Welcome to Cognyte First Quarter FYE 2023 Earnings Conference Call. My name is John. 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]. As a reminder, this conference call is being recorded.

And I will now turn the call over to Dean Ridlon. .

Thank you, operator. Hello, everyone. I'm Dean Ridlon, Cognyte's Head of Investor Relations. 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 would like to mention that accompanying our call today is a presentation.

If you would 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 would also like to draw your attention to the fact that certain matters discussed on 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 January 31, 2022 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 and 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, 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 and comparative purposes.

The non-GAAP financial measures the company uses have limitations and may differ from those used by other companies. Now I'd like to turn the call over to Elad..

Thank you, Dean. Welcome everyone to our first quarter conference call. Our Q1 results reflect the challenges we discussed during our last earnings call.

We are clearly disappointed in our result, but we believe the challenges we're facing are temporary in nature and are taking steps to navigate the current environment, improve our execution and cost structure, and emerge stronger once conditions improve. Our Q1 non-GAAP revenue came in at $87 million, a significant decline year-over-year.

Later on, David will provide further details on our revenue and the impact it created on gross margin and the overall profitability. Today, I would like to provide an update on what we saw in the market during Q1 and how we're responding. Let me start with a view of Q1 booking activity.

In Q1, we continue to win large deals from existing customers that demonstrate the need for technology, the strength of our customer relationships, and how customers look to us to help them address evolving security threats. First is another $50 million deal from a National Security Agency to expand its existing platform.

Our customer is dealing with an increase in data volume, which is why they turn to us to expand the platform. This is a good example of how we help customers scale the solutions to address evolving security threats. The second order is from a law enforcement agency for over $5 million of our solutions to combat drug trafficking and criminal activity.

This is a follow-on order after the customer was pleased with the operational results of a previous deployment of our solutions last year. The third order is also $5 million for a national intelligence unit that purchased additional solutions to address terrorist activity along their borders.

These large orders highlight the confidence our customers have in our technology and our ability to deploy large complex solutions. In terms of the overall Q1 bookings activity, I believe it is useful to look at the sequential trends in our revenue performance obligations, or RPO, from Q4 to Q1.

Just to remind you, RPO represents contracted revenue that has not yet been recognized. We finished last year with a total RPO of $512 million and we finished Q1 of this year with an RPO that is a few million dollars higher. We use RPO as a proxy for total backlog that is available for deployment over time.

A sequential increase in backlog even if small is important to note given the year-over-year decline in revenue. Regarding backlog, as you know, we usually enter the quarter with a majority of our expected revenue already booked and included in RPO. This typically provides us good near-term visibility.

However, in Q1, supply chain challenges presented uncertainties to our ability to deliver on our quarterly expectations. Let me share an example to help explain this point. We had a multimillion dollar ordering backlog that we expected to deploy in Q1.

In this case, our customer ordered software from Cognyte and separately ordered hardware from another vendor to run our software. During Q1, this customer informed us that their hardware delivery was delayed. The customer requested to reschedule the deployment of the Cognyte software until after the hardware had arrived.

The impact of this customer delay was that Cognyte could not deliver the software and recognize the revenue in Q1 per the original schedule. In addition to supply chain that continued to cause delays, I would like to provide more details on the other issues we discussed last quarter, the slow conversion for our pipeline to actual orders.

We believe the reasons we experienced lower pipeline conversion are related to combinations of the following two factors. First is internal execution and second is customer delays in placing orders that could be related to the impact of the overall macroeconomic and geopolitical environment.

As we discussed on our last call, five months ago, we hired a new CRO to improve our internal execution.

Some of the actions we've already taken include focusing our sales teams on territories where we see the highest potential, identifying the most pressing customer pain points, and using a more consultative sales approach, and increasing the frequency of pipeline inspection, coupled with stronger collaboration between our sales and product teams.

Over the last few months, our CRO and his team has met many individual customers to better understand the reasons behind the slow pipeline conversion. While it's too early to reach conclusions from his customer interviews, I would like to share some anecdotal examples, which I hope you will find useful.

The first example is a government agency, which told us that their agency's budget for the year has decreased, and as a result, they have begun a process to adjust their operating plans. We believe the delays we experienced with this customer are the result of their process to reconsider their project priorities.

Second example is another government agency, with which we completed the sales process in Q4 last year for a multi-million-dollar order. In this case, we expected the order to be pledged during Q1, but the order has not landed yet. It's not clear what are the reasons for the delay.

But based on discussions with the customer, we continue to expect the order. Third example is related to Europe where we had a healthy Q1 pipeline and we experienced very low conversion of the pipeline across Europe. This may or may not be related to the crisis in Ukraine and how other countries in Europe react to it.

It is important to note two additional observations we concluded for our conversation with customers in analyzing Q1 pipeline conversion data. First, we believe we have not lost key deals due to competition, and that we maintained our differentiated product position.

Second, we believe our relationships with our customers remain strong and that this slow pipeline conversion was not caused by customer dissatisfaction with Cognyte solutions or services. Given the supply chain and slow pipeline conversion, our ability to focus this year with sufficient position is still limited.

We are encouraged that the Q1 bookings activity resulted in maintaining total RPO north of $500 million, but we are still facing a broad range of potential outcomes going forward and are unable to provide guidance at this time.

We believe the issues that we and our customers are facing are temporary in nature, and we will continue to monitor the environment and resume guidance as soon as practical. Given the disappointing Q1 results, we have taken specific steps to reduce our cost structure.

Our current headcount is around 1,900, approximately 5% lower than our headcount at the beginning of the year. We are also taking steps to focus on improving pipeline conversion by helping customers wherever we can to address the top priorities they have in the current environment.

I would like to conclude my prepared remarks with a summary of the key drivers for our long-term opportunity. First, security threats are pervasive and governments continue to seek innovative solutions to address these threats. Second, we are a market leader in investigative analytics with a long history of growth and innovation.

And third, we have developed deep relationships with our customers around the world and have a strong track record and reputation in the security market. Now, let me turn the call over to David to provide more color about our Q1 results.

David?.

Thank you, Elad. And hello, everyone. Our discussion today will include non-GAAP financial measures. A reconciliation between our GAAP and non-GAAP financial measures is available, as Dean mentioned, in our earnings release and in the Investors section of our website. As Elad said, we're not happy with our Q1 results.

Revenue for Q1 came in at $86.4 million, a significant decline from last year. Our revenue mix includes three streams – software, software services and professional services and other. In Q1, we experienced a mixed change relative to Q1 last year as follows.

Software revenue was $24.9 million, a sharp decline year-over-year due to customer deployment delays and slow pipeline conversion. Let me start with the customer deployment delays, as Elad mentioned, we had customers that had their own supply chain issue, which impacted our revenue for the quarter.

With regards to slow pipeline conversion, we continued to experience delay in converting our pipeline to orders, which then impacted our book-to-ship revenue. Regarding software service revenue, it came in at $45.8 million, down by $4.9 million year-over-year, primarily due to federal customer reducing support and subscription spends.

This revenue mix change impacted our gross margin results. Our non-GAAP gross margin and gross profit were 60.8% and $52.7 million, respectively. The gross profit decline of approximately $31 million year-over-year is primarily due to the decline in overall revenue. About $22 million of this decline is due to the lower software revenue.

Our Q1 non-GAAP operating expense was $74.8 million, similar to Q4 level. We had a non-GAAP operating loss of $22.1 million and adjusted EBITDA loss of $18.2 million. Non-GAAP diluted EPS came in at $0.79 loss. I would like to mention that our diluted EPS loss reflects a $29.5 million non-GAAP tax charge.

This is the result of our non-GAAP tax methodology that is based on expected cash tax rate for the year, consistent with previous year's practice. This methodology can create volatility. Our actual cash tax payment in Q1 were $3 million. As Elad mentioned, earlier in Q2, we took steps to reduce our cost structure.

And we expect these actions to result in non-GAAP Q3 OpEx of about $70 million. Turning to the balance sheet, we ended the quarter with $107 million of cash, cash equivalents and short-term investments. This balance reflects Q1 solid collections and include $50 million from our existing credit facility.

To remind you, during Q4, we drew down our $100 million credit facility and, during Q1, we paid back $50 million. Overall, cash used in operation in Q1 was $8.7 million, mainly due to our loss.

Regarding inventory, given the supply chain environment, we took steps to increase our level of inventory by a few million dollars to allow better flexibility to address market demands for our solution.

Our balance sheet also reflects a $6.2 million accrual related to an alleged infringement of an [indiscernible] patent claim, which was settled and paid in Q2. As we look ahead, let me summarize where we stand today.

We believe the issue we're facing are temporary in nature, and we're taking specific steps that will enable us to emerge stronger over time. We will continue to monitor the environment and resume guidance as soon as practical.

Cognyte has more than two decades of delivering innovative solutions, strong customer relationships, profitable growth and managing through periods of volatility. We have a long-term opportunity in front of us in helping our customers to address the security threats.

With that, I would like to hand the call over to operator to open the line for questions..

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

The first question I had, I know that we're now essentially done with the second month in the second fiscal quarter, right, two months under our belt here.

With that said, I'm curious, have you guys seen any changes so far in pipeline conversion or supply chain constraints that would make you think that the business is getting either worse from where we were in April quarter or better from where we were in the April quarter? Just curious if you could talk to what's played out in May and June so far..

We are clearly in a period of low visibility. During the call, I shared examples of multi-million dollar orders slipped out of the quarter that were expected for the quarter. One of them was related to an order that is in the backlog already.

The other one was an order that was supposed to be book ship order that we were supposed to book and deploy the same quarter. So, the situation is still volatile. And for that reason, there is still broad range of potential outcomes and the uncertainty is it's a level that we cannot give guidance at this point of time.

About the pipeline, I can tell you the pipeline is a healthy pipeline. We see lower conversion rate. On the other side, we didn't see any losses of key deals. And we are focusing on accelerating pipeline conversion..

I was going to say, on the RPO, I know that you guys had mentioned that we saw a sequential increase by a few million dollars, I think is what you guys had called out.

Could you help us think about the composition of that RPO? And what I mean by that, I know that there's a certain amount of RPO, which can be recognized over the next 12 months versus RPO that can be recognized thereafter.

So, the sequential increase in RPO that we're talking about, was it expected to be recognized in the next 12 months then? Or is it longer term in nature?.

Usually, we enter the deal with an RPO – and two-thirds of the RPO is for the year and one-third is for the years after. So, usually, that's the range. And I think it's similar at this point of time as well..

Last question before I turn it over to my colleagues, but on the inventories, I know that you guys have cited the increases you're seeing in inventory, which is reflected on the balance sheet, as providing you guys increased flexibility.

Is there more to do there as far as continuing to take the inventory balances up? Or is this something you're comfortable with it at the current state?.

Just to warn everyone, about 20% of our business is related to software that is installed on embedded product. A portion of it is related to the shortage of components challenge that we faced. At this point of time, we increased the inventory level to a level that is sufficient for us.

And just want to remind you that we also want to redesign process that should be completed in Q3. So, we do have the mitigations we need for that..

Our next question is from Peter Levine from Evercore ISI..

Obviously, if you look at growth and sales are really funnel metrics. I went to RSA a couple of weeks ago and it seems like security spending across the board, corporate and federal, seems pretty healthy.

So, was there a new competitor that had a feature you didn't have? Or maybe you're just not selling well against? I know you called on the prepared remarks, but maybe talk about just the competitive landscape.

Any new developments evolving that you see that perhaps may be contributing to kind of some of the pipeline conversions or pipelines just not building a strong..

Maybe I'll share with you what we hear from our customers. Our customer is telling us that they face growing challenges, growing security challenges, they need more analytics, their security challenges are becoming more complex, and they need more investigative tools. So, this is no change and customers do need our technology.

About competition, we don't see any significant change in competition. As you remember, we are many years in this business, more than 25 years. We have a large customer base in more than 100 countries. And we have deep relationship and reputation among our customer base and also superior technology.

So, when we talk to customers, we do not see any or hear anything that is related to change in the competitive landscape. And we believe that we are still in a market leadership position. About the pipeline, the pipeline is healthy. It's not about the size of the pipeline, but it's about the low conversion rate of the pipeline.

And we shared earlier in the call what we see. We see challenges that are related to supply chain in the customer side. And we also see the changes in the environment, the macroeconomic and the geopolitical environment that might be really related to what we are facing in the market.

But I do not think the competitive landscape has changed in any significant way..

Maybe just a final question. Maybe two parts here. One is, can you explain to us what the new CRO, what he's doing today versus kind of what you saw a year ago? Like, what changes is he making? And then second, you talked about a reduction in headcount.

Can you explain to us where that's coming from? Is it sales and marketing? Is it R&D? Just curious to know where the reductions are?.

So, let's start with the CRO. First of all, I must say that I'm really excited having him joining the company. He is a senior executive with a great addition to the team. His main focus, of course, is accelerating pipeline conversion. That's what we see as the main challenge for us.

Obviously, now, when the borders are open, he and his team are meeting with customers extensively. The focus is to better understand the customers’ challenges and main pain points and to focus the sales force on the top priorities of each and every customer. As I mentioned earlier in the call, there are many interviews we're doing with the customers.

We try to understand where they focus, where there remain challenges and to try and help them solve it. So, I'm pleased with the progress he's making. And we also have the entire executive team that is focused on this conversion of pipeline. In terms of the cost reduction, it was across the board.

It was not related to one specific area, but it was across functions and total about 5%, including R&D..

Our next question is from Brian Ruttenbur [ph] from Argio Capital [ph]..

Next series of questions on cash from operations. Given the cuts, and you said – across the board, I believe you said, roughly 5% cuts.

Will that impact second quarter and third quarter to a positive where cash flows from operations turns back positive?.

As we mentioned during the call, we did the cost saving across the organization. And actually, when we’re looking at Q3, we expect our non-GAAP operating expense to be around $70 million. Obviously, given the fact that we are not providing any guidance, we also will not refer to the cash.

But if we look at the overall, we believe that the current situation [indiscernible] $107 million of cash should there be enough to capitalize our operation..

Maybe I’ll elaborate on that. If you remember, we drew the credit facility back on December last year. And given that we had $107 million of cash by the end of Q1, we decided to repay $50 million. We believe this is sufficient to run the business. .

Along those same lines, do you anticipate any further headcount? Or is this where you are on a kind of stable for the next couple of quarters?.

We gave it a lot of thought. We believe that the challenges that we are facing are temporary in nature. And given that the pipeline is healthy and we believe that it's temporary in nature, we think that this is the appropriate level of cost reduction that we had to make. We took the decision and we completed that in June.

So, for now, we believe this is the level of cost structure that we need to run the business given the current environment..

Last question. Just real quick. Just trying to understand, your government customers that are dragging their feet and you relating this primarily to the – is there a reason, a specific reason? I know there's a lot of reasons out there.

But there's a slowness and the conversion, I'm trying to point to, is it COVID, is it the war? Is it a combination of everything? I'm just trying to narrow it down..

I don't think the COVID is an issue anymore. I think that the COVID now, while it's behind us, it's easier for us to meet customers face to face, and we do it extensively. What we see generally is that it's related to – it might be related to supply chain.

I gave an example earlier in the call and also, potentially to macroeconomic and geopolitical situation. But customers will not provide us with the precise reason. So, it's all speculations..

[Operator Instructions]. And we have a question from Mike Cikos from Needham & Company. .

I just had a couple more questions I wanted to fine tune on my side. And maybe just to help the crowd here.

But for David, can you remind us how much of your revenue each quarter typically comes from perpetual licenses versus the term-based licenses?.

It's actually most of our revenue coming from perpetual licenses. The term based is relatively minor..

So, I'm assuming north of 50%? Like, is it close to [Technical Difficulty] percent or 90%? How high is that perpetual contribution?.

It’s the main majority. Like, close to – more than 75% of our revenue coming from perpetual when we look at the software revenue..

When we think about the linearity of each quarter, again, just can you help us think – that third month each quarter, what is the typical revenue contribution to the total sales for the quarter? Is the third month of the quarter, call it, 50%, is it 60%? How should we be thinking about typical cadence within each quarter?.

As Elad mentioned, like, we have two type of source of revenue in any given quarter. Revenue that's coming from the backlog that is planned to deliver through the quarter and is the revenue that's coming from, what it's called, like book to ship orders that we get within the quarter and are planned to be shipped in the same quarter.

At any given quarter, the change between the months can be different. Usually, like any other software company, the last month of the quarter, and obviously, also the last two weeks of the quarter are highly important..

And then one more question, if I could. There was a comment I think in the prepared remarks that several customers were reducing their support and subscriptions with Cognyte, which impacted your software services during the quarter.

Can you help us think about what's causing customers to reduce that support and subscription piece? And I'm guessing it's atypical in the fact that you're calling it out.

But how should we be thinking about that?.

First of all, it's important to say that the customer is still with us and those are active customers. Some of them or most of them are with us for many years and bought multiple part solutions over the years.

For whatever reason, they have they decided to reduce spend in some areas related to support and subscription and to free some budget to other purposes. It could potentially be that they'll buy other solutions from us. This is a possibility, but this happens from time to time.

But all those customers are still with us and continue to be important customer for us for many years..

Our next question is from Brad Reback from Stifel. .

I think just a couple of quick ones here. The $70 million of OpEx, just to clarify, that's for 3Q.

So, it should be something higher than that here in 2Q?.

It's for Q3. Obviously, we don't – when we do the cost reduction, it takes some time until everything is effective. So for Q3, we are expecting non-GAAP operating expenses of $70 million..

On the maintenance question, I know you talked about the historical precedent that it happens from time to time where people cut back.

Can you give us a sense the last time maintenance declined 10% year-over-year historically?.

No, I can't remember by heart now. No, but it might be sometimes the customers decide to move, shift budgets from relatively old solutions to new solutions and update and upgrade their more new and modernized solution. So this might happen. But I cannot remember by heart. We can check it offline and come back to you, Brad..

Now, I’d like to turn the call back over to Dean Ridlon for closing remarks..

Thank you, operator. And thank you everyone for joining us on today's call now. Should you have any additional questions, please feel free to reach out to me and we look forward to speaking with you again next quarter..

Thank you, ladies and gentlemen. That concludes today's call. Thank you for participating and you may now disconnect..