you're making, given the strength in the business?
Stu Sjouwerman:

I'll take a quick stab and then I'm going to give Lars the opportunity to give some more detail. In KnowBe4, we have the similar rule as salesforce that half of our employees are in sales. And we are definitely even increasing our outreach in the recruiting area. We're hiring more recruiters, so we can expand our outreach, especially international. But Lars has more detail on exactly where and how much for different groups. Lars?
Lars Letonoff:

We've pretty much been on a very consistent headcount growth plan that matches our growth in ARR. I would say, you're going to see a lot more acceleration in the international markets as we grow those. And then, with the introduction of some of the adjacencies that are coming along, as well as the Compliance Plus, you're going to see us a lot more efficient with headcount. Because, for instance, like a Compliance Plus, we really don't need to add headcount to sell the product. It's really just another skew on the new sale. And then, the CSMs can easily just add that up or cross sell that to our existing base. And then as far as delivering it, delivering CMP is really just flipping a switch and turning it on into console. So, we're not going to need additional customer success managers to deliver that.
Operator:

Your next question comes from the line of Roger Boyd with UBS.
Roger Boyd:

Congrats on the results. I was wondering on free cash flow, if you can talk through the puts and takes on the upside there. I think part of it – CapEx came in a little late again. I'm wondering if maybe you could talk about your PPE spending plan for the rest of the year and maybe if you're thinking about anything differently as relates to office space and remote work long-term.
Krish Venkataraman:

I can add a little bit color on our free cash flow. I think one thing to understand is that, since I think the beginning, since Stu founded this company, he's always wanted to maintain a strong balance between growth and FCF. And that is basically ingrained into every employee's DNA, whether you are at the front desk or you are the CEO. So, that will continue going forward. Now, if you look at seasonality in terms of FCF, you do see some level of seasonality in FCF, especially if you look into the later half of the year. But at the same time, we have never been a very CapEx intensive business, right? We are going to actually increase some CapEx in H2 versus H1 as we actually build out some of our facilities in anticipation for our employees to come back into a hybrid mode in Q4. But none of this is going to be really large to create any significant imbalance in our PPE expense over the last couple of years.
Operator:

And at this time, I'll turn the call back over to Mr. Sjouwerman, CEO, for closing remarks.
Stu Sjouwerman:

Thank you very much for attending. We appreciate your interest in KnowBe4. We look forward to an exciting back half of the year.
Operator:

Thank you. That concludes today's conference call. You may now disconnect.

KnowBe4, Inc. Q2 2021 Earnings Call Transcript

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KnowBe4, Inc.
Q2 2021 Earnings Call Transcript