IronNet, Inc.

Greetings and welcome to IronNet Inc. Fiscal 2023 Q1 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Nancy Fazioi, Investor Relations. Please go ahead.

Thank you, Operator. Hello, and thank you for joining us. Today's conference call will address IronNet's financial results for the fiscal first quarter ended April 30, 2022, that were announced this afternoon. Before we begin, please note that some of the statements we will be making today are forward-looking. These matters involve risks and uncertainties that could cause our results to differ materially from those projected in these statements. We therefore refer you to the risk factors included in our latest SEC filings. Supplemental information is also provided on the Investor Relations website from time to time. And now I'll turn the call over to our founder and co-CEO, General Alexander, who is joined by our co-CEO, Bill Welch, and CFO, Jamie Gerver, all of whom have some brief remarks before we move to the question and answer portion of the call. General Alexander, over to you.

Thank you, Nancy. Good afternoon to everyone, and thank you for joining us today. I am quite optimistic about our progress. We had a new transactional annual recurring revenue, ARR, of 5.5 million in the first quarter. As noted in our earnings release, our revenue and net ARR results were consistent with our expectation that certain customers in our transactional business would be delayed in signing or renewing their contracts. Those delayed opportunities and one non-renewal resulted in a decline of $7.2 million in ARR per quarter, leading to a net decline of $1.5 million in ARR quarter over quarter. We would like to reiterate that we see the significant majority of these ARR opportunities as pending rather than lost. Two of these pending transactions representing approximately $5 million in ARR are public sector customers impacted by budget delays. Another non-renewed contract, the only one we would categorize as lost, represents approximately $1 million in ARR. This is a structural issue. It is an opportunity that has not been fully deployed due to the FedRAMP authority to operate, or ATO, not being achieved. We have achieved FedRAMP ready status, but not ATO. This is an area where we are making progress and we hope to have it resolved this fiscal year. Once this is achieved, we also expect this customer to come back in as well. We believe FedRAMP ATO status has the potential to uplift our sales momentum when complete. We do not see it as an impediment to closing the majority of public sector strategic opportunities that are in our pipeline today. Our issue continues to be largely timing and bureaucracy, not a lack of perceived value by our customers. And this is important to highlight as a reason for our high confidence and our ability to bring this business back. Our customer wins this quarter were in sectors that represent important areas of growth for us, healthcare, space, state agencies, energy, and public utility. Bill will provide additional color on these wins and give insights into the value customers are finding. Pipeline opportunities from strategic customers, which to remind you, we define as those exceeding $5 million in ARR, remain as robust as discussed last quarter. We feel confident that we will see these opportunities start to close in the next couple of quarters. As a team, we continue to show strong thought leadership and to increase our brand awareness, from customer engagement at Gartner Security and Risk Management Summit, to our targeted presence at the resurrected RSA event in San Francisco, to our presentation at the National Association of State CIOs, where we partnered with AWS to present on the importance of a whole-of-state approach to cybersecurity. We will maintain this pace and momentum in highlighting our value proposition while also continuing to show discipline in our approach to sales and marketing. In April, in partnership with the New York Stock Exchange CISO Steve Pugh, we hosted National Cyber Director Chris Inglis and Southern Company CEO Tom Fanning for a virtual webinar on collective defense. It was well attended by critical infrastructure and particularly energy company executives and IT leaders. There are two noteworthy comments from the presentation that I believe speak eloquently to IronNet's unique value proposition. Director English remarked that cyber defenses must evolve to a point where you have to beat all of us to beat one of us. CEO of Southern Company Tom Fanning cautioned that none of us can individually own the talent in our organizations or to adequately support our own supply chain working alone, rather that we must work collectively. He also highlighted that addressing these gaps is a fiduciary responsibility for boards and management teams. I would like to add that there is simply no amount of cybersecurity investment, even for the most sophisticated among us, that will enable us to prove the positive in our environments the way collective defense can. This perspective comes from my experience leading the offense for our nation. An isolated approach to cybersecurity is a legacy, and from my perspective, a short-sighted and dangerous approach. What we have set out to accomplish in transforming cybersecurity through collective defense is hard and has not been frictionless. Yet our approach and our technology are increasingly being validated, as I have just noted, And as Bill will further illuminate for you through customer insights, we are encouraged about our opportunity and confident that we are on the right path. With that, let me now turn it over to Bill for his remarks.

Thank you, General. I'd like to echo the General's long-term outlook and share what our customers see as the value of the IronNet Collective Defense Platform, speaking to what is the value that IronNet brings to markets. Here's a snapshot of customer perspectives from this quarter. A customer in our Iron Dome for space that has a highly sophisticated environment and cybersecurity investment posture. This customer indicated that they start their day with IronNet by logging in and evaluating every alert. For this customer, IronNet is a valuable source of information on attacks and vulnerabilities that they're not getting from any other vendors. Ours is a highly differentiated level of visibility. Their perspective and level of sophistication is similar to that of one of our financial customers in Eastern Europe, for whom IronNet fills specific gaps in their technology staff. As a result, they frequently call on us for support when they are under attack. A second customer, a large healthcare consortium with a mature posture and sophisticated level of investment, was concerned about potential attacks against payers and potential for ransomware. and the theft of personal health information and the resulting HIPAA consequences. They have been relying on intrusion detection systems, IDSs, and looking for an NDR solution that could fit their needs and scale. They chose Ironit because of our behavioral analytics and unique ability to detect unknown unknowns. Our platform enabled them to eliminate IDSs. A third customer, a mid-sized college without its own security operations center, was a victim of a costly and disruptive cyber attack and saw IronNet as a low cost, high value insurance policy against cyber attacks. As a result of the institution's proof of value and selection of us, the institution is now transforming the sophistication of its overall approach to cyber defense. In a short time, this institution has become a powerful evangelist for IronNet collective defense and is seeking to build a dome for institutions of its size. A fourth customer, a new customer on the West Coast, came via referral from New York Power Authority, its public utility peer. The team was already sharing information with its ecosystem and was impressed by IronNet's approach to automated collaboration. A competitive NDR solution was about to get in order prior to our introduction. Our pilot project identified vulnerabilities in the customer's environment that were not previously detected. A fifth customer, a healthcare clinic that is part of a larger healthcare community of providers, saw IronNet as the first step to defending in collaboration and an on-ramp to a more sophisticated posture. They are an early adopter for their size in seeing the power of leveraged cyber resources. Their decision to buy, following a strong pilot program, was also based on recognizing the value of going beyond compliance to being secure. This customer validation is energizing for our team and enables us to feel highly optimistic as we drive awareness and market adoption of what we believe to be our highly transformational cybersecurity solution. Let me turn it over to Jamie now for some comments on guidance and cash before we take your questions. Jamie.

Thanks, Bill, and good afternoon. We have reaffirmed our prior fiscal year 2023 revenue and exit ARR guidance based on the visibility we have on pending new and renewal opportunities in the transactional side of the business, as well as confidence around certain strategic opportunities. Our pipeline remains healthy and has grown. We still expect ARR and also revenue to build more strongly into the second half of the fiscal year. If we're able to execute on the opportunities we believe we have in front of us, we think we could achieve record revenue in the third and fourth quarters of this fiscal year. With regard to our cash and liquidity, and with ongoing careful management, we believe our financial position can remain sound. We have not yet drawn on our equity line with Tomb and Stone Capital, and we will continue to benefit from having options for liquidity from being a public company. We will continue to take a disciplined and balanced approach to growth, being mindful of cash preservation and with a goal to get as close to cash neutral as possible. We believe the network effect potential of our business model, enabling us to bring in a community of customers via single strategic deals coupled with tight expense management will enable us to strike this balance. In addition, We benefit from being in a growing market for cybersecurity investment and providing a solution that not only defends across sectors more effectively and also drives significant IT cost efficiencies in human capital for our customers. We remain quite encouraged as we navigate the business forward this year and for the longer term. Thank you. Operator, we are ready for our first question.

Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Your first question comes from Mike Sikos with Needham & Company. Please proceed with your question.

Hey, guys. Thanks for taking the questions here. I did want to first circle up on the ARR. I know that you guys went through that in the opening remarks, so I just want to make sure I'm clear on this. So you added $5.5 million in new transactional ARR, and the comment was that, there was $7.2 million decline in ARR from the combination of delayed customers and that one non-renewal that we spoke about. Am I thinking about that properly?

Yeah, Mike, this is Bill, and then I'll ask Jamie and the general to come alongside me. But the offset to our strong new and renewal ARR on the transactional side of the business in Q1 was a result of delayed renewals due to some government delays, not lost deals. So, We first saw, as indicated on the Q4 earnings call, that we might not be able to finalize a couple key deals in Q1, which is what happened. We recognize this is an area of needed improvement for us. We have to get better about shortening the timelines for these new and renewal contracts. There have been some structural impediments, as we've referenced before, like the continuing resolution at the government funding level. But as that has been resolved and is resolving, there's an opportunity for us to work more effectively with our public sector sponsors to help push through with the government contractors as well. And then on top of it, we've also realized some great value with our customers, with our value management selling, and the value that we've been delivering to them.

Okay. Okay. And I guess that $7.2 million decline that we were talking about earlier as well, are those two – how do I want to phrase this? are those two transactions from the public sector customers that were delayed or impacted by funding? Is that the bulk of that $7.2 million? Like, can you help us conceptualize what those two customers represent?

Yeah, Mike, that is accurate. That's an accurate statement is that we have, of the ones that have been paused and not lost, the majority of that churn is opportunities that have been paused or delayed but not lost. But mechanically, we had to take them as a loss.

Understood. Yeah, so it was $5 million.

That's $5 million there in those two that we had to pause on. And until those deals are finalized, we couldn't count them this quarter. And then there's another million in a deal that we're waiting on the ATO. As soon as we get the ATO, we think that one will be back. So that's why we wanted to be clear and transparent that those aren't lost deals. Those are deals that have been delayed, in large part, two of them, because of the continuing resolution and the impacts on the federal government.

Okay. And then two more follow-ups on the ARR, if I could, before I turn it over to my colleagues. The first, Tom, I know that you guys reaffirmed the guidance here for the year on both ARR and revenue. Yes. Can you help us think about 2Q? Like, should we expect ARR to increase from Q1 levels? And I guess the second question, while we're still on the ARR topic, there was commentary with respect to the reaffirmed guide that you guys have a visibility and confidence around certain strategic opportunities. Maybe I'm reading too much into the weeds, but Are you starting to include strategic deals in the guidance here, or no, strategic deals remain excluded from the guidance today?

I'll jump in on that one. I think the key number to focus on remains the annual number here. We do have a number of opportunities still in play for this quarter. I think in terms of giving any updated guidance for that, you know, we're going to hold. I think the most important thing is to keep an eye on announcements that we've said that we'll make as important transactions come along.

Okay, okay.

Can I add to that? Yeah, remember, I'm the guy who knows the least about this. So what we had said in our last quarter was is that we weren't going to count the strategic deals in, but that we would announce them and, if appropriate, raise guidance accordingly. So what we see is, you know, they look promising, but we still don't want to guide because we're dealing with a government, but we remain optimistic.

I see. Okay. Thank you. I'll turn it over to my colleagues. Thank you very much, guys.

Your next question comes from Joseph Gallo with Jefferies. Please proceed with your question.

Hey guys, appreciate the question. I guess following up on that line of questions, what's the confidence in that 6.2 million of slipped but not lost deals coming in fiscal 23? I think you had verbiage that was like, I hope it closes in fiscal 23. And so it's kind of, why not just lower the full year guide by the 6 million? So I'm just trying to get your visibility into that.

Yeah, we still are very confident, as I had answered on Mike's question, is that the timing is the only thing that we want to make sure that we get very accurate. And as the general said, as we secure those transactions, we will announce them. But very confident in the value we're delivering, very confident in the proof of values that we have done, very confident in the executive sponsorship, every confidence in the technical results that we have seen. So it is a matter of just getting through the budget process, the funding, and then the award of the contract.

I guess if I can slip it apart, and again, I think you hinted at this in the last question, but what's the confidence that this, I guess, won't be a problem going forward? Like in our models, should we decline Should we model a 1Q decline sequentially each year going forward? That appears to be the trend the last two years. How should we think about the gross renewal rate as we're modeling ARR going forward?

No, I would not model that, but we don't see no implication for future quarters.

Okay, and then maybe just for the general and you, Bill, maybe just walk us through the demand environment. I think you mentioned POVs were up 300% last quarter, but at RSA, I think people are certainly cognizant that the macro is worsening. Are you seeing an extra level of approvals? I'm sure the pipeline is strong, but are you seeing an extra level of approvals or scrutiny? Are cycle times elongating, and does your guidance reflect any of that?

Yeah, I believe that we are seeing, first of all, absolutely, I believe that customers are reviewing their budgets, but cyber is still very, very, very important, and the long-term viability of cyber continues to be a very active business. We have seen the rationale for IronNet's existence to be being stronger given the threat landscape and and what you see in the reasons of concern across the world, whether, you know, the world continues to become even more and more dangerous, what you're seeing over in Ukraine and Russia. You're seeing where cyber is an element of national power, you know, the mummy spider threat group, you know, wiper viruses. We think we're uniquely positioned because we prove the positive in environments on the on-the-spot analytics with our threat indicator. We also provide anonymized collaboration across the community. So, you know, a one plus one really equals a multiple of three for efficiency. And, you know, the 5X growth of 5G and then really the human element of cyber is really challenged right now in a race that many cannot win. And I think that the ability to bring collaboration, network detection, still in the early phases of the market, but we're going to continue with our thought leadership of collective defense and, as you saw, great industry recognition by companies the JCDC, or the Joint Cyber Committee, around SE Labs with a AAA rating, and then also some very strategic partnerships you saw with the announcements with Mandian and others.

And, Joe, I just might add that, yeah, Joe, I was just going to also add that out at RSA, we were actually seeing quite strong affirmation from the CISOs there, particularly in the network detection subsegment of cybersecurity, which, of course, is one of our foundation technologies here. So I think in terms of the overall economic environment, obviously, we're very cognizant of that. But I think in terms of the demand signals that are particularly focused in our part of cyber, we are continuing to see some good good reaction from the buyers, the CISOs out there. And certainly in terms of the contracts that are out there, these ones that have paused here in the first quarter, that those signals have remained very strong too.

Yeah, so Joe, I want to add in. You know that when we started the company, we were focused on the commercial sector. After SolarWinds, we shifted to starting to support the public sector, the federal government and state governments. I think now, given what's going on in the markets, that has been a really good move for us. Now, the downside is those are harder to predict. The upside is those are significant long-term contracts for us that when they do come in will be, I think, significant for our companies. And it also helps us build what we said we were going to do, a public-private partnership where you could bring a commercial and a federal government together for defending our nation. So I think when you look at it, we're in a good position for that. Now, the continuing resolution has been resolved. The federal government's getting their money, and it's working through that process. So we're optimistic about that, Joe.

Awesome. Really appreciate the color. Thanks, guys.

Your next question comes from Gray Howell with BTIG. Please proceed with your question.

Hi, this is Stefan. I'm for Gray. Thanks for taking my question. I guess to start off and similar to previous line of questioning, could you talk about linearity in the quarter? Were there any changes in customer buying patterns?

Yeah, I think as Bill was just referring to, the changes that we saw in ARR in first quarter really were two fairly large transactions. So I don't think that one should read seasonality into that. Now, you've asked about linearity within the quarter. And again, the primary transactions are quite large and lumpy. The really good news is that we had a One of our largest orders, certainly in the last two quarters, signed within the very first month of first quarter. So, you know, where we see, you know, good demand all through the quarters and, you know, we're very, very pleased to see that. But it's we're still a little too kind of too few deals to really call for some and identify some linearity patterns.

Got it. Okay, that's helpful. And then just switching to gross margins, I saw in the press release you called out some sensor inventory charges. Was there anything else impacting gross margins?

Well, the gross margin is one that we're actually still very optimistic about where some new – some of our new technical configurations that are just getting deployed into the marketplace right now can continue to drive our margins on up. I think you did note the 3% effect on this quarter just from the fact that we've got a fair amount of inventory standing by for – a couple of these upcoming orders. And it's really just the warranty there that we're taking some charges on right now while we hold that. But we're very optimistic about the effects of, you know, on lowering our compute and improving our margins as we continue to deploy this new technology version.

Got it. Thank you very much.

Your next question comes from Andrea Soderstrom with Sudoti. Please proceed with your question.

Hi, yes, thanks for taking my question. I just have a few follow-ups. For the inventory that you are holding on to for future deployments, are those the strategic deals that you are anticipating, or are those for the transaction that you already have in the book?

Well, it's for both, but needless to say, these strategic opportunities are the good, you know, noticeably larger ones, and we have positioned ourselves properly to be able to respond quickly.

Okay, so it seems like they're very, you might have announcements soon, but then I wonder for the full year guidance, and those are just for transactional, right? So if you are When you are announcing a strategic deal, you will adjust the guidance accordingly, and that should add on to the strategic guidance you have, or the transactional guidance you have for the year.

Yes. That's correct. That's correct.

Okay. Thank you. And then just the last one from me. In terms of the new customer count, I think I alluded to it in your commentary already, but... It was a little bit light in the addition of customers for the quarter. Can you just talk to the dynamics around that?

Yes. On our customer count, there are certain strategic public sector opportunities that we think have the potential to serve as that ability to grow both in customer count and revenue and ARR and cash flow. As we mentioned, these are pause deals, not loss deals. We expect these pause deals to return. Five of the six are on pause and have either already come back in or are in a position to come back. Mechanically, we had to net them out. And we're encouraged by what we were able to achieve in Q1 and what we see the reaffirmation of the year. And we see good growth through the year potential.

Okay, great. Thank you. That was all for me.

Your next question comes from Taz Kujagi with Guggenheim Securities. Please proceed with your question.

Hey, guys. Thanks for taking my question. I have a question on the deal that did not renew, and I think the gentleman mentioned that it was because of the FedRAMP ATO certification. Can you give some more color on that? Was that a new requirement that came up for that customer – And then secondly, for you guys to get to that certification, what does it take? And is there any kind of timeline that you guys can provide on how long it takes to get to that certification?

Thanks, Taz. So, yes, when we started out with the customer, they didn't realize that the FedRAMP was going to be an issue from their perspective. So they actually brought that in and said, hey, we'd really like you to be FedRAMP. certified and go through the ATO process. We were in the process of doing that anyhow. So that deal was paused. And as we said, that one is, we considered it lost, but we think it will come back. We've talked to both the CEO and their CISO and leaders. Once we get ATO, we think we'll be back in. They're a partner with us as well. So we think that will come back as well. The FedRAMP process, is a long process, as you know, for companies. What you have to do is go through all the certifications. We've done the FedRAMP-ready portion of that and are now working with one of the departments to get to a FedRAMP certified. That'll take probably several more months. Once we get an ATO, which they can give us over the next four or five weeks, we are good to work with everybody. So we don't see this impacting any deals. It just impacted this one with a company that works with the defense industrial base and the federal government.

Got it. Very helpful. I have a few more follow-ups. On the deals that the renewals that got delayed, you mentioned continuing resolution as one of the reasons. And the way I understood how the budget process worked, I thought when you're in a continuing resolution, you could not buy new stuff. but whatever you have already deployed can be renewed. I guess that's not the case. Can you just explain a little bit more how the continuing resolution impacts both new purchase and renewables? It looks like it's impacting renewables as well. While we have thought that it impacts all these new purchases.

Yeah, so on those deals, the issue for the continuing resolution was actually in a POD. We're doing a POD, a proof of value, And what happened for that customer is that POV got delayed with the continuing resolution. They can't take a POV. That's considered a new start. So that was delayed. They had some other issues internal to that. We have overcome those with that customer and are in the process of bringing that one back on. That's the majority. When you look at those two combined, that's five of the seven million right there.

Yeah, and one last one. The average duration jumped up quite a bit this quarter from, I think, last year and last quarter. Was there one large deal that skewed that duration, or are you seeing average durations go up for new business this quarter?

Yeah, so, right. So the good news here is that we have been renewing longer deals and It's a factor of actually two things. One, a longer deal coming online, and two, one or two shorter deals that went into this pause as they are getting ready to sign this longer deal. So it's a little bit of a factor of both things coming into the next quarter, but longer is better. Yep, got it. Thank you.

Thanks a lot. Your next question is a follow-up from Mike Sikos with Needham & Company. Please proceed with your question.

Hey, guys. Just two quick follow-ups on the gross margin items that we were talking about earlier. I just want to make sure I'm thinking about this properly. So the 3.1% impact on gross margins we're talking about, that was the impact on total gross margins, correct?

Yeah, the effect from services is really quite small on that. So, yeah, it's effectively the same on both.

Okay. Okay. And then the other question I had for you, I know that this is – I guess you have inventory standing by for upcoming orders is the way that you had phrased it earlier. But to the extent that these orders don't come through in 2Q, let's say it's more of a second-half event, Is there potential that we incur additional charges related to the sensors now in 2Q?

Well, they are ongoing charges. So, yes, if we go on another quarter here, then we'll just see that same amount of warranty charge without revenue for the quarter. But it's, you know, yes, you can expect it. But that's a cost of standing by to be ready.

Understood. Understood. Thank you for that.

Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to Mr. Bill Welch, co-CEO for closing remarks.

Yeah, actually, General, would you like to wrap up? Yeah.

Bill, are you there? So let me just wrap this up for all of you. First, as we stated, we are optimistic about this quarter and the follow-on quarters. As you know, some of the lost revenue is not lost. It's delayed, and it stays in part. We believe that our future for the second half is growing, and something that we're very proud of. And we believe the company is on a sound financial position with our cash and other things. Jamie stated, and we all agree, that we see the revenue that we told you we were going to do, we're going to do at least that. We believe that's the future for this company. And finally, this has been a tough journey, changing the culture in terms of cybersecurity, but we all believe it's important for our nation, and we're starting to see traction from comments from people like Chris Inglis. So with that, thanks for the time. Thanks for everything that you all are doing. Have a good evening.

This concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.