Ladies and gentlemen, thank you for standing by and welcome to Verint Systems Inc. Q3 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised today's conference is being recorded.
[Operator Instructions]. I would now like to hand the conference over to your speaker today, Alan Roden, Senior Vice President of Corporate Development. Thank you. Please go ahead, sir..
Thank you, operator. And good afternoon and thank you for joining our conference call today. I'm here with Dan Bodner, Verint's CEO, and Doug Robinson, Verint's CFO. Before getting started, I'd like to mention that accompanying our call today is a WebEx with slides.
If you'd like to view these slides real-time during the call, please visit the IR section of our website at verint.com, click on the Investor Relations tab, click on the Webcast link and select today's conference call.
I'd like to also draw your attention to the fact that certain matters discussed on the 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 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 more detailed discussion of how these and other risks and uncertainties could cause Verint's actual results to differ materially from those indicated in the forward-looking statements, please see our Form 10-K for the fiscal year ended January 31, 2019 and other filings we make with the SEC.
The financial measures discussed today include non-GAAP measures as we believe investors focus on those measures in comparing results between periods and among our peer companies. Our financial outlook and targets are provided on a non-GAAP basis only.
Please see today's WebEx slides, our earnings releases in the Investor Relations section of our website at verint.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 included because management believes it provides meaningful supplemental information regarding our operating results when assessing 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 Dan.
Dan?.
Thank you Alan. Good afternoon, everyone, and thank you for joining our third quarter earnings call. We have a lot of exciting news to share and I plan to cover five topics during today's call. First, I will review our Q3 results by segments. Second, the strategic plan we announced today to separate Verint into two independent public companies.
Third, the agreement for strategic investments from Apax Partners. Fourth, the new share buyback program. And last, our enhanced disclosure in connection with our plans to separate Verint's two businesses. Starting with Q3, we're pleased with our performance and our strong execution throughout the year.
In Customer Engagement, we're experiencing strong cloud momentum. In Cyber Intelligence, our transition to a software model is progressing ahead of our plan. Our segment results drove a 10% increase in non-GAAP EPS in Q3 and a 16% increase year-to-date versus last year.
We believe we are on track to achieve our annual non-GAAP earnings per share guidance of 14% growth. Now, let's review our results by segment. In Customer Engagement, we reported 11% non-GAAP revenue growth in both Q3 and year-to-date or 12% on a constant currency basis.
We're pleased with our performance and the revenue linearity this year, and expect to finish with a strong Q4 of 11% non-GAAP revenue growth. We believe there are three key drivers behind the strong momentum. First is cloud leadership.
We design our cloud software for both SMB and enterprise customers and offer them cloud deployment models that are flexible and designed to address the specific cloud journeys. Our primary cloud model is bundled SaaS where Verint software runs in the Verint cloud. This is the most cost efficient model and our recommended choice for our customers.
Therefore, bundled SaaS revenue is growing faster than the other cloud choices we offer. Second is our agnostic go-to-market approach. Our software portfolio is open and compatible with customers' communications infrastructure choices.
Customers, resellers and communication partners benefit from our agnostic go-to-market approach, and we believe it has been a significant competitive differentiator behind many competitive wins and displacements.
And third, we continue to infuse automation across a broad software portfolio, helping organizations to achieve even higher efficiencies, while at the same time elevating customer experience. Let's take a closer look at the cloud momentum we experienced in Q3.
Non-GAAP cloud revenue increased 62% year-over-year, coupled with a strong 130% increase in new SaaS ACV. We're also pleased to report an increase in cloud adoption by large enterprise customers. In the third quarter, we had 11 cloud contracts with TCV greater than $1 million compared to only 4 in the same quarter last year.
Over the last three quarters, we had 23 cloud contracts with TCV greater than $1 million compared to 8 in the same period last year. Today, we are introducing another important operational cloud metric that management is using to measure the growth in our software bookings regardless of whether the contract was perpetual or SaaS.
This new operational metric is called new perpetual equivalent bookings, and Doug will discuss it later in more detail. I'm pleased to report that we are achieving strong double-digit growth on this metric, driven by our differentiated software and many competitive wins. Turning to Cyber Intelligence.
Our non-GAAP revenue growth year-to-date is 4.2% or 5.4% on a constant currency basis. Our transition to a software model is significantly ahead of plan, both in Q3 and year-to-date and we continue to derive less revenue this year from low-margin hardware and services compared to last year.
As a result, we now focus on gross profit growth as we believe this is a better metric to understand our true growth during this transition. We are pleased to report that our Cyber Intelligence estimated fully allocated gross profit increased double-digit year-to-date on both GAAP and non-GAAP basis.
Our broad portfolio data mining solutions help customers gain critical insights that accelerates security investigations across government and enterprise. One of the security threats that law enforcement and national security organizations are trying to address is identifying on unknown suspects.
Clearly, this is an important security objective, and many of our customers are looking to improve their capabilities in this area.
Verint has a differentiated data mining solution designed to address this unknown suspect challenge, and I'm happy to report that we recently enhanced our predictive intelligence capabilities to further differentiate our solution.
Our competitive and differentiated capabilities have driven some of the large orders we recently received, including an order for over $25 million, an order for approximately $10 million and two customers around $5 million each.
As previously discussed, we're gradually transitioning our Cyber Intelligence business from an integrator model to a software model. Historically, large deals sold under the integrator model included pass-through hardware, custom development and other low-margin services.
Over the last two years, we've made product investments, giving the choice to our customers to procure third-party hardware themselves and to leverage our open software design.
We believe there are significant benefits to our customers, making our software easier to implement and more rapidly refreshed Many customers realize that, while the integrator model provides them one-stop shop, it also comes with limitations in terms of their ability to quickly deploy software enhancements.
The software benefits Verint by improving our competitive differentiation and expanding our gross margins.
Given that the rapid reduction of low-margin hardware and services is significantly ahead of our plan, we're adjusting our non-GAAP annual revenue guidance to $460 million, while at the same time guiding to non-GAAP estimated fully-allocated gross profit of more than 10% growth for the year. This adjustment is expected to be neutral to overall EPS.
I would now like to discuss our plans to separate Verint into two public companies.
With the Customer Engagement business approaching $1 billion in annual revenue and our Cyber Intelligence business approaching $500 million in annual revenue, we believe our two businesses will benefit from the separation and becoming independent publicly traded companies.
In preparation for the separation, we've taken steps over the last several years to strengthen the two businesses operationally and believe we are now well-positioned to execute this separation plan.
We believe that both our businesses are leaders in their respective markets and the separation will enable them to achieve even better performance over the long term as the two companies are expected to benefit from separate boards with further differentiated skill sets, company-specific incentive programs and capital structure tailored to the unique characteristics of each business.
In addition, the separation will make it easier for investors to evaluate and make investment decisions in each business. Later, Doug will discuss our enhanced disclosure as we make progress towards the separation.
From a timing perspective, we believe we are well-positioned to complete the separation, tax free to shareholders shortly after February 1, 2021.
Over the last few years, as part of our strategy to give each business more operational agility, we have already substantially separated our sales, services, marketing, product management and R&D organizations. We are in the process of separating our shared services functions, including finance, legal, HR and IT.
Our plan is to complete much of this separation over the next year and use a transition services agreement post-separation. Regarding our filings, we plan to complete audited carve-out financials and make an initial filing with the SEC by the third quarter of fiscal 2021. We will provide updates over the next four quarters.
In connection with the separation, we entered into a minority investment agreement with a leading private equity firm. We chose Apax as our partner as they bring significant experience in both carve-outs and cloud transitions. We worked very closely with Apax over the last few months to structure the investments to meet our strategic goals.
The investments will be made in two tranches. The first tranche will be for $200 million and is expected to close next quarter and be used to fund our share buyback program, which I will discuss in a minute. Following tranche one, Apax will have a 5% minority interest in Verint.
The second $200 million tranche, which is expected to close at the time of the separation, will be used to further strengthen our balance sheet post-separation. Including both tranches, Apax will have between an 11.5% and 15% minority interest in our Customer Engagement business.
We're very excited to have Apax as a partner in connection with our separation. Today, we also announced a $300 million stock buyback program to be executed over the period through the planned date of separation. It will be funded partially by the tranche one proceeds discussed earlier and by available cash and debt.
We're excited about our longer-term opportunity for each of our two businesses and believe it's an opportune time to buyback our stock. As we prepare for the separation, we are adding two new directors, both with significant cloud and business model transition experience.
Andrew Miller was elected to the Verint board, bringing over 20 years of software experience. Andrew is also serving on the Verint's audit committee. Most recently, Andrew was EVP and CFO of PTC where he successfully led their transition to a subscription business model.
Prior to PTC, Andy was an executive with enterprise software companies, including Cadence and Autodesk. Also joining the Board is Jason Wright, a partner at Apax Partners. Jason will join the Verint board upon closing of the first tranche investment.
Jason leads Apax technology practice and has significant experience in carve-outs and cloud transitions. We're excited to have both Andrew and Jason join our board as they bring significant experience that is relevant to our cloud journey.
Before handing the call over to Doug to review our Q3 results and guidance, I would like to mention that, in preparation for the separation, we are enhancing our disclosure in several areas.
We have a new format for our earning release which provides more detail about our two businesses and we have a new IR website with separate areas for Customer Engagement and Cyber Intelligence, including dashboards to help investors understand the underlying drivers of our businesses.
Finally, we plan to hold an Investor Day in New York in April after our fourth quarter earning call to provide further updates on our business and the separation. And now, I will hand the call over to Doug. .
Yeah. Thanks, Dan. As Dan just mentioned, we are launching a new investor relations website tonight.
The website will provide separate financial dashboards for each of our two segments as well as information about shared services On today's call, I'd like to walk you through the new dashboard and use them to review our third quarter and year-to-date results. Let's start with our Customer Engagement segment.
This is a slide from the new dashboard for our Customer Engagement business. It's available on our website in a downloadable Excel format for your convenience, as are all of the other dashboard slides we'll discuss today. As you can see, there are five sections. Let me briefly take you through each section as we discuss our third quarter results.
The first Customer Engagement section titled revenue metrics breaks our revenue stream into two lines – software, including cloud and support, and professional services. As our business shifts more to the cloud, professional services have become a smaller percentage of our overall revenue.
In Q3, professional services as a percent of revenue was 15% compared to 18% in the same period in the prior year. We expect this trend to continue. Within software, we're breaking revenue down into perpetual, cloud and support. Cloud continues to drive most of our revenue growth. In Q3, our non-GAAP cloud revenue grew 62%.
This cloud growth is increasing our non-GAAP recurring revenue which now represents 77% of our non-GAAP software revenue. The second section is titled revenue and bookings metrics. Here you'll see our new SaaS ACV growth which, as Dan mentioned earlier, increased approximately 130% year-over-year in Q3.
You will also see new perpetual license equivalent bookings, which is a new operational metric which we are providing to help investors understand the growth in our software bookings on a more comparative basis. In Q3, new perpetual license equivalent growth was 19%. I'll discuss this new metric in more detail in a few minutes.
In the third section, titled cloud revenue detail, we're breaking down our cloud revenue into bundled SaaS, unbundled SaaS and optional managed services. In Q3, all three components increased nicely year-over-year and sequentially.
We believe providing this detail will help investors to better see the quarterly trends in our cloud revenue which can vary based on the choices our customer make in any given quarter. In the fourth section titled operating expense metrics, we're providing estimated fully allocated SG&A and R&D expenses for our Customer Engagement segment.
These expenses include shared-service allocations for IT, finance, HR, legal, facilities and some other shared service costs based on our estimates of the use of these resources in each segment.
We believe that we have world-class operating margins and our operating expenses as a percent of revenue are at an efficient level based on our current scale. Finally, in the fifth section titled profitability metrics, we're providing estimated fully allocated gross margin, operating margin and adjusted EBIDA margin.
In Q3, Customer Engagement estimated fully allocated adjusted EBIDA margin reached 30%. Overall, we're very pleased with our third quarter Customer Engagement results, which reflect strong new SaaS ACV and cloud revenue growth as well as strong margins.
Now, I would like to take you through a new operational metric we are using to track our software growth on a more comparable basis.
To normalize between new perpetual license bookings and new SaaS bookings, we have calculated new perpetual license equivalent bookings by multiplying new SaaS ACV bookings excluding maintenance conversions by a conversion factor of 2 and adding that amount to new perpetual license bookings.
The conversion factor of 2 is an estimate derived from an analysis of our historical bookings. We used new perpetual license equivalent bookings to better understand the growth of our software bookings and the shift between perpetual and SaaS. Going forward, we will include this new metric as part of our guidance and report on it each quarter.
Overall, our Customer Engagement business has continued to perform well in Q3, with significant growth in cloud revenue and new bookings. New perpetual license equivalent bookings grew 19% in Q3 and 14% year-to-date, reflecting our strong competitive differentiation. Turning to Cyber Intelligence, this is a slide from the new CIS dashboard.
As you can see, there are four sections. Let me briefly take you through each one. The first section, titled revenue metrics, breaks out revenue streams down into recurring revenue and non-recurring revenue.
As we execute our software model transition, recurring revenue has become a larger percentage of our total revenue and we expect this trend to continue. The second section, titled growth metrics, includes our revenue growth and estimated fully allocated gross profit growth.
We continue to make good progress with reducing the percentage of revenue from low-margin hardware and services. We believe that gross profit is now the best way for us and investors to measure the growth of the business.
Going forward, we'll provide guidance for both revenue growth and estimated fully allocated gross profit growth for Cyber Intelligence. In the third section, titled operating expense metrics, we're providing estimated fully allocated SG&A and R&D expense.
Finally, in the fourth section, titled profitability metrics, we're providing estimated fully allocated gross margin, operating margin and adjusted EBIDA margin using the similar shared service allocation methodology we discussed for Customer Engagement.
Overall, we are ahead of plan with our software model initiative this year and non-GAAP estimated fully allocated gross margin is up 530 bps year-to-date. We expect gross margin to continue to expand and are now becoming consistent with typical software gross margins. This slide is our new corporate dashboard showing our consolidated results.
I would now like to focus on the middle section titled shared support metrics. In this section of the dashboard, we break our expenses down to two categories – segment expenses and shared support expenses. Segment expenses are direct and controlling expenses which are associated with one of our two segments – Customer Engagement or Cyber Intelligence.
In Q3, 82% of our non-GAAP expenses were segment expenses and 18% were shared service expenses. Verint's organizational structure utilizes shared services to support both segments in a more centralized manner. A good portion of these shared service expenses are already dedicated to just one of the segments.
But as we work towards separation into two public companies, we will split the non-dedicated shared service portion into each business. Now turning to guidance for the current year ending January 31, 2020.
We are maintaining our non-GAAP revenue guidance for Customer Engagement of approximately $900 million revenue, reflecting 11% growth year-over-year. For our new perpetual license equivalents bookings metric outlook, we're expecting healthy double-digit growth for the full year.
In Cyber Intelligence, we're providing updated revenue guidance and introducing gross profit guidance to help investors better understand the impact of the software model transition.
Our non-GAAP revenue guidance is adjusted to $460 million for the year, reflecting the reduction in low margin hardware and services as our transition plan has been ahead of schedule. We expect non-GAAP estimated fully allocated gross profit to grow at about 10% this year.
Because the Cyber Intelligence revenue adjustment reflects the reduction in lower margin hardware and services, it has limited impact on our overall earnings. Thus, we're maintaining our non-GAAP EPS guidance of $3.65 for the year, reflecting year-over-year EPS growth of 14%.
Overall, non-GAAP consolidated revenue for fiscal 20 is expected to be $1.36 billion, plus or minus 2%. We expect the Apax investment to close in our first quarter ending April 30th, 2020 and we have also not factored in any share repurchase benefit as it shouldn't have much impact on a weighted share basis to our full fiscal year EPS.
Today, we'd also like to introduce our initial non-GAAP guidance for our fiscal year ending January 31, 2021. For Customer Engagement, we expect the following. 7% non-GAAP revenue growth, which reflects our anticipated mix of perpetual and SaaS bookings, and 10% growth for new perpetual license equivalent bookings.
As we have discussed today, we are using this operational metric to better understand our two software bookings growth regardless of mix shift. For Cyber Intelligence, we expect the following.
Also 7% non-GAAP revenue growth, reflecting continued reduction in low margin hardware and services, and 10% non-GAAP estimated fully allocated gross profit growth, more reflective of the true growth of this segment. Overall, we expect 10% non-GAAP EPS growth and are guiding to approximately $4 per share.
This initial guidance does not include any dilution from the Apax investment as we believe our planned share repurchases will offset dilution from that investment. We expect to incur some one-time expenses over the next year associated with the separation, which will be excluded from our non-GAAP results.
I'd like to now summarize the other announcements that we made today. We're targeting completing the separation of our two businesses shortly after the completion of our next fiscal year. We expect the separation to be done via a tax-free-to-shareholders spin of the Cyber Intelligence business.
Following the spin, Verint shareholders will own shares in two separate companies. We expect the first tranche of the Apax investment of $200 million to be completed in the first quarter, subject to regulatory clearances and the proceeds will be used as part of a $300 million share repurchase program.
We're pleased to be making today's announcements and believe this is an exciting and opportunistic time for Verint's investors, employees, customers and other stakeholders.
So, with that, operator, can we please open up the call for questions?.
[Operator Instructions]. Our first question is from Ryan MacDonald from Needham. Your line is now open. .
Good afternoon. Thanks for taking my questions. Great to see the news about sort of the planned, I guess, separation of the two businesses here. I guess I'd just like to get a little bit more thoughts on the process you kind of went through as you were making this decision.
And as you look out over the next 12 months, how should we begin to think about, once these two businesses are split, who will be running each of the businesses as we look forward? Thanks..
Yeah, sure. As we discussed many times over the last several years, our two businesses started to operate in a distinct manner both in terms of end markets and business model.
And we discussed for at least two years, operational agility which was basically to give each management team the direct control over all the resources they need to be successful in the market. And we completed this and we have two management teams for the businesses, with separate R&D, sales, services and so forth.
So, the whole design of separating the company has been in the works for quite some time. We also spent time separating legal entities because we were operating around the world with legal entities that had representatives of both businesses. So, we have to do this on a tax-free basis.
And in some cases, we approached the local tax authorities for ruling. And all that, in all the significant countries, we've done that as well. It's behind us. So, we've got to a point now with two businesses at scale, as I mentioned before, and we feel that we're ready to take the last step, which is today announcing the separation.
Over the last several months, we engaged many advisors in operational and talks and other areas to help us to prepare the plan and prepare the timeline and to gain confidence that we can actually do this with a little bit over a year from now.
And we will be executing over the year mostly around separating the shared services function that Doug mentioned, making sure that we're doing it in a very efficient way, not duplicating costs where it's not necessary and being ready for the separation. And we also mentioned we expect that the two companies will sign a transition services agreements.
Actually, we expect the TSA and a reverse TSA for the two companies providing services to each other post-separation in order to complete that in a very orderly fashion and efficient fashion. In terms of the way we're going to do it, the customer engagement business will continue to be part of Verint and we have the management team to run Verint.
And the Cyber Intelligence business will be spun into a new public company and the management team of that business will be running the new public company..
Excellent. Thanks for the clarification there. And then, as we look at sort of the updated guidance sort of provided for this year, I think it's clearly understood sort of the moving parts there.
But, I guess, as we look out into the initial outlook for FY 2021, I think previously – earlier this year, you had talked about, particularly within the Customer Engagement business, sort of revenue targets and that sort of 10% per year CAGR over the next three years.
Can you talk about maybe perhaps what you are seeing that sort of changed that view of that, I think, as we're now seeing Customer Engagement growth next year expected to be in the 7% range versus more of that 10%? Thanks..
Yeah. So, as we discussed earlier, we introduced a new metric which we've been using now in order to understand what's the true growth of software. When we transition to the cloud, few things happening in that dynamic.
First, we expect our professional services to be flat because, typically, the more professional services needed for perpetual on-premise deployments than in the cloud. So, that's kind of one dynamic. So, while significant growing double-digits, we expect professional services to be kind of flat.
Also, we expect that our maintenance, which is over $300 million, is going to start to convert to cloud as well. We expect the maintenance revenue next year to be flat.
If the conversion will be faster, we'll see a little bit of decline in maintenance, but we will see much higher cloud revenue growth and overall growth because, as we discussed before, we have an uplift when we convert customers. We expect over two factor on revenue from maintenance to cloud. So, all these things work together.
Our software is currently growing very nicely, 19% in Q3, 19% year-to-date. And we measure software growth because that's really the true dynamic in terms of our competitive dynamics and how we win business. So, we expect double-digit growth this year in software and double-digit next year.
At the same time, the other dynamics around the cloud is driving our 7% revenue growth, with a 10% new perpetual equivalent booking growth..
Excellent. Thank you very much. .
Thank you. Our next question is from Paul Coster from J.P. Morgan. Your line is now open. .
Yeah. Thank you for taking my questions.
First of all, on the deal itself, on the separation, why did you go with Apax and why did you go with the convertible stock? Why not just issue debt without a partner and buy back shares that way and still proceed with the separation? And why, for that matter, is it a preferred convertible rather than just straight equity, given that it seems to convert almost immediately judging by the way the stock has moved?.
Yeah. We spent a lot of time around this topic and we engaged with many private equity firms over the last six months. We chose Apax because of the experience they bring to us in carve-outs and in cloud transitions and because of their overall track record in shareholder value creation.
And when we start to discuss the deal structure, we structured the deal with Apax to achieve our strategic objectives. And also, we spent significant time making sure that Apax is aligned with all other shareholders.
So, for example, in tranche one, we structured a deal with a 17% premium and we also intend to offset the dilution with our new buyback program. And post tranche one, Apax is fully aligned with other shareholders to help the company to complete the separation and to accelerate the cloud transition.
When we look at tranche two, we structured the deal around a pre-determined valuation for our Customer Engagement business and this valuation is subject to a collar, but it potentially represents a significant premium to the current valuation. And also, post tranche two, we will have a stronger balance sheet.
And Apax will be aligned with other shareholders in helping the company to pursue cloud growth and M&A. So, overall, when we looked at all the alternatives, we are excited to have Apax as a partner in connection with our separation plan and the strategic objectives..
Got it. So, let me just dwell a moment on the new Cyber Intel business. I apologize, Doug. The slide is not in front of me, but you depicted the new pro forma EBIT margins for the Cyber Intelligence business.
Does that include an allocation from the shared services?.
Yeah, Paul. The numbers that we talked about are fully allocated at each of the levels, the gross profit as well as the operating expenses – the operating margins. .
So, just one other question on Cyber Intelligence because people will be looking at it sort of fresh. It looks like the recurring as a percentage is slightly lower than the Customer Engagement business. Is that – and you haven't expressed – you haven't carved out the percentage of revenue associated with professional services.
To what extent now is the Cyber Intelligence business sort of free of professional services? What is that as a percentage of overall revenue?.
Overall, professional services, including integration services, right, and hardware and custom development, all the services we've been doing is around 25% and declining pretty fast because, as we discussed, hardware for many years – and, Paul, you were reminding us that this is something that will be very beneficial.
So, finally, the hardware is declining very quickly, but you're also starting to see custom development services declining as customers are more comfortable to buy our plain vanilla software and use APIs to develop custom capabilities. And we see a little bit of our professional service change as well.
So, overall, we expect the mix to change towards less services. And for us, as we move to more software model, another benefit is that the recurring revenue is growing much faster. We have very, very little cloud in Cyber Intelligence, but we have a growing subscription piece.
That's something that, as we complete the transition to the software model, we expect also to see more recurring revenue. But for now, I think we get great benefit from the reduction in low margin hardware and services. So, gross margin expanded more than 5 points year-to-date. Gross profit is growing more than 10%.
And, of course, it's not just the financials. We see a lot of benefits to our customers because they can refresh the software much faster. When they buy under the integrator model, it's very hard for them to refresh the software. And as we know, in today's world, especially around AI and predictive intelligence, software refresh is very important.
So, great benefits to our customers from the software model and great – obviously, great benefit to Verint and I expert services to continue to decline and recurring revenue to continue to increase next year..
Welcome developments. Thank you very much, Dan. .
Thank you. Our next question is from Daniel Ives from Wedbush. Your line is now open. .
Yeah, great. And it's great to see the news. In my opinion, it's just a smart strategic decision.
To that point, maybe talk about from a timing perspective, how this frees up, strategically, the management team in terms of focusing more on the software, customer service part of the business rather than the Cyber Intelligence? Maybe you can just talk about, day to day, how this is going to change things today versus, let's say, a week ago?.
I think it's an evolution. I think we've been going through this evolution in our operational agility initiatives. So, for myself, I can say that I've been delegating more and more to the management teams of both businesses, building capabilities. We've been hiring a number of key executives in both areas.
We've had some great hires recently of cloud experts from some of the best cloud companies that we were able to attract to Verint. Obviously, we expanded the board now with two people that have cloud experience and specifically experiencing cloud transitions, which is something we pay attention to.
So, overall, I think we've been evolving in this direction and I don't expect that over one week, as you said, the company will change. We believe our strategy is working. So, there's no reason to change the strategy. We believe our teams are very focused on execution. So, I think this will be very exciting for our employees and to our customers.
And I just see more excitement and more passion about winning deals. But we'll build more and more capabilities around the separation and we expect to be ready with scale in both businesses to run as two separate public companies. .
Okay.
And then, Doug, can you just maybe talk about – do you have any concerns with stranded costs and the usual sort of issues with these types of transactions? Is that something you feel like the next year pretty scripted out in terms of no surprises?.
Yeah. As Dan mentioned, we've spent the last year or two really working on the operational separation. So, the sales, the R&D, really everything operation is already separated. We've done a lot of work already separating the entities. So, legal entities for each business already exist in the major countries.
So it's more of a back office separation, right? So, we have to build out another data center from an IT standpoint and split the applications and we have to double up a little bit kind of the finance and some of the other support resources. But, clearly, we have a year to get that done and it should be fairly straightforward. .
Yeah. And I'd like to add that because of the approach we're taking with TSA, with transition services agreement, we don't expect to ramp up the cost next year because we can basically continue to do what we need and support from each company to the other company and continue that into the following year.
So, there will be some one-time costs next year, which we're excluding from our non-GAAP reporting. But in terms of our EPS guidance for next year, initial guidance for approximately $4, we don't expect the separation to impact this guidance. .
Okay. Dan, are you going to miss all the questions about why the company doesn't get broken up? Or – okay, thanks..
Yes. I think – I'm sure I'm going to get more exciting questions. .
Thank you. Our next question is from Brian Essex from Goldman Sachs. Your line is now open. .
Hi. Good afternoon. Thank you for taking the question. And again, good to see the news on our end. Just a quick question for, I guess, whoever wants to field it.
I guess, as part of this process, maybe if you could highlight, were there other strategic alternatives that you pursued? What kind of led you down the road to be committed to this transaction? And then, maybe as a part B to the question, what are the critical hurdles left if we have certain benchmarks that we need to be aware of, such as shareholder approval, or the covenants or the debt agreement where you need to refinance the debt, what do we need to look out for and keep on our radar as we kind of look forward to the transaction?.
Okay, let me take the first part and then Doug will talk about the second part of the question. In terms of strategic alternatives, yes, we looked at many different strategic alternatives. First, we did that ourselves.
We were looking at different options and then we brought investment bankers to help the board to compare the different strategic alternatives. And we believe that this tax-free separation provides investors the ability to make the investment in each company separately.
The way mechanically this will be done is Verint investors are going to get shares in the new company where we're going to contribute to dividend basically, the Cyber Intelligence business in the new company. And investors can make these decisions on their own.
And we concluded – and as we announced – the board decided unanimously to approve the tax-free separation that we announced today. .
Yeah. Brian, in respect to kind of the requirements and the financing of the debt, the deal is subject to tax approvals, rulings from both the Israeli tax authority, ITA, and also the IRS. But we've been engaged for some time with tax advisors and feel fairly comfortable we'll be able to get those rulings in a timely fashion.
With respect to the current debt, we do have the convertible and the Term Loan B out there. We expect that we would be refinancing really both of those, perhaps with some smaller amounts. We have the Apax capital to work with as well.
We would expect that, given a lot of the EBIDA is with the Customer Engagement business, that the debt would be with the Customer Engagement and not with the Cyber business.
But we'd look to have this Customer Engagement business be very – have a very strong balance sheet out of the gate with minimal leverage and positioned very well for future growth ahead of it. .
Got it. And then, maybe just one quick follow-up.
Does this require shareholder approval and have you talked to any major customers about this?.
It does not require a shareholders vote. In terms of customers, one of the reasons we're doing the separation is because we have very few customers that are joint. And even those that have need for products from both businesses, there are different divisions, different parts of the organization.
It could be large banks that have – they have customer engagement needs and security needs that are different parts of the organization. So, in terms of customers, there's no impact. There's no – we already separated the R&D organization and technology.
So, the products we deliver to our customers today are not dependent on technology from the other company. And there's not going to be any service interruption, obviously, because there's no dependency on service resources from the other company. So, we believe that customers will see that as a non-event short-term.
But, obviously, we'll be excited longer-term that they will have pure-play companies. .
Right. Very helpful. Thank you very much. And congrats again. .
Yeah. Sure, Brian. Thanks. .
Thank you. Our next question comes from Shaul Eyal from Oppenheimer. Your line is now open. .
Thank you. Hi. Good afternoon, guys. Apologies in advance for some background noise here. Congrats on this long-awaited transaction. Looks absolutely promising. A couple of questions on my end.
Could be a little maybe premature, but do you guys know or can you estimate with respect to your NOL, in what direction it could be going down the road?.
Yes, Shaul. Yeah, the NOLs that we have now will stay with the parent company and it will be utilized as such. So, a lot of the income – US income is the Customer Engagement company. So, we expect those NOLs to get fully utilized efficiently with the structure that we've come up with for the separation..
Understood. Got it. And I want to go back actually to, I think, the first question that was have with respect to the guidance. And given the changing mechanics between a perpetual and cloud and the impact on revenue, I know, Doug, you typically don't guide to cash flow. Then, again, it could be a little too early here.
But any impact from that transition on cash flows as well down the road?.
Yeah. We'll grow about $200 million in free cash flow this year. And the cash really kind of follows the EBITDA, Shaul. So, about three quarters of our EBIDA is with the Customer Engagement business. So, about three quarters of the cash generation will be with that business as well. .
And let me give you a sense of next year. When we talk about Customer Engagement growth, we still expect about 4% perpetual software growth, right? And we expect – obviously, the cloud booking growth is going to be very high because we guided to double-digit software growth.
But it's not like our entire perpetual business is going to shift into SaaS overnight. And, therefore, the cash flow impact is very gradual. But in a couple of years, we're starting to get more cash from contracts that we signed last year and the year before.
So, we don't expect to see a big decline in cash like you would see for companies that are going through a transition in a very short period of time..
Got it. This is great. Final one, if I may, Dan, maybe a little bit – actually, back to the business, the Customer Engagement, I know everybody is still focused on the transaction. You did indicate – you did mention a $25 million win on the customer engagement.
Is that a displacement? Is that greenfield? Can you talk a little bit about that 8-digit win?.
So, look, we mentioned two things to that. Let me just clarify. We mentioned the $25 million order – more than $25 million order in Cyber and we also mentioned 23 deals over $1 million TCV in Customer Engagement. So, I think both are interesting. Cyber, from time to time, we get big deals.
That's kind of expected because of the nature of our government customers and they have large needs. But I think very interesting in customer engagement, to your point, is a very significant growth, 23 deals that are over $1 million compared to only 8 in the same period last year.
So, there's clearly more adoption in the enterprise customers and we're well-positioned to win the multimillion dollar TCV deals because the software scales very well. We mentioned that we work both with SMB and enterprise customers.
But one thing that differentiates Verint is not only that we scale well, but we also perform very well at the large enterprise. And we see that we still have very little competition when it comes to large and more complex requirements that large customers have in customer engagement. .
Got it. Thank you for that. congrats. Good luck.
Yeah, thank you. .
Thank you. Our next question is from Jeff Kessler from Imperial Capital. Your line is now open. .
Thank you. I know I'm probably in the minority here, but you know what area I'm going to be focused on. And one of the things that I'm interested in is you've traditionally had your cybersecurity business divided up into like three segments – situational intelligence, the actual surveillance and then cybersecurity itself.
And now, I see on your slide show, you've got it spun out a little bit more.
Can you talk a little bit about – after the separation, what areas of the cybersecurity business do you see being freed up from constraints that they had as part of a company that was tied together? In other words, are there areas of cybersecurity that are going to be free to grow or free to act slightly in a different manner than what they are doing now, now that they're having shared services and things like that?.
Yes. I think that, as you know very well, the security market is very fragmented. And we've been operating in cyber intelligence, cyber security and physical security, as you mentioned. The future of the Cyber Intelligence business as a pure-play company is really to expand in all three areas.
We see growth opportunities across physical, across cyber and in the government domain. And I believe that the company will have board of directors with skill sets that would be within the security industry and they will be able to guide the company, whether it's M&A or whether it's organic investment into new exciting areas.
There is really a lot of security needs. And I think we have a lot of technology in the company and it's just a matter of getting even greater focus on our customer needs and being able to continue to execute the software model, which I think we need another couple of years to get to high 60s or 70% gross margin.
And from there, I think we'll be able to grow and offer our customers a typical software model and more subscription. So, the company can be do very well in the future. And having separate management and separate board of directors will be a benefit. .
Okay. You've kind of – that's a segue into my second question, is related to what you just said. And that is, you talked about how the margin – you've been talking about how margins would be developing or hope to be developing in cyber for the last couple of years, the potential for a multiple of what the margin is now.
What are the main milestones or what are the main tests you have in front of you to get those margins up to that 60% to perhaps 70% area?.
Yeah. You remember that, not too long ago, our margins were in the 50s. Now, we're around 66%. And we guided for another year of margin expansion next year with the gross profit that we expect to grow 10% next year. So, our software portfolio is growing at a nice double-digit growth.
And at the same time, we lose some revenue by design that are low-margin the hardware and services. And we expect that trend to continue and we're still going to provide services in this business, professional services. And I expect that the margins will be around 70% in the long run.
But more important to me is that the software model provides our customers the ability to really refresh their software very quickly. And it's really critical in this environment because when they buy a product, they can wait three, four years to refresh the product. Technologies just move too fast today.
And that was the main issue with the integrator model, when you see customers looking to buy customized solutions, is that they basically find it very hard later to refresh those customized solutions.
And we've been educating customers for years now that it's in their interest to move to software model and we're very happy to see that more and more customers are adopting the new model. And we see benefits for the customers and for Verint..
So, you're hoping to essentially be that one throat to choke in cybersecurity?.
We're hoping to have an open software design that allow our customers to develop customization using APIs. Or if they prefer that Verint does it, we can still do it for them, but we'll do it outside of the core product through our own APIs.
So, many of our customers will prefer to use local integrators, IT integrators to do some customization outside the core and that's perfectly okay for Verint because our expertise is in the core software and we're happy to share customization with third-party integrators..
Okay, great. Okay, thank you very much. And congratulations. .
Yeah. Sure. Thanks, Jeff. .
Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Alan Roden for closing remarks. .
Thank you, operator. And I'd just like to mention again that, immediately following this call, our new IR website will be up and running. There'll be separate sections for our Customer Engagement and Cyber Intelligence businesses, as well as the dashboards that Doug reviewed earlier.
We appreciate everyone joining the call today and have a great evening. Thank you. .
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect..