Welcome to the Cognyte 2Q FYE'22 Earnings Conference Call. My name is John and I’ll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] And I will now turn the call over to Matthew Frankel..

Thank you, 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 Investors section of our website at cognyte.com, click on the Investors tab, click on the webcast link, and select today's conference call.

I'd 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 a 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, 2021 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 useful to 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?.

Thank you, Matt, and welcome, everyone, to our second quarter conference call. I'm pleased to report another strong quarter with both revenue and diluted EPS coming in ahead of our expectations. In Q2, we continued to see the benefit of our software model strategy in our results.

Revenue increased 10% year-over-year, while gross profit increased at an even faster pace of more than 13%. We are particularly pleased with our gross margin which increased 250 basis points year-over-year. Adjusted EBITDA came in strong at $18.5 million and non-GAAP EPS came in at $0.17.

It's a similar strong story for the first half of the year with revenue going 11% year-over-year and gross profit growing 16%. We are pleased with the progress of our software strategy which is ahead of schedule and we’re raising our profit guidance for the year, reflecting the better software mix which David will expand upon later.

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'll briefly review our market opportunity and discuss several large second quarter orders. Our customers are facing security challenges across many use cases.

Well organized, well-funded adversaries are becoming harder to detect, as they take advantage of the latest technologies to hide in the shadows. At the same time, there is growing volume and diversity of structured and unstructured data and data is augmented and spread across organizational silos, making investigations more difficult.

Many customers recognize that the homegrown solutions can no longer keep pace with these evolving security challenges, and have increasingly sought open analytics platform that can support multiple use cases, 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 analytics 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 stages.

And with new nearly 1,000 people in R&D primarily based in Israel, we are focused on developing highly sophisticated security analytics software. Let me take you through several large Q2 wins that reflect the successful execution of our strategy.

The first example is a $13 million order from an existing National Security Agency customer that is expanding the capacity of the platform. This is a good example of our platform can scale and help customer address their growing needs to accelerate complex investigation with sophisticated analytics.

The second example is a $10 million order from an existing National Law Enforcement organization customer that is expanding to a certain use case. This customer initially deployed our platform with real time analytics for investigating drug trafficking and is now expanding our platform to investigate human trafficking.

This is a good example of how our customers can use the platform to address multiple use cases and enables us to grow with our customers’ needs. The third example is a $7 million order from an existing Homeland Security customer that is using our platform to investigate cross-border smuggling of drugs and weapons.

The customer decided to replace ongoing system which they had used for many years but found it to be inflexible and expensive to maintain. Behind these wins is our ability to evolve our platform to address multiple use cases. Today, let me double click into one investigating analytics use case that we are seeing a growing interest in, cybercrime.

Cybercrime is becoming more frequent, and the methods that are being used are becoming more and more sophisticated making verifying bad actors much more difficult. Our customer mission is to identify the bad actors and prevent cybercrime activities that can lead to significant economic losses and security breaches.

Many security organizations today are using homegrown solutions that are unable to keep pace with current threat are difficult to maintain and are expensive to operate. Our open analytics platform provides our customers with strong analytics tools to accelerate investigations, identify bad actors and prevent cybercrime.

Our platform is built with deep domain expertise, easily integrates into our customers’ ecosystem and is frequently refreshed to keep pace with the evolving technology and security challenges. Cybercrime is a good example of how our open analytics platform can address multiple use cases.

In summary, we are pleased to have a strong second quarter as a pure play security analytics company.

For the current year, we expect approximately 12% gross profit growth on 10% revenue growth, and are pleased to be in a position to raise our annual outlook for EBITDA and annual guidance for non-GAAP EPS due to the successful execution of our software strategy.

Looking beyond this year, we believe market demand is strong for security analytics software, and we are well-positioned for continued growth. As discussed on past calls, we are pleased with the execution of software strategy and going forward we will offer more use cases on our platform for a subscription model.

We expect customers to adopt subscription model gradually over time. Now, let me turn the call over to David to discuss our results and outlook in more detail.

David?.

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 second quarter with revenue, gross profit and EPS coming ahead of our expectations. During Q2, we won multiple 7 and 8 figure orders from existing and new customers, driven by ongoing demand for our analytics software and our strong differentiation.

Revenue for Q2 came in at about $116 million, up approximately 10% year-over-year. Non-GAAP gross profit came in at $85.6 million, up more than 13% year-over-year. And non-GAAP diluted EPS came in at $0.17. Adjusted EBITDA was $18.5 million in the second quarter.

Behind our strong results was the demand for our solutions and the successful execution of our software model strategy, which I'd like to discuss in greater detail.

In the first half of the year, over 50% of our revenue was recurring and 89% of our revenue came from software, up 200 basis points year-over-year, reflecting the adoption of our analytics platform and the reduction of hardware reselling and professional services.

Our H1 non-GAAP gross margin increased over 300 basis points to 73%, and our non-GAAP gross profit increased approximately 16% year-over-year as a result of this improved mix. Over the last few years, we have made investments to transition from a system integrator model to a software model. These investments are now behind us.

And we are seeing the benefit of this investment in our software mix and gross profit growth. Now, let us turn to our FY '22 outlook. Starting with revenue, our outlook for FY ‘22 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 annual recurring revenue including subscription and support revenue to represent approximately 50% of our total revenue. As Elad mentioned, we're offering more for our platform use cases through a subscription model, and we expect gradual adoption of subscription over time.

Regarding profitability, we are pleased that our software strategy is ahead of plan, and we are raising our annual outlook for gross margin and adjusted EBITDA, and our annual guidance for diluted EPS.

For non-GAAP gross margin, we now expect slightly above 72% for the year, more than 100 basis points improvement over the prior year, with non-GAAP gross profit growing approximately 12% year-over-year. We expect our non-GAAP diluted EPS to come in at $0.82 at the midpoint of the revenue range, up from our prior year guidance of $0.80.

Our diluted EPS guidance reflects $87 million of adjusted EBITDA, up from our prior outlook of $85 million. Our outlook for $87 million of EBITDA reflects 18% year-over-year growth, normalized for the spin-off dis-synergies. Let me also discuss how we see the year progressing.

We are pleased with our strong first half and ended Q2 with more than $500 million of RPO reflecting strong demand for our platform. When looking at our backlog and the timing of our customer deployment, we expect Q3 revenue in the range of $112 million to $117 million and to finish the year with our typical strong fourth quarter.

Regarding EPS, as I just mentioned, we're raising our outlook for the year to $0.82. And based on our revenue mix and OpEx level for H2, we expect EPS of about $0.10 in Q3 and EPS of about $0.35 in Q4 at the midpoint of our revenue outlook. With that, I would like to hand over to the operator to open the line for questions.

Operator?.

[Operator Instructions] Our first question is from Mike Cikos from Needham & Company..

Hey guys, you have Mike Cikos on the line here. Thanks for the time. I did have a question for you regarding the revenue, obviously, putting up some strong growth in the first half of the year, maintaining the fiscal '22 guidance.

So can you walk us through the 3Q revenue guide? Just looking at the $112 million to $117 million would imply, I guess, a year-on-year decline at the lower half of that guidance if I'm looking on a sequential basis and about flat year-on-year if I'm looking at the -- at last year's result.

Can you walk us through some of the puts and takes and understand the typical seasonality you guys would see for the 4Q pickup? But the 3Q is really what I'm driving at. .

Thanks, Mike. It’s David. So we ended Q2 with more than $500 million of RPO. And when looking at our revenue backlog and timing, we expect Q3 to be between $112 million and $117 million and finish the year with a typical strong Q4. Timing of few deals that we had originally modeled in Q3 are currently scheduled to be in Q4.

And for the year, as we mentioned before, we are raising our outlook for EPS on [$10 million] revenue growth. That gives you like the core on Q and why we’ve guided this first..

Alright, that's helpful. And it might just be my phone, but you were breaking up just a little bit, just a little bit. But I did have another question for you. I know that you guys cited again back to back quarters now where you're seeing these multiple seven and eight figure deals that you're winning in each quarter.

And I'm curious, can you just help us then -- in the $500 million plus RPO exiting 2Q, can you help us think about the pipeline of deal activity that you're currently seeing? And the customer demand is, would you say that visibility is actually improving for your business based on this successful execution of the software model transition? Maybe the demand environment is actually strengthening, if we look back even three or six months ago.

Anything on the, I guess, demand dynamics would be helpful there. .

So let me give you some color and let know if the line is there okay. So we started the year with strong Q1 and Q2. In H1, we completed 47% of our revenue for the year, already done, which is good. We see the demand remains to be strong and demand -- our solution continue to be used and we ended the Q2 more than 500 million in RPO.

And again, it is a very significant figure, which gives us a significant level of visibility. And by doing that, we have like a strong level of visibility..

Yes, maybe -- Mike, hi, this is Elad speaking. About market demand, our customers are facing more and more complex security challenges. We continue to see demand for our open analytics platform. And we are focusing mainly on replacing homegrown solutions. These were some of the examples I gave earlier in Q1 and also in this call.

As David mentioned, we started this strong, we do have good visibility for H2, driven by our recurring business, which is about 50% of the repeat business from existing customers, which is about 9% and the strong RPO of $0.5 billion that David just mentioned. So overall, I feel good about it..

And one more if I could just real quick on the subscription, I know that you guys are very early in the process and that is going to be a gradual process for you guys.

But the question is, I guess as your sales force is talking to either existing customers or prospective customers, can you help us understand, how those customer conversations been trending and how receptive has your customer base been to potentially transitioning to a more subscription-oriented offering?.

Sure. Thanks, Mike. So currently, around 50% of revenue is recurring, and about a quarter of which is already a subscription. We have an open dialogue with our customers. We are discussing with them their transition to subscription. In some government agencies, we see more openness to transition, while others are not yet ready.

And given what we see in terms of customer behavior, the existing backlog and pipeline, we expect recurring revenue to stay around 50% next year. Going forward, beyond next year, we expect subscription revenue to grow faster than overall revenue. We have to remember that government customers are a little bit conservative.

We saw that also when we transitioned to software. It took for them some time to adjust. They are lagging behind the global market. But we believe that at a certain point of time, they will accelerate the adoption. It's just about the amount of time and we’re ready, we already are offering subscription. Some of them already adopted subscription.

But as you mentioned Mike, it will be a gradual and slow process..

Our next question from Daniel Ives from Wedbush..

So could you -- kind of to the last question, but just to expand that out more, in terms of deal sizes, in terms of pipeline.

Are you seeing a clear change in terms of the larger deal sizes that you guys are working on, especially deals become more strategic and broader?.

This is Elad. Actually, we don't see any change in the market. It's similar to what we saw was before. There are deals of seven and eight digit as we give -- for example, there are some smaller deals.

Generally speaking, we are focusing on existing homegrown solutions, customers to choose whether to start big or -- and evolve over time or buy from us the holy grail platform with all use case, so with many use cases at once. So -- but generally speaking, there is no change in the ecosystem. We see similar trends in the market, as we saw before.

I hope this helps..

And then just like on the subscription model transition, obviously trying to accelerate that more and more.

I mean, is that something where you're continuing to sort of drive that even to the next level, through the go-to-market strategy as we're thinking about that transition over the next 6, 12 months?.

Yes. So, maybe a little more color about subscription. So as I mentioned before, we're in open dialogue with our customers, government customers are more conservative. And from what we hear, we do expect a modest market adoption.

In addition, we should remember that we have strong RPO of more than $0.5 billion and proposals that are out, which are in perpetual model, so -- and it takes more time for government customers to transition. But eventually, we believe they'll catch up.

At this point, it's hard to tell how long it will take and we believe that trying to force customers, mainly government customers to shift too early, when they're not ready or receptive to that, may result a negative impact. And we saw that, again in the transaction to software.

It took some type for government organizations to adopt, but eventually they've adopted and we see very good results. The software transition is ahead of plans, and the gross margin is very strong. I believe it will be a gradual over time process, but the endgame will be where we want it to be. I hope I answered it..

And our next question is from Brad Rebeck from Stifel..

I think you guys mentioned that you've had some early success or some early customers move to subscription.

Can you give us a sense of what the revenue uptake is when a customer does that?.

Yes, some of the use cases we offer in subscription, we do see about one-third of our recurring revenue in the subscription. When we go to customers, existing customers, that are with us to more than 20 years, are still in the perpetual model and we are discussing with them to shift. For new customers, it's easier to adopt the subscription.

So that's the reason we expect a gradual process.

Have I answered or any other comments?.

I'm sort of interested, if the customer spending $1 historically with you on license and maintenance, and they move to subscription, what's that $1 become?.

It's, David. I will add some color on that. Actually most of -- look, historically we started like few years with the transition into software model, we didn't have any subscription offering.

In the last few years, we introduced some subscription offering on certain offerings, and allow the customer to move to subscription where there was like a willingness from the customer to move to this direction.

Now, in high level, the equivalent between $1 spent on perpetual versus like -- versus subscription was about like $3, but it's a dependent on the use case and what we're offering and what we can actually offer the customer.

You need to remember that we are in the beginning of the process, actually, we’re now creating more open discussion with the customer and internally working on our offering to make it attractive. .

Our next question is from Kirk Materne from Evercore ISI..

Elad, can you just expand a little bit on the opportunity around crypto, and how -- is that a needle moving opportunity for you all in terms of what it could add from a product perspective to your existing base? So I was just kind of curious, if you could add a little bit more color around that opportunity? Thanks..

Sure. So, we discussed cryptocurrency in previous call. We discussed that it's becoming very important for our customers to have this use case, because illegal transactions are done in the cryptocurrency ecosystem. It's another use case.

Actually, our growth plan is relying on evolving the platform to support more and more use cases, and cryptocurrency is one of them. In terms of where we are today, we launched it last quarter. We see this as an opportunity for both expanding with existing customers, as well as acquiring new customers.

And obviously, lots of customers will have an interest in this use case. At this point of time, we are running multiple POCs with customers and the results so far are encouraging..

That's helpful. And then David just two quick ones for you. One was just sort of a follow-up on the earlier question around just the seasonality in 3Q and 4Q. And sorry if I missed this.

But is that just more of a rev rec issue or are just the bookings also more fourth quarter weighted, meaning, last year it looked like it wasn't quite as pronounced, but going back two years ago, it looked like you guys had more seasonality from 3Q to 4Q.

So, I'm just trying to get a sense on, those are deals that have been, you’ve been selected but haven't invoiced or booked yet, or is it more just that the pipeline builds or buyers are more pronounced in the fourth quarter?.

So, as we spoke before, like we gave an RPO of about $0.5 billion and it's a matter of timing of revenue. Q4 is typically strong. And again, when we look at the Q3 and Q4 ahead of us, we are still guiding for a 10% year-over-year growth.

Recurring revenue continues to be a significant element on our business with more than 50% of our business, and the strong RPO give us direct level of visibility towards the end of the year..

Okay. And last one for you. Just on the professional services side of the equation, where it's less emphasized at this point in time.

But is this a good run rate do you think going forward for us to think about from a modeling perspective? Meaning is this around 14 million sort of the new base for you all or can that grow or kind of how should we think about that, as it relates to kind of your longer-term aspirations to accelerate?.

Yes. So, again, our strategy is to reduce professional services and hardware reselling over time. We started the journey like few years ago and we’re able to grow from the level 80s this quarter to like more than 89%.

From a modeling perspective, the long-term, I would assume that 90% of our revenue will be from software and remaining 10% will be from professional services and hardware reselling. This is in the long-term. In the coming years, I think that we will -- gradually will go there.

I think that 86%, 87% of our revenue on the software is a good range in this phase of transition..

Our next question is from Brian Ruttenbur from Imperial Capital. .

Yes, thank you very much. One housekeeping and one big picture question. The housekeeping, and I may have misheard this, you stated, I believe total subscription revenue was currently a quarter or 25%. I had written down and I may be incorrect but last quarter you were talking 16%, 17% were subscription.

Did -- am I incorrect with my numbers or correct with my numbers?.

The current subscription portion of the total recurring revenue is one quarter. So, around 12% to 13%..

Got it. Oh, there we go. That's where I didn't -- I did the total revenue. It was a math problem. Okay, so that's number one. Number two is, you're talking about replacing homegrown solutions as one of the biggest drivers.

What is the biggest decision factor for these government agencies? Is it saving money? Is it resources, it is ease of use? What is kind of the number one, number two reasons for them ripping out their solution and using yours?.

Yes. So actually, homegrown solutions have many downsides for customers, I'll focus on the top ones. The first one is that it cannot keep pace with technology changes.

When you do a tailor made solution developed to the one time for yourself, it's very easy to develop it, modernize it and keep pace with the technology when you'll have to invest only for one single solution. When you go to an open analytics platform from a global vendor, that is for many other customers.

So, you grow together with the pace of technology, this is one. The second is related to the high costs in order to maintain it. And the third issue that it’s very difficult to add more and more use cases and the world is changing. We discussed that the use cases, the trivial once where the different criminal activities.

Another example is cryptocurrency and you have to develop and evolve. And taking all of it together, this is becoming very inefficient, the value of the system is declining over time, and it's ineffective economically. So altogether, actually, they don't get the value they need and they pay a lot of money.

So, this is the formula for them to transition and replace it with an open analytics platform. .

Thank you. Our next question is from Louie DiPalma from William Blair. .

Good morning, Elad and David. Is there opportunity for you to partner with mobile forensics extraction software providers, like Grayshift or MSAB. Magnet Forensics recently IPOed in Canada and they have a solution called AXIOM Cyber, that is very similar to yours for cyber incident response software.

And they have partnered with Grayshift for mobile forensics extraction. They have built in integrations to help law enforcement and they have significant customer overlap with you for intelligence communities and law enforcement.

So, I was wondering in terms of your go-to-market strategy, if that's an area that you could pursue partnership opportunities to accelerate your growth?.

Yes. So, thanks for the question. So actually, if you look at our platform, it fuses different data sources, structured and unstructured at scale and run strong analytics, addressing many different security use cases, that's what our platform do. The digital forensics and these kinds of solutions are actually capturing data for the customers.

So behind the scenes, customer can feed this data also into our platform together with other data sources such as social networks and dark web and criminal records, and vehicle records and other data sources. But this is for the customer to -- and according to regulations, what data he has access to and what’s to feed into the platform.

So this is for us another data source that the customer may feed into the platform in order to improve the analytics and investigation and the insights. I hope this answers..

[Operator Instructions] And I have no further questions at this time. .

All right. Thank you, operator. And thank you everyone for joining us today. Of course, feel free to reach out with any questions and we look forward to speaking to you soon. Have a good day..

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. And you may now disconnect..