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spk04: The conference will begin shortly. To raise your hand during Q&A, you can dial star 1-1. Good day. Thank you for standing by.
spk05: Welcome to Cognite's third quarter fiscal year 2023 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. To ask a question during the session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. 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, sir.
spk08: Thank you, Operator. Hello, everyone. I'm Dean Ridlon, Cognite's Head of Investor Relations. Thank you for joining us today. I'm here with Elad Sharong, Cognite CEO, and David Abadi, Cognite 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 investor section of our website at cognite.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, Cognite 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 Cognite's actual results to differ materially from those indicated in these forward-looking statements, please see our annual report on Form 20F for the fiscal year ended January 31st, 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 investor section of our website at Cognite.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.
spk02: Thank you, Dean. Welcome, everyone, to our third quarter conference call. In Q3, we continue to win large orders. Our booking came higher than revenue, and our backlog increased sequentially. At the same time, slow backlog conversion drove a sequential revenue decline. We believe Q4 will be a turning point, and we expect to resume sequential revenue growth. We also expect fiscal 24 revenue to grow by approximately 5% compared to current year. I'll discuss the trend driving our growth outlook in a few minutes. Revenue declining year to date drove significant losses. As a result, we took actions to reduce our losses and cash burn, and we are targeting to achieve about break-even cash flow from operations in Q4 and for next year. Operationally, we improved the focus of the company during a period of tough macroeconomic conditions. In that regard, as previously announced, on December 1st, we successfully completed the divestiture for our situational intelligence solutions, which we refer to as SIS. Looking forward, we believe our differentiated technology and strong customer relations position us well for long-term growth and profitability. We have been navigating the business through the current storm and continue to closely engage with our customers to drive new business and to improve visibility by firming up the backlog conversion schedule. With that, let me now give you a little bit more color about Q3 trends. In Q3, like in previous quarters, despite the challenging macroeconomic environment, we continue to win multiple large deals. We operate approximately 100 countries, and so different demand dynamics across countries. We currently see that in some countries, there are customers having temporary challenges related to budgets or professional readiness. At the same time, we continue to operate in many countries that are not significantly disrupted by these challenges. I would like to review some of the large deals we won during Q3. Our investigative analytic solutions help customers address a variety of security use cases across national security, law enforcement, national intelligence, and cyber security agencies. The first deal is for over $20 billion with a government agency to combat cyber security threats. This is a new customer for Cognite. Our solutions will enable the customer to fuse, analyze, and reach data to investigate cyber threats. We were selected due to our superior technology and domain expertise. The second deal is for approximately $3 million from an existing national intelligence agency. We were selected based on the strength of our technology and the deep relationship with this customer. The customer is using our solution to investigate and combat organized criminal activities. The third deal is also for approximately $3 million, and it presents a follow-on order from an existing national security agency. We were selected based on the value our solution generates. The customer is now adding new capabilities to address anti-terror and border security. We have increased our self-focus in the geographic areas where we believe the best opportunities exist. We make these decisions on a country-by-country basis, focus on customers with budgets and operational readiness, and are pleased with our booking activity and another quarter of book-to-bill ratio greater than one. Next, I would like to discuss the dynamics we see in our backlog conversion. As you know, while our backlog has been growing this year, some customers have been delaying deployments. We have been actively engaged with all of our backlog customers to discuss a firm commitment to the delivery schedule. I'm pleased to report that as a result, our visibility into backlog conversion has improved, positioning us to provide guidance for Q4 and for next year. We believe the improved visibility is due to customers' progress in budget planning, as well as prioritizing their urgent needs to deploy innovative technology to address the evolving security threats. The work we've done with our customers provides us with better understanding and more confidence with the timing of backlog deployment. Turning to our cost structure. Over the last few months, we took actions to reduce our expenses level in line with our outlook. We started the year with non-GAAP OPEX excluding SAS of about $70 million in Q1 and expect to end the year with Q4 OPEX of $55 million. These cost saving actions will continue to gradually reduce our OPEX in the next two quarters across R&D, selling, marketing, and G&A. We believe these actions are necessary in the current environment, and we designed our cost structure to support our outlook for growth. Turning to our Q4 outlook. Given the divestiture of SAS, we are providing performer results excluding SAS, which David will discuss later. Excluding SAS non-GAAP revenue, we are currently expecting Q4 revenue in the range of $63 million to $72 million, up from $61 million in Q3. On this basis, we expect revenue for the year ending January 2023 to be in the range of $275 million to $294 million. The combination of higher Q4 revenue and lower expenses is expected to result in improvements of stability. Our cash flow from operations for Q4 is expected to be about break even. For fiscal 24, we expect revenue to grow approximately 5% over year. Our view is based on current expectations for a similar demand environment next year, and the discussions we had with our customers on timing of backlog deployment for next year. While we are not assuming better macro environment conditions, our backlog has been growing this year, and the conversion of this backlog supports a revenue growth outlook for next year. Turning to margin, our cost reduction actions this year will benefit next year profitability outlook. As a result, we are targeting about break-even cash flow from operations next year. In summary, we are pleased to regain visibility and to be in a position to provide guidance. We expect sequential revenue growth in Q4 and year-over-year growth in fiscal 24. We believe that the actions we took to focus the business and reduce costs position us for growth next year with significantly improved profitability and cash flow. We also believe security threats are pervasive and customers need our market-leading solutions to address the rolling threats. I would like to thank our employees for their strong dedication to customer success. We are managing the companies with the current storm and look forward to returning to profitable growth. Now, let me turn the call over to David to provide more details. David?
spk03: Thank you, Elad, and hello, everyone. Our discussion today will include non-GAAP financial measures. The conciliation between our GAAP and non-GAAP financial measures is available, as Dean mentioned, in our earning release and in the investor section of our website. Our website includes a financial dashboard with a tab that details our historical results, excluding the recently divested situational intelligence solutions. Revenue for Q3 came in at $71.3 million. Looking at the revenue mix, software services came in at $43 million, reflecting strong renewal rates. Software revenue came in at $22 million, a significant decline from last year, reflecting background conversion delays, as I've explained. Professional services and other revenue came in at $6.3 million, impacted by our software revenue level. As a result of the SAF divestiture, I will discuss our results for the current year without SAS. NAMDAP revenue for Q3 came in at $61.5 million. During Q3, our booking activity came in higher than our reported revenue and drove an increase in our backlog. Q3 RPO was $527 million, an increase of approximately $20 million from the end of Q2. RPO for the next 12 months is $248 million. The RPO reflects all adjustments to our contractual obligations. Turning to gross margin, Q3 gross margin was 61.1% on a non-GAAP basis, primarily due to a loss on professional services. We expect to improve the margin on professional services as a result of our cost reduction initiative and improved deployment efficiency due to better visibility. Our Q3 non-GAAP operating expense was $59.6 million, $5.8 million lower than Q2, and $9.5 million lower than Q1, reflecting our cost control activities. Despite the improvement in OPEX, the lower revenue level in Q3 resulted in a non-GAAP operating loss of $22 million for the quarter. Cash used in operation was mainly driven by EBITDA loss and an increased level of inventory. Turning to the balance sheet, we ended the quarter with net cash of about $11 million. Following the divestiture of SAS, our current net cash increased to about $55 million. Next, I would like to provide more details on the SAS divestiture. Historically, SAS was about 10% of Cognite consolidated non-GAAP revenue. During FY22, SAS generated non-GAAP revenue of about $35 million, and during the first nine months of FY23, SAS generated non-GAAP revenue of about $28 million. Our dashboard provides further information on Cognite results excluding SAS. As a result of this divestiture, during the fourth quarter, we received $42.3 million in cash. We expect to receive an additional few million dollars next year related to the holdback and other price adjustments. Also, there is a potential to earn future payment over the next three years related to an earn-out. At this time, we cannot be certain whether and to what extent any earn-out will eventually be received. Turning to Q4, we are currently expecting revenue to increase from $61.5 million in Q3 and be in the range of $63 to $72 million in Q4. Our cost reduction efforts are expected to result in further decrease in our operating expenses from the Q3 level. As a result, we expect Q4 operating expenses, excluding SAS, to be about $55 million. The combination of higher Q4 revenue and lower expenses is expected to result in improved profitability. As a reminder, Q4 will also include one month contribution of SAS of approximately $2 million of revenue and about $1.5 million of incremental OPEX. Let's turn to Q4 cash flow from operation. We expect improved profitability and also sequential improved working capital due to better collection activity and reduced inventory level. This will result in about a break-even cash flow from operation. I would like to add more color about our FOA24 outlook. We expect next year revenue will grow approximately 5% from FOA23 level. And you can assume in your model, modest sequential increase throughout the year. Our revenue outlook is driven by our current view of backlog deployment schedule for next year's best customers' dialogues. Our cost structure will continue to improve from Q4 level into the next year. During our next journey call, I will provide more detail on our profitability expectation for FY24. We expect next year cash flow from operations to be about break-even, primarily driven by projected revenue growth and our lower cost structure. In addition, we expect about $10 million of payment for CapEx partially offset by additional receipts from the SAS divestiture. We believe security threats are pervasive and our customers need our innovative solutions to address the evolving trends. We are a market leader in investigative analytics and have a strong track record with customers around the world. We have a long-term opportunity in front of us, and we are managing the business through the current environment to return to growth and profitability. With that, I would like to end the call over to the operator to open the line for questions. Operator?
spk05: Thank you. At this time, to ask a question, you'll need to press star 1-1 on your telephone. Please wait for your name to be announced. Please stand by while we compile the Q&A roster. Our first question comes from the line of Mike Nikos with Needham and Company. Your line is now open.
spk06: Hey, guys. Thanks for taking the question. You have Mike Nikos on the line here. Appreciate you guys calling out this visibility and the guidance that you have, but maybe can you just provide us a little more color? I know you've been working with customers on better understanding the deployment of that backlog that's been building this year. But can you provide additional details as far as what gave management the confidence to reinstate guidance at this time?
spk02: Yeah, so hi, Mike. This is Elad. Yeah, we're in the turning point. We expect to go sequential in Q4 and near very next year. In the past few quarters, we're working with our customers to confirm the deployment schedule. If you remember, we were able to increase backlog an RPO each and every quarter this year. However, we experienced some backlog conversion delays related to customers' readiness of budgets. So we spent a lot of time with our customers, intensive meetings and discussions to better understand what are the reasons behind it. And also try to be helpful and prioritize with them the deployments going forward. And we have also to remember that this time they usually also plan the budgets going forward. So the result of those discussions were that today we have visibility towards the deployment schedule for the next quarters and for next year. And this actually provides us with a confidence level, with high confidence level in the outlook, and that's the reason we resumed guidance. Just a little bit more color, if you look at our RPO, so we have an RPO of, total RPO of about $530 million, more or less. And if you look at the short-term RPO, after the discussion with our customers, it stands on about $250 million, which is more or less 50% of the total RPO, but also reflects more than 80% of the outlook for next year. So this gives us the confidence that we have in order to provide guidance this time.
spk06: That's great. I appreciate that. And if I could just ask one more question with respect to that confidence that you guys have in the guidance here. It's just interesting to me, like I know this year we've obviously seen delays to that backlog conversion. Is it fair to think that customers are behaving differently or thinking differently about next year now? Just because I'm trying to understand why we would have more confidence in that backlog conversion for next year, just given maybe some of the delays that we've experienced this year.
spk02: Yes, so we have to remember that the macroeconomic environment affected also our customers. Also for them it took time to digest, they now planned their budgets again, they looked into their availability and readiness. Our discussions with them gave us the confidence level that we now have the deployment schedule that is more realistic. And that's actually the baseline for the short MRPO that we believe will be converted. So it's a combination of strong backlog that increased over the year. together with many discussions we had with them to reconfirm the deployment schedule and prioritize it. And we also have to remember that not all of countries were affected by that. There are certain countries that were affected more, some affected less, some were not affected at all. So overall now we have a very good view about the deployment schedule. And obviously, when market turns and revenue hopefully will go up once this storm is behind us, and given the high softer margins, I would also expect the growth rate to increase and the margins to expand. So this is it in a nutshell. I hope I answered.
spk06: No, you did. That's great. That's great. And a final question before I turn it over to my colleagues. But I just wanted to make sure I was clear on the gross margins. Obviously, we saw that professional services and other, I think, was below what we had been forecasting on our side. So can you help us think about what led to the professional services gross margin contracting this quarter? And then the other comment is, historically, from Q3 to Q4, gross margins have compressed. And I just wanted to see, should we expect a similar pattern as we think about Q4 gross margins? And that's all. Thank you, guys.
spk03: Okay. Hi, Mike. It's David. So when we look at the gross margin, the main driver for our gross margin is actually the software revenue, which that affect our ability to improve gross margin over the years. When you look at the Q3, we had professional services with a negative gross margin, and it was mainly driven by two things. One of them is that low level of software revenue, and the other one is because of the cost structure associated with the deployment schedule that we were planning. Given now that we have much better visibility and the cost reduction that we already made, that will allow us to improve the gross margin on professional services over time. And in the long term, we'll be able to return back to the level of software gross margin of overall 70%. When you look at the... As for your question about Q4 and the future period, so overall, we believe that it will take some time to do the recovery. And from a gross margin perspective, I would assume slight improvement from the current level that we're seeing right now.
spk06: Okay. Thank you very much, guys.
spk05: Thank you.
spk04: One moment for our next question. And our next question comes from Peter Levine with Evercore ISI.
spk05: Your line is now open.
spk01: Great. Thanks for taking my question here. Maybe just to follow up on the prior question is, can you kind of just help us understand, like, what's the recession playbook for you guys? Obviously, we've seen other companies take steps in terms of employees, willing to kind of dial that back. Obviously, you've kind of built in some efficiencies this year, but Obviously, if the economy gets worse, what's the recession playbook? What cards do you have in your back pocket to kind of offset, I think, some additional call it headwinds that you guys might face next year?
spk02: Yes, so I assume you're asking, I just want to make sure I understand the question, Peter. I assume you're asking what are assumptions for NXT in terms of macro environment? That's the question?
spk01: Correct, yeah. And assuming, obviously no one knows what's going to happen, but I think you saw the guide for next year, but what's the offset to that, right? Like where's the risk, and then what do you see as the risk in terms of you perhaps not hitting those numbers?
spk02: Yes, so when we built our guidance, we assumed similar macroenvironment conditions as this year. So we didn't assume that the situation would be better. We also don't have any signs that it will be worse. So the assumption was that it will be similar to this year. Obviously, we took some actions related to cost structure to make sure that we are aligning the organization to the outlook and generate break-even cash flow from ops. This was the goal. And the thinking behind it was that first, we have to stand behind the commitments to our customers. And second, that we preserve the opportunity to resume growth when market conditions improve. So overall, the assumption is a similar macro environment as this year.
spk01: Okay. And maybe can you kind of touch upon like the competitive landscape and maybe what your customers are doing today I think the deals that are getting deferred, are you seeing more companies compete in RFPs? Are these customers just pulling back completely or do you get a sense that maybe they're allocating their budget elsewhere? Can you just kind of give us a sense of the appetite from your customers in terms of their budgets and where that allocation is kind of heading towards?
spk02: Yeah, sure. So we saw demand also this year. If you look at the bookings and RPO, it was increasing. The problem was not actually the main issue was not the bookings, but it was the backlog conversion, mainly the backlog conversion. So actually POs that the customers gave us and when customers give POs, you know, they do it because they need a product and they need a solution and they have to address their challenges. So this is something that gives the confidence that the demand is there. You know, we run the company in a tough macro environment. Having said that, we do have very good relationship with our customers. We maintain market leadership in terms of product differentiation. We are global. We work in more than 100 countries. So overall, the leadership position remains. Of course, some customers are having budget issues, and they have to slow down either buying or to push or delay the conversion, and that's what we're focusing on. About competitors, I tend to believe that competitors face the same challenges that we do. Different competitors are operating in different parts of the market, not all of them have the rich portfolio that we do and address in many use cases. So it depends on what competitor and what area he is serving. I do believe that by the end of this macroeconomic storm, some of the competitors will be struggling and maybe it will be, you know, it will be interesting for us to consider M&As in the future.
spk01: Okay, fair enough. If I can squeeze one last one is, Yeah, we talked about backlog conversions, but can you talk about maybe what you're seeing at the top of the funnel today, meaning like net new RFPs coming in on top? Are you seeing an uptick in activity when looking at the funnel today, call it versus six months ago or even three months ago?
spk02: Yeah, so I assume you're asking about the funnel, right?
spk01: Yes.
spk02: So as part of our decision to focus our efforts on areas where we can maximize opportunities, because we know that in certain countries they are suffering budget constraints and not ready, et cetera. So our decision was to focus the business on where the opportunities are and maximize the ROI. And what we do now is we are focusing on a subset of the funnel that will generate the highest potential for us. And the funnel we have today is big enough to support book-to-bill greater than one also next year. It was that way this year. Book-to-bill was greater than one this year. We expect the same to be next year.
spk01: Great. Thank you for taking my questions, and enjoy the holidays and New Year.
spk02: Thank you, Peter.
spk05: Thank you. One moment for our next question. And our next question comes from Brian. Rudenberg with Imperial Capital. Your line is now open.
spk07: Great. Thank you very much. A couple of follow-up questions along the lines of guidance. For fiscal 24, you know, with the divestiture and you're talking about 5% growth, back of the envelope, I come up with a 270 to 280 million number. Is that the right ballpark to be thinking about in terms of total revenue?
spk03: So we share the guidance for Q4, which give you a range between $63 to $72 million. If you take from the mid 0.5%, you will be around 290. So this should be like around the number that you should get.
spk07: OK. Thank you. So it's roughly ballpark 290. I didn't know how. you know, things will ebb and flow quarter to quarter because certain seasonality in there. So that's why I was trying to get clarity on that. So roughly 290 in revenue, gross margins should be in the low 60s. I didn't catch it should be up from previous high 60s. What was the number on gross margin?
spk03: So So let's separate the discussion about overall growth margin. So growth margin is driven by our software model, and as the revenue will grow, we'll be able to drive more dollars with higher profitability. When we look at the... Q4 and the next year, we expect a slight improvement on the gross margin due to the increase on the top line. So, I would say low 60s for modeling perspective.
spk07: You said low 60s instead of – is that correct?
spk03: That's correct, low 60s.
spk07: Okay. And then there should be a decrease in – I saw a drop in R&D from second to third quarter You know, I'm just trying to understand the breakdown of those operating expense SG&A and R&D going forward now that you've completed the divestiture, just trying to understand what kind of levels we're looking at in terms of R&D and SG&A moving forward.
spk03: So in general, we'll provide much more color on our cost structure during our next earning call. We do think that the overall Q4 OPEX will be at around $55 million, and we will continue to benefit from our cost-saving initiative over the next year.
spk07: Okay. Is there a percentage breakdown? It's roughly historically... close to 50-50, but a little bit higher SG&A versus R&D, and that's how, of that 55 million, I'm just trying to put it in buckets. Is that how it should be still weighted, you know, like historical?
spk03: You should say, like, that the trends will be similar. Perfect.
spk07: And then you also said cash flow break-even in 2024. Is there a specific, you know, second half of 2024 is Or is it all going to be fourth quarter? Any kind of guidance along those lines?
spk03: So cash flow for operation, we expect it to be breakeven in Q4 this year and also for next year. As you look at next year, we think that there will be sequential growth on revenue throughout the year, and the OPEX benefit we will enjoy also during the year. So, given these trends, you should expect that H2 will be better than H1 from cash flow from operation.
spk07: Great. Thank you very much.
spk05: Thank you.
spk07: Thank you.
spk05: And I'm showing no further questions at this time. I'd like to hand the conference back over to Mr. Ridlon for any closing comments.
spk08: Thank you, Operator, 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.
spk05: This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.
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