Q3 2020 Earnings Call

Hello, and welcome to the varied systems Inc. Q3 earnings conference call.

This time all participant lines are in listen only mode. After the speakers presentation. There won't be a question answer session to ask a question. During the session you want each press star one on your telephone please be advised that today's conference is being recorded.

If you require any further assistance. Please press star Zero I would now like Dan The conference over to your Speaker today, Alan Roden Senior Vice President corporate development. Thank you. Please go ahead Sir.

Thank you operator and good afternoon. Thank you for during our conference call today.

And Bonder, Barents, CEO , and Doug Robinson Barents Sea above.

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That certain matters discussed in the call may contain forward looking statements within the meaning of the private Securities Litigation Reform Act and I 95, and other provisions on the federal Securities laws.

Well what these statements are based on management's current expectations are not guarantees of future performance actual results could differ materially from those expressed and implied by the forward looking statements.

These statements are made as a day this call except as required by law parents seems obligation to update or why that's the cautioned not to place undue reliance on these forward looking statements.

For more detail discussion, how these and other risks and uncertainties. The called parents actual results could differ materially who knows indicated in the forward looking statements. Please see our Form 10-K for fiscal year ended January versus 19, and other filings we make the FCC.

The financial measures discussed today include non-GAAP measures as we believe that's just spoken with measures in comparing results between periods.

Among our pure companies.

The outlook and targeting relied on a non-GAAP basis only.

You see today's Webex all eyes are easily says that's relations section or website <unk> Dot com reconciliation of non-GAAP financial measures to GAAP measures.

non-GAAP information is not be considered an isolation from a substitute for or spirit to gapping information is included about magically used to provide meaningful supplemental information regarding our offerings ultimate assessment business as useful to investors from national and comparative purposes. The non-GAAP financial measures. The company uses had limitation.

And I may differ from those used by other companies.

Now I'd like to try to cover the Dan Dan.

Thank you Alan.

Good afternoon, everyone and thank you for joining a third quarter earnings call.

We have a lot of exciting news to share they went to cover five topics during today's call.

First I will review, our Q3 results by segment.

Second the strategic plan, we announced today separate variant into two independent public companies.

Third the agreement for strategic investment from April partner.

For the new share buyback program.

And last our enhanced disclosure in connection with a plan to separate variance to businesses.

Starting with your Q3.

This is our performance.

I don't execution throughout the year.

Dr engagement, we're experiencing strong cloud momentum.

In cyber intelligence, our transition to a soft tomorrow is progressing ahead to fall plan.

I suddenly results drove a 10% increase in non-GAAP EPS in Q3.

And 61% increase your today.

Last year.

We believe we're on track to achieve our annual non-GAAP .

Earnings per share guidance were 14% growth.

Now, let's review our results by segment.

[noise] customer engagement.

We reported 11% non-GAAP revenue growth in both Q3 and year to date.

<unk> expense.

At constant currency basis.

We're pleased with all performance.

The revenue linearity this year.

And expect to finish we just don't Q4 of 11 cents non-GAAP revenue growth.

We believe there are three key drivers behind a strong momentum.

First is cloud leadership.

We design Oclock softer for both SMB and enterprise customers.

And offered them cloud deployment model that a flexible and designed to address the specific cloud journeys.

Our primary cloud moral is bundle so.

We're very softer runs into very cloud.

This is the most cost efficient model.

And now recommended choice for customers.

Therefore bundled service revenue is growing faster than the other cloud choices we offer.

Second.

These are not to go to market approach.

I felt the portfolio is open and compatible with customers communications infrastructure choices.

Customers reseller and communication partner.

Benefits prognostic 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 information across a broad fell for the portfolio.

Helping organizations to achieve even higher efficiencies.

What are the same time ever beating customer experience.

Let's look 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.

And you saw seems to be.

We also pleased to report and increase in cloud adoption by large enterprise customers.

In the third quarter, we had to let them cloud contract.

We should be greater than $1 million.

Compared to only four in the same quarter last year.

Over the last three quarters, we had 23 Clark on drugs, which seems to be greater than one even door.

<unk> eight 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 softer bookings.

Regardless of what are the contract with perpetual or south.

This new operational metric is called you perpetually people in booking.

And Doug will discuss later in more detail.

I'm pleased to report that we are achieving strong double digit growth on this metric.

Driven by our differentiated softer and many competitive wins.

Turning to cyber intelligence.

Our non-GAAP revenue growth year to date is 4.2%.

5.4% on a constant currency basis.

Our transition towards Dolphin mall is significantly ahead of plan.

Both in Q3 and year to date.

And we continue to derive that's revenue this year from low margin hardware and services compared to last year.

As a result.

I'll focus on gross profit growth.

We believe this is a better metrics to understand our true growth during this transition.

We're pleased to report that our cyber intelligence estimated full year located gross profit.

Increased double digits year to date on both GAAP and non-GAAP basis.

Our work with full year old data mining solutions.

Helps customers gain critical insights that accelerates security investigation of course governments and enterprise.

One of the security threats that law enforcement and National security organizations are trying to address.

He is identifying unknown suspects.

Clearly this is an important security objective.

And many of our customers are looking to improve their capabilities in this area.

Very different differentiated data mining solution.

Designed to address this ongoing south Big Challenge and I'm happy to report that were recently enhanced our predictive intelligence capabilities.

To further differentiate our solution.

Our competitive and differentiated capabilities.

And given some of the large orders we recently received.

Including an order for over $25 million and older were approximately $10 million.

And to customers around $5 million each.

As previously discussed.

We are gradually transitioning our cyber intelligence business from an integrator moral this off them all.

Historically large deal sold under the integrator tomorrow.

Included bust 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 hoggard himself and leveraged opens software design.

We believe there are significant benefits to our customers.

Taking a softer easier to implement.

And more rapid me refreshed.

Many customers realize this was the integrate tomorrow.

Provides then one stop shop.

It also comes with limitations in terms of their ability to quickly deploying softer enhancements.

The software model benefits variance.

Moving to our competitive differentiation and expanding our gross margin.

Given that the rapid reduction of low margin hardware and services.

Significantly ahead of our plan.

We're adjusting our non-GAAP and your revenue revenue guidance to 460 minute doors.

Why did the same time.

Guiding to non-GAAP estimated what do you indicated gross profit.

More than 10% growth for the year.

This adjustment is expected to be neutral to overall, yes.

I would now like to discuss a plan to separate variants into two public companies.

We have a customer engagement business, a fortune $1 billion in any revenue.

Cyber intelligence business approaching $500 million an annual revenue.

We believe our two businesses were benefits from the separation.

And becoming independent publicly traded companies.

If the bracing for the separation we've taken steps over the last several years.

The two businesses operationally.

And believe we are now well position to execute this separation plant.

We believe that both our businesses I'll leave it would be in their respective markets.

And the separation will enable them to achieve even better performance over the long term.

The two companies are expected to benefit.

From separate boards will further differentiate it feels good.

Company specific incentive program.

And capital structure tailored to the unique characteristics of each business.

In addition.

Separation will make it easier when investors to evaluate and make investment decisions in each business.

Later, Doug will discuss our enhanced disclosure as you make progress towards the situation.

[noise] from accounting perspective.

We believe we're well positioned to complete the separation.

<unk> shareholder.

Shortly after February one 2021.

Over the last few years, it's part of our strategy to give each business more operational agility.

We have already substantially separated ourselves services marketing work management and R&D organizations.

We are in the process of separating our shirt services functions.

Including finance legal HR and I see.

Our plan is to complete much of the separation over the next year.

And use it transition services agreements post separation.

Regarding a filing we plan to complete audited carve out financials.

And make an initial findings we actually see like this third quarter fiscal 21.

We will provide updates over the next four quarters.

In connection with the separation.

We entered into a minority investment agreement with the leading private equity firms.

We chose eight Bucks is a partner.

As the brings significant experience in both carve outs and cloud transition.

We worked very closely was eight bucks over the last few months.

The structure the investments to meet our strategic goals.

The investments will be made in two tranches.

The first launch will be for 200 million Dawn.

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 eight bucks will have a 5% minority interest in very.

The second 200 means all tranche, which is expected to close at the time of the separation.

Well be used to further strengthen our balance sheet post separation.

Including both tranches.

It looks will have between and 11.5% and 15% minority interest in our customer engagement business.

We're very excited to have a box 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 plant date separation.

It will be funded partially by the tranche, one Crawford discussed earlier and by available cash and debt.

We're excited about our longer term what puts you into <unk>.

<unk> each of our two businesses.

I believe it's an opportune time to buyback our stock.

As we prepare for the separation, we're adding two new direct doors.

Oh, we significant cloud and business model transition experience.

Andrew Me there was elected to the variance boards.

We have over 20 years of softer experience.

Andrew was also serving on the variance audit Committee.

Most recently.

Andrew was GBP and CFO Oh PTC.

Where are you successfully led their transition.

Scripts and business model.

Prior to PPC and he wasn't executive was enterprise software companies.

Including cadence and offered that.

Also joining the board these Jason writes a partner or partners.

Jason on the joined the varying board upon closing or the first tranche investment.

Jason needs eight Bucks technology properties.

And that's significant experience to carve outs and cloud transitions.

We're excited to have both Andrew and Jason joined our board.

Is it brings significant experience that is relevant to our cloud journey.

Before handing the call over to Doug to review up here Q3 results and guidance.

I would like to mentioned it in preparation for the separation we are enhancing our disclosure in several areas.

We have a new formats for earning release.

Which provides more detail about our two businesses.

And the revenue IR website, we separate areas for customer engagement and cyber intelligence.

Including dashboards to help investors understand underlying drivers of our businesses.

Finally, we plan to hold in Investor Day in New York in April after our fourth quarter earnings call.

To provide spread or updates on our business and the separation.

And now I will hand, the call over to Doug.

Thanks, Dan Dan just mentioned, we are launching a new Investor Relations website Tonight. The website will provide separate financial dashboards for each Archie 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 the slides in the new dashboard for a customer engagement business. It's available on our website downloadable excel format for your convenience as they're all the other dashboard slides will discuss today.

As you can see there are five sections, let me briefly take you through each section as we discuss a third quarter results.

The first customer engagement section titled revenue metrics.

So revenue stream into two line software, including cloud and support and professional services.

That's a business shifts more to the cloud professional services have become a smaller percentage of her 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.

Q3, our non-GAAP 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 titled revenue and bookings metrics.

Sure, you'll see our new SAS HCV growth, which as Jim mentioned earlier increased approximately 130% year over year in Q3.

We'll 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 comfort of basis.

In Q3, new perpetual license equipment growth was 19%.

I'll discuss this new metric in more detail a few minutes.

In the third section titled Cloud revenue detail.

We're breaking down our cloud revenue into bundled to unbundled Hsas and optional managed services.

In Q3, all three components increased nicely year over year in sequentially.

We believe provides a detailed will help investors to better see the quarterly trends in our cloud revenue, which can vary based on the choices or customer, making any given quarter.

In the four section titled operating expense metrics.

We're providing estimated fully allocated as gionee and R&D expenses for our customer engagement segment.

These expenses include shared service allocations for Iraqi 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 in our operating expenses as a percentage of revenue or inefficient level based on current scale.

Finally in the first section titled profitability metrics, we're providing estimated fully allocated gross margin operating margin and adjusted EBITDA margin.

In Q3 customer engagement estimated fully allocated adjusted EBITDA margin reached 30%.

Overall, we're very pleased with a third quarter customer engagement results, which were strong which reflects strong new soft HCV and cloud revenue growth as well as strong margins.

Now I'd like to take you through a new operational metric, we are using to track or software growth and I'm more comparable basis.

To normalize between new perpetual license bookings and new SaaS bookings, we have calculated new perpetual license equivalent bookings by multiplying nusa HBV bookings, excluding maintenance conversions.

Hi conversion factor of too.

And adding that amounts to new perpetual license bookings.

The conversion factor too is an estimate derived from an analysis of the historical bookings.

We use new perpetual license equivalent bookings to better understand the growth of our software bookings and the shift between perpetual and fast.

Going forward will include just 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 significant growth in cloud revenue and 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 for the new see I guess dashboard.

As you can see there are four sections, let me briefly take you through each one.

The first section titled revenue metrics.

<unk> revenue streams down into recurring revenue and nonrecurring revenue.

As we execute our software model transition between revenue has become a larger percentage of our total revenue and we expect this trend to continue.

The second section titled growth metrics includes a 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 will provide guidance for both revenue growth in estimated fully allocated gross profit growth for cyber intelligence.

In the third section titled operating expense metrics.

We are providing estimated fully allocated SG ne and R&D expense.

Finally in the four section titled profitability metrics, we're providing estimated fully allocated gross margin.

Operating margin and adjusted EBITDA margin using 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 a 530 bips 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 focus in the middle section titled shared support metrics.

And this section of the dashboard, we break or expenses down to two categories segment expenses and shared support expenses.

Second expenses, our direct and controlled 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%, which shared service expenses.

There is organizational structure utilizes shared services to support both segments in a more centralized manner.

Good portion of the shared service expenses are already dedicated to just one of the segments, but as we work towards separation into two public companies will split the non dedicated shared service portion into each business.

Now turning to guidance for the current year ending January 30, Onest 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 equivalent bookings metric outlook, you're expecting healthy double digit growth for the full year.

In cyber intelligence, we are 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 as adjusted to 460 million for the year, reflecting a 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 a reduction in lower margin hardware and services. It has limited impact on overall earnings.

We are 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 apacs investment to close in our first quarter ending April Thirtyth 2020, we've also not factored in any share repurchase benefit as it shouldn't have much impact on a weighted share basis to a full fiscal year, yes.

[noise] today, we'd also like to introduce our initial non-GAAP guidance for fiscal year, ending January 30, Onest 2021.

For customer engagement, we expect the falling.

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've discussed today, we are using this operational metric to better understand our true suffer bookings growth regardless of mix shift.

For cyber intelligence, we expect to falling.

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 two growth of the segment.

Overall, we expect 10% non-GAAP EPS growth and our guiding to approximately $4 per share.

This initial guidance does not include any dilution from the ATAX investment as we believe our plan share repurchases will offset dilution from that investment.

Thank you incur some onetime expenses over the next year associated with the separation, which would be excluded from our non-GAAP results.

I'd like to know summarize the other announcements that we made today.

We are 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 shareholder spin of the cyber intelligence business.

Following the spin Virent shareholders will own shares in two separate company.

We expect the first tranche of the ATAX investment of 200 million to be completed in the first quarter subject to regulatory clearances and the proceeds will be used as part of the 300 million share repurchase program.

We're pleased to making today's announcement and believe is an exciting an opportunistic time for parents investors employees customers and other stakeholders.

So with that operator can we please open up the call for questions.

As a reminder to ask a question you want me to press Star one on your telephone to withdraw your question press the pound <unk>.

Please standby only compiled the culinary vascepa.

Our first question from Ryan Macdonald from need him. Your line is now fan.

Hi, good afternoon, thanks for taking my questions.

Great to see the news about sort of the planned or I guess separation of the two businesses here I guess should just like to get a little bit more thoughts on your on the process you kind of went through as you are making this decision and as you look out over the next 12 months how should we begin to think about you know once these two businesses are split how who will be running.

Each each of the businesses as we look forward. Thanks.

Yeah sure.

So you know as we discussed many times over the last several years, our two businesses.

Started to operate these are the sticks manner.

Both in terms of end markets and business model and we discussed for 15 years operational agility, which was basically to give each a management team the direct control over all the.

Resources, they need to be successful in the market.

And we've completed days than we have to management teams with.

The two businesses, we separate R&D.

Sell services and so forth.

So so the whole.

Design separating the company.

He is being in the into works for quite some time.

We also spent time separating the legal entities, because we were operating around the world with legal entities that had.

Representative of both businesses do 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 got two points now the two businesses that scale.

As I mentioned before and we feel that.

We are ready to take the loss that which is today announcing the separation over the last several months we engaged many advisors.

Operational and and talks in other areas to help us think refer to plan as the proto timeline and to gain confidence that we can actually do this was a little bit over a year from now.

And we will be executing over the year, mostly around shipped separating the.

The shared services function that Doug mentioned on making sure that we didn't get into very efficient way.

Do you can duplicate duplicating cost, where it's not necessary and being ready for the separation and you also mentioned we expect the two companies will find a transition services agreements actually we expect the Ts say and they have reversed yesterday, the two companies providing services to each other post separation in order to come.

Fleet that in a very orderly fashion and efficient fashion.

In terms of.

The way, we gonna do it Oh, the customer engagement business, we continue to be part of variant.

And we have the management team drawn variance.

And this cyber intelligence business will be spawn into a new public company and the management team of that business will be running the new public company.

Excellent. Thank you. Thanks, a clarification there and then as we're looking at sort of the updated guidance are provided for this year I think it's sort of clearly understood sort of the moving parts there, but I guess says we look out into the initial outlook for that's why 21 I think previously the early this year you had talked about particularly within the customer engagement.

This sort of revenue targets and that sort of 10, 10% grew year CAGR over the next three years.

Can you talk what maybe perhaps what you're seeing that sort of change that deal better I think as were now seeing customer engagement girls next next year expected to be in the 7% range.

Versus more of that 10%. Thanks.

Yeah. So as we as we discussed earlier, we introduced a new metric, which we've been using now you know to understand whats the true growth with software.

When we transition to the cloud.

A few things happening in that in that they nomics first we expect all professional services to be flat because typically the more professional services needed for perpetual on premise deployments. Then then in the cloud. So so that's kind of one one dynamic.

So a softer well it's not the born double digits, we expect a profession services to be kind of flat.

Also we expect that our maintenance, which is over 300 million doors.

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 little bit of a 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.

You know over to back door on revenue form our maintenance to cloud.

So all these things worked together are softer is currently growing very nicely, 19% in Q3.

Since year to date.

And we measure softer growth.

Because that's really the true.

Dynamic in terms of how competitive.

Dynamics and how we win business. So we expect double digit growth this year in softer and double double digit next year.

At the same time to other dynamics around the cloud.

He's driving our 7% revenue growth.

With that 10%, a new perpetual covenant booking growth.

[noise].

Excellent. Thank you very much.

Thank you. Our next question is from Paul Coster from JP Morgan. Your line is now fan.

Yes. Thank you for taking my questions first of all on the deal it so on the separation.

Why did you go without you packs and why did you go with the convertible start why not just the shoe debts without a partner and a buyback shares that were still proceed with the separation and why for that matter is that the preferreds.

Convertible rather than just straight I could see given the so it seems to almost immediately judging by the way the stocks moved.

Yeah.

We spent a lot of time around this topic and we engage with many private equity firms over the last six months.

Oh, we chose eight bucks because of experience they bring <unk> bring to us in carve out and in cloud transition.

And because of the overall track record and shareholder value creation.

And when we start to discuss the deal structure we.

Structure lose eight bucks to achieve our.

Our strategic objectives is also we spent significant time, making sure that eight bucks is aligned with all other shareholders.

So for example in tranche one.

We structured the deal with the 17th defense premium.

And we also intend to offset the dilution with our new buyback program.

It's both Darren it's both brunch one eight bucks is a fully aligned with other shareholders.

To help the company to complete the separation and it took celery the cloud transition.

When we look at a tranche two oh, we structured the deal around.

Predetermine devaluation for Crestwood customer engagement business.

And this solution is subject to a color, but a it potentially represents a significant significant premium to the current valuation.

And also post brunch true.

We will have a stronger balance sheets.

And eight bucks would be aligned with other shareholders in helping the company to pursue cloud growth and M&A.

So overall when we looked at all they do alternatives. We are excited to have eight bucks as a partner in connection with our separation plan and the strategic objective.

Well the so let me just to 12 among on the the new sovereign so business.

All the choice dog <unk>. The the spokesman in front of me, but do you have to picks up the new pro forma EBIT margins for the cyber intelligence business does that include.

Allocation from the should services.

Yes.

Yeah Paul.

The numbers that we talked about our fully allocated.

Okay.

At each of the levels of the gross profit as well as the operating expenses operating margins.

So just one other question on sort of intelligence because you know people will be looking in the sort of fresh.

It looks like the recurring as a percentage just slightly lower than the.

The customer engagement business is that you haven't expressed to you have carved out the since its revenue associated with professional services to what extent now is the cyber intelligence business sort of free on professional services, what is that as a person.

Overall revenue.

Yeah.

Overall professional services, including.

Integration services ride and hardware and custom development all the services we've been doing.

It's around 25% and declining pretty fast.

Because as we discuss hardware.

For many years and pulled you were.

Reminded us that this is something that.

You know will be very beneficial to finally, the hardware is declining very quickly, but you're also starting to see a custom development services declining.

As customers are more comfortable to buy you know a plain vanilla softer and use apiay wise.

Develop custom capabilities.

And we see little bit off of professional services change as well so overall.

We expect that mix to change towards a less services.

And of course.

As we move to more softer Mo and not there.

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 fees.

You know that's something that as we complete the transition to the soften mall, we expect both with the see more recurring revenue.

But for now I think we get great benefits from the reduction in low margin hardware and services.

So gross margin expended no more than five points youre a 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 we first or softer much faster in a.

When they buy onto the integrating the moral.

It's very hard for them to refresh the softer and as we know in today's world, especially around.

Hi, and predictive intelligence softer refresh is very important so great benefits to our customers want to soften moral and great.

Obviously, good benefits variant and expert services to continue to decline and recurring revenue to continue to increase next year.

Welcome development. Thank you very much then.

Thank you. Our next question is from Daniel Eyes from Wedbush. Your line is now fan.

Yes, great and it's great to see the news and I in my opinion, the smart strategic decision.

To that point I mean, maybe talk about.

From a timing perspective.

How this result.

Strategically the management team in terms of focusing more on the software customer service part of the business ride in the cyber intelligence, maybe you can just talking about de that day, how this change things today versus let's say a week.

Yeah, I think it's an evolution I think we began.

Going through this evolution in our operational agility initiative.

So for myself I can say that I've been delegating more and more to.

Through the management teams of both businesses.

Building capabilities, we've been hiring a number of key executives in both areas. A we've had some great hires recently of cloud experts from some of the you know best cloud companies.

That we were able to a truck to variance.

Obviously, we started the board now is to people that have cloud experience in specifically experiencing cloud transition which is.

Something we pay attention to.

So so overall I think we we've been evolving in this direction.

And I don't expect that over one week as he said.

The company will change.

We believe our strategy is working so there's no reason could change the strategy. We believe our teams are very focus and execution. So I think this would be very exciting to our employees and to our customers.

And and I just to be more excitement and more passionate about you know winning deals.

But we'll build more and more capabilities.

To to around the separation and we expect to be.

Ready we scale in both businesses to run as two separate public companies.

Okay, and then Doug maybe talk about.

It should you have any concern with stranded costs.

And the usual short issues with with these types of transactions that something you feel like the next year pretty scripted out in terms and no surprises.

Yeah, you know as Dan mentioned, we spent the last do you know year or two really working on the operational separation.

So the sales the R&D really everything operation was 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.

Some more it's more of a back office separation right. So we have to build out another data center from Nike standpoint, and split the applications.

And we have to double up little bit of kind of the financing. So many other support the resources.

You know clearly we have a year to get that done and.

It should be fairly straightforward.

Yeah, I'd like to add that because of the approach we ticking with P. Assai was 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 help you know support from each other from each company through to the other company and continue that into the phone year. So.

No there will be some onetime cost next year, which we were excluding from our non-GAAP .

Reporting, but but but in terms of.

Our EPS guidance for next year initial guidance for approximately $4.

We don't that we don't expect the separation to this this guidance.

Okay. Dan are you going to Miss all the questions about wise the company doesn't get broken up or [laughter].

Okay. Thanks.

[laughter].

Yes, I think.

I'm sure I'm going to get more exciting question.

Thank you our next questions from Brian Essex from Goldman Sachs. Your line is now fan.

Hi, Good afternoon. Thank you for taking the question and you know again good to see the news on our end <unk>.

Just a just a quick question for I guess whoever wants to field it.

I guess as part of this process, maybe if you could highlight our there were there other strong strategic alternatives that you pursued.

What kind of lead 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.

We have certain benchmarks that we need to be aware of such a shareholder approval.

The covenants with a debt agreement that where you're going to need different refinance the debt.

What do we need to look out for and 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 looking for the question Surendra slippage conservative.

Yes, we looked at many different that digital authorities.

First we do that so.

So we were looking to different options and then we brought.

Investment bankers to help the board to compare the differences digital alternative.

And we believe that these you know this success, we separation provides investors that ability to mixed investment in each company's separately.

The way.

You know mechanically this will be done is you know various investors.

Going to get.

Sure as in in the New company.

We are we going to contribute the dividend basically the cyber intelligence business into new company addresses can make these decisions.

On their own and.

We concluded that as we announced a the the board has studied unanimously.

To to approve the tux pre separation that we announced today.

Yes, Brian in respect to kind of the requirements and ER and the financing in the debt of 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 the 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 the convertible and term loan b out there.

We expect that we would be refinancing really both of those perhaps with some smaller amounts we have the apacs a capital to work with as well we would expect that a you know given a lot of the EBITDA is with the customer engagement business that the debt would be with the customer engage.

It's been did not with the cyber business.

But we would look to have this customer engagement business be very had very strong balance sheet out of the gate.

With no minimal leverage.

And positioned very well for future growth ahead of it.

Got it and maybe just one quick follow up.

Does this requires shareholder approval in heavy you talked to any major customers about this.

So.

It does not require a shareholder vote. Okay in terms of in terms of customers. One of the reasons. We're doing this accretion is because we have very few customers as our joint and even those that have.

Needs fruitful for a product from both businesses there are different.

Divisions of different parts of the organization.

It could be large.

Banks that have you know.

The f. customer engagement needs, but and security needs that are.

Different parts of the organization.

So in terms of customers, there's no epoch, there's no.

We ought to be separated the R&D organization and technology, So the products with de lever to Americans today.

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 the customers, we'll see that as a non event and 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.

Yes, sure Brian Thanks.

Thank you Sir our next question comes from Shani Young from Oppenheimer. Your line is now fan.

Thank you hi, good often.

Paul.

Of course.

Background noise here.

Matt.

So the way to transaction.

Absolutely promising.

A couple of a couple of questions on my end.

A little may be premature, but do you guys know or can you estimate with respect to youre in a well.

Got direction.

Going down the road.

Yes shell.

Yes, the any wells that we have now a will stay with the parent company and there will be utilized is such a so a lot of the income.

I think come is the customer engagement company. So we expect those dental wells to get the fully utilized efficiently with a structure that we've come up with up with the separation.

Understood got it and I want to go but actually too.

The first question.

With respect to the guidance in any given.

Changing mechanics between a perpetual and and cloud.

And the impact on revenue.

I know God.

Typically don't die to cash flow and again it could be a little too early here, but any impact from that trend they shouldn't on cash yields as well down the road.

Yes, no we.

Well grow about 200 million a in free cash flow this year.

And the cash really kind of follows the EBITDA shell. So you know about three quarters of our EBITDA is with the customer engagement business. So about three quarters of the cash generation will be with that business as well.

And you know and let me give you a sense of you know next year, when we talk about customer engagement growth, we still expect.

About you know, 4% perpetual software growth.

Right and we expect.

You know obviously, the the cloud booking growth is going to be very high because we guided to you know double digit softer growth.

But it's not like our entire perpetual business is going to shift into.

That's what Tonight.

And therefore, the cash flow you Buck is very gradual but in a couple of years, we're starting to get more cash from contractors. We signed you know last year in the year before so you don't you don't and we don't expect to see a big decline in cash like you would see for companies are going to a transition in a very short period of time.

Got it that's the right up final 1.8 that maybe little bit actually back to the business. A couple of my age, but I know everybody. So focused actions you did indicate you did mention at 25 million dollar win on.

Gauge, but.

It is that.

Placement is that clean Phil can talk a little bit but about that eight.

So so look we mentioned two thinks that they let me just clarify we mentioned the 25 million, though order more than 20, if I'm going to grow older inside there and we also mentioned 23.

23 deals over $1 million PCV in customer engagement. So I think both are interesting you know fiber we from time to time, we get big deals that that's the kind of expected because of the nature of our government customers and large needs.

But I think very interesting in customer engagement to your point is that it's very significant growth 20 to 23 deals that are.

Well, they're moving dollars compared to only eight in the same period last year. So that's clearly more adoption into enterprise customers and we have well position to win the multi million dollar TCV deals.

Because of the softest scales very well, we mentioned that we work both SMB and enterprise customers, but one thing to differentiate variant is not only that we scaled well, but we also performed were very well at the large enterprise.

And we see that we feel we still have very little competition.

When it comes to a large and more complex requirements that large customers having customer engagement.

Got it thank you for that congrats good luck.

Yes. Thank you.

Thank you our next question from Jeff Kessler from Imperial Capital. Your line is now fan.

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 I'm I'm interested in is you had a traditionally had youre.

Sure Cyber security business developed.

Divided up into like three three SEK three segments.

Situational intelligence, the actual Oh, actual surveillance and cyber security itself and now I see on your on your slide show you've got to develop.

Put out a little bit more can you talk a little bit about.

After after these after the separation.

What areas of the cyber security business do you see being freed up.

From any constraints.

Some constraints that they had as part of a as part of a company that was that was that there was tied together in other words are there areas of cyber security that are going to be.

That are going to be free you up free to grow or free to act slightly in a different manner than what they are doing now now that the part that they have now that there is 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.

Dave.

The future.

Fabric 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 you know in the government domain.

And I believed that the company will have.

The board of directors with Ah skillset that would be.

It was into security industry, and they will be able to guide the company with everything M&A, whether it's organic investment into new exciting areas is really a lot of security.

Needs and and I think we have a lot technology the company and it just a matter of getting even greater focus on a customer needs and being able to.

Continued to execute the softer model.

Which I think we need another couple of years to get a two to two.

Hi, six is almost 70% gross margin and from there I think we'd be able to grow and offer customers.

A typical softer moral and more subscription so the company can really do very well.

In the future and you don't having separate management in a separate board of directors will be benefit.

Okay, and 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 these margins you've been talking about how margins would be developing or hope to be developing.

In cyber over for the last couple of years the potential for.

Multiple of what the margin is now.

What are the what are the main milestones or what are the main.

The main tests you have in front of you to get those margins up to up to that 62, perhaps 70% area.

Yeah, you know you remember, there's not too long ago on margins were in the 50 is now you know we're around 66 defense.

And you know we guided for another year margin expansion next year with gross profit that we expect to grow 10% next year.

So a softer portfolio is growing at the at the nice double digit growth ended the same time, we lose some revenue by design that are you know the low margin Hoggard services, and we expect that trend to continue and you know.

We still we still going to provide services in this business professional services.

And you know I expect that.

The margins will be around 70%.

The long Ron.

But.

More importantly that.

So for the model provides.

Our customers the ability to really refresh their softer very quickly and it's really critical.

In this environment.

Because when when when they buy.

A product the can wait three four years.

To do we first the product technologies, just moved to pass today and that was they the debate issue would be integrator more wouldn't you see.

Customers looking to buy customized solutions is that they basically funded very hard leader to refresh those customized solution.

And we've been educating customers for.

Years now that you know, it's endeavor eating their interest to move to softer mall and we're very happy to see this more and more customers are adopting the new moral and a and we see benefits for the customers and for variance so you're hoping to essentially be that one throat to choke in cyber security.

We were hoping to have an open a softer design that allow customers to develop customization using <unk>.

Or if they prefer to varying does it we can still do they for them, but we'll do it outside of the core product through our own <unk> <unk>.

<unk> so.

You know many of our carstens will prefer to use loco integrators.

I see integrators to do some some you know customization outside the core and that's perfectly okay forbearance because our.

You know our expertise into core softer and we're happy to share.

Customization with.

Third party integrators.

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 just like I mentioned again that immediately following this call our new IR website will be up and running well be set protections for our customer engagement and cyber intelligent businesses and.

As was 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. Thanks for participating you may now disconnect.

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