Alan Roden - SVP, Corporate Development and IR Dan Bodner - President and CEO Douglas Robinson - CFO.

Gabriela Borges - Goldman Sachs Dan Bertram - RBC Capital Markets Paul Croitoroo - J.P. Morgan Securities Nandan Amladi - Deutsche Bank Alexander Hu - Credit Suisse Jonathan Ho - William Blair Jeff Kessler - Imperial Capital.

Good day, ladies and gentlemen, and welcome to the Verint Systems Inc. First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Alan Roden, Senior Vice President of Corporate Development. Sir, you may begin..

Thank you, operator. Good afternoon and thank you for joining our conference call today. I am here with Dan Bodner, Verint's CEO and President, and Doug Robinson, Verint's CFO. Prior to this call, we issued a press release that includes financial information for our first quarter ended April 30, 2017. Our Form 10-Q will be filed shortly.

Each of our SEC filings and our earnings press releases is available under the Investor Relations link on our Web-site and also on the SEC Web-site.

Before I turn the call, I would 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 or implied by the forward-looking statements.

The forward-looking statements are made as of the date of this call, and except as required by law, Verint 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 risks and uncertainties could cause Verint's actual results to differ materially from those indicated in these forward-looking statements, please see our Form 10-K for the fiscal year ended January 31st, 2017 and other filings we make with the SEC.

The financial measures discussed today include non-GAAP measures, as we believe investors focus on these measures in comparing results between periods and among our peer companies. Our financial outlook is provided only on a non-GAAP basis.

Please see today's earnings release and the Investor Relations section of our Web-site for a reconciliation of non-GAAP financial measures to GAAP measures.

Non-GAAP financial information should not be considered in isolation from, or as a substitute for, or superior to GAAP financial information, but is included because management believes it provides meaningful supplemental information regarding operating results when assessing our business and is useful to investors for informational and comparative purposes.

The non-GAAP financial measures Verint uses have limitations and may differ from those used by other companies. Now, I would like to turn the call over to Dan.

Dan?.

Thank you, Alan. Good afternoon, everyone, and thank you for joining us today. In the first quarter, on a GAAP basis, we delivered $261 million of revenue and a net loss per share of $0.32. On a non-GAAP basis, we delivered $266 million of revenue, or $268 million on a constant currency basis, and $0.49 of diluted net income per share.

Non-GAAP revenue increased approximately 7% year-over-year, supported by growth in both our segments, Customer Engagement and Cyber Intelligence.

We are pleased to start the year strong and our revenue growth combined with operating margin expansion drove a 23% year-over-year increase in non-GAAP operating income as well as $60 million of cash from operations.

We believe our first quarter results reflect our market leadership in actionable intelligence and is a good start for achieving our plan for the full year. Now I would like to review our first quarter results by segment.

Starting with Customer Engagement, non-GAAP revenue increased approximately 3% year-over-year to $177 million on a constant currency basis.

Verint is a leader in customer engagement with over 10,000 customers around the world using our broad portfolio across many market verticals, including financial services, insurance, telecom, healthcare, retail, the public sector, as well as SMB contact centers.

We believe our reputation for innovation and domain expertise has made us a strategic vendor for organizations across many industries as they evolve their customer engagement strategies. Many organizations currently use only a portion of our broad portfolio and are gradually adopting more solutions over time.

As previously discussed, our strategy is based on four pillars. First, we provide organizations deployment flexibility. Our solutions can be deployed on premises, in the private cloud, public cloud, or in a hybrid fashion with some solutions deployed on premises and some in the cloud.

Second, recognizing that organizations are evolving at different paces with unique journeys Verint solutions are designed to be highly modular, open and simple to integrate, so customers can start anywhere within our portfolio and add the pieces they need over time.

Next, Verint offers the industry-broadest and most innovative portfolio of best-of-breed solutions for holistic customer engagement across contact centers, branch, back-office operations, customer experience, and digital marketing. Our solutions help organizations leverage real-time shared intelligence across the enterprise.

And finally, we have invested in building an extensive partner network, including technology partner and a network of resellers, and they provide customers interoperability and simplicity in purchasing our solutions. We believe our ACD neutrality and our large and growing partnership program is a competitive differentiator.

Two weeks ago, we held our annual user conference in Orlando, with more than 1,000 people in attendance, and we discussed several new products we plan to launch in the near future. I would like to highlight some of the innovations we discussed with our customers in the areas of business automation and shared intelligence.

In the area of business automation, we are investing in machine learning and robotics capabilities to help our customers drive efficiencies. For example, our new automated quality monitoring solution is designed to automate and improve the agent's scoring process, freeing up managers for more value-added activities.

Another example is the launch of a new back-office robotic solution which is designed to replace manual repetitive processes with machine-learning automation, reducing cost and increasing employee productivity.

A third example is our new bots development toolkit, designed to enable easy integration and deployment of bots developed by Verint as well as by third parties. And in the area of advanced analytics, we are investing to help our customers gain insights and achieve their business objective by leveraging real-time shared intelligence.

For example, our speech processing solution has been enhanced to enable real-time alerts and agent guidance. Another example is our new enterprise multimedia recording solution, which includes open access to data to enable data mobility and analytics across the enterprise.

And a third example is our new knowledge management analytical solutions, that leverages best practices across agent and self-service channels, enabling more timely, consistent and accurate answers for agents and customers.

We believe our investments in innovation enable us to win new customers, expand our footprint with existing customers, and become a more strategic vendor. Here are some examples of recent wins.

$3 million in orders from a leading insurance company; this customer previously deployed some of our applications in the cloud and decided to add multiple additional applications from our portfolio deployed on premises. This customer is a good example of how our flexible hybrid deployment model is enabling us to become a more strategic vendor.

Approximately $3 million in orders from a leading transportation company that decided to replace two legacy vendors as well as some home-grown solutions with multiple applications from our portfolio. This demonstrates the value organizations are getting from taking a more integrated suite approach to customer engagement.

Approximately $3 million in orders from a global financial services company as part of its strategy to standardize its customer engagement operations around the world; this customer, which is expanding the deployment of our solutions in the Americas, EMEA and APAC regions, shows how we are a strategic vendor that can scale globally.

Approximately $2 million in orders from a healthcare company that decided to replace the legacy recording vendor and add speech and desktop analytics. This is an example of a customer that moved to our recording suite due to our sophisticated analytical capabilities.

In summary, we believe we have become a more strategic partner to our customers and are extending our market leadership by expanding our portfolio of innovative solutions, offering customers flexible deployment models, and growing our partnership program. We look forward to another year of growth in Customer Engagement.

Now turning to Cyber Intelligence, Q1 non-GAAP revenue increased 19% year-over-year to $91 million. As we discussed previously, as we scale we expect our operating margins to improve. Our Q1 Cyber Intelligence revenue growth drove a 5% year-over-year improvement in our fully allocated non-GAAP operating margin.

In our Cyber Intelligence business, revenue typically lags booking to some extent, and our strong Q1 revenue growth reflects not only the business activity within Q1, but also the strong business activity we had last year.

We believe that there is ongoing demand for data mining security and intelligence solutions to address terrorism, crime, cyber attacks and other threats that remain pervasive around the world.

Detecting, investigating and responding to security threats is becoming more complex and security organizations are increasingly seeking advanced data mining solutions to help them capture data and generate actionable intelligence. Verint is a leading provider of security and intelligence data mining software.

Our solutions, which combine sophisticated data mining technology and deep domain expertise, are used for a broad range of use cases including national security, law enforcement, cyber security and situational intelligence.

The use cases in which we are currently seeing significant interest from customers include national security and law enforcement agencies, which use our solutions to capture and fuse data from many sources, analyze the data, gain insights and take action.

We have significant experience deploying large-scale solutions for these types of agencies globally, including winning and delivering $10 million-plus projects. Our success in winning large-scale projects is driven by our data mining capabilities, domain expertise and broad portfolio.

The second use case are government cyber security organizations which use our solutions to build intelligent security operating centers and leverage data mining to make their cyber analysts more effective in responding to and eliminating cyber threats.

We recently issued a press release for a multimillion dollar win for Latin American government for a project to protect that country against sophisticated cyber attacks. During Q1, we continue to win large deals, including two orders for around $10 million each and an additional order for $5 million.

While we continue to focus our sales effort on advanced solutions for national security, law enforcement and government cyber security, we're also investing to expand our total addressable market to the critical infrastructure and enterprise security markets. We believe these investments will contribute to faster growth over time.

We also expect to gradually improve our margin profile as we create further scale in our security business.

In summary, we are pleased with our Cyber Intelligence growth in Q1 and we are well-positioned to achieve high single-digit growth this year, as organizations around the world seek sophisticated security and intelligence data mining solutions, such as ours.

Now before discussing our guidance, I would like to provide an update on our initiative to increase operational agility.

As discussed in the past, we are providing the management team of each business segment better control over the business, with improved tools and new business processes, to quickly respond to market dynamics in their respective markets. In our last conference call, we discussed alignment of compensation plans and some new business metrics.

Today we are pleased to report that we have substantially completed the upgrade of our ERP system, which we expect will provide a better foundation for business tracking and reporting in each segment. This is a significant system upgrade and we are pleased that it will be completed on time and on budget.

We believe the steps we are taking to improve our operational agility will result in improved business performance for each segment. Turning to guidance, we had a strong start to the year and continue to expect mid single-digit revenue growth in Customer Engagement and high single-digit revenue growth in Cyber Intelligence.

We continue to invest in our two businesses to drive long-term growth, and expect our earnings this year to grow slightly faster than revenue, with some margin improvement. And now, let me turn the call over to Doug to further discuss the financial results and guidance.

Doug?.

Thanks Dan. Good afternoon everyone. Our discussion today will include non-GAAP financial measures. A reconciliation between our GAAP and non-GAAP financial measures is available, as Alan mentioned, in our earnings release and in the IR section of our Web-site.

Differences between our GAAP and non-GAAP financial measures include adjustments related to acquisitions, including fair value revenue adjustments, amortization of acquisition related intangibles, certain other acquisition related expenses, stock-based compensation, as well as certain items that can vary significantly in amount and frequency.

For certain metrics, it also includes adjustments related to foreign exchange rates. I'll start my discussion today with the areas of revenue, gross margin and operating margin. In the first quarter, we generated $266 million of non-GAAP revenue, or $268 million on a constant currency basis.

Segment revenues were $175 million in Customer Engagement, or $177 million on a constant currency basis, and $91 million in Cyber Intelligence. This compares to $249 million of non-GAAP revenue in the first quarter of the prior year, with $172 million in Customer Engagement and $77 million in Cyber Intelligence.

In terms of geography, in Q1 we generated non-GAAP revenue of $148 million in the Americas, $81 million in EMEA, and $37 million in APAC. This compares to $139 million in the Americas, $73 million in EMEA, and $37 million in APAC in the first quarter of the prior year. Q1 non-GAAP gross margins were approximately 63%.

As we've discussed in the past, due to product, services and revenue mix, within or across segments, overall gross margins can fluctuate significantly from period to period.

From a segment perspective, our Customer Engagement business is primarily software and services and our non-GAAP gross margins in that segment were in the high 60s for the quarter, similar to other software companies with the same product/services mix.

Our non-GAAP gross margins in our Cyber Intelligence segment are lower than Verint's overall gross margins, reflecting the mix of hardware, software and services, including from third-party vendors in that business. For the year, we continue to expect our total non-GAAP gross margins to be in the mid-60s, similar to last year.

During the first quarter, we generated non-GAAP operating income of $42.7 million, with an operating margin of 16.1%. Our adjusted EBITDA for the quarter came in at $50.3 million or 18.9% of non-GAAP revenue. Now let's turn to other income and interest expense.

In the first quarter, non-GAAP other expense net totaled $7.1 million, reflecting $6.2 million of interest and other expense and $0.9 million of foreign exchange charges primarily related to balance sheet translations. Our non-GAAP tax rate was 10.8% for the first quarter.

As we've discussed previously, we expect to enjoy a low non-GAAP tax rate for several years due to our NOLs and the amount of income we generate in low tax rate jurisdictions. For the quarter, we had 63.5 million average diluted shares outstanding. These results drove diluted non-GAAP EPS of $0.49 for the quarter.

During our last conference call, we discussed our expectation for operating expenses to increase in Q1 to support our growth. While we continue to expect expenses to increase this year, expenses increased more gradually in Q1 than we initially expected, contributing to the overachievement in EPS.

Now turning to the balance sheet; at the end of Q1, we had $409 million of cash and short-term investments, including both short-term and long-term restricted cash. Cash flow from operations on a GAAP basis in Q1 was $60 million, providing a good start to the year.

We ended the quarter with net debt of $400 million again, including both short term and long term restricted cash and excluding discounts and issuance cost primarily associated with our convertible debt.

The term loan market is currently very attractive and we are looking to refinance our term loan facility with a view to extending its maturity and obtaining some improvement in terms. Before moving to Q&A, I'd like to discuss our guidance for the year ending January 31, 2018. Starting with revenue, our outlook remains unchanged.

In Customer Engagement, we expect mid single-digit revenue growth. In Cyber Intelligence, we expect high single-digit revenue growth. Overall, we expect revenue of $1.14 billion, with a range of plus or minus 2%. From an operating margin perspective, we expect operating margins in the current year to improve slightly from last year.

In Customer Engagement, we expect fully allocated operating margins to slightly improve as we deliver another year of margins in the low 20s. In Cyber Intelligence, we expect fully allocated operating margins to be above 10% this year, compared to approximately 10% last year.

Longer term, we expect our Cyber Intelligence margins to continue to trend upwards as we scale the business.

You can approximate our fully allocated segment operating margins by distributing our unallocated expenses, which are shown in our 10-Q Segmentation footnote, excluding our non-GAAP adjustments provided in our earnings release, proportionately to segment revenue.

We expect our non-GAAP quarterly interest and other expense to be approximately $6 million, excluding the potential refinancing of our term loan that I mentioned previously and excluding the potential impact of foreign exchange as well.

Given volatility in foreign exchange rates, there could be future gains or losses related to balance sheet translations in our future results which are not included in our guidance. We expect our non-GAAP tax rate to be approximately 11% for the year, reflecting the amount of cash taxes we expect to pay this year.

Based on these assumptions and assuming approximately 64.3 million average diluted shares outstanding for the year, we continue to expect non-GAAP diluted EPS at the midpoint of our revenue guidance to be approximately $2.70.

In addition to our annual guidance, we would like to provide you some color on the progression of the year for modeling purposes. For revenue, last quarter we discussed a $10 million sequential increase from Q1 to Q2.

While we over-achieved revenue in Q1, we continue to expect approximately $270 million of revenue in Q2, followed by sequential increases in Q3 and Q4. As a reminder, our typical seasonal pattern is for the second half of the year to be stronger than the first half.

Relative to margins, as discussed earlier, our expenses in Q1 came in lower than expected. However, we continue to expect operating expenses to ramp up in Q2 sequentially by approximately $8 million, with a slight improvement in gross margin of approximately 1%.

In conclusion, we are pleased to start the year strong and believe we are well-positioned for sustained growth in both Customer Engagement and Cyber Intelligence. Longer term, we believe the steps we are taking to increase operational agility will enable each operating segment to improve performance and extend their market leadership.

This concludes my prepared remarks.

With that, operator, can we open up to questions?.

[Operator Instructions] Our first question comes from the line of Gabriela Borges of Goldman Sachs. Your line is now open..

Congrats on the solid quarter. Dan and Doug, my question is on the seasonality of revenue growth that we should expect from here.

I'm trying to reconcile the very strong Cyber Intelligence growth in the quarter, with your full year guidance for high single digits, and then likewise for Customer Engagement, coming up 3% in the quarter, with your guidance in the mid single digits for the full year.

Could you just give us a little color on the expected drivers of acceleration in Customer Engagement and deceleration on the Cyber Intelligence side? Thank you..

Okay. So this is just the first quarter and we are happy to start the year strong. But as we mentioned, we have an unchanged view of the overall year. We believe the drivers in both markets are strong for growth. In Customer Engagement, we are projecting 5% growth.

But as we said in our prior call, and we continue to say the same thing this quarter, we expect our cloud business to grow 25%, or actually more than 25%, like last year. So, what we see in Customer Engagement are strong growth drivers that are based on our very broad, best-of-breed portfolio and hybrid cloud and customer flexibility.

We have a very large customer base. A lot of the customers just have a portion of our portfolio and continue to expand over time with Verint, and of course we win new customers. So we see all these positive things going on. And of course the cloud revenue growing more than our overall growth is contributing to the mix of mid single digit growth.

We do have all our products cloud enabled. We provide customers flexibility how they want to deploy and we still see many customers deploying on premises, many customers like the hybrid model, and the result is our mix of cloud growing faster than overall growth. But we believe that the mid single-digit is achievable for the year.

In terms of our security drivers, clearly we discussed strong business activities last year, and that created many projects that we started to deploy. Some of these projects we deploy over a number of years. So, that's one area where we are going to gradually make investments, so that we have more capacity to deliver projects.

And as we look at the projects as we are going to deliver every quarter, there will be a different mix that can result in different growth rates each quarter. So, it could be a little bit lumpy in terms of the growth rates in security. Q1 is 19%, which is great, but we still think we can achieve high single-digit for the year..

That's helpful. Thank you. And as a follow-up, if I could, you mentioned a little bit the ACD neutrality in the prepared remarks.

Maybe you could give us a little more color on how important the CCI vendor is in recommending or reselling WFO software in your relationships and why that neutrality is important?.

ACD neutrality we think is a winning strategy and we're very much invested in this strategy, because we see that the voice infrastructure market is very fragmented. Last quarter we discussed AWS coming into the market. We continue to see lots of vendors, legacy and new vendors, that are offering voice infrastructure solutions.

And we see that all of these vendors need business application partners, and we have a very broad portfolio of business applications. So we are a natural partner to the voice infrastructure market. We don't want to be in that market. We think it's highly competitive.

And at the same time, we see that we have many strong partnerships that are getting stronger because some of our competitors have chosen to participate in the voice infrastructure market, and that obviously makes them competitors and we see more of their competitors focus on Verint as their partner.

So, longer-term, we think it will be great for our customers to be able to make decisions on business application and voice infrastructure separately, because we are integrated with basically all of the leading vendors.

That gives the customer the flexibility to either keep what they have in voice infrastructure or upgrade what they have in the voice telephony infrastructure, and decouple that decision from what they do with business application, whether it's workforce automation or voice of the customers, on analytics, business automation, enterprise intelligence, all these are very important decisions the customer makes and they don't need to make them coupled with the telephony decision.

So, the way we approach the market, for the enterprise market we work directly with customers and through channels, and we are completely agnostic and allow them to make those decisions with complete flexibility. And in the SMB market, we have more than 100 resellers that resell our products bundled.

So they bundle the telephony of their choice with our applications and they provide customers with bundles, and we do recognize that SMB customers like to buy packages and bundled solutions, but we are very happy to be able to deliver that through our very extensive partner network..

That's helpful. I appreciate all the detail..

Our next question comes from the line of Dan Bertram of RBC Capital Markets. Your line is now open..

So we just finished off the first quarter here. I'm curious if there are any changes made to the sales force for the new year from an allocation coverage quota perspective. I know last year we had somewhat of a pivot to more land and expand strategy..

That's a very good question. So first, it's all behind us. We defined a go-to-market strategy and aligned the sales force with our objective. And of course one of the objectives we had is 'land and expand' because we have very large customer base, we also have a very large portfolio.

So clearly one of the things we have done, and we believe it's going to help accelerate growth, is that our sales force will be more productive with our entire portfolio. We have a go-to-market that allows our customers to start anywhere.

So we are not asking our customers to buy a certain product, we are not asking them to upgrade voice infrastructure in order to get new capabilities.

They can start with business automation and they can use machine learning to automate a process and get right away, and of course that decision is totally decoupled from any other upgrade that they need to do. So our sales force is very much a consultative sales force.

We help the customers identify business needs based on their own priorities, see where they can get the best return on their investment, and then we offer them ideas how they can implement parts of the Verint portfolio.

And as you can see, for the examples we gave earlier, some customers decide to just do a more gradual upgrade, one module at a time, and others take two or three modules in one purchase.

But more importantly, I think they recognize the power of the suite and they recognize that with Verint, buying a suite doesn't mean that they have to compromise on best-of-breed. So we allow them to buy best-of-breed discrete solution but we also allow them to enjoy the integrations that we invested.

And one key differentiator that I think our sales force is using very effectively is around business automation and shared intelligence.

I think this is very important to our customers to be able to share the insights across the enterprise, not just to keep them in silos, and Verint's approach to having an open and simple to integrate portfolio supports that.

And of course business automation with the advancement in artificial intelligence and machine learning, there is more and more analytics that we put into our solutions. And it's not just an analytics module. We actually embed analytics in each and every one of our best-of-breed modules and that resonates very, very strongly with our customers.

And again, to the voice infrastructure question from before, I think more and more customers realize that they can keep their routing product. There is no reason necessarily to upgrade routing if they want to enhance business automation or shared intelligence.

And that's where the sales force is focusing, let's do what the customer really need and not focus on what the vendor agenda is..

Thanks.

And then on the security project for Latin America, just curious if that's reflective of less FX pressure in the region or is that still a significant constraint for customers or potential customers there?.

I think that there is some constraints there still from currencies in the Latin America region, but I think last year when we discussed the problem with slowdown in economy and currency weaknesses, I think we made a prediction that security will remain a high priority.

So while it's not back to what it was three years ago, we do see some improvement in funding security, because it's a high priority for this government..

Our next question comes from the line of Paul Croitoroo of J.P. Morgan. Your line is now open..

Dan, there seems to be a pretty steady cadence of new wins in the Cyber Intelligence segment. To what extent – you have already mentioned FX, commodity prices have stabilized, that's probably helping in emerging markets, and you have also got various activities happening in France and U.K. that presumably stimulate demand for your product.

Can you talk about the pipeline as it currently stands, is it quite deep? Can you also talk about how much visibility you have from the backlog of projects, at least as far as fiscal year 2018 is concerned, 2017 calendar year?.

Thanks Paul. You raised a few points. So first in terms of pipeline, yes, it is growing, our pipeline is growing both for potential megadeals, and megadeals are $10 million-plus deals, as well as smaller chunks. So we see pipeline growth in both areas. It is global in nature.

So there are strengths in different parts of the world, and as you know, we sell into 100 countries globally our security products. The unfortunate events in Europe which continue, do increase the awareness that intelligence is important, not just to expedite the investigation of events, but also hopefully to prevent such events.

And to create better intelligence is complex. It requires collection of data from a lot of different sources, fusion of this data, a lot of analytics and our data mining solutions are very effective but we also have domain expertise in this area.

I talked about how we work closely with national security organizations and cyber security organizations in governments around the world. So we help them to do things in a way that will be effective, and one of the issues that governments around the world have with intelligence is shortage in data scientists and cyber analysts.

So, part of what we do with data mining is help to automate the intelligence gathering, so that there is less need for these people that are not only very expensive but also very difficult to get and train to be effective. So that's part of the intelligence challenge.

It's the budgets that they allocate in order to buy this type of solutions, but also it's how those solutions really are designed to work within their own environment to deliver the type of domain expertise that is very different for this type of security organization and the type of challenges that they have.

So we continue to invest in this data mining approach and helping customers not only gather better intelligence, but do that effectively with less reliance on cyber analysts. So overall, I think we are well-positioned. We are a market leader in this global market.

National security, law enforcement and government cyber security are the main areas where we generate the majority of our revenue. But also as we discussed several times, we want to invest to expand this into the critical infrastructure and enterprise market, and we believe that will increase our TAM and accelerate our growth.

So, with last year events, we obviously could not afford investments and we were more focused on the core markets, but as we scale back our security business, we expect that beyond national security and government cyber security, you will see more enterprise and critical infrastructure activity..

And what about visibility for the current fiscal year? I mean, I imagine you've got very good visibility through the year.

What percentage of revenue do you think you can look into?.

Yes, we got good visibility. So I can give you an example obviously. Last year we announced the $200 million contract, so that's one. Last year we had revenues about $30 million. This year we expect $50 million to $60 million. And of course that leaves more than $100 million for next year. So it's good visibility for the current year and for next year.

And as we discussed before, the ability to accelerate growth in our security business is somewhat constrained by the resources that we have to deliver, because this project require attention to how we deploy with quality. And we are ramping up resources.

We discussed increasing investments $8 million in Q2, which is predominantly going to be in the security business and predominantly will be in technical resources, and that's part of leveraging the visibility but also being able to translate those contracts into revenue that we can recognize upon delivery..

Thank you very much..

Our next question comes from the line of Nandan Amladi of Deutsche Bank. Your line is now open..

So Dan, you mentioned the cloud business, you expect to grow that by 25% this year.

How is the customer behavior, I guess the buying behavior changing, and what impact might that have both on your license growth as well as your maintenance renewals over time as customers begin to convert, how much of this is existing customers converting versus new business?.

A lot of it is new business actually. So when we look at the customer engagement market, we see that the voice infrastructure market is moving to the cloud quite fast. But the decisions, as I mentioned before, the decision to buy business applications do not need to be coupled to the decision that customers make with their telephony systems.

So while the telephony can move to the cloud, many customers choose to keep their applications on prem, especially when we deal with areas where there is a lot of data and customers are concerned about security or just customers that have large internal networks and they want to keep it in their internal cloud, they don't want to go to public cloud.

So what we find is that while the telephony market or the voice infrastructure routing market may go to the cloud, our customers really like that flexibility, they can choose to do something different with the business applications that we have.

So, almost in every deal now customers like to see proposal from Verint, cloud and non-cloud, sometimes they want to see more than two or they want to see public cloud, private cloud and on-premises proposals, and they can compare and decide what's the right decision in their circumstances.

So, the 25%-plus growth that we report now is really a reflection of how customers like to deploy. It's not something that we push to the market. But it's mostly new customers, and I would say that if this continues, which we expect to continue, then we'll see our 60% recurring revenue growing into high-60s or 70% recurring revenue.

There are still going to be some customers who will prefer to buy the license rather than rent the license just because it's more economic, especially large customers, but we think that over time we'll have more recurring revenue and that obviously is positive in terms of visibility..

Thank you. And a follow-up if I might, you have talked for the last couple of quarters now about making the two divisions within your Company somewhat independent operationally and so on. You just talked today in the prepared remarks about the ERP systems being up and running.

If you do indeed decide to separate the Company into two independent divisions, what are some of the factors you would take into account for that decision to be basically approved by the Board?.

We are moving forward with the operational agility and we reported progress. So we believe that that initiative is driven by improving business performance and focus on market dynamics that are different in the two markets. So, for example, we talk about cloud in Customer Engagement, but national security agencies do not buy cloud.

So this is obviously different dynamics. We have a project approach in security which we actually have this model for many years and we are going to transition the security market to be more product-oriented. So that's an initiative that our security business is focusing on.

So, what we found is that as we scale the Company and we reach the 1 billion-plus level, we have two businesses and just need to focus on two different agendas. And rather than drive those agenda from a corporate level, we want those two management teams to each drive their own agendas and focus on the dynamics in their markets.

That's agility that creates better response, faster response to customer demand, and eventually that's going to lead to better business performance. We also discussed the fact that we are keeping the shared services model.

So we are not going to duplicate our finance, IT, legal, HR, and all these functions, which obviously that creates good synergies to keep the two together. And at the same time, we are upgrading some systems that we think is a good foundation to start to build those metrics and processes for each business.

And I mentioned before that we completed an ERP upgrade, which was pretty complex, and I'm very pleased that it was done on time and on budget. And of course that's going to give a lot of flexibility to each of the two businesses to continue to improve their reporting and metrics that they need in order to be agile. So, all these things are ongoing.

It doesn't require, to your question about Board approval, it is part of the strategic plan and it's part of the plan to accelerate growth for each business..

So we are trying to create that operational agility while not duplicating costs and impacting our margins..

Thank you..

Our next question comes from the line of Michael Nemeroff of Credit Suisse. Your line is now open..

This is Alex Hu on for Michael. Thanks for taking my questions and congrats on the quarter.

Just curious longer term, let's say three or five years out, how do you guys view the growth prospects and the operating margin profile for Customer Engagement as well as Cyber Intelligence?.

So in terms of the long-term model, starting with security, other than last year which was an anomaly, we had a history of double-digit growth. And with the security emergences around the world, we believe we can get back to double-digit growth in security.

In Customer Engagement, as I said before, we are targeting right now mid single-digit, but that's with a mix of 25% plus growth in cloud. So at some point I think we can start to accelerate also the growth rates as we move more into the cloud in terms of the mix of customer engagement.

So, with some improvement in revenue growth over time, when we look at the long-term model, we believe that right now gross margin are in the mid-60s and should improve a couple of points over time.

We believe that our operating margin, which we expect to be around 20% this year, should also expand over time, both because of the gross margin improvement but also because of increased scale. And all this will result in EPS growing faster, slightly faster than revenue due to this margin improvement.

I also think that we will be – also as I mentioned before, I think we'll be also in recurring, from a recurring revenue, I think with this cloud growth rates, we will have more recurring revenue. So we will be more stable in terms of our visibility..

Great. That's actually very helpful.

And just one more follow-up, just curious if you guys were to monitor your spending just a little today and let a bit more cash and earnings flow to the bottom line, do you think there would be a material impact to your growth prospects? Specifically, how do you assess the amount and/or ratio of spending needed versus the potential growth that you could achieve in the future?.

It really comes to the sacrifice of the future revenue, right. So yes, we could do that and we could go after short-term margins, but certainly we'd put a lot more risk on the long-term revenue growth. So we have to strike that balance where we feel we are making the investments necessary to drive the revenue that we need to drive..

I agree with Doug. I think if we look at the two businesses, we are a market leader in both businesses with good market share and many years of activity and building customer relationships in both markets. And we believe that both markets are good markets.

The customer engagement market is going through a lot of changes and there is a lot of focus on intelligence and insight and automation, and the security market, and I repeat myself, but a lot of positive drivers.

From our perspective, it makes sense to do what Doug said, which is make sure we have some margin improvement, but also at the same time while we have slight margin improvement, we make the right investments for long-term growth..

Okay, great. Thank you and congrats on the quarter again..

Our next question comes from the line of Jonathan Ho of William Blair. Your line is now open..

I just wanted to start with the expense side. You guys talked about that growing a little bit more slowly than you anticipated for the first quarter.

Can you talk about maybe what drove that, was there any difficulty in finding qualified people or what are sort of the driver behind that slower than expected expense growth?.

I think that our appetite, as we just said, our appetite for investment is obviously a big appetite because we see the long-term growth potential.

But as we look at Q1, the mix of projects that we deliver in Q1, we just thought it wasn't really necessary for us to ramp up the investment to make Q1, but that doesn't mean we don't need to make these investments, right. So that's why we said, in Q2 we're going to make the investments of $8 million..

Got it. And then in your prepared remarks, you also talked about the increase in terms of automation and some of the new products in the robotics area.

Can you talk about how you balance maybe the potential for a reduction in call center seats with these automated processes and what you can sell on that side?.

So, unlike again the infrastructure market, it is very much dependent on seats and the pricing models on a per seat basis. We don't see necessarily the number of seats the driver for spending with on Verint solutions. When you look at different type of engagement channels, social media, e-mail, chats, these are not anymore on a seat basis.

When you look at large management automation, it's not on a per seat basis.

Just to give you an example of automation, just an anecdote that I heard from one of our guys yesterday, that we are automating basically a back-office process for a customer that is a refund process that use a group of people offshore to process refund request by customers, and this is a very mechanical process, and with some machine learning we are going to basically eliminate the need for that process and of course the people can focus on more interesting activities in customer engagement.

So, for Verint, it's not a traditional per seat model. We have a very large portfolio that addresses voice of the customer. It has nothing to do with the number of seats in the contact center. This is more about soliciting insight from customers about their experiences.

We have a security [indiscernible] customer engagement where we help organization identify fraud, authenticate customers. So, I don't think that number of seats is a driver in terms of our ability to grow the business..

Our next question comes from the line of Jeff Kessler of Imperial Capital. Your line is now open..

Looking at your cyber business, it has a number of components in there that have been you want to call them legacy or deep domain legacy pieces of the business that you've had.

Can you talk us through how, granted that each project is different, I realize that, how do you go about determining with the customer how much software, what hardware in terms of video or audio goes into the project, how much customers, what customer services do they need, and as you start moving out of the government and national intelligence channels toward your goal of getting into both enterprise, getting into enterprise and critical infrastructure, does the nature of what you are going to be installing, the nature of the project itself change a little bit, and do the gross margins change a little bit?.

I think it's a very good question because a lot of things are going to change as we expand our TAM, but what's not going to change is our core product with our data mining software products.

So, if you look at what we actually design, and more than 95% of our R&D effort is in the data mining software area, but sometimes the government agencies would like us to provide them a turnkey solution, so we deliver projects.

And as I mentioned before, over time we want to change our models from projects to products, because the value of our software is productized and we want to be better at still delivering a turnkey solution for our customers, but managing better the various components of the project.

So, I would think that for very large national security organization where we land the $20 million, $30 million, $50 million contracts, obviously we are more flexible in working with them to address a turnkey solution, and when we go to critical infrastructure and enterprise where typically the projects are sub-$1 million or a few million dollars, obviously we sell product, and there is a system integrator that does the rest of the work.

Verint is not a system integrator, but we do some system integrated work for our larger customers. And when we do system integrated work, we also incorporate third-party products, which could be hardware and software, and that obviously reduces our overall margin.

So the margin on our products is pretty high, but the overall margin when we incorporate third-party products, we get some lower margin.

So I would think that in our core strength, national security, law enforcement, large government cyber security organization, we certainly will continue to have the same approach because this is the way customers will like to buy.

And then as we expand to additional markets, we will have a more productized approach and we're going to leave it to system integrators to deliver third-party products and services..

Okay. Just a quick follow-up directly related to that question, there are fewer and fewer system integrators out there that have perhaps the IT IQ to be able to do these projects, particularly on the physical side, and there is not that many on the IT side that have logistical capabilities.

Are you wiggling down the number of system integrators to those who can provide essentially the best services on both ends, and if they can, does it necessarily means the gross margin has to be hit?.

I think that what you are describing is a slow transition in the market to more capable integrator dealing with advanced security solutions.

But still many integrators are doing the legacy security of sensors and wiring and there are fewer integrators that are capable of delivering advanced security, big data type of projects, but I think that there are integrators that are moving into this market slowly and we will be happy to partner with those integrators.

Our model is to be a product company. We don't want to be a system integrator. Again, we are happy to do some system integrator jobs on large projects, because our customers believe that we are the best partner for them. But when we have capable integrators, we are happy to partner and leave those system integrator functions to our partners..

So Verint brand still stay in those projects where the system integrator comes in? Are you still….

Very much so, because in addition to software, we deliver a lot of domain expertise. The world of cyber intelligence is very, very specific world where integrators need Verint people to come in and help them and we are very visible to the customers.

So, very rarely in a multimillion dollar project, the end-user doesn't know that Verint is the supplier. They know that, they see the Verint people, and they learn a lot from Verint in terms of best practices and how to implement those types of technology in their environment..

Thank you very much, Dan. I appreciate it..

Thank you and I'm showing no further questions at this time. I would now like to turn the call over to Mr. Alan Roden for closing remarks..

Thank you, operator. Thank you everyone for joining us tonight. We look forward to talking to you on our next call. Have a great evening..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day..