2023-09-26 11:31:07 ET
Summary
- I expect Verint's performance to remain weak due to the ongoing weak macroeconomic environment.
- The company's recent 2Q24 results showed a decline in revenue and a significant deceleration in cloud revenue growth.
- Management attributes the poor results to macroeconomic softening, longer sales cycles, and deal delays, indicating uncertain and weak near-term performance.
Overview
My recommendation for Verint Systems (VRNT) is a neutral rating for the near term, as I expect performance to remain weak as the macro environment is unlikely to recover anytime soon. Hence, despite the huge drop in share price, I don't think this is an attractive entry point. I would wait for cloud revenue to show signs of reacceleration before considering an investment stake.
Business
Verint Systems serves businesses in various countries with its actionable intelligence solutions. The company's operations can be broken down into two main categories: customer engagement and cyber intelligence. The mission of the Customer Engagement division is to assist businesses in assessing and enhancing their customers' experiences while cutting costs by simplifying, modernizing, and accelerating their enterprise-wide customer engagement processes. Like many software companies on the market, VRNT is also undergoing a transition from non-recurring to recurring (SaaS). As a result of this shift, VRNT's revenue growth has slowed, and coupled with the recent macroeconomic downturn, growth slowed to low single digits in FY23 and has touched negative numbers in 1H24.
Recent results & updates
VRNT's recent performance in 2Q24 provided further evidence that the business is going through a tough time, and I expect it to continue in the near term. Hence, I am recommending a neutral rating. Specifically, for 2Q24, revenue declined further by 6% to $210 million, missing the consensus of $225 million. The miss was driven by cloud revenue growth of only 6% to $126 million.
Management's explanation of poor results at VRNT was that of a macroeconomic softening, which leads me to believe that this factor is indeed having a negative effect on the company. It was pointed out that longer sales cycles are delaying the closing of deals. While $11 million was booked in the second quarter, an additional $8 million was delayed until the third quarter. Management anticipates a further $10 million to be deferred into FY25 for the fourth quarter. One encouraging nugget is that the lack of demand was not mentioned, only a delay. Nonetheless, it was sufficient evidence to convince me that the stock's near-term performance is likely to be uncertain and weak. Additionally, it's important to note that revenue recognition rules, particularly for unbundled SaaS deals, have a significant impact, as these revenues are recognized upfront (2Q24 saw outsized impact because of this, and this could happen again).
The reason this is important is that our mix of unbundled SaaS and bundled SaaS bookings can vary quarter-to-quarter and impact year-over-year growth trends in SaaS revenue. This is exactly what happened in Q2.
Of $8 million ACV we didn't book in the quarter, approximately 50% or $3.5 million were for unbundled SaaS deals. Since revenue from the unbundled SaaS deals are recognized upfront with a standard term of three years, the revenue impact from the $3.5 million deal shortfall was $11 million of revenue in Q2.
the shift, the right of new SaaS ACV, but as Grant explained, at the same time, we think that a lot of the unbundled SaaS deals are being pushed, and also SaaS -- what we saw is unbundled SaaS is becoming bundled SaaS, and because when we apply the. From: 2Q2024 earnings call
While management did their part to help ease uncertainties by providing SaaS ARR quarterly data ($503 million in 2Q24, up 17% year over year), the market will likely be focused on the fact that cloud revenue growth has decelerated from 50+% just 2 years ago to 6% (the fact that the stock price tanked by ~20% post-earnings is evidence of my claim). Unfortunately, until this metric shows a sign of recovery, I believe the stock will be rangebound.
Furthermore, it's important to bear in mind that management has reduced their projections for FY24, providing further evidence of the unfavorable outlook. Due to the influence of broader macroeconomic trends causing delays in purchasing decisions and expansion agreements, management has revised down the FY24 revenue guidance from $935 million (at the midpoint) to $910 million. It's worth noting that this revised figure remains below VRNT's initial FY24 guidance of $945 million.
Regarding profitability, VRNT expects an expansion in gross margins as the transition to cloud services progresses, forecasting a 100 basis point (bps) increase for FY24, compared to the previously anticipated 50 bps. While this is positive news on its own, it will be somewhat offset by declines in gross margins related to non-recurring revenue. Consequently, any additional gains in gross margin are unlikely to have a significant impact.
While I am pessimistic about VRNT's prospects in the near term, I believe the stock has the potential to outperform in the medium term. The debate that management needs to address (by showing results) is that cloud growth is not all about the transition of an existing customer base. Remember that in 1Q24, the transition away from perpetual was powered equally by customer base conversion and new logos? For FY24, management has stated that new logos will account for two-thirds of growth and transitions will account for one-third. Even though it's still early, I'm keeping a positive outlook on management meeting their targets after they added more than 100 new cloud customers in 2Q24. Specifically, VRNT has increased new SaaS ACV year-over-year so far in FY24, and the company projects that it will increase this metric by double digits by year's end. While VRNT saw only 3 deals with more than $1 million TCV in 2Q24, and less than the 20+ deals with >$1 million TCV seen in 2023, it is still promising that VRNT is able to find promising opportunities in the present macro climate.
Valuation and risk
Author's valuation model
According to my model, VRNT is valued at $24.50 in the near term, implying that the stock is fairly valued at the current share price. This target price is based on my growth forecast of flattish growth (1%) in FY24, as I expect the weak macro to continue impacting VRNT's ability to find larger deals and expand current contract value with existing customers. The sales cycle will continue to remain elongated, delaying revenue recognition. In FY25, I expect the economy to recover, and VRNT will benefit from it; hence, I modeled a return to mid-single digits (5%) revenue growth.
VRNT is now trading at 2.3x forward revenue, which I believe will stay at this level in the near term as performance uncertainties continue to cloud the business. When compared to other application software providers, VRNT has historically traded at a 50% discount due to its slower growth. Given my outlook for even slower growth ahead, I believe the discount will persist.
Summary
In summary, I recommend a neutral rating for VRNT in the near term due to the persistently weak macroeconomic environment and a significant deceleration in cloud revenue growth. VRNT's recent 2Q24 performance indicated ongoing difficulties, with revenue declining by 6% to $210 million, missing consensus estimates. Management attributes this to macroeconomic softening, leading to longer sales cycles and deal delays. While demand remains intact, these factors suggest uncertain and weak near-term performance. Additionally, revenue recognition rules, particularly for unbundled SaaS deals, have had a significant impact on results. The market's focus on cloud revenue deceleration is evident from the stock's recent decline. Despite the substantial drop in share price, I do not view this as an attractive entry point, and I would advise waiting for signs of a reacceleration in cloud revenue before considering an investment.
For further details see:
Verint Systems: Wait For Signs Of Reaccelerating Cloud Revenue