Verint Systems Inc.

Ladies and gentlemen, thank you for standing by and welcome to the VARINS third quarter conference call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Alan Roden, Senior Vice President of Corporate Development. Thank you. Please go ahead, sir.

Thank you, Operator. Good afternoon, and thank you for joining our conference call today. I'm here with Dan Bonner, Verin CEO, and Doug Robinson, Verin CFO. Before getting started, I'd like to mention that accompanying our call today is a WebEx with slides. If you'd like to view these slides in real time during the call, please visit the IRS section of our website at verin.com Click the Investor Relations tab. Click on the webcast link and select today's conference call.

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may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other provisions of the federal securities laws. These forward-looking statements are based on management's current expectations and are not guarantees of future performance. Actual results could differ materially from those expressed in or implied by these forward-looking statements. The forward-looking statements are made as of the day of this call and, except as required by law, the parent assumes no obligation to update or revise them. Investors are cautioned not to place undue reliance on these forward-looking statements. For more detailed discussion of these and other risks and uncertainties that could cause veterans' 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, 2020, and other filings we make at the SEC. The financial measures discussed today include non-GAAP measures, as we believe investors focus on those measures in comparing results between periods and among peer companies. please see today's WebEx slides or earnings release in the Investor Relations section of our website at barron.com for a reconciliation of non-GAAP financial measures to GAAP measures. The non-GAAP financial information should not be considered in isolation from, as substitute to, or superior to GAAP financial information, but is included in course management beliefs and provides meaningful, supplemental information regarding our operating results when assessing our business and is useful to investors for informational and comparative purposes. The non-GAAP financial measures the company uses have limitations and may differ from those used by other companies. Now, I'd like to turn the call over to Dan. Dan?

Thank you, Alan. I'm pleased to report a strong third quarter with revenue coming in better than expected and strong year-over-year adjusted EBITDA growth of 17%. Cash flow operations year-to-date was also strong, increasing 16% compared to the same period in the prior year. Looking ahead, we believe our cloud momentum will continue. We see perpetual deals gradually coming back and our visibility has improved from prior quarters. We are resuming guidance for the year with expectations for a strong Q4. Also, I'm pleased to report that we are on track to complete our separation into two public companies shortly after fiscal year ends. We already made our initial confidential filing with the SEC and plan to file publicly within the next two weeks. Ahead of our separation, we will be holding investor days and management road shows in January.

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Turning to customer engagement, in Q3, we experienced significant cloud momentum, and we believe the industry shift to the cloud is being accelerated by COVID. During Q3, we continue to win new cloud customers and displace competitors due to the significant differentiation of a cloud platform. our artificial intelligence and analytics innovation, and our partner agnostic strategy. Here are three examples of large cloud deals. An $11 million cloud order from an existing insurance customer related to their decision to transition to SAS. A $3 million cloud order from one of the largest pharmaceutical companies due to their rapid growth in self-service interactions. And a $2 million cloud order from one of the largest BPOs. This competitive displacement was driven by our open and agnostic partner approach and our ability to easily integrate into their operations. In addition to these large cloud orders, we saw a gradual return of perpetual license orders in Q3 which we believe will continue in Q4. Behind these large wins is our ability to address the following recent industry trends. First, customers are looking to address the lasting impact of COVID on the workforce. We believe our recent cloud momentum is in part due to our ability to help our customers navigate the COVID environment creating significant opportunity for Variant going forward. Second, customers today are even more focused on addressing a key strategic problem, which is how to strike the right balance between cost efficiencies and exceptional customer experience. Variant has been a market leader in workforce engagement for over two decades, and we are uniquely positioned to help organizations address this strategic problem. Third, the role of partners in our industry is increasing and a strong partner ecosystem has become an important competitive differentiator. Unlike many competitors that offer closed solutions, Variant's open cloud platform increasingly makes us the partner of choice across the industry ecosystem. And finally, We have a large customer base and are seeing an increasing number of customers express interest in converting their legacy deployments to SaaS. And we launched an attractive conversion program in Q3, which we expect will increase the pace and number of conversions. To summarize, we believe we are uniquely positioned to address these recent industry growth trends with our focus on the evolving work environment our open cloud platform, and an expanding partner network. Turning to our outlook for the current year, we expect $835 million of revenue for our customer engagement segments at the midpoint of our guidance range. Our guidance reflects a strong market shift for SAS, and we expect to reach two important milestones this year which I would like to highlight. First, this year we expect approximately half of all the new software bookings to come from SAS as compared to about a third in the prior year and only a quarter two years ago. We are pleased to be crossing over the 50% new bookings mark. And second, we expect 80% of our software revenue to be generated from recurring sources, up 400 bps from the prior year, and up 900 bps from just two years ago. We expect these KPIs to improve further next year, which I will discuss next. Looking ahead to next year, we expect our cloud revenue growth to accelerate to approximately 30% driven by strong new software bookings and SAS conversions. From a mixed perspective, next year we expect two-thirds of our new software bookings coming from SAS. We also expect that the percentage of our software revenue that is recurring to increase to 85%, another 500 bps improvement from the current year. Achieving the 85% level marks the substantial completion of a cloud transition, which will provide us many benefits, including improved visibility, better economics over the lifetime of the customer, and less revenue headwind associated with cloud transitions. Today we are introducing long-term targets for our customer engagement business ahead of our plan separation. We're targeting an approximate 30% CAGR for cloud revenue over the next three years. Like other cloud transitions, we expect our revenue growth and margins to gradually improve in fiscal ending 23 and 24. We're targeting $1 billion of revenue in fiscal year ending 24, with approximately 90% of our software revenue generated from recurring sources. We will provide more detail on our three-year targets, as well as review our growth strategy, TAM, and competitive differentiation during our virtual investor day for customer engagement to be held on January 21st. Moving to our cyber intelligence business, today I'm excited to announce the new name for this company, which will become official upon the separation. Cognite is coined from the words cognition and ignite to reflect the powerful analytical nature of our security software solutions. Cognite will be headquartered in Israel and will be listed on the NASDAQ under the symbol CGNT as a foreign private issuer. Our security analytics software generates actionable intelligence for many government and enterprise security customers around the world. After some COVID-related impacts earlier in the year, we experienced strong sequential revenue growth in Q3 and entered Q4 with improved visibility. Customers come to Variant for our mission critical security software to help accelerate investigations of terror, crime, and cyber threats. In Q3, we received multiple large orders, including one for approximately $15 million, one order for approximately $7.5 million, and four orders for approximately $5 million each. In addition, we continue to execute well on our software model strategy. During Q3, our non-GAAP estimated fully allocated gross margins came in at 74%, a 900 bps year-over-year increase, and non-GAAP gross profits increased 21% year-over-year. We're very pleased with the progress we are making on our financial and strategic goals. Looking over the last three years, you can see the positive impact of the software model transition is having on our financials. The percentage of our revenue that is generated from software has been steadily increasing as we reduce the amount of revenue we generate from services. the percentage of our revenue that is recurring is also steadily increased. The biggest positive impact to our financial model has been on gross margins. Our estimated fully allocated gross margins have increased approximately 800 basis points over the last three years, and are expected to reach 70% this year for the first time. For revenue, we expect $445 million this year at the midpoint of our guidance. Overall, our cyber intelligence management team is executing well and has built a solid foundation to be a successful independent public company. Looking forward, we believe that Cognite is well positioned for growth and market leadership. Cognite is a market leader in security analytics software. We have developed trusted long-term relationships with our customers and have a very successful track record of profitable growth. Behind our leadership is our technology strength. Cognite is at the forefront of advanced artificial intelligence and machine learning technology, which are critical for addressing the security challenges our customers face. We participate in a large $30 billion addressable market, which is growing as security challenges become more complex and customers seeking innovative open security analytics software to meet those challenges. Overall, we believe that the market trends are favorable and can support sustained growth over the long run.

For next year, we expect 10% revenue growth for our cyber intelligence business. For fiscal year ending 23 and 24,

We're targeting revenue growth to improve, driven by greater adoption of our open security software solutions. We will provide more detail on our three-year targets, as well as review our growth strategy, TAM, and competitive differentiation during Cognite's Virtual Investor Day to be held on January 11. And now I would like to summarize. I'm very pleased with the execution of our cloud strategy in customer engagement and our software model strategy in cyber intelligence. I'm also very proud of the work we've done to prepare for the separation and believe that both businesses will continue to prosper and appeal to investors as two independent public companies. Now, let me turn over the call to Doug. Doug?

Thanks, Dan. Good afternoon, everyone. Our discussion today will include non-GAAP financial measures. A reconciliation between our GAAP and non-GAAP financial measures is available, as Alan mentioned, in our earnings release and in the IR section of our 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, separation-related expenses, as well as certain other items that can vary significantly in amount and frequency. For certain metrics, it also includes adjustments related to foreign exchange rates. Today I'll cover four topics. First, I will review our Q3 results and fiscal 21 guidance. Second, I will review our initial outlook for next year on an as-is basis. What we mean by as-is is what Verint would look like if we remained as one company. This is meant to help you update your models on a consolidated basis until the separation of our two businesses occurs. We plan to provide you additional information at our investor days that will enable you to start to build models separately for each business. Third, I'll provide some additional detail regarding the separation, including the anticipated capital structures and the amount of dis-synergies we expect. I'll take you through our long-term targets for each business. We're pleased with our 6% sequential revenue growth, which, as Dan mentioned, came in ahead of expectations and drove a 17% year-over-year increase in adjusted EBITDA in Q3 and a 16% increase in GAAP cash from operations on a year-to-date basis. We expect to finish the year strong, and given our improved visibility, we are providing guidance We expect non-GAAP revenue of $1.28 billion with $330 million of adjusted EBITDA and $3.40 non-GAAP diluted EPS at the midpoint of our revenue guidance. Overall, we're pleased with our performance this year, and despite COVID delaying some perpetual license orders, we expect to grow adjusted EBITDA by about $5 million year-over-year. Looking ahead to next year, we believe the momentum we experience this year will continue and are introducing our initial as-is outlook. We expect non-GAAP revenue to increase around 5% to $1.35 billion. We expect adjusted EBITDA to increase at a similar rate before separation to synergies, which I'll discuss in a minute. Excluding the impact of the separation, we expect around $20 million of non-GAAP interest expense and a non-GAAP share count of 71.5 million shares. Again, we are providing this information to help you update your consolidated models pending the separation. At our investor days in January, we'll provide more detail regarding the post-spin models of the two companies. As Dan noted earlier, we plan to file our 20F publicly in the next two weeks, and we expect to consummate the separation shortly after year end. Today, we'd like to provide some additional visibility into capital structures and its energies. Both companies will have strong balance sheets, adequate working capital, and strong cash generation post-separation. Following the separation, Variant will have modest net leverage of about one times adjusted EBITDA, excluding the preferred stock. At this point, we expect each company to have about $15 million of separation synergies. Most of these synergies are related to public company expense, IT, and other shared business service expenses. Now I'd like to provide further information for each business on a standalone basis, starting with customer engagement. As Dan discussed earlier, we think it's very helpful to analyze the customer engagement cloud and perpetual revenue stream separately. On the cloud side, we expect the momentum we experience this year to accelerate next year. New SaaS bookings, which is a leading indicator of cloud revenue growth, is expected to increase more than 40% this year. and will help drive approximately 30% cloud revenue growth next year. We expect our bookings mix to continue to shift to cloud, with about two-thirds of new software bookings coming from SAS, compared to about half this year. We are also expecting recurring revenue to reach 85% of our software revenue, up 500 bps from this year. Regarding perpetual licenses, Due to our cloud-first strategy, we expect a reduction to around $140 million of revenue this year. Next year, we expect a further decline as we approach the completion of our cloud transition. Overall, for fiscal 2022, for new bookings, we expect 10% growth in new perpetual license equivalent bookings, and for revenue and adjusted EBITDA, we expect low single-digit growth before the synergies. We are targeting cloud revenue growth of approximately 30% CAGR over the next three years, driven by strong new SaaS bookings, healthy renewal rates, and ongoing SaaS conversions. We expect our revenue growth to improve over time following the completion of our cloud transition in fiscal 22. In fiscal 23, we expect our perpetual license revenue to level off at around 100 million, as certain customers will continue to prefer perpetual licenses. Regarding margins, we expect a one-time step down in fiscal 22 due to the separation disintegrities I discussed earlier, followed by ongoing margin expansion. In addition to margin expansion, the cloud model will provide us with better economics over the longer term. Overall, we're targeting $1 billion of revenue in fiscal 24, with 90% of our software revenue being recurring. Now let's turn to our cyber intelligence business, which will soon be named Cognite. I'll start with a review of our historical performance. Over the last three years, our EBITDA, on an estimated fully allocated adjusted basis, has increased at a 25% CAGR, driven by our business transformation as part of our software strategy, where we have been steadily improving our software services mix and increasing our gross margins. This trend continued in the current year, where we have experienced a 7% year-to-date increase, an estimated fully allocated non-GAAP gross profit year-over-year, and a 35% year-to-date increase in estimated fully allocated adjusted EBITDA versus last year. Regarding revenue, we have seen strong sequential growth after the initial impact from COVID. For the year, despite this COVID impact, we are expecting another year of growth in estimated fully allocated adjusted EBITDA and to reach 70% estimated fully allocated gross margins for the full year for the first time. Over the next three years, we are targeting Cognite's revenue growth to improve driven by greater adoption of our open software and expect margins to gradually expand after a one-time step down next year due to the separation of synergies. Overall, Cognite will have a strong financial profile post-separation. We look forward to providing you more detail at our Virtual Investor Day on January 11th. In summary, we at a strong Q3 are expecting to finish the year strong and look forward to providing more information regarding the separation at our upcoming Virtual Investor Days. So with that operator, let's open up the line for questions.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from . Your line is now open.

Thank you. Good afternoon, guys. Congrats on the ongoing solid performance and guidance. Dan, really great cloud momentum yet again, if I may add. Can you talk to us about what is driving this strong momentum and how do you see this momentum evolving over the next few years as you move through the cloud transition? And I have a follow-up.

Okay, sure. So thank you. Yes, we see strong cloud momentum and we see it across all regions. We've built an open cloud platform and this allows our customers to easily turn on new cloud applications so they can expand, and we have a broad portfolio, as you know. It also allows our partners to easily integrate and add value, and I'll talk about partners perhaps later. So that's on the cloud platform side. From a Salesforce perspective, our Salesforce is leading with SaaS, and now we see great market adoption in our area, in our business application area, and this is partially due to COVID. So we're pleased to cross over the 50% mark of new bookings that's coming from SAS, and we, based on pipeline, expect to have two-thirds of our new bookings next year to come from SAS. We target 30% cloud revenue growth next year, so from $270 million give or take this year to $350 million next year. As well, we're targeting 30% CAGR over the next three years. So... I think it's important to explain your question of how the SAS transition is evolving because we mentioned on prior calls and today again that we expect to complete the SAS transition next year. So when you look at our perpetual license revenue, they decline. This year we expect about 140 and it was 185 last year, so a big decline. in perpetual license, but next year we expect a further decline as we finish the transition, but then level off in fiscal 23. And as we have certain customers that will continue to buy perpetual and expand, we expect some growth in perpetual license, but it will be around $100 million, so we expect it to be 90% of our software will be recurring. So that's kind of the perpetual revenue. And what that does is basically the headwind from the perpetual revenue decline will be substantially over and the tailwind that we get from the cloud revenue growth will fully contribute to the top line growth. And the margin perspective actually follow the same trend. Margin expand at the end of the cloud transition and we'll see that during fiscal 23 and 24. And then over the long run, the economics of a cloud model are actually better than the economics of the perpetual license. So we expect a lot of good positive outcome from the momentum we see now. We do need to finish the transition next year, which we feel we are very good with the metrics we shared. We are on our way to do that. And for fiscal 24, we're targeting about $1 billion, which is a CAGR of mid to high single-digit revenue growth, obviously with improving growth rates as we move toward the out years.

Got it. Got it. And my follow-up is concerning Cognite. Congrats on really being ready to bring it to the market, the entire separation process. Over the course of the past two months, Palantir has gone public. We've been getting many questions on it from investors. Can you discuss how you, on one hand, similar to what they do, but maybe on the other hand, differ in some other ways?

Sure. So, first, you know, we are excited to have Cognite start the next chapter of their growth as a public company. We shared a lot of information today on the historical growth of Cognite and margin expansion, huge margin expansion. So, we have great opportunity ahead. We'll share even more information and You know, we're going to file the 20F document in two weeks, and then two weeks later on January 11, we'll share more information on Cognite. But let me briefly touch on your Palantir question. We are pleased to have Palantir as a public comp. Cognite and Palantir have similar capabilities, but historically had different go-to-market strategy, which is important to understand. So first, in terms of the similarities, Both companies share the vision of open analytics and delivery technology platforms that can help customers find the needles in the hashtags and to make the world safer. And there's a big opportunity. But historically, the companies approached the opportunity with different go-to-market strategy. And I think best is to look at a couple of examples. So Cognite had a strategy of profitable growth, as you all know, as part of Variant, while Palantir is a private company incurred losses for many years. So one of these, the impact of this is that, for example, Palantir has about 150 customers, and they have higher average revenue per customer, so they went deeper into their customers. Cognite has more than 1,000 customers, But our strategy was to lend and expand and grow these customers over time.

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Another example is the difference in global coverage. Palantir is stronger in the U.S., while Cognite is stronger in the rest of the world. And the reason that historically, we at Variant believe that the investment in developing the U.S. government market takes significant time and resources, and we saw more attractive opportunities outside the U.S. consistent with this profitable growth strategy that we were pursuing. So these are two quick examples, and we will discuss the security landscape in more detail during the investor day.

Got it. Thank you so much for that. Good luck. Good job.

Thank you. Our next question comes from Daniel Ives with Wedbush Securities. Your line is now open.

Thanks. So maybe first just talk about, Dan, your conversations with customers and what you're hearing from Salesforce. I mean, how things are changing in terms of the sort of cloud strategy. Do you think it's more just the product footprint, or is it customers now adopting, getting to that stage where they're looking for more significant deployments? I mean, how do you sort of view where we are in terms of the sort of cloud build-out that we're seeing on the customer base?

Yeah, that's a good question. I think we're going through some interesting changing dynamics Some of them are driven by COVID and the lasting impact of COVID on the workforce dynamics. And I think we have great solutions we are discussing with customers and already brought some new innovation in our cloud platform to address these changes. There's more interest in automation driven by AI. Again, COVID is also an economic impact and people are looking to create efficiencies through automation, and there is, I would say, an acceleration in the cloud transition, which started, obviously, a few years back, but we do see customers much more open to actually execute on it. Now, it's very important for customers, and you know that the majority of revenues come from mid to large enterprises, and they have complex needs and infrastructure. So they are looking for a bridge. They're not just gonna move overnight and they need to preserve the processes, they need to preserve data, and they cannot disrupt themselves, definitely not through COVID when people are working from home. So they're looking for a partner that can help them navigate through the cloud transition and help them move to the cloud in a more orderly fashion. And what's interesting about that is when you look at a 20% cloud revenue growth that we are expecting this year by the end of Q4, and that 20% we mentioned excluding 4C, 15% of that came from new bookings and only 5% came from conversion of legacy solutions. So that tells you that while they're moving to the cloud, as fast moving their legacy, because it's working, it's there, they got their data centers and there's no reason to disrupt, but they're buying new functionality, they're comfortable buying it in the cloud. And we saw some really great accounts this year, one of the leading food delivery service companies, one of the leading grocery delivery, one of the leading cloud infrastructure companies. These are the new economy companies doing very well with COVID and expanding, and they chose Variant in the cloud. So it is easy for new customers to buy in the cloud. It's easy for existing customers to buy new functionality in the cloud. And they are looking at Variant to help them to migrate their legacy solutions to the cloud over time. And we're ready to help them in all these different scenarios.

Great. And then maybe you can just sort of address in terms of cost structure. And obviously strategically this has been well mapped out for many, many months. But just maybe stranded costs as well as just plans in place to hit the ground running as soon as this thing gets to green light. Just maybe talk about that and just sort of preparation from a cost structure perspective?

Yeah, so I think we kind of figured out the cost structure. We discussed earlier and clearly we'll provide more details over the next few weeks about the capital structure, how that's going to be allocated, and also in terms of the dis-synergies, we do expect approximately $15 million of separation dis-synergies in each company. We expect that to be a one-time step down which we can grow out of, but there is obviously certain inefficiency with breaking a public company into two public companies and certainly out of the gate.

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So a lot of that has been already in place as we were growing into the separation. We do expect to have a TSA, a transitional services agreement between the two companies and a reverse TSA as well. So both companies will provide for some time services to each other. But these are relatively small. A lot of the resources already been identified as which one is going to which company and there is a few million dollars of TSA services that will go back and forth. And of course, that will decline over time. So we think that we're prepared. We expect to file the document publicly for Cognite in two weeks. And then in January, we'll be out there with the management teams of both companies to discuss with investors, I think, investors will meet a lot of new people. Certainly, we have the management team for Cognite ready as the management team of the division. We're going to have a new board for Cognite. Three directors from Variant will continue with the Cognite board. We're targeting seven directors, so there will be Three continuing from Variant, the new CEO, Alad Sharon, will join the board, and we are looking for three new directors to join the company. So all of that will be kind of solving in January. Thanks. That's great.

Thank you. Our next question comes from Ryan McDonald with Needham. Your line is now open.

Hi, good evening. Thanks for taking my questions and congrats on a nice quarter and appreciate all of the future Outlook disclosures as we're looking at these two businesses. I guess as we look into next year and sort of the 30% cloud growth, Kager, what's your expectation in terms of mix of that coming from existing customers versus net new? And how does this conversion program that you started in the third quarter, how do you expect that to sort of accelerate that transition as we look into next year?

Yeah, so I mentioned before that the 20% this year is 15% from new booking and 5% from conversion. The 30% next year actually is also 15% from new booking. So we're not dialing in a huge growth in new booking relative to what we just did in the COVID year. But the conversion we expect to be 15%. So that's up from 5% to 15%. We launched a new program in Q3. We already saw a pickup in Q3 and the beginning of Q4. So based on the conversion pipeline, I think in the early days of COVID, customers hesitated to convert because they were more sensitive to disruption. The new program we introduced in August is basically no disruption. So we allow them We created some technology that they can continue to work on premises and test the new product in the cloud, in parallel, and then just overnight switch over, which was obviously very appealing for anyone who's concerning about operational disruption. So we think the conversion program will pick up next year, and that's about 50-50 between new booking and conversion.

Excellent. That's very helpful. And just curious to get your thoughts on as you've looked over the past month, as we've seen throughout EMEA and a little bit in the U.S. here, obviously, you know, some shutdowns and lockdowns again. How does the environment compare as you're going out and selling to what we saw earlier this year? Would you say that businesses are better suited or better prepared, I guess, this time around to kind of continue business as usual and sort of sales cycles as usual?

I think so. I think, look, we have very little exposure to travel, industry, entertainment, industries that are still suffering from the COVID impact. Our exposure is really, really minimal. So in the main verticals that we're addressing, this was mostly about on-premises deals being affected by travel and just workforce at home. Some of the perpetual deals that we had in the pipeline this year moved to cloud, but some actually pushed to next year, so they're still in the plan. We do see some on-premises deals, so it's getting better. It got better in Q3, and we feel like it's getting better in Q4. But we also see that some of these perpetual deals will come back next year as cloud deals. So I would say that it's not business as usual, but companies are focusing on their priorities, and I think customer engagement is a priority. Having the tools to manage the workforce remotely And increased automation is a priority. So I think COVID is actually providing us some good tailwind into next year.

Great. And then just one final one for me. I'll hop back in the queue. Great to see some nice competitive wins that you announced during the quarter. I'm just curious to see how that competitive environment is evolving and I guess what your thoughts are on the recent announcement of Salesforce with their own workforce engagement management. I imagine that's likely more of a competitive dynamic down market, but love your thoughts there. Thanks.

Yeah. Yeah. So, you know, we're not very competitive with Salesforce, and we also, which is a very small part of our portfolio, and we also partner with Salesforce, and we have some products in their marketplace. So it's a competition with the CRM guys and the SICAS guys. And, you know, we clearly see interest from the CCAS and CRM vendors to offer business applications like we do. Advanced business applications are critical to our customers, and as they're looking to address the workforce dynamics and automation, as I mentioned before. So some vendors have some capabilities, but many already partner with Variant, and many are looking to partner with Variant. due to the strengths that we bring with our leading applications and our open platform and our partner agnostic strategy. For example, we find ourselves in RFPs where there could be multiple vendors bidding and we are in all the bids. That's great because we don't really care who's going to win. The dynamic is such that we think partners are going to be more important, and we're not only partnering with the CCAS and collaboration vendors, but we also have regional resellers, and they can resell, you know, another vendor and variant and add value. And very important about this is in the competitive landscape is we saw this year The system integrators actually are increasing their role as more customers are seeking advice and integration services. And that's obviously a good variant because we have the open approach and our open platform is an ideal choice for system integrators. So just last example, and we'll talk more in InVEST today about the competitive landscape. But when you look at the social security administration deal that we won, this is a Verizon deal where Verizon is the system integrator for the social security. Avaya was chosen as the collaboration platform and we are the partner for choice for the business applications. So I think that's the dynamics. I think customers want to get what they need and they do it in many different ways. And we think that there's a strong opportunity for growth with a partner agnostic strategy.

Thank you very much.

Thank you. Our next question comes from Brian Essex with Goldman Sachs. Your line is now open.

Hi, good afternoon. Thank you for taking the question. And congrats for me as well on the quarter. It's a nice reacceleration. um i was wondering if you maybe could give us a little bit more color on the cognite team i think you mentioned that elad sharon would be the new ceo but um you know how how how well um established is the management team for that business and is it just um you know you know personnel just moving over underneath that umbrella that are already working at the company or is there a lot of new hiring and reorganization that's going to take place once that spins off

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Yeah, so in preparation for this, and as you know, we've been preparing for a long time, we had two objectives. One is we wanted to complete the software model transition. and get to the 70% gross margin and position this company to really focus on growth as a software company. So a lot of effort in strengthening the management team to bring that experience and change the business model. And the second thing is to prepare the company to be an independent public company. And we did it through a combination of promoting people from within and hiring people. I'll just give one example, you know, which we hired, this year we hired our chief product officer, who is really gonna be responsible for the product and go to market, and he was, some years back he was the president of NICE, not in the cognite space, in the customer engagement space, but clearly a strong addition to the management team. So I feel like it's a strong team. You're going to meet them on January 11th. Unfortunately, it's going to be a virtual day, so you're all going to get together virtually, but you definitely get a chance to see the new management team And, you know, part of what we want to do is also introduce the, you know, the spirit of the company and obviously their passion of, you know, growing and becoming a very successful pure place security analytics company.

Okay. But is that all established at this point or is there additional transition that needs to happen? I mean, the whole sales organization, is that already in place and you're ready to go or is there more that needs to happen there?

It's all in place. Sales, services, R&D, management, all in place. The only things I mentioned before, there are some transitional services that they will get from Variant, and it's really in the area of some financial advice on public company readiness, legal advice, IR advice. These are functions that will continue to build during next year, but in terms of the business functions, they're all in place.

Got it. And maybe just to follow up, any update on APACs and where they stand with regard to the second tranche after the spin? It looks like we're above, I think it was a $50 floor on the collar here. Any expectations around that in particular with regard to your capital structure expectations going forward?

Yeah. Yeah, I believe from memory that the threshold was $48. But, you know, so pleased to have APAX joining the company. They have a one designated board member, as part of tranche two, we agreed that we will add another board member that is jointly agreeable to APEX and Variant, an independent board member. And in terms of the capital structure, maybe I'll turn it over to Doug just to say a few words on capital allocation. Doug?

Yeah, sure. Yeah, hey, Brian. Yeah, so we expect the APEX second tranche provided makes that threshold to be funded sometime in Q1, and it's just subject to the closing conditions that we previously had shared with folks. In terms of use of that cash, you know, general corporate purposes or perhaps supply into the outstanding debt, we will outline better for you at the investor days the capital structures, but, you know, cognite is being spun, you know, debt-free. We keep them with, you know, adequate working capital. apply excess cash to bring the debt down and try to be sensitive to not too much leverage on the CES, you know, main co, if you will, side of the business. So we would expect a, you know, debt to EBITDA ratio of, you know, one-ish or so on that business. So we just have some cash to move around. We're doing that as part of the spin structure, aligning the legal entities. We'll take you through all that in a little bit more detail when we have our investor days.

Got it. Super helpful. Thank you very much.

Sure, Brian.

Thank you. Our next question comes from Paul Koster with JP Morgan. Your line is now open.

Yeah, thanks for taking my question. So it sounds like you'll have some TSA arrangements in place for a period as the two companies go through the separation. But are there any other relationships that will last beyond the separation date? Meaning, for instance, is there any commonality in the board Is there any cross-licensing, or is the separation otherwise completely clear?

There shouldn't be any other relationship other than TSA. In terms of board crossover, we expect two people to be on both boards. That's two out of seven from Cognite. So that, I think, is important for continuity. But that's the end of it.

There won't be any constraints imposed on Cognite from the perspective of, you know, selling the business, for instance, obligations that are due to variants in the future.

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No. Any obligations or restrictions on the COVID-19 business?

Okay, great. Your cloud business is accelerating, which is very welcome. It's accelerating a little bit after some of your peers. Why is it that you're experiencing this strength but a little bit later than everyone else? What's the cause of the phasing here, Dan?

I think we actually have the far peers. It depends on what you would refer to as peers. They are the collaboration and communication platforms. We know that there are about 100 companies now that have SICAS or UCAS or some sort of collaboration platform in the cloud. And I think the space of vision has accelerated in its transition to the cloud. It's very much an IT infrastructure change from collaboration platform or what used to be unified communication platform, right? Now it's called collaboration. It's pretty much an IT change to the cloud, which was accelerated for a lot of good reasons. But the business applications that we sell, we feel like we are ahead, even ahead of a close competitor in terms of how much we move to the cloud. It's really worth the market adoption. Again, business applications require companies to change more than IT to change processes and so on. And they were slower in adoption. We talked before about the fact that we sell across the enterprise, not just . We saw, for example, in our branch business, there was a lot of adoption to cloud adoption. Solution we sell to the marketing department, almost entirely cloud. And then, you know, back office and some contact center, we saw that the market was lower. But all that is, I think, is history because whether it was COVID or whether it was just natural evolution, it looks like this year the market was ready and we are ready. So, you know, we're moving from one-third to last year to half this year to two-thirds, which we feel is we can achieve next year. Uh, I think that's the pace that, uh, uh, we were hoping to get before, but we, we, we're getting now.

Got it. And my last question on the cyber Intel front, you had three deals. Uh, do these deals have similar characteristics or were they diverse from the perspective of geography and application?

Uh, no, I don't see any, anything unusual. Um, You know, the large deals usually represent customers that buy more than one functionality. That's why it becomes larger. So they kind of bundle several things they need into a bigger contract. But I think what we see across the deals, including the large deals, is the trends that we were hoping to see, which is less hardware. I think hardware was less than $5 million in Q3. very small, less services. It's not just hardware decline, but the services decline because of the investment we did in productizing. And we also, you know, customers can do more of the services themselves. So the mix is changing. Of course, the big deals as well toward the software mix. We had a 74% gross margin in Q3, but that was probably a little bit of an anomaly. So we only expect 70%. for the full year, but this was 66 last year and 62 the year before. So very quick shift and we will continue to improve the growth margin beyond 70%, but obviously the big acceleration is behind us. And I think from now we'll see some more modest margin expansion. When we talk about, you know, 10% growth for next year, We expect some margin expansion as well, and we hope to target growth rates in subsequent years as an independent public company.

Okay, got it. Thank you.

Thank you. Our next question comes from Dan Bergstrom with RBC Capital Markets. Your line is now open.

Yeah, thanks for taking my questions. So, Doug, you mentioned some COVID-delayed federal license orders. obviously not impacting the numbers or outlook, but could you expand on those comments, maybe quantify the impact, what you're seeing in federal or status of those deals?

Yeah, sure. I mean, so all year we've seen impact from COVID. As you know, in the beginning of the year, we felt we couldn't provide guidance because of that. But as we've gone through the year, I think everyone's learned to kind of work remotely. Our customers are functioning better, getting more, I think, comfortable with, you know, ongoing nature of their business and making better commitments. You know, we're hoping perpetual licenses, you know, start to get a little bit more on track into next year. I think that was a large impact. But largely, you know, the plans haven't changed. Our customers have a lot to do. They know they have to do it. I think, you know, as Dan, you know, mentioned several times, you know, COVID certainly has kind of woken people up as to the need to get to more of a, you know, infrastructure in the cloud that's more straightforward, accessible, et cetera. So it's hard to quantify it, right, because, you know, deals slide and they're smaller and COVID is behind a lot of that. But we do see just, you know, continual improvement in the overall business environment as people are coping with COVID better. And that's the reason for, you know, getting back to guidance and providing some outlook for next year and longer term.

Great.

Thanks. Sure.

Thank you. And our next question comes from Jeff Kessler with Imperial Capital. Your line is now open. Thank you. Jeff, if your line is muted, please unmute. I'm not showing any further questions at this time. I would now like to turn the call back over to Alan Roden for closing remarks.

Thank you, operator, and thank everyone for joining us today. We will be quite active next six weeks. We look forward to seeing you at our two investor days and also on our road show in January. Have a great evening.