Cognyte Software Ltd. (CGNT) Q2 2024 Earnings Call

Cognyte Software Ltd. (NASDAQ:CGNT) Q2 2024 Earnings Conference Call September 12, 2023 8:30 AM ET

Company Participants

Dean Ridlon - Head of Investor Relations

Elad Sharon - Chief Executive Officer

David Abadi - Chief Financial Officer

Conference Call Participants

Mike Cikos - Needham

Operator

Good day and thank you for standing-by. Welcome to the Cognyte Q2 FYE ‘24 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference 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.

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'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 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, 2023, 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 would like to turn the call over to Elad.

Elad Sharon

Thank you, Dean. Welcome, everyone to our second quarter conference call. I'm pleased to report that our positive momentum continues. During the quarter we continue to win deals with existing customers, as well as with new strategic customers, recognize the strengths of our innovative technology and the value it delivers. Our team executed very well and we had another quarter of solid results.

Revenue grew both year-over-year and sequentially on an SIS adjusted non-GAAP basis and came in ahead of our expectations at $77 million. We also saw further improvements in gross margin, which was up 450 basis points over Q2 last year. And gross profit increased 13% year-over-year on an SIS adjusted non-GAAP basis.

Adjusted EBITDA was positive for the quarter, two quarters earlier than projected and free cash flow was positive again this quarter due to the positive EBITDA and continuing strong collections. As a reminder, we took many actions last year to address the challenges we faced and put the business back on track. We focused the business on fewer agendas, divested SIS, adjusted the cost structure, improved our capital structure, and focused our investment on high potential opportunities in R&D and sales, including investing in AI. We are realizing the benefits of our actions and improved execution. We regained visibility, resumed guidance, and have raised our outlook for the year three quarters in a row. We believe the positive momentum will continue and we are on a path of sustainable growth.

Now, I will start with a review of our significant wins, then I'll share with you a few use cases that illustrate how our use of AI and other innovations differentiates our solutions and delivers a significant value to our customers. And lastly, I'll discuss our updated outlook for the year.

I will now review some of our recent significant wins that highlight our market-leading differentiated technology. Our investigative analytics solutions help national security, law enforcement, national intelligence, and other security organizations to accelerate and perform more effective investigations. The first win is for more than $20 million with a new national security customer for its mission to combat terrorism and national threats.

We believe we are selected because of our cutting edge technology, including how we leverage artificial intelligence, which delivers the impactful results. We consistently outperform solutions from other vendors during a variety of real-world operational scenarios. In addition, we believe the customer valued our deep domain expertise and views us as a strategic partner to help them address their long-term evolving needs.

The second win is for approximately $4 million from a new unit inside an existing national intelligence customer to combat terror activities. We replaced an incumbent vendor and believe we are selected because of our higher investigation value. The customer was seeking a state-of-the-art solution to address the evolving needs by enabling a broader group of users with varying skill sets and expertise to maximize the intelligence value delivered.

The third win is with a new national intelligence customer for approximately $2.5 million to identify and prevent threats during operations. The customer chose us after a competitive process due to our superior technology. We delivered better operational results during comprehensive field trial in different operational scenarios. Also, we recently had another new customer win in the U.S., we replaced an incumbent vendor for an competitive bid, and we continue our focus on expanding in the U.S. market over time.

Our cutting-edge solutions and deep domain expertise drive our leadership position and help us to continue to win significant deals from both existing and new customers. Customers view us as a strategic trusted partner that provides innovative solutions that help them generate timely critical insights from their data, accelerate investigations, and improve the speed and accuracy of their decision-making. In our last call, I talked about the reuse of artificial intelligence in our solutions.

Now I'll drill down a bit more on our innovative technology and examples of a few customer use cases. Cognyte’s focus is on investigative analytics to help our customers improve the speed and success rate of their investigations by effectively analyzing enormous amounts of structured and unstructured data and generating timely impactful insights. We have been doing this for many years and developed unique domain expertise and a vast technology in investigative analytics. We believe that recent investments in AI technology is accelerating our innovations and positions us as a highly differentiated leader in the investigating analytics market. We have embedded AI models in our solutions to improve velocity and accuracy of customers' insights from data.

For example, the introduction of cutting-edge AI technology for pattern recognition enables our customers to reveal previously undiscoverable connections among entities under investigation, such as bad actors and financial transactions. This technological advancement improves investigation success rates and accelerates down to resolution. Customers are reacting positively to these recent advancements.

To help illustrate customers' benefits for our solutions, let's look at two security use cases. The first use case is for combating drug trafficking. Law enforcement units better responsibility of detecting and preventing drug trafficking activities along major international borders. This illicit trade often involves organized groups that exploit well-established routes, conceal their identities, and attempt to master illegal activities as legitimate ones.

Within our solutions, AI models play a pivotal role in expediting the analysis of our customers' data sources. Our software helps customers identify suspicious activities, such as unusual behavior, and automatically trigger alerts for users by using AI pattern recognition. In addition, our use of AI enables our solutions to more quickly predict potential hotspot and routes for drug smuggling activities. Those valuable insights help investigation units in closing cases faster and more effectively.

The second use case is related to detection and prevention of terror activities. Financial intelligence units are tasked with detecting and disrupting the flow of funds to terror organizations. Terror funding involves illicit financial transactions, money laundering, and other covert activities that facilitate terrorist activities. The challenge lies in the fact that these transactions are often masked as donations, charity, and fraudulent purchasing of goods. Our solution utilizes the algorithm to analyze vast amounts of financial transaction data from various customer data sources, including bank records, money transfer services, and cryptocurrency exchanges.

The system utilizes their part of recognition algorithms to continuously monitor these data streams to identify patterns and anomalies in financial transactions that may indicate potential terror-funding activities. We continue to leverage the latest AI development for commercially available models and our own AI research lab. Looking ahead, we believe our ability to embed the latest AI innovations quickly, together with our domain expertise in investigating analytics, will further enhance our differentiation and the value we provide to our customers. We continue to invest in AI to generate demand and contribute to driving long-term growth.

Turning to our outlook for this fiscal year, given the important visibility and our performance during Q2, we are raising our revenue guidance for the year to $307 million, plus or minus 2%, representing 8.5% year-over-year growth at the midpoint on an SIS adjusted non-GAAP basis. With revenue expected to grow by 8.5%, we now expect gross profit to grow faster at more than 15% year-over-year on an SIS adjusted non-GAAP basis.

Given our positive adjusted EBITDA in Q2 and our improved revenue outlook and profitability, we are now expecting positive adjusted EBITDA for the year. Looking beyond this year, given the recent innovations in AI, we have identified potential opportunities to expand our business with both existing and new customers. We believe that the combination of positive industry trends, our innovative technology, and our large global customer base positions us well for growth.

Before I summarize, I would like to recognize the significant contributions Dan Bodner had made to Cognyte over the last three decades in his roles as Verint CEO and after the spin-off as Cognyte’s Chairman of our Board. Dan had a tremendous impact on the creation and growth of our business over the years, and his wisdom and knowledge were a great asset to Cognyte. I personally I’m appreciative for all his support and advice. We then stepping down as a Director, I'm looking forward to collaborating with Earl Shank in his new role as our Chairman, and with the rest of the board to continue to drive growth and profitability at Cognyte.

To summarize, our customers continue to face significant challenges across many use cases and looked to us to help them accelerate investigations and mitigate the right variety of threats. We have established a long-term relationships with many of our customers and they view us as domain experts and trusted partners. These relationships will continue to be a significant asset for us. We are pleased with our second quarter results and positive momentum and are raising guidance for the current year. Long-term, we expect continued growth and improved stability.

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

David Abadi

Thank you, Elad, and hello everyone. Our discussion today will include non-GAAP financial measures, reconciliation between our GAAP and non-GAAP financial measures is available as Dean mentioned in our earnings release and in the investor section of our website. Our website also includes a financial dashboard with a tab that details our historical results excluding the divested situation intelligence solutions.

We are very pleased with our improved performance over the last few quarters. In Q2, revenue, gross margin, adjusted EBITDA, and cashflow from operation came in ahead of our expectation. We continue to win deals from both existing and new customers, reflecting the demand for our cutting-edge investigative analytics solutions.

Q2 revenue grew both sequentially and year-over-year, coming in at $77 million, up $3.7 million from Q1 and $4.2 million from Q2 last year. About 87% of our revenue was software. Gross profit grew faster than revenue and was up 6.2% sequentially and 13.1% year-over-year. Q2 gross margin was 69.2%, up 450 basis points from Q2 last year, primarily due to the increase in software revenue. We are pleased with our software gross margin of 77.4% and our professional services gross margin of 16.1%.

Our gross margin inflates our competitive differentiation and ability to continuously create value for our customer. All the metrics I just discussed are on SIS adjusted non-GAAP basis. Our Q2 non-GAAP operating expense were $54.3 million, similar to Q1 level. Over the last few quarters, we focused the organization and improve our cost structure, resulting in sequential revenue growth, higher gross margin, and return to positive adjusted EBITDA and significantly reduced operating loss.

Our Q2 non-GAAP operating loss was $0.9 million and adjusted EBITDA was positive $2.3 million. We generated break-even adjusted EBITDA for the first-half of the year ahead of our expectations.

Turning to cash. During Q2, we delivered positive cash flow from operation of $6.3 million. For the first-half of the year, we had positive cash flow from operation of $25.2 million. The positive cash flow from operation was driven by our improved financial results and strong cash collection. In terms of balance sheet, we entered the quarter with cash of about $77 million and no debt.

Our long and short-term RPO continued to be strong. Total RPO at the end of Q2 was $581 million, and short-term RPO was $282 million, approximately the same level as Q1. This healthy backlog coupled with our continuous solid results allows to increase our outlook for the current year for the third consecutive quarter. For fiscal 2024, we are now raising our revenue outlook to $307 million plus or minus 2%, reflecting approximately 8.5% year-over-year growth on an SIS-adjusted non-GAAP basis at the midpoint of the range.

Now, let me share with you more color on how we see the remainder of the year evolving. For revenue, we expect Q3 to be at a similar level to Q2. We're increasing our full-year non-GAAP growth margin expectation to 68%, an improvement of 150-basis points versus our previous outlook and year-over-year improvement of 520 basis points on an SIS adjusted non-GAAP basis. Gross margin may fluctuate between quarters based on the revenue mix.

For our non-GAAP operating expense, we expect total expenses of approximately $220 million for the full-year. Our improved cost structure combined with revenue growth will allow us to improve operating margins over time. Given our strong performance in Q2 and our expectations for the second-half of the year, we now expect to have a positive adjusted EBITDA of about $2 million for the full-year at the midpoint of the revenue range. We continue to work on optimizing our cash tax payment.

As a result of this work, we are expecting to record a non-GAAP tax provision of about $9 million for the year versus our initial estimation of $12 million. In terms of EPS, we are now expecting a $0.33 annual non-GAAP EPS loss at the midpoint of the revenue range, an improvement of $0.20 versus our previous outlook.

Our non-GAAP EPS for the second-half of the year is expected to be about zero, due to fluctuation in our non-GAAP tax expenses, we currently expect Q3 non-GAAP EPS to be slightly positive and offset by similar negative non-GAAP EPS in Q4.

To summarize, we are very pleased with our improved performance over the last few quarters. We continue to leverage our financial results and drive revenue growth and margin expansion. Our healthy backlog coupled with our continuing solid results allow us to increase our outlook for the current year for the third consecutive quarter.

We are a market leader in investigative analytics and have a strong and legacy track records with customers around the world. We continue to add capabilities and improve the performance of our solutions by leveraging the latest technologies, including emerging innovation in artificial intelligence. We believe these technological innovations increase the operational value our customers generate from our solutions and help drive demand.

Looking beyond FY ‘24, we believe our financial result will continue to benefit from the recent positive momentum. The combination of our cutting-edge technology, large and loyal customer base, and the opportunity to address the needs of existing a new customer position us well for growth.

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

Question-and-Answer Session

Operator

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

Mike Cikos

Hey, thanks for getting me on the Q&A. Mike Cikos here from Needham. And I have two questions here. The first two, Elad, so Elad, congratulations on that new customer went for over $20 million. I wanted to ask, can you give us additional insight, I know that you have discussed use cases for AI, like drug trafficking as an example, but for this customer specifically, that $20 million new customer, some of the use cases or some of the AI capabilities that Cognyte has which allowed you to win that new customer? And also any comments you have as far as how competitive this competition was versus maybe other solutions out there on the market. That would be very helpful.

Elad Sharon

Yes, sure. Thanks, Mike. So our customer's mission is mainly to increase the speed, accuracy and the success rate of the investigations and time is of essence here. And actually, it was a competitive bid with a few bidders. The need was actually to be able to uncover hidden insights relations between entities and patterns and anomalies in behavior out of this data.

Over the competitive process, we're able to demonstrate over POC, our capabilities, the competitors did the same. And actually, over time, both of them were disqualified and we were the last one to meet the technical needs. So the win was a competitive win, a new customer, a National Security One. His main challenge was -- is related to investigate terror activities and predict terror risks. The data is a large amount of data that he has to deal with. And the idea is to be able to accelerate investigation in a way that they'll be able to find and -- actually hidden relations and hidden behaviors that cannot be done with legacy technology.

So AI, in this case, was playing a major role. In addition to being able to deal with a large amount of data and diversify data and also being able to do this in a very efficient manner in terms of user flows. So this is a very important win for us, and we are pleased to have another new customer, a large one. And also the others are wins from -- one of them is from another new customer, the other one is new department of existing customers. So it's very good to see that the customers appreciate our technology differentiation and advanced technology.

Mike Cikos

That's great. Thank you, Elad and congratulations again on that large customer win. If I just turn to the financials for a second and probably a follow-up here for David. But one of the things that kind of struck me when we were going through this is the spike in professional services revenue? And I just wanted to get a better sense, when we see pro serve revenues jump like this. Is it fair to think that, that is a reflection of the new customer wins that Cognyte is talking to here? Or is there something at play where you might have an incremental professional service benefit tied to servicing, let's say, existing customers. Can you help us think about that as well as potentially what benefited that professional services revenue during the second quarter here?

David Abadi

Yes. So in Q2, actually, we had slightly more revenue that's coming from professional services, and they came also with the 60% of gross margin. But again, like the majority of the revenue 87% of the revenue came from software. When we -- looking from a trend perspective, you can have at a given quarter a little bit more professional services. But if you look at the H numbers, you will see that almost 88% or 89% of the total revenue came from software. So I don't think that it's a peak or it’s just a fluctuation that may take place between quarter-over-quarter.

As for the wins, the wins took place this quarter, but obviously, the revenue will be recognized over a future period. Usually, this type of deals that are large deals can recognize over multiple quarters. So it didn't impact the Q2 revenue.

Mike Cikos

Got it. Thank you. And one quick follow-up as well. I know that you guys are taking up the gross margins for the full-year as well. That improvement that we're seeing, it seems to be a reflection of the growing software revenue mix. Is there anything else that you guys are doing internally to help that software gross margin? And I'm wondering if it's just a matter of tighter procurement from your vendors or engineering on your side to figure out a better way to drive efficiencies in your own cost in delivering these solutions to your customers? Anything there on the software gross margins and what you guys are doing to drive that improvement would be beneficial as well? And then I'll turn it over to my colleagues. Thank you, guys.

David Abadi

So we are very pleased with the gross margin in H1 and Q2. And actually, we are very pleased that we are able to increase our gross margin to 68% for the full-year, and it represents 520 basis points more than our initial plan. Looking at the trends and what drives the gross margin, I think the gross margin is the clear evidence of our differentiated solution and how the customer appreciate the value we provided. Elad mentioned the deals that we’ve been, but those that are not in the revenue, but they’re consist with what we see in the market and how the backlog looks. We're seeing good backlog with the high quality that will allow us to drive a gross margin. So from that perspective, this will be also an impact in the future.

When we're looking what changed, you could see that one of the things that changed this quarter is the professional services and it's basically as a result of actions that we took to improve our professional services cost structure to allow us to be in a better position. Overall, when we look at the gross margin, we're monitoring carefully if it's like from a cost perspective, but I think that the major thing that impacts gross margin is the ability to sell our solution as a premium solution, the customer demonstration of our appreciation for this value that allow us to sell it in the right pricing.

Mike Cikos

Thank you very much.

Operator

[Operator Instructions] And I'm not showing any further questions at this time. I'd like to turn the call back over to Dean.

Dean Ridlon

Thank you, operator, and thank you, everyone, for joining us on today's call. Elad, David and I are planning to visit Boston and New York early next month and hope we can see some of you then. In the meantime, should you have any questions, please feel to reach out to me, and we look forward to speaking with you again next quarter.

Operator

Thank you. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.