Hey, thank you to everyone for joining us today. I'm Mike Cikos, w ith me, I'm pleased to announce that we have the management team from Cognyte, the CEO, Elad, and the CFO, David. And just for some quick logistics before we jump right into it with the fireside, but I do appreciate if we can make this as interactive as possible. You guys should have a chat function of some sort on your interface, so feel free to lob in questions as we go. If you'd rather, you can just ping me email as well at mcikos@needhamco.com, and I'll do my best to make sure we get to while we have the management team. With that out of the way, Elad and David, thank you very much for making time today. We definitely appreciate it.
Thank you.
Thank you, Mike. Hello, everyone.
And I know you guys have been around for a couple of years now, but maybe for some of the people who are newer to the name, if we could just start with a basic intro as far as who is Cognyte, what value are they providing to customers today, and the overall market opportunity that Cognyte is addressing?
Yeah, sure, Mike. So, with your permission, just, two words about Israel. I want to start to thank all employees, customer, partners, investors, and our friends around the globe for standing with Israel and for the inspiring show of solidarity of everyone, o f course, our hearts goes out to those affected in the recent horrible attacks in Israel, and your support is highly appreciated. So thanks all of you, all of you for that. So about Cognyte, let's start maybe with our customer mission. Our customer's mission is to increase the speed, accuracy, and success rate of investigations, in order for them to be able to identify and prevent risks, and primarily related to terror and crime.
We are a global leader in investigative analytics, and we have strong customer base of about 400 customers in more than 100 countries, and we are in the market almost three decades. Our customers are primarily security agencies like national security, national intelligence, and law enforcement agencies, and their challenges are growing. The bad guys are becoming more sophisticated, hiding better over time, using advanced technology themselves. And our customers have to deal with this complexity together with increased data volumes and diversity. And for them to be able to address this challenge, they need technology, advanced technology with strong analytics and AI in order to uncover hidden insights and identify and prevent risks potentially before they unfold.
So we help make the world safer by empowering our customers with our investigative analytics technology. Actually, in a nutshell, it's fusing and analyzing data at scale and diversity in order to uncover more and more insights to identify threats and help our customers to come with quick decision-making in order to prevent those threats. Given that our customers' challenges are dynamic and growing, we expect the demand also for advanced technology to continue and grow. We primarily address the government security segment, but we're also looking at longer term for other opportunities to leverage the technology beyond the security. So I think this is in a nutshell.
Great. Thank you for that. I know it's just been top of mind all year, but on GenAI, right? One of the things that I think a couple of people are trying to frame out, and I'd appreciate your input on this too, but there's the thought that GenAI, in some way, changes the market opportunity for Cognyte, right? Would be interested to get your sense, how does that market opportunity change with GenAI? The second piece would be, does it in any way improve funding or budget for your customers, just given you do have that larger public sector exposure?
Yeah. So AI in general, and GenAI in particular, do have an effect on the market. Again, in order for our customers to increase the speed, accuracy, and success rate investigations, they need to quickly generate more and more insights of their existing data set. Recent AI developments and GenAI in particular, and as an example, the LLM such as the GPT, have created new expectations from our customers. Actually, it can come up with the human-machine interactions, for example. So it's important when users want to perform complex inquiries across multiple large and diversified datasets. Actually, today, in order to ask a simple question, but you need to consolidate different data sources that are structured and unstructured. It's very difficult to do that. It's very complex.
You have to go through very sophisticated queries, and here the GenAI come into play. Just as an example to make it clear, so as an investigator, if you want to ask a seemingly simple question like: Did the number of members in a particular organized criminal group increase, yes or no? So this is a very simple question, but in order to answer it, you have to go through different data sources and different indicators, such as you know some gangs have different tattoos, criminal records, social activity behavior, communication profile, relationship.
So you can imagine that it goes through many data sources, and in order to get this very simple answer for this very simple question, if you do it manually, it takes ages. If you do it with GenAI, it's very easy and quick to get to ask the question and to get the insights. So it's very important. And when it comes to security, time is of essence, and accuracy and the speed is very important.
Got it. Got it. I also just wanted to take a step back and go to the most recent quarter as well. Yeah, just to highlight two pieces. But the first, I know that the company's obviously divested the SIS and implemented also more of a cost discipline management across the organization, right? And I'd really like to highlight those two pieces specifically. So I know it's a little bit more backwards-looking, but can you just remind folks as far as what was the benefit from divesting SIS? And then the second piece, which is probably more relevant for today and where the organization is headed, but how sustainable are these cost discipline activities that management is putting in place, as well as the roadmap for even potentially improving profitability from today's current trajectory?
Yeah, sure. So, our philosophy remains the same, profitable growth, a nd we have a long history of profitable growth, for many years. Again, we are in this market for almost three decades. And we set our cost structure to support current needs, but also future potential. So we look at what we need now and what is required in order, for example, to generate more innovation, to increase differentiation, to maintain leadership in the market, and that's how we think about the cost structure. Given our strong RPO and our customer base, and level of visibility, we continue to believe that profitable growth opportunities help us.
And as we discussed, we also see that the gross margin is improving, and we ended Q2 at 69% of gross margin, which is good indication that our differentiated technology is appreciated by customers. And, yes, as you mentioned, we in Q2 generated positive EBITDA, and we also expect positive EBITDA for the year. As of the SIS divestiture, the decision was not related to cost structure, it was related more to strategic decision, to focus the business on opportunities that would deliver better returns. We didn't find the SIS standing in this position, and for that reason, we decided to divest it and focus our efforts and energy on areas that are more related to investigative analytics for the government agencies.
And with the current momentum and growth opportunity, we believe that we can further leverage on our financial model, and while growing top line, also have margin expansion that continues.
Got it. And I don't wanna put words in your mouth, so correct me if I'm wrong. I don't wanna mischaracterize this. But when I think about that divestiture of SIS, the way I interpreted it is that, like, it allows Cognyte to become more focused from where you wanna place your bets, how to manage and allocate resources and budget, right? Is that, would you say that's a fair characterization of what went through that, that strategic rationale to divest SIS?
Yeah, SIS was actually more in the physical security domain. Actually, analytics that is related to physical security, we found this market less exciting for us. And we decided that if we have to choose whether to put more investments in SIS or to put more investments in other areas, the better return would be to put efforts and investments in other areas. And with this decision, we decided that we cannot stand behind the SIS growth and profitability over time, as we don't want to invest in it. And it was a strategic decision to focus on where the higher opportunities are, and that's the reason for the divestiture.
Got it. Got it. Okay, thank you. Thank you for highlighting that. On the question of guidance as well-
Mm-hmm.
So the most, w ell, I guess this is, again, coming back to the quarterly results before we get to guidance, but for the most recent quarter, Cognyte actually delivered a pretty significant level of upside for professional services revenue. And I just wanted to tease out again for some of the investors who might be newer to the name or who had questions around the upside that came from ProServ. What was it that drove the stronger-than-expected professional services revenue in the most recent quarter?
Yeah. So first of all, it's important to understand that our focus remains on software revenue growth, because that is that reflects our differentiation and the value of solutions generated for our customers, and it's also reflected in our increasing gross margin. So that's our focus, a s for professional services, this fluctuate quarter to quarter, depends on the mix of deliveries. So, this comes together with the software, the site of the software, it can fluctuate, but the focus, our focus is not professional services, it's software. Overall, if you look at the overall results, we are very pleased with our software mix. And, if you look at H1, the first half of the year, our software portion was 89% of revenues, with gross margin of our software revenue of about 78%.
And this is the main focus, to continue with the very strong mix of software and leverage on gross margin.
Got it. And maybe for clarification here, the reason that I'm asking about the ProServ, not to beat a dead horse and understand the software SKU, but wanted to get a better sense, like, is that in any way a potential leading indicator for software revenue to follow? Or not necessarily the two., y eah, yes, there's some correlation between the two, but I can't just make that direct of a linkage between Pro Services was larger than expected in the most recent quarter, we should expect software revenues to come hereafter? Is that-
No, not, not necessarily. Not necessarily.
Okay.
Professional services is actually a result of customers who wants us to do the deployment services and the development services, and we are trying to maintain a mix of software revenue. Of course, for specific customers, we are willing to do also professional services. But it may fluctuate from quarter to quarter, and you cannot conclude that there is a trend of something like this. But the most important one is that we maintain high portion of software with high gross margin.
Got it. Got it. Again, this comes back to the question of profitability. So really appreciate the most recent quarter where you guys demonstrated the positive EBITDA, right? It's two quarters ahead of plan, y ou took up the full year guide, now expect to be EBITDA positive for the full year. One of the things that I get from folks is, hey, with that profitability, first, how sustainable is it? I think you touched on that a little bit earlier, but really where I'm going with this is, where are you looking to drive additional efficiencies? If we're thinking about, hey, this organization is dedicated to sustainable profitability and improving that, what levers can you pull on to help bolster that margin profile?
Yeah. So actually, we want to be where we were before, actually, and to continue with the profitable growth. That's the history of the company. So, the drivers for profitable profitability are the combination of top-line growth, obviously, together with effective cost structure. In the last few quarters, we defined and executed cost structure adjustments. We took cost structure down, we did the adjustments that were required to the current situation at that time. Taking into consideration, as I mentioned before, current need, but also future potential. And we continue, if you look at our investments in R&D, we continue to invest in R&D in order to maintain differentiation. It's important for us. So we see the opportunities to gain further leverage on our financial model.
We did have positive momentum, and we were able to increase top line and raise guidance over the last two quarters. And we are pleased with the progress. So it's a matter of top-line growth together with, of course, cost structure management that fits the profitability level, but also that is able to give us the investment level that we need in order to go for the long term.
Got it. Okay. Okay. If I shift gears to competition, again, I know that the team here has a lengthy track record of performing in this market, right? You said earlier you've been here for three decades. What I think would be great to hear is, like, even on the most recent quarter, the team cited an expansion deal, which actually won out over competing solutions and replaced incumbents. So the question there becomes: Who is it, Cognyte is competing against? And then, how have win rates tracked? Are you guys actually seeing improving win rates versus maybe some of those competitors? Or is it more of the same as far as how those win rates have tracked?
Yes. So our solutions address many use cases, and we operate globally, and for that reason, we have many competitors. Some competitors compete against us in certain territories, some competitors compete against us in certain use cases. So it's a wide variety of companies, and the market is fragmented. We typically see different vendors in different geographies, but not necessarily. So if you look at the competition landscape, you can see global competitors like L3Harris, Palantir, Rohde & Schwarz, and these kind of companies. If you look at the point solution competitors that are competing against us only on a few use cases, you may see JSI and SS8-like companies. And our main focus is not necessarily the competition, but replacing homegrown solutions customers have.
And if you remember from previous quarters, we said that many customers used to go to tailor-made solution, which means they either develop their own solutions or to go to a third party to develop their own solutions for themselves. The problem with this methodology is that if you do a one-time investment, first of all, you do not benefit from the experience of the entire market. Second, it's very difficult to upgrade. And third, you cannot keep pace with the technology changes and with, for example, incorporating new AI capabilities, because you have quite a rigid solution. So very important for us is also to replace homegrown solutions that were developed by customers over the years.
In the examples I gave last quarter in Q2, I gave one deal of over $20 million. It was indeed a competitive bid. This kind of large bids usually require a POC, proof of concept. You have to go to the site to install a small capacity solution, present it to the customer, and actually be much better than competition. I can tell you that we were the most expensive ones, but still, we're able to win because of the differentiated technology, including AI. As of the win rate, we do feel comfortable with the win rate. We see that the funnel is healthy, and that when we come to demos and POCs, we're able to beat the competition in many cases.
So overall, we see the market as we saw it two months ago, the market is countries are recovering from the previous economic challenges that they had before, and we are able to to collect more money in cash and also see more wins with new customers and also existing customers that come to us with repeat business, which can be either upsell of upgrades and and expansions or or new customers that come to us either replacing their homegrown solutions or competition. So overall, we feel very good about our leadership in the market, and and we have the confidence level of of our customers that come to us again and again. The repeat business is very strong, so this is a vote of confidence for our customers.
I think. So thank you for that. That was great. I think one of the things that people would like to hear as well, if you, to the extent you can elaborate on it, but when we think about customers potentially switching off, let's say that $20 million bid, that came from that customer, and even though you were more expensive, you won over competitors, right? So price aside for a second, if we just talk about the stickiness of the solution, I guess, how difficult is it for a customer to switch out from some other competing solution to a Cognyte? What are some of the steps and processes that need to take place on the customer's part to switch over to Cognyte?
Yeah. So, first of all, these kind of solutions are mission-critical for organization, and for that reason, customers need to take a decision to replace. It's not an easy decision, but it's a decision they have to take, if the value that is created by the existing solution doesn't address the challenges. And if a security agency cannot create value and uncover hidden insights out of the datasets using a specific solution, although it's not an easy task to switch, they'll do it. So when customer views us as a leader in the market, and you come with a strong proof of concept, and you show them that you are much better than competition, that you can generate insights that other competitors cannot do with the same datasets. Actually, everybody gets the same datasets.
So our customers are looking at the effective solution, and they choose a solution that is able to keep pace with the challenges they have, and also in the future, keep pace with evolving technology. It's important that they do both of them. So it's not an easy decision, but as you can see, they make those decision if they see that you can generate much more value for them. And fortunately, and with our R&D, strong R&D and analytics capabilities, when we come to our customers, first of all, we made it quite easy for them to integrate our solution into their environment, so it's easier for them to take the decision.
And also we give them upgrade path always an upgrade path for more and more analytics, more use cases, more AI, so they stay with us for many years. So it's not an easy decision, but given that we give much more value, they take the decision and move to us. And it was actually in Q2, the all three examples I gave were new customers. So customers are willing to take the decision if they find the value good enough for them to switch.
Got it. Okay. Okay. Yeah, I know that you started the top of the call, and we'll echo the same comments around the travesty that's taking place over in Israel, so appreciate you opening with that. I think one of the things that I'd be interested in hearing is obviously the team has executed in this difficult time at a high level. They've been able to maintain that, right? So can you maybe talk about the pillars of the company's continuity plan, how Cognyte has been able to ensure both the safety of its employees, while still maintaining this track record of execution here?
Sure. So, the company knows how to respond to different circumstances, including this one, and we make necessary adjustment to our operations and business continuity in order to stand behind our commitments to our customers. We have a detailed business continuity plan, always. We have to execute on it from time to time. I want to remind everybody that we are a global company, so we have employees in Israel, but not only in Israel. We have about 1,600 employees globally, about 50% are in Israel. So we are able to use global presence with our global employees when necessary. Obviously, the health of, and safety and wellbeing of our team is our top priority.
Our employees are our main asset, but also important for us as human being. So we are providing them with the flexibility these days to work remotely. Also, the business in Israel is running relatively smoothly also at this time. So overall, we were able to mitigate the disruption that we had due to the 7 October incident. We do it by people in Israel taking the extra mile and doing more, other global employees that take some load when necessary. And we had to make some small prioritizations with the focus to stand behind our customer commitments, and we're doing it, I think, successfully. So we see that the market momentum is good.
Nothing has changed in terms of our view in the market. Customers continue to work with us, as usual, and we are able to deliver upon our commitments. So overall, I think we were able to mitigate it quite successfully.
Great. That's great to hear. And maybe if I could shift gears for a second to some of the metrics that are out there. First one, a little bit more qualitative in scope, but if I think about pipeline building, how should investors consider the business's, I guess, continued execution in the current environment? Like, where would you point us to when thinking about pipeline or pipeline coverage that's embedded in the guidance? How would you flesh that out on pipeline specifically?
Actually, if you look at the demand, and that's the main question, I think,
Yeah
There is no change of how we saw the market two months ago. If you're referring to specifically the event in Israel or in general? Just for-
This is more on a general basis.
Okay.
This is independent of Israel now. Yes.
Yeah. So we see good momentum in the market, and actually, customers are facing growing needs. If you look at existing customers, they need to keep pace with growing data volumes, they need more functionality and analytics, and they go to upgrade path, and when they do that, the install base volume is growing, and the maintenance is growing. If you look at new customers, we've just discussed customers that need to modernize the solutions in order to address the more complex environment. Actually, the bad guys are more sophisticated, the data volumes are growing, and we discussed that it's becoming even more difficult to uncover hidden insights. And we continue to maintain a product differentiation, and we love this. So overall, we see very good traction from customers.
Actually, as we speak, our team are in Milipol. It's a security conference in Paris that is running. There is lots of traction from customers. The demand of our solution is healthy. We do see that the investigative analytics technology remains a key success factor for our customers. And also, we have to remember that recent AI developments that help create even more value for customers are also creating more appetite to upgrade and continue with the modernizing the solution and adding more functionality. So overall, I feel good about where we are today and also believe that there is a good opportunity ahead of us.
Got it. And I know you guys obviously have multiple lenses you look at the business internally, right? So pipeline is one of the things, obviously, but you also have book- to- build, backlog. I guess, is there a way that investors should think about how that book- to- build, l ike, what is a typical coverage rate, or what is it that management internally is looking to achieve with its book- to- build or backlog? Do you guys manage the business towards these metrics or not necessarily?
Actually, the management focus is to execute on backlog. That's the main focus. So if you look at the RPO, which is a proxy to backlog, you can see that our RPO is very healthy, both the total RPO as well as the short-term RPO, s hort-term RPO refers to 12-month RPO. So if you go back to Q2 call, we shared that the total RPO stands on about $580 million. The Short-term RPO is about $280 million, and it's a healthy RPO that gives us the confidence that we can deliver upon our commitments. It remains very strong. We are pleased with it.
And because the RPO is healthy and our confidence level is good, we're able to raise guidance three times in a row over the last two quarters. I believe it supports our current needs and also future growth with very good visibility.
Great. Great. A little bit more of a macro question here, but this really looks at budget, and it's a little bit different for you guys, again, just because you're nearly 100% government, so maybe some of those trends in enterprise IT aren't as relevant for you. I'd be interested in getting your sense, though, how would you characterize government customers' budget status as we approach the new year? Right, we just came out of the September quarter, which is the U.S. federal year, but at the same time, I think a lot of people are trying to get a better sense of how budgets are coming together when we think about the next twelve months.
So what we saw over the last few months, and also, I think it started late last year, is that more and more countries are recovering in terms of economic headwinds that they had. If you remember, they had to shift budgets, some countries went into recession, there were constant evaluations in certain territories and countries. We do see now that the momentum is positive. More countries are more confident about the budgets. They have better visibility. We do see that the traction with customers is very good. We do see that the sales activities are tense. So, and also, you could see that we're able to collect lots of cash in H1, which means that the customer resumed payment.
So overall, the sentiment of government is improving. It's not the same in each and every country, but overall, if you look at the government budgets and visibility into their budgets now and they see also for next year, I think, they're in a better place than it was last year. And it's evidenced again in the appetite, in the traction with our sales guys, and in their attendance in conferences, ours or general conferences related to security. And we can get many indications that they are in a better shape now.
That's great. And probably, I know we're bearing down on the end of this time slot, but last question on our side before we turn it back. But really, the question here is centered on the chairman. So earlier this year, obviously, Cognyte appointed Mr. Earl Shanks as chairman of the board. And one of the things that I'd appreciate your perspective on is if we could hear the rationale for Mr. Shanks' appointment, the expertise he brings to the company, why go with Earl for the chairman of the board?
Yeah, sure. So, Earl has been with us, as a director of Cognyte since the spin-off. Actually, he left Verint and joined us, and he's with us now. And we know each other, Earl and myself, for many years. Earl has a deep knowledge of Cognyte, already from the times of Verint. So he was involved in the business, he knows what we do, he has deep knowledge on us. In terms of general skills, he has a technology industry experience, including software and services. He had a significant public company board experience in value creation. He was sitting in boards many years, so he knows the role of a good board member. He has extensive investor relations experience.
He was, you know, a CFO of other companies, so he knows also the IR side of the business. He's also understands the strategy and execution and the combination between the two, how to look at the company in terms of execution, short-term execution and executing upon plans, but also thinking long-term about strategy, growth factors, and others. And he has a solid relationship with other board members and with management, and the relationship is very supportive, collaborative, and we work together in a very good way. So overall, I think in terms of skill set, understanding the market, knowing Cognyte, I think he's a very good choice as a chairman for our board.
That's awesome. That's great to hear. And I know with that, I'm not seeing any questions in the queue, and we're wrapped on our side, but thank you very much for the time today. I really do appreciate it.
Thank you.
Thank you so much.
Take care, guys.