Great. Thank you to everyone for joining us today. I'm Mike Cikos, the lead analyst covering infrastructure software over at Needham. With me, I'm pleased to say that we have the management team from Cognyte. So we have the CEO, Elad, as well as the CFO, David. Thank you, both of you, for joining us today. We really do appreciate it.
Thanks, Mike. Thank you.
I have a list of questions on my side, but to the audience who's tuned in, if you have inbounds that you specifically want to get answered while we have the management team here, please feel free to lob those in. Wanna make sure we're utilizing your time as best as we can. With the logistics out of the way, though, the first thing I wanted to talk about with you guys was really visibility. I think it's a top-of-mind question for a lot of investors as we turn the page to the new year. With you guys, you've spoken, I wanna say, for a couple of quarters now, at least about backlog and your ability to execute against that backlog, where investors, I guess, almost look at RPO as a proxy for that.
In recent quarters, RPO has consistently been around, let's say in the $500 million-$600 million range. I'm just trying to get a better sense, is there like a sweet spot that the company manages its RPO to, which is deemed healthy? Or what is your view of that backlog and that RPO in the context of, I guess, your visibility in the business?
Yes. So, thanks, Mike. As you said, RPO is a proxy to backlog, for backlog, and there are a few primary factors I would say that impact RPO at any given time. Those are the sales cycle, the deployment cycle, obviously, the length of contract, the renewal timing, and seasonality. So RPO may fluctuate from one period to the other. So there is no real sweet spot at a given time that we have to deal with a specific number. What you focus on is actually maintaining an RPO that supports future growth. And at the end of Q3, we reported a total RPO of $586 million.
Lastly, we also presented a new metric, which is the short-term RPO that by the end of Q3 was $291 million. We believe our current RPO range that you mentioned before is healthy and supports our future growth with good visibility. We can expect fluctuations, but the RPO is very healthy at this point in time.
Mm-hmm. I guess the other question as it relates to visibility, but you guys have this customer base. I wanna say it's approximately 400 different customers using Cognyte, and so there is a large installed base here. I'm interested in hearing, like, is there a typical upgrade cycle for existing customers?
Yeah. So maybe, a word about the basics. Customers, what they need from us is to help them accelerate, the speed, the accuracy, and the success rate of their investigations. Their mission is actually to, be successful with their objectives. They understand that advanced technology is essential to achieve their objectives. Legacy technology and manual analytics is no longer enough. And there are specific demand drivers, our customers are having. First of all, and we discussed it a lot before, that bad actors are more sophisticated, they're better hiding, they're also using advanced technologies, and it's very difficult to find them. The other one is related to the data.
It's growing in volume and diversity, and customers have to grow with their capability to address more and more data sources and different ones. So in order for them to do that, they need a technology with more analytics, including AI, to uncover more insights after their existing data sets. So when they upgrade, they'll upgrade based on their specific needs. So each customer has specific environment and specific needs. It may be related to additional capacity or new functionality, including analytics and AI. And also it could be new use cases. Customer may have other basic use cases that he started with, and now he wants to deal with cryptocurrency use cases, so it might happen as well. So it based on needs.
So customers may upgrade or expand frequently, which means within the first year or within the next two years after they put the order, and for others, it may take a bit longer. But it's important for me also to mention, Mike, that in addition to expanding in our customer base, we also focus on adding new customers. And when we add new customers, they sometimes start small and then grow over time. And this is also very important for us, that while we maintain leadership and grow with cross and upsell with existing customer base, that we add new logos into our customer base. So we work on growth with both existing and new customers, leveraging our advanced technology.
Thank you. Thank you for calling that out. I'm sorry, I'm gonna be toggling back and forth between the mute buttons just 'cause there's a ton of construction outside my office.
Yeah, that's-
Gotta love New York City. But, let me ask you, just because so much of your revenue is tied to the existing customer base, right? So is there a way to think about the average deal size or typical contract duration?
Yes. So deal size ranges between a few $100K to tens of million dollar. Actually, in the earnings call, I give examples for each quarter. You can see a few million dollar deals. You can see 15+ million dollar deals. So we have a range of quite wide range. In terms of the contract duration, we typically sell our software under perpetual license, and it is aligned with the government agencies' purchasing behavior. And these usually include maintenance, which has initial period of between one or three years, depends on the customer. And our repeat business is very strong. Some customers are expanding, upgrading, actually, during the initial contract period, to address the evolving needs if they face it.
I would say that average deal size would be within this range, a few millions of dollar. This is the average deal size, and the contract duration would be one to three years, something like this.
Thank you for that. And I also wanted to touch on gross margins for a second, but Cognyte has been demonstrating continued expansion of its software gross margins. And I wanted to get a sense, is there more to do there, and is there potential for more software gross margin expansion? And can you help us think about, is it coming from potentially better engineering the solutions, or is it really more dependent on what is shipping from your backlog?
Yes. So, I will take it. So, we are very pleased with the gross margin improvement over the last few quarters. In the first nine months of the year, we were, like, at 69%+ gross margin. And, yes, the majority of the backlog is impact from the backlog that we have, so orders that we already got, and we're seeing the continuous improvement there. But we can also improve our gross margin by due to scale, so additional revenue will impact the total margin. And overall, we believe that over time, gross margin can expand further.
And what about on the gross margin for professional services? And again, I'm sure that is influenced as well just by the utilization of the team. But is there anything you guys can do there to help expansion on that front?
Yes. Also here, we think that we can impact. Again, if you look at the last few quarters, we did some improvement in the professional services gross margin. The way that we are structured the team is we are looking at the future, and we believe, like, what would be the growth and the business growth, and based on that, we set the cost structure. And over time, we think that we can improve our gross margin of professional services further.
Okay. With respect to leverage in the model, I know that you guys have taken up your EBITDA guidance each quarter this year, so we're now looking for about $8 million in fiscal 2024. When thinking about the medium or long term, I mean, how do you guys view this business for EBITDA margins, and/or where are we expecting to get the most amount of leverage when thinking about the different OpEx line items?
Our philosophy is profitable growth. This is our philosophy over the years, and we have managed the business like that all over. We continue to manage the cost structure in the way that we think to address the current needs and the future growth potential, and based on that, we structure the organization. Over the last few quarters, we were able to have some leverage in our model, and we were driving better profitability. When you look to the future, we do think that there is an opportunity for further increase in the gross margin, and also some leverage in OpEx, mainly related to R&D. Due to the scale, we will see some leverage there.
And that's exactly one of the things I wanted to hit on, right? So I, I know that you guys. It's a bit striking compared to other companies in our space because R&D for you guys is about 30% of revenue, which is well above a number of other names that we follow. So is that really just a function of, are we going through a large innovation cycle right now, or again, how do we get the leverage out of that R&D line?
Yeah. So, actually, when we look at R&D, we look at where the market will be in the future. So, we are a premium vendor. We deliver high-end solutions. We sometimes much more expensive than competition. Actually, I gave a few examples this year, and one of them was a $20 million+ deal that we won this year, we were double the price of the second one, and the third competitor was disqualified because of technology gaps. So R&D is very important for us. We want to maintain market leadership, we want to be able to increase value to customers, we have to maintain differentiation, and we want to be able to continue and improve profitability, and for this, we need to be better than competition.
And of course, when the value is growing, customers will be willing to pay. I think that, being in this level of R&D, 30% is higher than the industry. We think that we will maintain a high level of R&D, but there is, of course, a potential of scaling up here.... Because we believe that, once we continue to improve the top line, the R&D level in terms of portion out of the OpEx will go a little bit down. Having said that, we are not... Our philosophy is to continue and be ahead of the market, and for that reason, we'll continue to maintain relatively high R&D level.
Understood. So it really sounds like to get leverage on that R&D, it's not like there's any one-time investment going on, it's really just a function of incremental revenue dollars and the flow-through based on that.
Correct.
If we think about the market, just taking a step back for a second, but Cognyte has historically had a very strong presence internationally. And so one of the things I was hoping you guys would be able to do is just help us segment the revenue base. If we look at U.S. or the broader Americas region versus Europe, LATAM, APAC, how do you guys view the world and where you guys are generating revenue today?
Yeah. So, we do have a strong global presence. We are active in more than 100 countries. We have hundreds of customers. Our revenue split in terms of territory split is roughly 50% EMEA, 40% APAC, and 10% Americas. And currently, less than half of the Americas revenue reflects the U.S.. So in the U.S., it's a few % of our business. And last quarter, we continued to win deals also in the U.S.. We said that we are going to expand presence in the U.S., and we are focusing in this agenda. And of course, if you want, I can elaborate more. I was actually visiting the U.S. last week and meeting customers. I can give a lot of more color if time allows that.
Terrific. Yeah. And the U.S., if we just stay there for a second, but I think it would be helpful for the audience just to discuss, like, why is the U.S. a relatively newer market for Cognyte? And maybe alongside that, what are some of the investments that you guys have made or making to help expand your presence here?
Yeah. So as part of Verint, our strategy was to focus on expanding other territories. When we spun out of Verint, we revisited the market opportunities. We found the U.S. market as a big opportunity for us, and we've decided to change priorities and to expand presence in this market. We do increase investments in the U.S. We hired more salespeople. We are pushing more demo solutions, and we continue to invest more and open the market even further. I can tell you that last week when I was there, and this is a penetration to a new market for us because there is no brand recognition yet across all the country, and it takes time.
Having said that, we did already have few competitive wins in the last two quarters, including Q3, we do see that the feedback for the customer is very good. We were able to push incumbents in all cases that we won. The feedback on our technology is very good, and actually, the existing customers that are already operational, using our solutions operationally, are already references for us, and they're discussing with their friends, which is very encouraging. What we're trying to do now is to open the market with new potential customers, and we are going to invest even further into next year. So what we have now is a solution that was proven as better than the incumbents.
We have the right commercial setup, we have the team, the sales team on the ground, which we are going to expand. We have signed with a partner to address the federal market in the U.S., and it's a journey. The progress is very good, and I was really encouraged with what I heard last week.
Are the U.S. investments this coming year, so are they expected to actually accelerate versus where we are today?
The U.S. investments in the sales force and the demo solutions, yes.
Okay. And is it maybe one thing that would be beneficial as well is, like, how I guess I'm trying to get a sense of how established is the groundwork that's been done already in the U.S., right? How big is the team? Is it predominantly centered on Washington, D.C., and pursuing federal, or is there an opportunity to win state and local as well?
Yes. So, our go-to-market strategy is different for state and local, and federal. For the state and local, it's direct sales, so we established our own team there. We hired a new GM, two years ago, a sales GM. We hired salespeople that were either working for competitors or ex organizations, relevant organizations. We delivered the demo solutions. We adjusted the product to fit the processes the customer is using to work with, so it will be easier for them to take a decision to switch. So we did a lot of progress along this year. If you look at the federal, we did sign with a partner, and this is an indirect sales.
For the state and local, we have some competitive wins already, and the rumor is starting to spread all over. For the federals, we are still working on the scheduling POCs and demos. I believe it will take a little bit longer than state and local, but the opportunity is there because also there, we already believe that our solution is better than the incumbents.
And that's great. Just a couple of things to tease out, right? So on the Q3 call, Cognyte actually cited two new U.S. customers that they had signed, right? And I think you actually alluded to that earlier, right? And so my question is, with the U.S., is it demonstrating either longer or slower sales cycles versus what you've seen in other regions historically? Or is it still too early to call, just given this is a newer initiative for Cognyte?
Yes. So now what we see is that the sales cycle is longer than in other territories, that our brand is known, that we are in most of the incumbents. So penetrating a new market is a different challenge. First, you have to excel and be better than competition, otherwise, there is no reason for customer to switch. Second, we have to work on brand recognition and brand awareness. And third, we have to excel in POCs, which we did already, so customers will be willing to take a decision to switch. So for now, the sales cycle is longer than in the other territories. Over time, I believe it when you know, when we are incumbent, and it's expansions and upgrades, I believe it will be shorter.
When the brand is stronger and well-known, maybe the decision of other new customers will be easier. For now, it's a longer sales cycle.
That all makes sense. I guess the other thing on the Q3 call, management cited these product adjustments to help drive U.S. penetration. Can you comment, as far as what needs to be changed at the product level to help drive penetration in the U.S. market?
Yeah. Actually, customers in the U.S. using incumbents, actually established some processes that fit the way the product is used. So it's not a matter of the fundamental technology, this is similar to what we have for the rest of the world, but it's more a matter of, UI and the specific processes that customers are used to work with, and we adjusted the product to fit into this, existing process, and the main reason is to make it easier for them to decide to switch.
Yeah.
So that's mainly the issue. It's not, it's not, it's not a major fundamental change in the product. It's just more cosmetics, I would say.
And then the follow-up again is that the product adjustments, I guess if we're talking about it's more at the UI layer, but it sounds like those are more one-time in nature, probably behind you guys, or no, is there still may be more to do, depending on different customers and agencies?
We think now the product fit is very good. Obviously, we continue to develop and innovate always, regardless of what market is. It is because the technology is moving on, the data scale is changing, everything, you know, is running. So we'll continue to innovate and maintain leadership. For now, our product fit is very good for the U.S., and again, according to what I heard last week, we presented better results in competition. Actually, in one of the cases, three competitors were invited to present in real time a POC in four actually different scenarios. Two of them were incumbents, we were newcomers, and actually we got the best rating out of the three.
So I'm convinced that the product fit is very good and that in this respect we are very good to win more customers over time.
I guess one of the things a lot of folks are trying to figure out as well is with the expansion into the U.S., does that, or how does that change your competitive set versus, I think at the top of the call, you were saying U.S. is maybe only a couple of percentage of total revenue today?
Yeah. So if you look at the competition in general, there are a few different competitive types, I would say. You know, there are the large integrators that sometimes bring other technology into a deal or develop themselves, and there are the local ones, and there are the global ones. The global vendors or the local vendors that are focused on specific use cases. So we do see now, or we compete against competitors that are U.S.-based and focused on the U.S. market. But we don't see a real change in the competitive landscape because those were known already before we started. And in the other territories, we don't see any significant change in competitive, in the competitive landscape. So generally speaking, I think that the competition is similar to what it was before.
Of course, as we expand to more use cases or more territories, we'll see competitors from the local market that are competing against us, but it's something that is, you know, it's natural, it's obvious, and we know how to deal with it.
So again, just taking a state of a competition-
Mm-hmm.
Can you help the audience think through, who is it Cognyte is typically competing against, especially when facing off against another vendor?
... So, there are different competitors. If you look at different integrators, it could be Elbit, it could be BAE, these kind of large integrators, that they come to a deal and they try to resell somebody else or use turnkey solutions, which means to develop it specifically for the, for the customer. We saw these competitions going down, and the reason for that was because it's more expensive, and it cannot keep pace with the technology changes. So this is about the large integrators. And also there are other different use cases and competitors in other areas. For example, in U.S., we see L3Harris. From time to time we see Palantir, although Palantir is more focused now on enterprise and other use cases rather than security.
We see other Plath in Germany. We see JSI and SS8 also in U.S. So there are different competitors in different territories, and we have the right pitch and also the advantages of the solution to address, you know, the competitive differentiation that we need in order for customers to switch.
I guess this is a very, very high-level question from someone in the audience, but-
Mm-hmm.
Since you had mentioned Palantir as a competitor, they said, "Can you talk a little bit about the differences or similarities between what you do versus what Palantir is doing as it relates to analytics?
Yeah. So, if you look at, at Cognyte, we are focused on investigative analytics, which means that, we fuse and analyze data at scale. Different data sources, structured and unstructured, with, you know, any kind of data. It could be images, videos, text, any kind of data, databases. Being able to fuse it in a very, clever way, integrate it easily into the ecosystem of the customer, and analyze it with, engines that fit into the investigative world. What we see with Palantir is that the concept of fusing, fuse analyzing data is similar, but we see Palantir going to different, direction and different verticals, not necessarily for security, and, we are focusing on security and investigation. So, similarities are both companies are focused on fusion analytics, including AI.
In terms of the differences, the focus of Palantir in terms of verticals and territories is different than ours. We focus on investigation. They have other, different use cases, and actually they focus on sometimes other countries, not necessarily. We don't see them necessarily in all territories we operate in.
Thank you for that. Just coming back to competition again, I just want to kick the tires here, but has Cognyte in any way seen a significant change, whether it's in the last year, as far as new entrants that they need to monitor, or someone who's coming up more frequently in deals when you go to respond to RFPs?
No, actually, we haven't seen any major change in the competitive landscape. We see similar competitors. We haven't seen any new competitor, or we didn't see any competitor that became more significant than before. Generally speaking, similar to what we saw, the last few years.
And then the final question, probably a little bit more go to market than competition, but with the investments that you guys are making in the U.S., can you help us think through the partner network that you have or that you need to establish to help get you more, at bats, or, I guess, help your hit rate? And again, are there certain system integrators or partners that you guys are courting to help you expand that presence in the U.S.?
Yes. So, if you look at the journey in the U.S., we first wanted to make sure that we have a product fit. So, this was the main effort in the last few quarters, to make sure that when we come to the U.S. with a product and our POCs and demos, or we sell to the first customers, it will be a success story, not a failure. So this was the focus: product, technology, and value. And then, of course, in parallel to that, we made sure that we are complying with all regulations and requirements of U.S. customers. The second step was to define the go-to-market strategy. We have decided that for the state and local, it will be direct, and for federal, it will be with a partner.
With state and local, we plan to also add partner or to increase the partner network. So not just working direct, but expand with the other partners, local partners in the U.S. The focus is that we need partners not just... not to give us the domain expertise or any other technology, because this we have already, but a long list of customers they have in their database, or customers they have intimacy with, that's what we are trying to find. For the federal, we did it successfully already, we do have the right partner.
For the state and local, we are negotiating with a few, and I believe that, over the next few quarters, we'll find more partners to help us expand the reach to new customers.
Okay. And if we shift over, I know you're saying the product readiness and the market fit to get it ready for the U.S., right? But if I just take a step back and think about your presence in Israel, and the question that I've received is ... Has that presence in any way seen maybe restrictions from the Israeli government on where or what you can sell, which countries you can engage with, especially given the more recent attacks on Israel on October seventh?
So no, there is no change in the Israeli policy. There are different products and different companies and different sensitivities. When it comes to our solutions and our market, no change in the Israeli policy, and we are not seeing any new restrictions that prevent us from doing business with the countries we do.
Okay. Another inbound we had is asking: Can you help put it into perspective as far as the revenue step down from where you are today versus at the time of the initial spin-off date? And I guess they're looking for you to place it in a bucket. They're looking at loss to competition or government funding. For the client, just so you're aware, if you're newer to the story, but Cognyte did divest a business called SIS, probably a little bit more than a year ago, which is gonna help explain some of that revenue step down that you're talking to. But I just wanted to put that out there because I know we did get an email from a client on that.
Yes. So, last year, we did have headwinds coming from different angles. We had the COVID impact, government budgets that are declining, some macroeconomic situation or challenges in different territories. Back in the COVID, we also had a harder shortage of components. So, this was a bunch of headwinds that came on us. In addition to that, you mentioned that we divested the SIS, which was about $35-$40 million, more or less. So, there were a few reasons why the revenue went down. And looking in the last few quarters, we are able to improve the financial results, and actually, we went back to growth, back to profitability.
We do see that, while the revenue is growing, we're able to increase the guidance and meet it, and also we maintain a strong RPO, which means that the demand is healthy. So if you look at all indications in the market, I do believe that we're in much better shape now. Growing revenue, improving profitability, maintaining a strong backlog, and increasing traction with customers, which is very important for us. I just mentioned in the last two quarters, that we are participating conferences. Next year, we plan to participate even more and do our own users meeting. So we maintain high engagement with customers.
Of course, with our customer base, we maintain intimate relationship for many years, and I believe that we'll continue to grow and improve margins over time.
Just to come back to it, but I know you were highlighting earlier, like, the importance of what you do and the analytics specifically pertaining to the security use case. So I imagine it's, it's a bit of a continuum because your customers, based on GenAI, probably have changing demands on them as far as what they need to do to achieve their mission or solve some case. But also, I imagine that inherently changes the expectations of what Cognyte's offering is able to do as well. Maybe on the theme of GenAI, can you talk about how those demands are changing, both for your customers as well as how you guys are feeding into that, or integrating GenAI technology into your own offering?
Yeah, sure. So first of all, it's important to understand that investigation is a process. So, customers have first to ask the right questions and then to get the best results they can. This is one aspect. The second aspect is does the solution itself automatically raise alerts, risk levels, and the prioritized results, et cetera. So, here, the AI comes into play. So, for example, if you look at the investigations, customers want to uncover more hidden relations or hidden connections between entities. So if the traffic is encrypted, for example, and the data sources are encrypted, you need AI in order to do that. Another direction is how the user interface with the machine, with the solution.
So, without AI or GenAI, you have to be more, I would say, more advanced user, sometimes data scientist, in order to query the solution the right way and get the right results. If you want the solution to be friendly also to simple users or users that are not technology experts, so actually you have to allow users to ask questions in simple language, and the machine to be able to convert it into sophisticated queries and come back with results. And also, when you get results, and we are talking about nationwide, sometimes nationwide deployments, so it's a lot of data that is fused and analyzed, and you have tons of results.
So it's important, and time is of essence here, that you classify and rank the results, so users will focus on the most likely threats before they unfold, and not running through a long list of results that are, you know, random in priority. So AI is becoming very important. It was important before. Given the recent developments, it's becoming even more relevant because it can accelerate even more the value for customers. And whether we hear from customers the demand from AI, the answer is yes. And we do implement and incorporate more and more AI capabilities into our solutions. Actually, we have an AI lab here at Cognyte. We have an AI team, experts of AI, that's what they do, and we'll continue to do that.
An example for AI capability is the cryptocurrency. For cryptocurrency, the main challenge, and I gave this example, I think, last call, the main challenge of customers of security agencies, is to find who is behind transaction, because transaction may be an illegal transaction, and now you have to find who is behind it. In the cryptocurrency ecosystem, the individuals or the entities who are doing transactions are encrypted and anonymized. So if you want, for example, to be able to uncover this, it's mandatory that you have AI capabilities. So AI can improve the hidden insights that can be uncovered that cannot be uncovered with the other legacy or manual analysis, legacy technologies or manual analysis.
It can accelerate the investigation and make it more accessible to users that are not technology expert users. And it also can prioritize the work in a way that you focus on the real high risks and not randomly across, you know, a long list of results. And it's very important for security agencies, mainly because the data is growing, so they need more analytics, but also time is of essence, where if it's not coming on time, it's sometimes too late. And we read in the newspapers threats that were materialized, but we don't read those that were prevented. And this is very important to understand that AI also helps in predictive analytics.
Great. Elad and David, to use your words a lot, but time is of essence.
Mm-hmm.
And with that, we're closed out. But hey, thank you to everyone for joining us today, and thank you again for your participation of the Cognyte team. We really do appreciate it.
Thank you.
Thank you, Mike.