Good day and thank you for standing by. Welcome to Cognyte Second Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please be advised that today’s conference call is being recorded.

I would now like to hand the conference over to your speaker today, Dean Ridlon, Head of Investor Relations. Please go ahead..

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 second quarter conference call. Our Q2 revenue came in at $81 million. This supporting revenue performance represents a significant decline year-over-year and sequentially, reflecting further adverse changes in customer behavior that I'll discuss shortly.

With regards to bookings, booking activity came in higher than reported revenue and drove an increase in our backlog. As a reminder, RPO is the amount of contracted revenue that has not yet been recognized and we are sharing this messaging with investors because we use it as a proxy to measure our backlog.

As of the end of Q2, our RPO was $534 million, an increase of approximately $20 million from the end of Q1. We have a significant backlog. However, we are not able to convert more backlog revenue during Q2, and I'll also explain the reasons shortly.

Our Q2 gross margin improved sequentially as a result of a better software mix, but given the relatively low level of revenue, we had an operating loss in Q2. David will provide further details and analysis of our Q2 financial results.

Next, I would like to focus my comments on what we are seeing in the market and the corresponding actions we are taking to return to growth and profitability. Let me start with new deals.

Despite the challenging macroeconomic environment, in Q2, we continued to win [multi-seven and eight figure deals] [ph], and our booking activity exceeded reported revenue and resulted in a backlog increase. Let me talk about a few of the large deals we won in Q2.

The first deal is for approximately $50 million from existing law enforcement customer to expand the solutions used to combat drug trafficking and other criminal activities. The longstanding relationship we have with this customer and our differentiated solution drove this expansion order.

The second deal is from an existing law enforcement customer to approximately $5 million to combat criminal activities. This customer is expanding its [indiscernible] while replacing the solution of a competitor. The customers selected our solutions because of the previous positive experiences with Cognyte and our superior technology.

The third deal is from a national security agency, which has been a long-term customer for approximately $5 million to help combat a variety of national security threats, including illegal immigration, drug trafficking, and organized crime. We won this deal because of our successful track record with this customer.

We believe that these large orders highlight the confidence our customers have in our technology and our ability to deploy large complex solutions. Our competitive position remains strong and we believe that we have not lost any significant deals to competitors during the quarter.

In terms of our booking activity, while we won many deals, including large deals in Q2, we also experienced longer sales cycles across all geographies, and we had many more deals that we expected to close in Q2, but were delayed by customers. Let me explain further on the changes in customer behavior that we are seeing in the market.

In addition to pipeline conversion delays, we have seen backlog conversion delays. Customers in many countries are facing reduced funding and budget constraints, which impact the ability to make payments [prior to] [ph] deployment. This changing customer behavior impacts our ability to accurately plan the deployment schedule for backlog.

We believe this behavior is due to deteriorating macroeconomic conditions and related budget cuts in some countries and does not reflect a change in their interest in new analytics technology to address evolving security threats.

While we believe security remains a high priority, the global economic slowdown has caused some of our customers to change behavior. Given the changes in the marketplace I discussed earlier, we are taking action in response across three main initiatives.

First initiative is to maximize bookings by focusing the company on the areas with the highest near-term potential. This includes geographical priorities to focus on countries that are less affected by budget cuts. For example, we increased our focus on the U.S.

government market and I'm happy to report that our solution was recently selected by the Baltimore Police Force. We're also focusing on security used cases that currently represents higher customer agency. Second initiative is to reduce our cost structure. We are reducing operating expenses.

We target to achieve below $70 million in Q3 and below $65 million in Q4. Third initiative is to regain visibility as soon as possible with a focus on predictable backlog deployments. Government contracts typically provide customers significant flexibility.

Recognizing reflexibility, we are collaborating with customers to achieve a more predictable backlog deployment schedule. We expect this will help improve our visibility and increase our deployment efficiency. Our goal is to return to growth and profitability as soon as possible.

And given the macro environment, I believe these three initiatives will help us achieve this goal. I also would like to mention that the actions we have taken previously to several operations, supply chain issues were successful and we are now seeing minimal supply chain impacts on our operations.

At this point, our visibility remains limited and we are unable to resume guidance. However, to provide color on our near-term revenue expectations, we believe third quarter revenue will be similar to or lower than the second quarter, and the fourth quarter revenue will increase above the Q3 level. We intend to resume guidance as soon as practical.

In summary, the global economic slowdown is affecting our near-term performance and we are taking actions to focus the company on territories and use cases with the highest potential to reduce our cost structure and to improve deployment predictability of our significant backlog, so that we can regain visibility.

The Board and management team are laser focused on returning to growth and profitability. We believe security threats are pervasive and customers need innovative solutions to aggressive volume threats. We are market leader in investigating analytics, with a long history of growth, and a strong track record with customers around the world.

Now, let me turn the call over to David to provide more details about our Q2 results.

David?.

Software revenue declined by $20.9 million year-over-year, and increased sequentially by $2.1 million. We see a change in our customer behavior, which disrupt planning of the backlog conversion into revenue. As Elad said, government contracts typically provide customer flexibility.

We are working with customers to achieve a more predictable backlog deployment schedule. This will help improve our visibility, increase our deployment efficiency. Software service revenue declined by $8.5 million year-over-year and 10 units similar level to Q1. Professional services and other revenue declined by $5.5 million year-over-year.

Booking activity during Q2 came in higher than our reported revenue and drove an increase in our backlog. As of the end of Q2, our RPO was $534 million, an increase of approximately $20 million from the end of Q1. We believe that our significant backlog will drive our future revenues. Turning to gross margin.

In Q2, gross margin improved to 65.1% on a non-GAAP basis, up approximately 400 basis points sequentially, primarily as a result of the increase in software revenue and mix.

Our Q2 non-GAAP operating expenses were $70.4 million and $4.4 million lower than Q1 level, reflecting our cost control activities, which we plan to continue in the second half of the year. Despite the sequential improvement in gross margin and OpEx, the lower revenue level resulted in non-GAAP operating loss of $17.4 million for the quarter.

Below the operating line, we incurred approximately $1 million in interest and other expenses had non-controlling interest expense of approximately $1 million, and our non-GAAP tax expense, which I would like to discuss further.

For purposes of non-GAAP tax expense, we have consistently used [methodology] [ph] that starts with our estimate of total cash tax payments for the year, compared to our forecast of pretax income to create an annual effective tax rate.

Each quarter, the year-to-date tax expense is adjusted based upon changes in the full-year estimates of tax payment and pretax income. For Q2, these adjustments resulted in a positive contribution to income of $16.7 million. Our actual cash tax payments in Q2 were $4.8 million.

Turning to the balance sheet, we ended the quarter with about [$55 million] [ph] of cash, cash equivalent and short-term investments. Cash used in operation was $18.8 million, inclusive of one-time payment of $6.2 million, related to the settlement of patent claim that I talked about last quarter.

In Q2, we reduced borrowing under our credit facility and as of July 31, we had $20 million of outstanding debt. Also, during Q2, we renegotiated some of the credit facility covenants to provide us more future flexibility.

Given the [macro environment] [ph], we recognize that we faced ongoing uncertainties relative to the timing of return to profitability. As a result, credit facility actions as well other actions we might take will be evaluated frequently. As we look ahead, we are taking steps in response to the current macro environment.

We expect revenue in Q3 to be similar or lower than Q2, and fourth quarter revenue to increase above the Q3 level. Cognyte has a long history of delivering profitable growth and managing superior volatility. We look forward to [resuming guidance] [ph] as soon as practical.

We have a long-term opportunity in front of us in helping our customers to address the evolving security threats. With that, I would like to hand the call over to the operator to open the line for questions.

Operator?.

Thank you. [Operator Instructions] Our first question comes from Mike Cikos with Needham & Company. Your line is open..

Hey, thanks. You have Mike Cikos here from Needham. I just wanted to make sure that I heard you guys correctly.

Can you comment again what was the revenue expectation for Q3 and Q4?.

Hi, Mike. Yes, sure. So, we expect Q3 to be similar or lower than Q2, and Q4 to be better than Q3..

4Q better than Q3. Okay.

And so, one of the things that I'm struggling with on my side and hopefully you guys can help with this, but I know that we're calling out the more difficult macro environment today, but at the same time, you guys were also talking about the increase to RPO, if I go back last quarter, you guys also had noted a slight increase to RPO sequentially, right? So, can you help us better understand, I guess, what gives you that confidence to start at least directionally guiding to the revenue in Q3 and Q4?.

Yes. So, maybe I'll give you some color, Mike, about what we see in the market and then I'll address the Q3. So, we do see economic slowdown and this result, of course, in budget cuts and customers' personal readiness.

It has an impact on deployment schedule of already committed orders, and actually, we are unable to convert some of the backlog to deployments and recognize the revenue. So, today if you look at the situation, we do see two different customers' behavior. The first one is related to the slow pipeline conversion.

And the second one is the backlog conversion issues and both of them are related to the budget cuts and macroeconomic slowdown and still we’re able to increase our backlog in Q2, as you mentioned then in Q3, and in Q3 actually – so in Q2, it was increased by approximately $20 million of RPO.

When we look at Q3, we do have the backlog and that's the reason we believe that it can be similar to Q2. However, we do see the issues that are related to the backlog conversion and customers readiness, some of them are not ready with the hardware that they need, some of them are no ready with the resources, some of them deferring some payments.

So, that's the reason we believe it can also be lower than Q2. In terms of Q4, we had some orders deployments that were shifted from Q2 to Q3 and the backlog entry point in Q4 seems to be stronger than previous quarters, and that's the reason we believe Q4 will be better than Q3.

Does this answer your question, Mike?.

Yes, yes. That is helpful. And I know that we've spoken to the pipeline conversion before. That also came up on the last quarter as well.

Can you just remind us what Cognyte is doing to help customers or I guess help convert that pipeline and drive that increased visibility? I know that you guys have a new Chief Revenue Officer and you're working on higher priority areas, but what is it specifically that you guys are doing to help increase visibility and convert that pipeline?.

Yes, sure. So, we are proactive in this respect. Late last year, we discussed the need to strengthen the management team and we hired a new COO. It was beginning this year. And I believe we have now the key leadership to execute the plan. And of course, make changes as necessary in response to changes in the market.

And we are also focusing on where the high potential is and this is related to first countries that have budgets. And second is the more pressing security used cases that customers are facing. So, it's actually [agreed] [ph] of budgets plus security pressing needs, and that's where we are focusing our sales force.

So, our sales force is focused now more efficiently in areas where we believe the pipeline can be converted faster and in countries that have the budget to support these orders..

If I could just build on that a little bit more and I don't mean to poke here, but if I'm just thinking about it like the – let's talk about those two initiatives that we had just spoken to, right, the idea that you're going to focus on countries with budget and focus on customers with more pressing used cases? Like in my head, shouldn't that be something that the sales force is already executing against? And so, the question becomes like how – is that something that you guys weren't doing previously or I'm just confused by how that's going to help you guys drive better execution? So, those two things I would think is what the sales organization is doing on a continual basis.

If you could just [help square] [ph] those two pieces. Yes, go ahead..

Yes, sure. So, let me give you an example of one of our customers and I believe it will give you some color. So, I'm with the company for more than 20 years now, and I know our key customers personally.

I was visiting one of them at the beginning of the year and we discussed the plan for this year, and actually, the customer indicated that the business is as usual. It's a country with no budget issues usually and also sticking to the schedule of deployment and I visited them again two months ago. And actually, the situation was totally different.

They updated us on budget cuts. They updated us that they had to defer some of the payments, and this will affect also deployments of existing orders. So, actually, you can see that only in a few months’ time the situation has changed. So, the macroeconomic slowdown is affecting some countries more than others.

Some security threats are more important today than others, so it's a dynamic situation that we have to adjust to and make sure that we focus the resources and efforts in the right places. And our objective is very clear. We want to return to growth on profitability.

And for that reason, we are focusing on both, converting pipeline in more efficient way.

Given the current situation, focusing on areas where we see the opportunities more mature and customers being able to fund, and the other area is to discuss with our customers and [firm up] [ph] the deployment schedule and their readiness, either it's readiness of [hardware resources] [ph] or payments in order for us to be able to convert the backlog in a more efficient way.

So, those are the two initiatives that we're focusing on and it's a dynamic situation. We have to monitor it and act accordingly, but we are proactive on this..

Understood. Thank you. I'll turn it over to my colleagues..

Thank you, Mike..

Thank you. One moment. Our next question comes from Peter Levine with Evercore ISI. Your line is open..

Great. Thanks for taking my questions. Maybe just a follow-up on the last one is, did you guys experience any higher level of [sales churn] [ph] within the sales force? And then second to that is, can you just maybe that sector sales funnel for us.

If it was – the sales force was not successful converting leads or adding leads at a similar level as planned, do you feel like you have enough reps in place or is it just folks just not [hitting quarters] [ph]?.

So, we do look at our sales force and the focus now, as I mentioned before, is to focus on areas where the higher potential is. And another example, I gave an example to Mike before, what we see in the market, another example is our initiative to expand our business in the U.S. This is an example of where we see more opportunities.

And with this [aspect] [ph], yes, we hired sales force – more sales force in the U.S. and we contracted with the channel. So, we are taking actions according to where the potential is. So, yes, we do take actions relevant to the current situation..

Have you experienced higher sales churn this year versus historically?.

Yes, we did..

Okay.

And then the final question here is, can you give specifics on, kind of your cost reduction plans? Like where those costs are coming from in sales and marketing R&D? And just kind of how you're thinking about balancing, I think, the near-term impact from those cuts towards the longer-term initiatives to, kind of reaccelerate the top line?.

Yes. So, [low-cost reduction] [ph] reduced OpEx already in Q2 and we started to take the OpEx below [70] [ph] in Q3 and below 65 in Q4. Cost reduction is more in R&D than SG&A, and we designed the cost reduction in a way, but first, it's not going to impact customer commitments.

And second, that it will not impact our ability to return to growth and profitability, and that's how we look at the cost reduction. And if I'll give you an example from R&D, we actually are reducing investments in technology foundation improvements that can wait for later stage. So, that's how we look at the cost reduction initiative..

Great. Thank you for taking my questions..

Thank you..

Thank you. One moment. Our next question comes from Brian Ruttenbur with Imperial Capital. Your line is open..

Yes. Thank you very much. A couple of follow-up questions to the previous. In terms of cash burn, the next couple of quarters, what are you looking at? I believe that you burned a couple of million this period, as well as the previous.

Can you give us any kind of indication where cash burn will be in third quarter and fourth quarter and what your plans are to maybe increase credit facilities or what your cash flow balance sheet look like?.

Yes. So, I will take it David. So, we used cash in our operation in Q2. And during Q2, we had a one-time settlement payment of $6.2 million, which we don't expect that it will continue later on. When you look at cash, there is two major aspects of cash from an operational perspective.

Obviously, there is a side of the expense and as we discussed like we are reducing our cost structure and we are aiming to be under $70 million in Q3, and under $65 million at Q4. As for collection, we have like two major pillars that drive our collection.

With our account receivables, which are sitting in our balance sheet and we actively collecting this [receivable] [ph], but on top of that, we have our backlog, which is off the balance sheet and it's very significant backlog as, you know. and we are taking action to convert this backlog faster, which would be another source for cash for us.

So, if you think like in a nutshell about the cash, we are aiming to return back to positive cash flow and we're doing it by two things like aligning our cost structure and accelerating our backlog conversion. And we have a track record of generating cash..

Okay.

Just as a follow-up to that, so you're talking about 70 million of operating expenses in the third quarter and 65 million in – of operating expenses in the fourth quarter, is that correct?.

Yes, non-GAAP operating expense in Q3 and Q4..

Okay. Thank you. That's very helpful. A couple other follow-up questions. Can you talk about headcount, you talked about 5% cut and I know everybody's been asking about this, and cut some R&D in a variety of other things.

Can you talk about what percent cut you're talking about in this next series of cuts?.

Yes. So, actually, when we look at the cost reduction, we’re managing carefully all [indiscernible] for operating expenses reduction, it's not just resources. And this environment, it's clear to us that the company needs to be very lean and to focus on the higher potential opportunities we have.

And we are learning the organization and resources accordingly. .

Okay.

Do you have a specific percentage like you gave last quarter?.

We share with you like the OpEx. I think that the key is – in the end is like, what would be the OpEx that we will end the year. So, we are driving the OpEx down quarter-over-quarter in Q3 again. Okay..

No, no, that's helpful. The last question I have is understanding governments pulling back and its primarily international governments, not the U.S., so you're getting growth out of the U.S., can you talk a little bit about what percentage of your total revenue right now is U.S.

facing?.

Yes. So, we have less than 10% of our revenues coming from the U.S. and obviously, we see higher opportunity in the U.S. and that's the reason we decided to expand our operations there. And I am very happy that we were able to win the Baltimore Police Force deal recently..

Okay. And then where is the biggest – so that's where the biggest growth opportunity is for you guys.

Where is it – EMEA, where is it that you're seeing the biggest cuts happening or pullback?.

Actually, when we look at the market, we don't see a really regional trend these days related to macroeconomic slowdown. What we see is that it is country by country and some countries are more affected than others. In some countries, there is no – almost no impact, in others there is a major impact.

So, we don't look at it in a regional way because we don't see regional trend. We go one-by-one..

Okay. So, there's no region that you can point to that says, hey, there's more cutbacks happening in this region in Europe, Western Europe or anything else, but it's a country by country situation.

Is that correct to summarize?.

Correct. It's a country by country, and as I mentioned before, we use the grid of – what countries are less suffering budget cuts and what are the pressing security used cases that they have. And this combination focuses on the – where to put our resources and the highest potential opportunities that we want to look after..

Okay. And then last question. In the U.S., I know that the federal government has been hesitant to buy from Israeli-based firms in the past at least by heavily.

Is that changed at all? Are you getting traction at the federal level? It seems like you're getting traction at state and local level, but can you address that on what the federal government is looking for?.

Yes. So, when we look at the U.S., we are doing business in the U.S. for quite a while. It's not recent. We are just now expanding and we want to go for federal and state and local. That's our plan.

For now, we are focusing more state and local and we'll see along the way whether there is a desire to – of ours and appetite to invest more if we see, of course, customers coming to us. And I do believe that given the differentiated technologies that we have and we have a differentiated technology.

And given that we are successful in many areas around the world, we are operating in more than 100 countries. Some customers as very advanced customers. I do believe that we'll be able to expand also in the U.S. in different government agencies..

Great. Thank you very much..

Thank you..

Thank you. And we have a follow-up from Mike Cikos with Needham & Company. Your line is open..

Hey, guys. Just a couple more questions if I could. First, I know that we spoke about the revenue for Q2 and then this outlook for the rest of the year.

Can you help us understand what happened with the decline that we saw in professional services revenue this quarter? Just because I think that's understanding what happened in Q2 and potentially your outlook for professional services in 3Q and 4Q is obviously going to impact our assumptions around how gross margin tracks just because so much of the gross margin improvement from Q1 to Q2 came from the mix shift with professional services falling off in Q2? So, can you help us think about that?.

I would [take to] [ph] answer all the questions, but there was a few questions on the same one. So, let's start first from the composition of our revenue.

So, as you know like we are working under our software model, which means that we are driving more software revenue and want to reduce the level of professional services and other revenue, which means that from a mix perspective, we want to have less revenue of professional services and much more revenue of software revenue.

Any incremental software revenue will deliver that we're going to deliver and we – even like when converting our backlog, we drive much higher gross margin. And you can see actually between Q1 and Q2 that the main reason for the improvement in the sequential – in the gross margin was because of this incremental software revenue.

So, when you look at the professional services, in Q2, we had relatively very low revenue on professional services and this is because – part of it is because of like the deployment of the backlog.

And we are working now in our point that we are not as efficient as we want to be with the professional services, giving the delays in deployment of the backlog.

So, the more we will be able to frame up the backlog and we'll be able to plan better, we will be able to achieve much more efficiency across the renovation and also it will allow us to improve our gross margin to the right levels. I hope it addressed your question..

Yes. So, the professional services revenue are around like $8 million or $9 million here.

Like, I know that you guys have been talking about this transition to the software model, like should we expect professional services to hangout around $8 million to $9 million now or will that move higher as revenues come back?.

So, there is a proportion between the overall mix of the revenue. The revenue of the Professional Services should be taking consideration with the overall revenue.

So, you need to look at the mix what would be the percentage of the total professional services out of the total revenue? In the end of last year, we were like very close to 88% of the total revenue software and around 12% of the revenue on professional services.

So, we don't see any reason to not to believe that the improvement in the overall mix that we will see less professional services over time will not continue. Actually, when I'm looking at my H1 performance, we think that our booking performance in the backlog by the end of the H1 is supporting our software model..

Understood. Thank you for that. And I know coming back to the OpEx and the color you provided there, if I go back to Q1 and the transcript, you guys had said that you expected to get to around 70 million in Q3, if I'm looking at how you guys executed in Q2, you're just about there.

You were at $70.4 million, right? So, just help me think what went right when thinking about the OpEx cuts in Q2? It just seems like you guys are realizing these cost savings in a [indiscernible] than what we had previously expected..

Yes. When we spoke like by the end of the Q1 earnings call, we were like targeting to be about 70 million in Q3. And we also mentioned that we already executed part of the plan of the savings. So, we look at our OpEx and we analyze and when we keep to like a savings plan.

And yes, we are already like there in Q2 and we are pleased with that because we want to be like to cut costs and be as little as possible and be efficient while we're allowing the company to continue to grow and to be successful. We are aiming to be under 70 during Q3 and under 65 in Q4. It's a process.

It's like, it’s something that we plan and we have like the action are already like as part of the [market] [ph] and we're doing the right things like to get there..

Thank you for that. And then just a final question, if I could, I know that [indiscernible] or a letter from Neuberger Berman, a couple of months ago. Can you just provide us an update or what Cognyte’s response was to that letter that had been sent over by Neuberger? Just curious if we can get an update on that front as well..

Yes. So, we got the letter, of course, the Board got it. And the body is discussing what will be the right response, and it's between the board and Neuberger..

Got it. Thank you very much..

Thank you, Mike..

Thank you. And there are no other questions in the queue. I'd like to turn the call back to Dean Ridlon for any closing remarks..

Thank you, Katherine, and thank you everyone for joining us on today's call. 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 all..

This concludes today's conference call. Thank you for participating. You may now disconnect..