Verint Systems Inc (VRNT) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Verint Systems Inc. first quarter earnings conference call. (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'm 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 website and also on the SEC website.

Before starting the call, I'd 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 can 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 31, 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 of 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 website for 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 our 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'd 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 a broad portfolio across many market verticals, including financial services, insurance, telecom, health care, 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 4 pillars. First, we provide organizations deployment flexibility. Our solutions can be deployed on-premises; in a private cloud; public cloud; or in a hybrid fashion, with some solutions deployed on-premises and some in the cloud. Second, recognizing the 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 agents' scoring process, freeing up managers for more value-added activities. Another example is the launch of a new back-office robotics 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're 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 2 legacy vendors as well as some homegrown 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 health care 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've 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 there is ongoing demand for data mining security 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 intelligence data mining software. Our solutions, which combine sophisticated data mining technology and deep domain expertise, are used for 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 intelligence 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 a Latin American government for a project to protect their country against sophisticated cyber attacks. During Q1, we continued to win large deals, including 2 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 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 2 businesses to drive long-term growth and expect our earnings this year to grow slightly faster than revenue with some margin improvements.

And now let me turn the call over to Doug to further discuss our financial results and guidance. Doug?

Yes, thanks, Dan, and 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 website. 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 in short-term -- 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 costs primarily associated with our convertible debt. The term loan market is currently very attractive, and we're 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, proportionally 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'd 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 overachieved 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're 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're taking to increase operational agility will enable each operating segment to improve performance and extend our market leadership.

This concludes my prepared remarks. With that, operator, can we open up to questions?

(Operator Instructions) And our first question comes from the line of Gabriela Borges of Goldman Sachs.

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 for 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?

Okay. So this is just the first quarter, and we're 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 our Customer Engagement are strong growth driver based on our very broad, best-of-breed portfolio and hybrid cloud and customer flexibility, where 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 are cloud-enabled. We provide our customers flexibility, how they want to deploy, and we still see many customers deploying on-premises. Many customers like the hybrid model, and we -- 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 that we are going to deliver every quarter, there will be a different mix that can result in different growth rates each quarter. So we 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. 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 part of the W4 software, new relationships there, why that neutrality is important.

Yes. 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 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 partnership that are getting stronger because some of our competitors have chose 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 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 Customer or analytics, business automation, enterprise intelligence. All these are very important decisions the customer make, 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 product bundles. 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.

And our next question comes from the line of Dan Bergstrom of RBC Capital Markets.

So we just finished out the first quarter here. 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.

Yes, that's a very good question. So first, it's all behind us. We defined the go-to-market strategy and aligned the sales force with our objective. And of course, one of the objective we had is land-and-expand because we have a very large customer base. We also have a very large portfolio. So clearly, one of the things we've 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 of -- that allow our customers to start anywhere, so we're not asking our customers to buy a certain product. We're 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 their process and get ROI 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're helping 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 part of the Verint portfolio. And as you can see from the examples we gave earlier, some customers decide to just do a more gradual upgrade, 1 module at a time, and others take 2, 3 modules in 1 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's more and more analytics that we put into our solutions. And it's not just in our 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 questions from before, I think more and more customers realize that they can keep their routing product. There's 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.

And then on the security project from 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 the slowdown in economy and currency weaknesses, I think we made the prediction that security will remain a high priority. So while it's not back to what it was 3 years ago, we do see some improvement in funding security because it's a high priority for these governments.

And our next question comes from the line of Paul Coster of JPMorgan.

Dan, it seems to be a pretty steady cadence of new wins in the Cyber Intelligence segment. To what extent -- you've already mentioned FX. Commodity prices have stabilized, that's probably helping in emerging markets. And you've also got sort of 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 '18 is concerned, 2017 calendar year?

Yes, okay. Thanks, Paul. You raised a few points. So first, in terms of pipeline, yes, it is growing. Our pipeline is growing both for potential mega deals, and mega deals is $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 their 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's 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's 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 these type of solutions. But also, it's how those solutions really 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 the 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 mentioned you've got very good visibility through the year. What potential revenue do you think you can look into?

Yes, we've got great visibility. So I can give you an example. Obviously, the -- last year, we announced a $200 million contract. So on that one, last year, we had revenues of 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 there'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 by $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.

And our next question comes from the line of Nandan Amladi of Deutsche Bank.

So Dan, you mentioned the cloud business. You expect to grow that by 25% this year. How is that sort of -- 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?

Yes. 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 decisions 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's 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 proposals from Verint, cloud and non-cloud. Sometimes, they want to see more than 2. They want to see public cloud, private cloud and on-premises proposals, and they can compare and decide what's the right decision that they -- 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's still going to be some customers who will prefer to keep -- 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.

And a follow-up, if I might. You've talked for the last couple of quarters now about making the 2 divisions within your company somewhat independent operationally and so on. You just talked today in the prepared remarks about the key systems being up and running. If you do, indeed, decide to separate the company into 2 divisions, 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 2 markets. So for example, we talked 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're 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 2 businesses that just need to focus on 2 different agendas. And rather than drive those agenda from a corporate level, we want those 2 management teams to each drive their own agendas and focus on the dynamics in their market. 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 do not -- going to duplicate our finance, IT, legal, HR and all these functions, which, obviously, that creates good synergies to keep the 2 together. And at the same time, we are upgrading some systems that we think is 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 are 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 2 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 into a 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 trying to create that operational agility while not duplicating costs and impacting our margins.

And our next question comes from the line of Michael Nemeroff of Crédit Suisse.

This is Alex Hu on for Michael. Just curious, longer term, let's say 3 or 5 years out, how do you guys view the growth prospects and the operating margin profile for Customer Engagement as well as Cyber Intelligence?

Yes. So in terms of the long-term model, starting with security, we -- other than last year, which was an anomaly, we had a history of double-digit growth. And with the security emergencies around the world, we believe we can get back to double-digit growth in security. In Customer Engagement, as I said before, we're 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 margins are in the mid-60s and should improve a couple 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 we will be -- also, as I mentioned before, I think we'll be also in a recurring – on the recurring revenue, I think with this cloud growth rates, we'll have more recurring revenues, so we'll 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 moderate spending just a little today and 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?

Well, it really comes as a 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're making the investments necessary to drive the revenue that we need to drive.

I agree with Doug. I think if you look at the 2 businesses, we are a market leader in both businesses with good market share and many years of activity and building customer relationship 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's a lot of focus on intelligence and insights and automation. And the security market, and I'll 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 improvements, but also, at the same time, while we have slight margin improvement, we make the right investments for long-term growth.

And our next question comes from the line of Jonathan Ho of William Blair.

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 enough qualified people? Or what's sort of the driver behind that slower-than-expected expense growth?

Yes. 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 looked at Q1 and the mix of projects that we delivered in Q1, we just felt 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 reduction in call center seats with these automated processes and what you can sell on that side?

Yes. So and like, again, the infrastructure market, it is very much dependent on seats and their pricing models on a per-seat basis. We don't see necessarily the number of seats is the driver for spending on Verint solutions. When you look at different type of engagement channels, social media, e-mail, chat, these are not anymore on a seat basis. When you look at knowledge management and automation, it's not on a per-seat basis. I'll just give you an example for automation. We -- just an anecdote that I heard from one of the guys yesterday, that we're automating basically a back-office process for a customer that is a refund process. They use a group of people offshore to process refund requests by customers, and this is a very operative, 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 it's not -- for Verint, it's not a traditional per-seat model. We have a very large portfolio that address Voice of the Customer. It has nothing to do with the number of seats in the contact center. This is more about soliciting insights from customers about their experiences. We have a security part of our Customer Engagement, where we help organizations 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.

And our next question comes from the line of Jeff Kessler of Imperial Capital.

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 customer -- 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 and getting into enterprise and critical infrastructure, does the nature of what you're going to be installing, the nature of the project itself change a little bit? And do the gross margins change a little bit?

Yes, 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 is our data mining software products. So if you look at what we actually design -- and more than 90%, 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 model 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 projects. So I would think that for very large national security organization, where we land a $20 million, $30 million, $50 million contract, 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-million dollars or a few million dollars, obviously, we sell products. And there is a system integrator that does the rest of the work. Verint is not a system integrator, but we do some system integrator work for our larger customers. And when we do system integrator work, we also incorporate third-party products, which could be hardware and software, and that obviously reduces our overall margin. So the margin of 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 would like to buy. And as we expand to additional markets, we'll have a more productized approach, and we're going to leave it to system integrators to deliver third-party products and services.

Okay. And 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's not that many on the IT side that have the logistical capabilities. Are you willing 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 mean that 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. There's still many integrators 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 these markets slowly, and we'll 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're happy to partner and leave those system integrator functions to our partners.

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

Very much so, very much so. Because in addition to software, we deliver a lot of domain expertise. The world of cyber intelligence is a 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 type of technology in their environments.

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.