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Verint Systems (NASDAQ:VRNT)

Q3 2014 Earnings Call

December 04, 2013 4:30 pm ET

Executives

Alan Roden - Senior Vice President of Corporate Development & Investor Relations

Dan Bodner - Chief Executive Officer, President, Corporate Officer and Director

Douglas E. Robinson - Chief Financial Officer, Principal Accounting Officer, Vice President and Corporate Officer

Analysts

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Paul Coster - JP Morgan Chase & Co, Research Division

Jeffrey T. Kessler - Imperial Capital, LLC

Nandan Amladi - Deutsche Bank AG, Research Division

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter Verint Systems Earnings Conference Call. My name is Celia, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Alan Roden, Senior Vice President of Corporate Development. Please proceed, sir.

Alan Roden

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.

By now you should have seen a copy of our press release that includes selected financial information for our third fiscal quarter ended October 31, 2013. Our Form 10-Q will be filed shortly. Each of our SEC filings and earnings press releases is available under the Investor Relations link in our website and also in the SEC website.

Before starting the call, I'd like to draw your attention to the fact that certain matters discussed in 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 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, 2013, or Form 10-Q for the fiscal quarter ended October 31, 2013, when filed and other filings we make with the SEC.

The financial information discussed today is primarily non-GAAP. A reconciliation of the non-GAAP financial measures to GAAP measures is included in today's earnings release, as well as on the Investor Relations link in our website. Non-GAAP financial information should not be considered in isolation or as a substitute for 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 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?

Dan Bodner

Thank you, Alan. Good afternoon, everyone, and thank you for joining us to review our third quarter results.

In Q3, we delivered $225 million of revenue and $0.80 of diluted earnings per share. Revenue increased 11% year-over-year, and operating margin improved to 25.1%, resulting in $61 million of EBITDA and strong cash flow from operations. We are pleased with our third quarter results and believe we are well positioned for long-term growth and market leadership in the Actionable Intelligence market.

Geographically, we experienced double-digit year-over-year growth in both the Americas and Asia-Pacific regions with 12.6% and 25.8% growth, respectively, and a 5.7% decline in the EMEA region. As discussed on prior calls, we are making investments in EMEA and expect the region to resume growth next year, assuming continued improvement in the macroeconomic environment.

Before I discuss our Q3 trends by segment, I would like to review our strategy for the Actionable Intelligence market. We continue to focus on helping organizations capture Big Data, glean insights from the data and then operationalize those insights to make better business decisions and make the world a safer place. Our customers use Actionable Intelligence to optimize customer engagement, to reduce risk and fraud and to enhance security. Our strategy is to accelerate growth and increase market share by expanding our solution portfolio, enhancing business partnerships and expanding our addressable market.

In Enterprise Intelligence, our Q3 revenue increased 3.3% year-over-year. We continue to see organizations looking to purchase Workforce Optimization solutions in the form of a unified suite and continued adoption of customer experience analytics, and we recently received several large orders for our suite. We received a $4 million order for a health care services customer in connection with its preparation for the Affordable Care Act, bringing total orders from this customer to more than $10 million year-to-date. This customer is deploying our Workforce Optimization Suite including recording, quality monitoring, speech analytics, text analytics and desktop analytics.

We received a $6 million order for a financial services customer in connection with its initiative to drive efficiencies while delivering a positive customer experience. This customer has previously deployed a quality monitoring solution and decided to consolidate its vendors by adding additional components of our suite, including workforce management, performance management, eLearning, coaching, desktop and process analytics, speech analytics and Enterprise Feedback Management.

We believe these large orders reflect the market trends towards purchasing multiple products as a suite from a single vendor. They also reflect the trends toward deploying multichannel analytics designed to optimize customer engagements.

Verint is well positioned to capitalize on these trends, given our broad integrated suite and large global installed base. We are well positioned with the cloud strategy that includes both direct hosting, as well as hosting through partners. We now have more than 20 different SaaS partnerships in place and are leading the market in giving customers the choice between deploying our solutions on premises or in the cloud.

In our Communications and Cyber Intelligence, Q3 revenue increased 30% year-over-year. We believe that terrorism, criminal activities and cyber and other security threats, combined with expanding forms of communication devices and protocols, are driving demand for innovative security solutions.

During the quarter, we received several large orders, including orders in excess of $20 million from a new customer in the Americas, an order in excess of $10 million from an existing international customer. We believe this order reflects demand for innovative security solutions and efficiently collect, fuse and analyze very large amounts of content to generate Actionable Intelligence. As a market leader with deep relationships with government customers around the world, Verint is well positioned to address this demand and help governments with today's security threats as well as new emerging threats.

In Video & Situation Intelligence, Q3 revenue increased 6.6% year-over-year. Our video strategy remains focused on high-value, high-margin applications to help our customers enhance business performance, reduce risk and fraud and safeguard people and assets. We view video as another important source of Actionable Intelligence, and we believe that many organizations that currently record video for general security purposes are in the early stages of adopting a more strategic approach and are looking to glean business and security insights from video.

As discussed earlier on this call, our overall strategy is to help organizations with Actionable Intelligence to optimize customer engagements to reduce risk and fraud and to enhance security. We are looking to further accelerate revenue growth by continuing to add more products in analytical capabilities. We are pleased with our performance year-to-date, and our outlook for the year has improved.

Turning to our guidance. As a result of the positive trends that we've discussed today, we are raising our guidance and now expect revenue for the year to increase in the range of 6.5% to 7.5% and for diluted earnings per share to be in the range of $2.75 to $2.80.

Looking ahead to next year, we believe our focus on innovation and the investments we have made, combined with our leadership position, will drive another year of growth. As a result, we expect revenue growth to accelerate and revenue to increase next year by 7% to 9% from the midpoint of our guidance for this year and earnings per share to grow at a similar rate.

Now I would like to take -- turn it over to Doug to discuss our financial results in more detail. Doug?

Douglas E. Robinson

Yes. Thanks, Dan. Good afternoon, everyone. Most of our discussion today will focus on 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 Investor Relations section of our website. Differences between our GAAP and non-GAAP financial measures include adjustments related to acquisitions, including amortization of acquisition-related intangibles, certain other acquisition-related expenses, stock-based compensation, as well as certain other noncash or nonrecurring charges. I'll start my discussion today with the areas of revenue, gross margin and operating margin.

In the third quarter, we generated approximately $225 million of total revenue across our 3 segments, with $126 million in Enterprise Intelligence, $28 million in Video Intelligence and $71 million in Communications Intelligence. This compares to approximately $203 million of total revenue in the third quarter of the prior year, with $122 million in Enterprise, $26 million in Video and $55 million in Communications Intelligence. In terms of geography, in Q3 we generated $119 million in the Americas, $49 million in EMEA and $57 million in APAC. This compares to approximately $106 million in the Americas, $51 million in EMEA and $46 million in APAC in the third quarter of last year.

Q3 gross margins were 69.1% compared to 68.8% in Q2 of this year and 70.2% in Q3 of the prior year. As we have discussed in the past, due to the product and revenue mix within or across segments and particularly within the security segments, overall gross margins can fluctuate significantly from quarter-to-quarter.

During the third quarter, we generated $56 million of operating income compared to $46 million in Q3 in the prior year. Operating margins in Q3 were 25.1% compared to 22.6% in Q3 last year. Our Q3 EBITDA came in at $61 million or 27% of revenue, up from 24.5% EBITDA margin we recorded in Q3 of the prior year. This brings our 12-month EBITDA to $222 million.

Now let's turn to other income and interest expense. In the third quarter, other expense net totaled $6.9 million, reflecting $7.3 million of interest expense which includes amortized interest costs, partially offset by foreign exchange. For the first 9 months, the negative impact of foreign exchange on our nonoperating income was approximately $2.5 million or about $0.04 to our EPS.

Our Q3 cash tax rate was approximately 10%, reflecting what we now estimate we will pay in cash taxes for the year. As we have discussed previously, we expect to enjoy a low cash tax rate for several years due to our NOLs and the amount of income we generate in low tax rate jurisdictions. These results drove diluted EPS of $0.80 in the quarter.

Now turning to the balance sheet. As of October 31, 2013, we had approximately $384 million of cash and short-term investments, including restricted cash, compared to approximately $356 million at the end of Q2. Q3 cash flow from operations cash on a GAAP basis came in strong at $42 million. For the first 9 months of the year, GAAP cash flow from ops was $115 million versus $65 million in the first 9 months of last year. We ended the quarter with total debt of $644 million and net debt of approximately $260 million. At quarter end, we had 53.9 million average fully diluted shares outstanding.

Before moving to Q&A, I'd like to discuss our guidance for the years ended January 31, 2014 and January 31, 2015. As Dan noted earlier, we are raising our outlook and now expect revenue for the year to increase by 6.5% to 7.5% from the prior year and for diluted EPS to be in the range of $2.75 to $2.80. We expect to finish the year strong, and our annual guidance implies Q4 revenue in the range of $250 million to $259 million, representing our second quarter in a row of double-digit year-over-year revenue growth. Q4 diluted EPS will be in the range of $0.81 to $0.86.

Looking ahead to next year, we believe our focus on innovation and the investments we have made combined with our leadership position will drive another year of growth. As a result, for the year ending January 31, 2015, we expect revenue growth to accelerate and revenue to increase by 7% to 9% from the midpoint of our guidance for this year and earnings to grow at a similar rate.

For modeling purposes, here's some additional detail for the year ending January 31, 2015. We are targeting operating margin similar to this year, slightly above 22%. Based on recent foreign exchange rates, we expect quarterly interest and other expense to be approximately $7 million. We expect our non-GAAP cash tax rate to be approximately 10.5% for the year, reflecting the taxes we expect to pay in cash during the year. We expect approximately 55.5 million average diluted shares outstanding for the year.

In conclusion, we're pleased with our performance year-to-date and believe we're well positioned to accelerated growth longer term.

So this concludes my prepared remarks. With that, operator, can we please open up the lines for questions?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of Daniel Ives, FBR.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Yes, guys, could you just talk about penetration of the suite today within a typical customer and where you see that going?

Dan Bodner

Yes, so the trend is -- as I discussed in my prepared remarks, the trend is for customers to their consolidate vendors and buy more components from a single vendor rather than point solutions. In terms of the trends -- qualifying the trends, we certainly see larger orders and we see more than $1 million orders in a quarter and that's kind of trending consistently with customers' preference to buy broader solutions from Verint. There was some recent research report that discussed the penetration of the trend. It's still kind of in the early stage between 15%, 20%.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Got it. When you think about next year, I mean, how should we think about just overall ASP? And are you expecting a continued climb higher just given what's happening with the suite and what you're seeing from customers?

Dan Bodner

Yes, I think we are. We saw a trend of more solution -- more large orders, and large orders represent a higher percentage of our overall revenue. And that's obviously, as we grow, we are becoming more strategic to our customers, and we expect to be able to sell them more products and solutions and that should be reflected in the higher ASP.

Operator

The next question comes from the line of Paul Coster, JPMorgan.

Paul Coster - JP Morgan Chase & Co, Research Division

I've got a few quick questions. The growth rate in the Enterprise segment was a little bit sort of disappointing relative to everything else. Is that -- are you experiencing the same thing as your nearest competitor, whether the deal is getting bigger and the revenue's just kind of getting pushed further and further out enhancing your visibility but sort of weighing on near-term revenue, or is there something else going on?

Dan Bodner

No, I think we -- year-to-date, we have 4% Enterprise growth, and Q4 is typically our biggest quarter, so yet to be seen what's going to happen in Q4. But I think what's happening this year and why we don't see the typical 5%, 6%, 7% organic growth is that EMEA is weak. And actually in the Americas, we do see mid- to high-single digits. So I would think that that's the explanation for our Enterprise performance this quarter.

Paul Coster - JP Morgan Chase & Co, Research Division

Okay. The other thing is, looking at the guidance, obviously, there's no leverage in the business. I suspect you're being conservative. But what could the reasons for that be? Especially in view of the fact that software seems to be an -- it systemically is an increased part of the mix even if any given quarter it might not be.

Dan Bodner

Right. So as we discussed in the past, we are aiming at accelerating growth. Next year, our guidance is 7% to 9%, and we discussed the fact that we are aiming at double-digit growth. So the trade-off here is between leverage that obviously exists in the software business and investing more organically to accelerate growth. And at this point, this is our initial guidance, we would like to invest and see further acceleration in growth for the long run.

Paul Coster - JP Morgan Chase & Co, Research Division

Okay. And my last question is, Dan, can you just give us an example of how you might see -- or if you can see additional revenue when you do one of these big $20 million cybersecurity-type deals with a government entity, is it kind of like one and done? Or can you even see more business after a $20 million deal, and can you sort of explain to us how that even works? Is it on a site basis? Is it on a kind of scope basis? Is it usage-based? How would the revenues grow?

Dan Bodner

Yes, so first, governments have many different agencies, and we sell into a lot of agencies even within the same country. An agency will have different missions, but they all share the same need, which is to collect Big Data and be able to analyze Big Data and make it actionable. So they will focus on certain part of their missions and come up with a project that is usually a pretty large project because that's typically the way the government works. And also, as we expanded our portfolio, what used to be -- years back, we were talking about $2 million, $3 million quarter -- $2 million, $3 million order every quarter, now fortunately, we are able over the last several quarters, to discuss 7-digit projects. That's just the nature of growing our portfolio. But to the question of whether this is sustainable with the same customers, absolutely, yes. We have a large number of our customers have come back and buy 7-digit projects, maybe not every year, maybe every other year, but they come back and buy more and that's to address different parts of their mission basically.

Operator

The next question comes from the line of Jeff Kessler, Imperial Capital.

Jeffrey T. Kessler - Imperial Capital, LLC

Can you elaborate a little bit on the increase or the percentage of multiple suite orders that you've gotten because this is seemingly a trend that began earlier this year and may have accelerated into the third quarter?

Dan Bodner

It's very difficult for us to quantify other than what we have discussed, which is the large...

Jeffrey T. Kessler - Imperial Capital, LLC

I'm sorry, multiple module orders, excuse me. I apologize.

Dan Bodner

Yes, yes, I understood that it's multiple modules. So we've seen, obviously, our ASP growing in the number of 7 -- 6-digit, 7-digit orders growing. So that's a reflection of customers just choosing to buy more products from Verint. So the way I think we -- some of this is a change in buying behavior. Rather than buying a lot of different point solutions from many different vendors, they now see the opportunity to buy everything from one vendor and obviously integrate it. And that provides a lower total cost of ownership and also a strategic partnership with a vendor that can help our customers to deploy the solution more strategically and benefit from the potential ROI. So it's certainly -- we've seen many other companies in the software industry that have consolidated a lot of different point solutions and were able to create more strategic relationship, and we are basically doing -- following the same strategy.

Jeffrey T. Kessler - Imperial Capital, LLC

Okay. Is part of this, are you getting some uplift from your partner in the small business area?

Dan Bodner

The small business is part of the market that we have not addressed historically. So most of our partners drive -- help us drive big projects for the high end. We do have some partnerships for the low end, but it was always a very immaterial part of our business. What we see now is, for that part of the market, for the low end of the market or the small business, an opportunity with SaaS because SaaS is providing us opportunity to partner with different type of hosted -- hosting providers to deliver very efficiently a solution to the small business that includes both infrastructure and Workforce Optimization. And we have now, I mentioned before, we have more than 20 different SaaS partnerships that are primarily aimed at the small business end of the market. So we see SaaS as giving us the opportunity to play in the market that we didn't play before.

Jeffrey T. Kessler - Imperial Capital, LLC

Okay. Are you satisfied now -- on the Video and the secure communications side, are you satisfied where the state-of-the-art is at this point in time with analytics? We've gotten to a point at which we've -- we've hearing less and less complaints about the failure of analytics and more and more complaints about focused analytics on a, let's say, numerically smaller basis, but the analytics working better. Is that the type of trend that you're seeing with the analytics that you're selling? You're selling more of a select group of analytics on the security and communications side?

Dan Bodner

Yes, I think the market has matured and it's easier to sell analytics in this market than it used to be. They were very skeptical, and perhaps also the technology has gotten better. So I'm satisfied from that point, but I do see a great opportunity in the security business with analytics because I think the vast majority of the market is still not leveraging analytics to the point that they can. So I think we -- there's more maturity in the product, and the early-stage adopters -- the early adopters are more satisfied, but I think that the vast market has not yet purchased analytics solutions.

Jeffrey T. Kessler - Imperial Capital, LLC

Okay. One final question and that is the -- before and certainly accelerating after the Boston Marathon incident, this push towards secured cities programs in which you have public-private partnerships, pub-private partnerships putting in money, the government anteing up other money for both video analytics and other types of access detection about what -- for the demands of the cities for various types of security projects. Those projects are moving on. Are you getting any traction in those secured cities' projects? Or are you finding that your -- that the competition is coming in at prices that you're not willing to bid at?

Dan Bodner

We are participating in the safe city market. Some opportunities are very competitive. But I think in others, we're able to differentiate ourselves, and we're not competing on price. We're competing on overall value. So we see that as an attractive market that we're investing in.

Operator

The next question comes from the line of Nandan Amladi, Deutsche Bank.

Nandan Amladi - Deutsche Bank AG, Research Division

Dan, you mentioned the growing number of suite sales and larger ASPs. Does that make, potentially if you're swapping out the competitor, say, is the sales cycle any longer? And does it make it easier or harder to actually swap out a competitor as you're selling the suite as opposed to client [ph] solution?

Dan Bodner

I think it's both. I think it's the sales cycle could be fairly longer when we sell to a new name customer because obviously, we present a much more strategic value and they need to get comfortable with that. But on the other end, if we already have something installed, deployed with the customer, they just expand over time and the sales cycle is shorter. And also, it may not be competitive at all. So I think the strategy really works well. And with new customers, while the sales cycle could be longer, but sometimes this is the reason why the customer would even consider Verint because we are differentiated with our broad portfolio. But I think overall, I think it's good for the customers, and I think it's good for Verint and I think the strategy is working.

Nandan Amladi - Deutsche Bank AG, Research Division

Okay. And a quick follow-up, if I may. You discussed some weakness in Europe in the quarter but that you expect it to turn positive next year and you're continuing to invest. Are you seeing any sort of green shoots, any signs of improvement in the macro environment that gives you the confidence that your investments this year will actually produce growth next year?

Dan Bodner

Yes, we do. We actually -- while we -- as we said, we expect this year to be down relative to last year. But if you dissect our performance this year, in Q1, we had $41 million. In Q2, we had $46 million. Now in Q3 we had $48 million; and we're expecting also slight sequential improvement in Q4. So we see the sequential improvement quarter-after-quarter this year. And from the macroeconomic signs and the responses from customers, we believe that we would be growing next year relative to this year.

Operator

The next question comes from the line of Brian Ruttenbur, CRT Capital.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

The question I have was about cash and cash generation. What are the plans for cash now that you're seeming to be stockpiling a lot of it? And then can you talk about what you anticipate would be some kind of proxy for cash generation next year and actual cash generated to the balance sheet after CapEx and other expenses?

Dan Bodner

Okay, Brian. So I'll ask Doug to answer the questions on the cash this year and next year, and then I'll come back and talk about our plans for the cash.

Douglas E. Robinson

Yes, so you're right, Brian. We had very strong cash flows in the quarter, $42 million on a GAAP cash from ops basis, that gave us $115 million for the year versus $65 million last year. So at these rates, we're expecting our cash from ops on a GAAP basis to be about $160 million this year, up significantly from the $123 million of last year. And going forward, we expect that cash flow to grow kind of commensurate with the earnings growth that we outlined in our guidance.

Dan Bodner

Okay. Thank you, Doug. And in terms of the plans for the cash, so we certainly are generating improved cash flow and have $385 million cash on the balance sheet. And our options with capital allocation is we can pay down the debt, which represents about 4% return on investment. We can do a buyback. We are limited somewhat by our credit agreement, but we could potentially do buyback. But that will give us high-single-digits return on investment. Or we can deploy the cash with acquisitions if we find attractive opportunities that have double-digit return. So those are pretty much our options, and we are considering those options as we continue to execute on the organic growth.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

And so what is the magic number that you need in cash before you start executing on some of those options given that you're approaching $400 million and next year it appears you'll approach $500 million in cash?

Dan Bodner

Yes, there is no magic number. It's really -- the opportunities that present itself in terms of the acquisition pipeline, and our appetite to do the stock buyback or to deploy the cash to create a higher ROI with acquisitions.

Douglas E. Robinson

And some of it, Brian, also is dependent on where that cash is. We have a little north of $100 million in the U.S. and to do a buyback, that would take U.S. cash. So depending on if we look at acquisitions, what opportunities are available where and where we have that cash also influences our decision.

Operator

We have a question from the line of Jeff Kessler, Imperial Capital.

Jeffrey T. Kessler - Imperial Capital, LLC

Even though you've guided higher in the fourth quarter, I am wondering, even still, did you -- was there any -- were there any orders that you received in this quarter that came in a little earlier than you expected? Obviously, your earnings -- obviously margins were better, clearly better than expected. Revenues were a bit better than expected although, again, Europe is weak as it is for just about everybody. But the question comes back to the numbers were big enough that one might suspect that there were some orders that came in earlier than expected, even though you're still guiding to higher numbers in the fourth quarter.

Dan Bodner

Yes, I think you're right. We do have better visibility that these -- the results of orders that we received in Q3, but also that was already received early in Q4. But generally, we have better visibility for Q4 that supports the improved guidance.

Jeffrey T. Kessler - Imperial Capital, LLC

All right. And just one other question. Following up on Paul's earlier question. I know you're trying to be conservative and I know that you're implying that there's -- that given you're up -- the leverage that you've shown in the business that there's -- you're going to take most of that leverage and you're going to put it into R&D or investments for sales or whatever to build your business. The question is, obviously, are you going to allow some of that leverage to, let's just say, eke into your earnings for next year if you're that confident that your revenue growth is going to be where it is?

Dan Bodner

So as I mentioned, it's initial guidance. We will consider other options and update the market as we make those decisions. But clearly, the way we think about it, if we can accelerate our growth further, then we just -- we'll generate a higher EBITDA just by accelerating top line. So top line acceleration, I think, drives more EBITDA even without leverage. And then you have to trade-off the amount of investment that you need to do in order to create that acceleration in top line EBITDA versus strong deleverage in the financial results. So it's a little bit of a short-term, long-term trade off, but we are looking to accelerate growth steadily. So we -- it's not like we are considering some investment that will pay off 3 or 5 years from now.

Operator

At this time, with no further questions, I'll turn the call back over to Mr. Roden for closing remarks.

Alan Roden

Thanks, operator, and thanks everyone for listening to our call. Talk to you next call. Thanks. Have a great night.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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